Epazz (EPAZ) 10-Q 2013 Q2 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2013

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

For the transition period from ____________ to ______________

Commission file number: 333-139117

EPAZZ, Inc.

(Exact name of registrant as specified in its charter)

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

309 W. Washington St. Suite 1225

Chicago, IL 60606

(Address of principal executive offices)

(312) 955-8161

(Registrant's telephone number)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes [X] No [   ]

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

Yes [X] No [   ]

Indicate by check mark whether the registrant is a large accelerated filer, and accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer [   ]	Accelerated filer [   ]
Non-accelerated filer [   ]	Smaller reporting company [X]

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

Yes [   ] No [X]

The number of shares of the issuer’s Class A common stock outstanding as of August 16, 2013, was 3,389,700,915 shares, par value $0.01 per share.

EPAZZ, INC.

FORM 10-Q

Quarterly Period Ended June 30, 2013

INDEX

		Page
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
PART I. FINANCIAL INFORMATION
Item 1.	Financial Statements	2
	Balance Sheets as of June 30, 2013 (Unaudited) and December 31, 2012	2
	Statements of Operations for the Three and Six Months ended June 30, 2013 and 2012 (Unaudited)	3
	Statements of Cash Flows for the Six Months ended June 30, 2013 and 2012 (Unaudited)	4
	Notes to the Condensed Consolidated Financial Statements (Unaudited)	5
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	27
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36
Item 4.	Controls and Procedures	36
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	37
Item 1A.	Risk Factors
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	37
Item 3.	Defaults Upon Senior Securities	37
Item 4.	Mine Safety Disclosures	37
Item 5.	Other Information	38
Item 6.	Exhibits	38
SIGNATURES		39

1

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

EPAZZ, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

	June 30,			December 31,
	2013			2012
	(Unaudited)
Assets
Current assets:
Cash	$	47,187		$	46,101
Accounts receivable, net		75,494			36,995
Other current assets		32,455			22,027
Total current assets		155,136			105,123
Property and equipment, net		141,157			196,297
Intangible assets, net		733,826			821,150
Goodwill		255,460			255,460
Total assets	$	1,285,579		$	1,378,030
Liabilities and Stockholders' Equity (Deficit)
Current liabilities:
Dividends payable	$	18,000		$	–
Accounts payable and accrued expenses		164,739			129,651
Accrued expenses, related parties		28,502			19,205
Deferred revenue		189,338			219,590
Lines of credit		74,937			77,047
Current maturities of capital lease obligations payable		25,247			25,699
Current maturities of notes payable, related parties		7,868			22,085
Convertible debts, net of discounts of $35,534 and $101,192, respectively		87,766			74,708
Current maturities of long term debts		312,864			218,699
Total current liabilities		909,261			786,684
Capital lease obligations payable, net of current maturities		8,160			17,421
Notes payable, related parties		100,000			–
Convertible debts, net of discounts of $10,922 and $37,876, respectively		35,527			152,973
Long term debts, net of current maturities		916,860			892,463
Total liabilities		1,969,808			1,849,541
Stockholders' equity (deficit):
Convertible preferred stock, Series A, $0.0001 par value, 1,000 shares authorized, 1,000 shares issued and outstanding		–			–
Convertible preferred stock, Series B, $0.0001 par value, 1,000 shares authorized, 1,000 shares issued and outstanding		–			–
Common stock, Class A, $0.0001 par value, 6,000,000,000 shares authorized, 2,482,976,187 and 1,177,789,125 shares issued and outstanding, respectively		248,297			117,779
Convertible common stock, Class B, $0.0001 par value, 60,000,000 shares authorized, 10,500,000 and 5,500,000 shares issued and outstanding, respectively		1,050			550
Additional paid in capital		6,065,329			4,324,916
Stockholders' receivable, consisting of 20,000,000 shares		(800,000	)		(800,000	)
Accumulated deficit		(6,198,905	)		(4,114,756	)
Total stockholders' equity (deficit)		(684,229	)		(471,511	)
Total liabilities and stockholders' equity (deficit)	$	1,285,579		$	1,378,030

See accompanying notes to financial statements.

2

EPAZZ, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Three Months						For the Six Months
	Ended June 30,						Ended June 30,
	2013			2012			2013			2012
Revenue	$	279,119		$	432,890		$	487,129		$	547,367
Expenses:
General and administrative		166,403			192,131			287,634			322,881
Salaries and wages		1,555,081			67,697			1,771,234			161,212
Depreciation and amortization		67,385			75,167			144,160			122,641
Bad debts (recoveries)		45			(42,847	)		(8,740	)		(35,072	)
Total operating expenses		1,788,914			292,148			2,194,288			571,662
Net operating loss		(1,509,795	)		140,742			(1,707,159	)		(24,295	)
Other income (expense):
Loss on convertible debt modification, related party		(14,240	)		–			(96,032	)		–
Interest income		–			33			–			38
Interest expense		(143,543	)		(42,854	)		(262,958	)		(83,929	)
Total other income (expense)		(157,783	)		(42,821	)		(358,990	)		(83,891	)
Net loss	$	(1,667,578	)	$	97,921		$	(2,066,149	)	$	(108,186	)
Weighted average number of common shares outstanding - basic and fully diluted		2,045,979,796			32,060,081			1,666,897,778			31,586,526
Net loss per share - basic and fully diluted	$	(0.00	)	$	0.00		$	(0.00	)	$	(0.00	)

See accompanying notes to financial statements.

3

EPAZZ, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the Six Months
	Ended June 30,
	2013			2012
Cash flows from operating activities
Net loss	$	(2,066,149	)	$	(108,186	)
Adjustments to reconcile net loss to net cash used in operating activities:
Bad debts (recoveries)		(8,740	)		(35,072	)
Depreciation and amortization		56,837			54,517
Amortization of intangible assets		87,324			68,124
Amortization of deferred financing costs		19,905			5,041
Amortization of discounts on convertible notes payable		128,612			14,978
Loss on convertible debt modification, related party		96,032			–
Stock based compensation issued for services, related parties		1,522,000			–
Decrease (increase) in assets:
Accounts receivable		(29,759	)		80,190
Other current assets		1,743			8,776
Increase (decrease) in liabilities:
Accounts payable and accrued expenses		38,748			117,936
Accrued expenses, related parties		10,536			(889	)
Deferred revenues		(30,252	)		(65,022	)
Net cash provided by (used in) operating activities		(173,163	)		140,393
Cash flows from investing activities
Proceeds from the sale of equipment		–			14,175
Purchase of equipment		(1,697	)		(145,947	)
Acquisition of subsidiaries		–			(39,200	)
Net cash used in investing activities		(1,697	)		(170,972	)
Cash flows from financing activities
Payments on capital lease obligations payable		(9,713	)		(17,007	)
Proceeds from notes payable, related parties		203,950			19,539
Repayment of notes payable, related parties		(119,167	)		(75,630	)
Proceeds from convertible debts		30,000			–
Repayment of convertible debts		(27,500	)		–
Proceeds from long term debts		271,095			293,487
Repayment of long term debts		(172,719	)		(120,811	)
Net cash provided by financing activities		175,946			99,578
Net increase (decrease) in cash		1,086			68,999
Cash - beginning		46,101			12,668
Cash - ending	$	47,187		$	81,667
Supplemental disclosures:
Interest paid	$	106,869		$	29,279
Income taxes paid	$	–		$	–
Non-cash investing and financing activities:
Acquisition of subsidiary in exchange for debt	$	–		$	460,800
Acquisition of leased assets for debt	$	–		$	17,855
Value of shares issued for conversion of debt	$	120,160		$	20,000
Value of shares issued for conversion of debt, related parties	$	100,239		$	–
Discount on beneficial conversion feature of convertible debt	$	33,000		$	–
Deferred financing costs	$	32,076		$	–
Dividends payable declared	$	18,000		$	–

See accompanying notes to financial statements.

4

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1 – Basis of Presentation and Consolidation

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

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

Principles of Consolidation

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

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

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

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

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

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

Segment Reporting

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

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.

5

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Fair Value of Financial Instruments

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

Intangible Assets

Intangible assets are amortized using the straight-line method over their estimated period of benefit of five to fifteen years. We evaluate the recoverability of intangible assets periodically and take into account events or circumstances that warrant revised estimates of useful lives or that indicate that impairment exists. All of our intangible assets are subject to amortization. No material impairments of intangible assets have been identified during any of the periods presented. Amortization expense on intangible assets totaled $87,324 and $68,124 for the six months ended June 30, 2013 and 2012, respectively.

Goodwill

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

Beneficial Conversion Features

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

Basic and Diluted Net Earnings per Share

Basic net earnings (loss) per common share is computed by dividing net earnings (loss) applicable to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted net earnings (loss) per common share is determined using the weighted-average number of common shares outstanding during the period, adjusted for the dilutive effect of common stock equivalents, consisting of shares that might be issued upon exercise of common stock options. In periods where losses are reported, the weighted-average number of common shares outstanding excludes common stock equivalents, because their inclusion would be anti-dilutive. There were no outstanding potential common stock equivalents for the periods presented. As such, basic and diluted earnings per share resulted in the same figure for the three and six months ending June 30, 2013 and 2012.

Stock-Based Compensation

The Company adopted FASB guidance on stock based compensation on January 1, 2006. Under FASB ASC 718-10-30-2, all share-based payments to employees, including grants of employee stock options, are to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative. Common stock issued for services and compensation was $1,522,000 and $-0- for the six months ended June 30, 2013 and 2012, respectively.

Revenue Recognition

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

6

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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.

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. We do not expect the adoption of the new provisions to have a material impact on our financial condition 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.

7

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Note 2 – Going Concern

As shown in the accompanying condensed consolidated financial statements, the Company has incurred recurring losses from operations resulting in an accumulated deficit of $(6,198,905), and as of June 30, 2013, the Company’s current liabilities exceeded its current assets by $754,125 and its total liabilities exceeded its total assets by $684,229. These factors raise substantial doubt about the Company’s ability to continue as a going concern.

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

Note 3 – Subsidiary Formation

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

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

Note 4 – Asset Purchase Acquisitions

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

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

8

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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.

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

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

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

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

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

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

9

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

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

	Combined Pro Forma:
	For the six months ended June 30,
	2013			2012
Revenue:	$	487,129		$	720,390
Expenses:
Operating expenses		2,194,288			1,130,649
Net operating income (loss)		(1,707,159	)		(410,259	)
Other income (expense)		(358,990	)		(87,396	)
Net income (loss)	$	(2,066,149	)	$	(497,655	)
Weighted average number of common shares
Outstanding – basic and fully diluted		1,283,603,738			31,586,526
Net income (loss) per share – basic and fully diluted	$	(0.00	)	$	(0.02	)

Note 5 – Fair Value of Financial Instruments

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

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

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

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

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

10

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The following schedule summarizes the valuation of financial instruments at fair value on a non-recurring basis in the balance sheets as of June 30, 2013 and December 31, 2012:

	Fair Value Measurements at June 30, 2013
	Level 1		Level 2			Level 3
Assets
Cash	$	47,187	$	–		$	–
Intangible assets		–		–			733,826
Goodwill		–		–			255,460
Total assets		47,187		–			989,286
Liabilities
Lines of credit		–		74,937			–
Capital leases		–		33,407			–
Long term debts, including current maturities		–		1,229,724			–
Notes payable, related parties		–		107,868			–
Convertible debts, net of discount of $46,456		–		123,293			–
Total Liabilities		–		1,569,229			–
	$	47,187	$	(1,569,229	)	$	989,286

	Fair Value Measurements at December 31, 2012
	Level 1		Level 2			Level 3
Assets
Cash	$	46,101	$	–		$	–
Intangible assets		–		–			821,150
Goodwill		–		–			255,460
Total assets		46,101		–			1,076,610
Liabilities
Lines of credit		–		77,047			–
Capital leases		–		43,120			–
Long term debts, including current maturities		–		1,111,162			–
Notes payable, related parties		–		22,085			–
Convertible debts, net of discount of $139,068		–		227,681			–
Total Liabilities		–		1,481,095			–
	$	46,101	$	(1,481,095	)	$	1,076,610

There were no transfers of financial assets or liabilities between Level 1 and Level 2 inputs for the six months ended June 30, 2013 and the year ended December 31, 2012.

Level 2 liabilities consist of various debt arrangements, and Level 3 assets consist of intangible assets and goodwill. No fair value adjustment was necessary during the six months ended June 30, 2013 and the year ended December 31, 2012.

Note 6 – Property and Equipment

Property and Equipment consists of the following at June 30, 2013 and December 31, 2012, respectively:

	June 30,			December 31,
	2013			2012
Furniture and fixtures	$	2,187		$	2,187
Computers and equipment		319,972			318,275
Software		67,986			67,986
Assets held under capital leases		134,800			134,800
		525,945			523,248
Less accumulated depreciation and amortization		(383,788	)		(326,951	)
	$	141,157		$	196,297

Depreciation expense totaled $56,837 and $54,517 for the six months ended June 30, 2013 and 2012, respectively.

11

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 7 – Intangible Assets

Intangible assets consisted of the following at June 30, 2013 and December 31, 2012, respectively:

	Useful	June 30,			December 31,
Description	Life	2013			2012
Technology-based intangible assets - PRMI	15 Years	$	480,720		$	480,720
Technology-based intangible assets - IntelliSys	5 Years		200,000			200,000
Technology-based intangible assets - K9 Bytes	5 Years		42,000			42,000
Technology-based intangible assets – MS Health	5 Years		124,000			124,000
Contracts – MS Health	6 Years		258,000			258,000
Trade name - K9 Bytes	5 Years		22,000			22,000
Other intangible assets – MS Health	2 Years		18,000			18,000
Other intangible assets - K9 Bytes	2 Years		26,000			26,000
Total intangible assets			1,170,720			1,170,720
Less: accumulated amortization			(436,894	)		(349,570	)
Intangible assets, net		$	733,826		$	821,150

Amortization expense on intangible assets totaled $87,324 and $68,124 for the six months ended June 30, 2013 and 2012, respectively.

Note 8 – Lines of Credit

Lines of credit consisted of the following at June 30, 2013 and December 31, 2012, respectively:

	June 30,			December 31,
	2013			2012
Line of credit of $50,000 from PNC bank, originating on February 16, 2012. The outstanding balance on the line of credit bears interest at an introductory rate of 4.25% for the first year, subject to renewal thereafter. Payments of $739 are due monthly.	$	49,947		$	49,606
Line of credit of $20,000 from US Bank, originating on June 8, 2012. The outstanding balance on the line of credit bears interest at 9.75%, maturing on June 5, 2019. Payments of $500 are due monthly.		19,673			19,641
Line of credit of $40,000 from Dell Business Credit available for the purchase of Dell products, such as computer and software equipment. The outstanding balance on the line of credit bears interest at a rate of 26.99%. Variable payments are due monthly.		5,317			7,800
Total line of credit		74,937			77,047
Less: current portion		(74,937	)		(77,047	)
Line of credit, less current portion	$	–		$	–

Note 9 – Capital Lease Obligations Payable

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

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

Lease #2 - Commenced on March 16, 2010 with monthly lease payments of $2,258 over the following 36 months. The lease was terminated on April 16, 2013 and the equipment was purchased pursuant to the mutual release and final payment of $5,500.

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

12

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The cost of equipment under capital leases is included in the Balance Sheets as property and equipment and was $134,800 and $134,800 at June 30, 2013 and December 31, 2012, respectively. Accumulated amortization of the leased equipment at June 30, 2013 and December 31, 2012 was $120,691 and $108,090, respectively. Amortization of assets under capital leases is included in depreciation and amortization expense.

The future minimum lease payments required under the capital leases and the present value of the net minimum lease payments as of June 30, 2013, are as follows:

Twelve Months
Ending
June 30,	Amount
2014	$	28,183
2015		5,757
2016		3,311
Total minimum payments	$	37,251
Less: amount representing interest		(3,844	)
Present value of net minimum lease payments		33,407
Less: Current maturities of capital lease obligations		(25,247	)
Long-term capital lease obligations	$	8,160

Note 10 – Notes Payable, Related Parties

Notes payable, related parties consist of the following at June 30, 2013 and December 31, 2012, respectively:

	June 30,		December 31,
	2013		2012
On various dates the Company’s CEO advanced and repaid funds to the Company at a 15% interest rate, due on demand. A total of $117,950 was advanced and repaid by the CEO during the six months ended June 30, 2013, and total proceeds and repayments were $349,560 and $411,073, respectively during the year ended December 31, 2012.	$	–	$	–
Originated June 12, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 10% interest rate, matures on June 12, 2015. In addition, a loan origination fee of $2,000 was issued as consideration for the loan on June 12, 2013, and is being amortized on a straight line basis over the life of the loan.		10,000		–
Originated May 16, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 10% interest rate, matures on April 1, 2015. In addition, a loan origination fee of $2,000 was issued as consideration for the loan on May 16, 2013, and is being amortized on a straight line basis over the life of the loan.		14,000		–
Originated April 12, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 10% interest rate, matures on April 12, 2015. In addition, a loan origination fee of $7,000 was issued as consideration for the loan on April 12, 2013, and is being amortized on a straight line basis over the life of the loan.		57,000		–
Originated April 1, 2013, unsecured promissory note payable owed to Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 10% interest rate, matures on April 1, 2015. In addition, a loan origination fee of $3,000 was issued as consideration for the loan on April 1, 2013, and is being amortized on a straight line basis over the life of the loan.		19,000		–

13

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Originated October 9, 2012, unsecured promissory note payable owed to an immediate family member of the Company’s CEO carries a 15% interest rate, matures on July 15, 2013. In addition, a loan origination fee, consisting of 1,088,957 shares of Series A Common Stock with a fair market value of $6,630 was issued as consideration for the loan on October 9, 2012.		13,000			13,000
Originated October 9, 2012, unsecured promissory note payable owed to a Company owned by an immediate family member of the Company’s CEO carries a 15% interest rate, matures on July 15, 2013. In addition, a loan origination fee, consisting of 144,928 shares of Series A Common Stock with a fair market value of $884 was issued as consideration for the loan on October 9, 2012.		2,000			2,000
Unsecured promissory note payable owed to a Company owned by an immediate family member of the Company’s CEO carries a 15% interest rate, matured on July 31, 2007. Currently in default.		5,868			7,085
Total notes payable, related parties		107,868			22,085
Less: current portion		(7,868	)		(22,085	)
Notes payable, related parties, less current portion	$	100,000		$	–

The Company recorded interest expense on notes payable to related parties in the amounts of $3,320 and $26,144 during the six months ended June 30, 2013 and 2012, respectively.

Note 11 – Convertible Debts

Convertible debts consist of the following at June 30, 2013 and December 31, 2012, respectively:

	June 30,		December 31,
	2013		2012
Unsecured $33,000 convertible promissory note, including an Original Issue Discount (“OID”) of $3,000, carries a 12% interest rate (“First JMJ Note”), matures on June 11, 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 $0.0018 per share, whichever is less, but not less than $0.00009 per share. The note was subsequently repaid in full on August 12, 2013 & thus the 12% interest was not assessed per the terms of the note. The debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares.	$	33,000	$	–
Unsecured $440,849 convertible promissory note due to a related party, carries a 10% interest rate (“Star Convertible Note”), matures on July 2, 2017. The principal and unpaid interest is convertible into shares of common stock at the discretion of the note holder at a price equal to 75% of the average closing price of the Company’s common stock over the five (5) consecutive trading days immediately preceding the date of conversion, or the fixed price of $0.005 per share, whichever is greater. The note carries a fourteen percent (14%) interest rate in the event of default, and the debt holder is limited to owning 9.99% of the Company’s issued and outstanding shares. This note was subsequently amended on March 5, 2013 to change the conversion price to, "equal to the greater of, (a) 50% of the Market Price, or (b) the fixed conversion price of $0.00075 per share". The modification resulted in a loss on debt modification of $81,792. The note holder converted $250,000 of outstanding principal into 50,000,000 shares pursuant to debt conversion on September 15, 2012, $46,000 into 50,000,000 shares pursuant to debt conversion on March 14, 2013 and $40,000 into another 50,000,000 shares pursuant to debt conversion on April 10, 2013.		140,849		190,849
Unsecured $56,900 convertible promissory note, including an Original Issue Discount (“OID”) of $4,400 and legal fees of $2,500, carries an 8% interest rate (“First Tonaquint Note”), matures on May 31, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to sixty percent (60%) of the average of the two lowest trading bid prices of the Company’s common stock for the ten (10) trading days prior to the conversion date, or $0.00009 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The note holder converted $5,000 of outstanding principal into 4,504,505 shares pursuant to debt conversion on March 12, 2013, $10,000 of principal into 15,151,515 shares on April 2, 2013 and another $10,000 of principal into 15,873,016 shares on April 24, 2013.		31,900		56,900

14

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Unsecured $16,500 convertible promissory note carries an 8% interest rate (“Sixth Asher Note”), matures on September 14, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to forty-one percent (41%) of the average of the three lowest trading bid prices of the Company’s common stock for the ninety (90) trading days prior to the conversion date, or $0.00005 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The note holder converted a total of $16,500 of principal and $660 of interest into a total of 40,857,143 shares in full settlement of the outstanding debt on June 24, 2013.		–			16,500
Unsecured $27,500 convertible promissory note carries an 8% interest rate (“Fifth Asher Note”), matures on July 18, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to forty-one percent (41%) of the average of the three lowest trading bid prices of the Company’s common stock for the ninety (90) trading days prior to the conversion date, or $0.00005 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The promissory note, consisting of $27,500 of principal and $21,716 of accrued interest and financing costs, was repaid in full with cash on April 15, 2013.		–			27,500
Unsecured $32,500 convertible promissory note carries an 8% interest rate (“Fourth Asher Note”), matured on April 26, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to fifty-nine percent (59%) of the average of the five lowest trading bid prices of the Company’s common stock for the ten (10) trading days prior to the conversion date, or $0.00009 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The note holder subsequently converted a total of $32,500 of principal and $1,300 of interest into a total of 24,461,538 shares in settlement of the outstanding debt on March 4, 2013 and March 6, 2013.		–			32,500
Unsecured $42,500 convertible promissory note carries an 8% interest rate (“Third Asher Note”), matured on March 29, 2013. The principal is convertible into shares of common stock at the discretion of the note holder at a price equal to fifty-nine percent (59%) of the average of the three lowest trading bid prices of the Company’s common stock for the ten (10) trading days prior to the conversion date, or $0.00009 per share, whichever is greater. The note carries a twenty two percent (22%) interest rate in the event of default, and the debt holder is limited to owning 4.99% of the Company’s issued and outstanding shares. The note holder subsequently converted a total of $42,500 of principal and $1,700 of interest into a total of 23,573,529 shares of common stock in settlement of the outstanding debt between January 3, 2013 and February 26, 2013.		–			42,500
Total convertible debts		169,749			366,749
Less: unamortized discount on beneficial conversion feature		(46,456	)		(139,068	)
Convertible debts		123,293			227,681
Less: current maturities of convertible debts		(87,766	)		(74,708	)
Long term convertible debts	$	35,527		$	152,973

The Company recognized interest expense in the amount of $30,867 and $2,916 for the six months ended June 30, 2013 and 2012, respectively, related to convertible debts.

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

15

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The aforementioned accounting treatment resulted in a total debt discount equal to $33,000 and $277,323 during the six months ended June 30, 2013 and the year ended December 31, 2012, respectively. The discount is amortized on a straight line basis from the dates of issuance until the earlier of the stated redemption date of the debts, as noted above or the actual settlement date.

The convertible notes, consisting of total original face values of $440,849 from Star Financial, $206,500 from Asher Enterprises, $56,900 from Tonaquint Inc. and $33,000 from JMJ Financial, Inc., that created the beneficial conversion feature carry default provisions that place a “maximum share amount” on the note holders that can be owned as a result of the conversions to common stock by the note holders is 9.99% and 4.99%, respectively, of the issued and outstanding shares of Epazz.

During the six months ended June 30, 2013 and 2012, the Company recorded debt amortization expense in the amount of $128,612 and $14,978, respectively, attributed to the aforementioned debt discount, including $3,411 of amortization on the $7,400 OID during the six months ended June 30, 2013.

During the six months ended June 30, 2013, the Company issued a total of 224,421,246 shares pursuant to debt conversions in settlement of $206,160 of outstanding principal and $3,660 of unpaid interest, including 100,000,000 shares pursuant to debt conversion in settlement of $86,000 of outstanding principal owed to a related party (“Star Convertible Note”). The principal and interest was converted in accordance with the conversion terms, therefore no gain or loss has been recognized.

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

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

The Company evaluated the First Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.02603 below the market price on May 27, 2011 of $0.056 provided a value of $43,421 of which $-0- and $7,769 was amortized during the six months ended June 30, 2013 and 2012, respectively.

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

The Company evaluated the Second Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.01298 below the market price on June 28, 2011 of $0.035 provided a value of $22,108 of which $-0- and $7,209 was amortized during the six months ended June 30, 2013 and 2012, respectively.

16

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On July 2, 2012, we modified a previously outstanding non-convertible debt of $342,321, consisting of $296,103 of principal and $46,218 of accrued interest in exchange for a Convertible Promissory Note with Star Financial Corporation (“Star”), a company owned by our CEO’s family member, pursuant to which we issued to Star a 10% Convertible Promissory Note in the original principal amount of $440,849. The modification resulted in a loss on debt modification of $98,528. The note was again modified on March 5, 2013, resulting in a loss on debt modification of $81,792. The Star Convertible Note has a maturity date of July 2, 2017, and is convertible into our common stock at the greater of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price. The “Variable Conversion Price” shall mean 50% multiplied by the Market Price (representing a discount rate of 50%). “Market Price” means the average of the five (5) Closing Prices for the Common Stock during the five (5) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.00075 per share. The shares of common stock issuable upon conversion of the Star Convertible Note will be restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the Star Convertible Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

The Company evaluated the Star Convertible Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00141 below the market price on July 2, 2012 of $0.012 provided a value of $112,382 of which $24,176 and $-0- was amortized during the six months ended June 30, 2013 and 2012, respectively.

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

The Company evaluated the Third Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00551 below the market price on July 2, 2012 of $0.012 provided a value of $36,082 of which $11,760 and $-0- was amortized during the six months ended June 30, 2013 and 2012, respectively.

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

The Company evaluated the Fourth Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00583 below the market price on July 24, 2012 of $0.0126 provided a value of $27,959 of which $11,751 and $-0- was amortized during the six months ended June 30, 2013 and 2012, respectively.

17

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

The Company evaluated the First Tonaquint Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.0047 below the market price on September 10, 2012 of $0.0033 provided a value of $56,900 of which $32,669 and $-0- was amortized during the six months ended June 30, 2013 and 2012, respectively.

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

The Company evaluated the Fifth Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00603 below the market price on October 16, 2012 of $0.008 provided a value of $27,500 of which $19,900 and $-0- was amortized during the six months ended June 30, 2013 and 2012, respectively.

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

The Company evaluated the Sixth Asher Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00518 below the market price on December 12, 2012 of $0.0064 provided a value of $16,500 of which $15,364 and $-0- was amortized during the six months ended June 30, 2013 and 2012, respectively.

18

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On June 12, 2013, we entered into a Securities Purchase Agreement with JMJ Financial, Inc., (“JMJ”) pursuant to which we sold to JMJ a 12% Convertible Promissory Note in the original principal amount of $33,000. The First JMJ Note had a maturity date of June 11, 2014, and was convertible into our common stock at the lesser of (i) the Variable Conversion Price and (ii) the Fixed Conversion Price, not less than $0.00009 per share. The “Variable Conversion Price” shall mean 60% multiplied by the Market Price (representing a discount rate of 40%). “Market Price” means the lowest Trading Price for the Common Stock during the twenty five (25) Trading Day period ending on the latest complete Trading Day prior to the Conversion Date. “Fixed Conversion Price” shall mean $0.0018 per share. The shares of common stock issuable upon conversion of the First JMJ Note were restricted securities as defined in Rule 144 promulgated under the Securities Act of 1933. The issuance of the First JMJ Note was exempt from the registration requirements of the Securities Act of 1933 pursuant to Rule 506 of Regulation D promulgated thereunder. The purchaser was an accredited and sophisticated investor, familiar with our operations, and there was no solicitation.

The Company evaluated the First JMJ Note and determined that the shares issuable pursuant to the conversion option were determinate due to the Fixed Conversion Price and, as such, does not constitute a derivative liability as the Company has obtained authorization from a majority of shareholders such that should conversion occur at the Fixed Conversion Price the appropriate number of shares will be available or issuable for settlement to occur. The beneficial conversion feature discount resulting from the conversion price of $0.00518 below the market price on June 12, 2013 of $0.0017 provided a value of $33,000 of which $9,581 and $-0- was amortized during the six months ended June 30, 2013 and 2012, respectively.

Note 12 – Long Term Debts

Long term debts consist of the following at June 30, 2013 and December 31, 2012, respectively:

	June 30,		December 31,
	2013		2012
On June 24, 2013, the Company received a loan of $15,000 from WebBank, c/o NewLogic Business Loans, Inc., (“NewLogic”) bearing an effective interest rate of 5.71%, consisting of 176 daily week day payments of $106, maturing on February 19, 2014. The loan is collateralized with MS Health’s receivables. The promissory note is also personally guaranteed by Shaun Passley, our Chief Executive Officer.	$	14,586	$	–
On June 11, 2013, the Company received a loan of $24,000, including $499 of loan origination costs, from Horizon Business Funding, LLC (“Horizon”) bearing an effective interest rate of 368.05%, consisting of 78 daily week day payments of $448, maturing on September 2, 2013. The loan is collateralized with the Epazz receivables. The promissory note is also personally guaranteed by Shaun Passley, our Chief Executive Officer.		21,878		–
On April 11, 2013, the Company received a loan of $70,000, including $1,650 of loan origination costs, from Small Business Financial Solutions, LLC (“SBFS”) bearing an effective interest rate of 95.6%, consisting of 240 daily week day payments of $394, maturing on March 13, 2014. The loan is collateralized with the Epazz receivables. The promissory note is also personally guaranteed by Shaun Passley, our Chief Executive Officer.		57,253		–
On May 1, 2013, the Company purchased licenses to develop data management software in the total amount of $51,250 from Igenti, Inc., bearing an effective interest rate of 11%, consisting of 36 monthly payments of $1,674, maturing on April 30, 2016. The loan is collateralized with the data management software. Igenti retained a total of $4,615 of financing fees and paid the remaining proceeds of $46,615 to the Company for future payment to Sveltoz Solutions for the development of the data management software. Given the nature and status of the software development, no equipment costs have been capitalized.		48,700		–
On February 22, 2013, the Company purchased licenses to develop data management software in the total amount of $102,500 from Igenti, Inc., of which $51,250 was financed pursuant to an equipment financing agreement with Baytree National Bank & Trust Company on March 7, 2013 bearing an effective interest rate of 11.48%, consisting of 36 monthly payments of $1,674. The loan is collateralized with the data management software. Igenti retained a total of $3,000 of financing fees and paid the remaining proceeds of $99,500 to the Company for future payment to Sveltoz Solutions for the development of the data management software. Given the nature and status of the software development, no equipment costs have been capitalized.		45,944		–

19

 EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On February 22, 2013, the Company purchased licenses to develop data management software in the total amount of $102,500 from Igenti, Inc., of which $51,250 was financed with an equipment finance loan from Summit Funding Group, Inc. equipment with a three year loan term consisting of monthly loan payments of $1,828, with $2,078 paid at signing. The loan is collateralized with the data management software. Igenti retained a total of $3,000 of financing fees and paid the remaining proceeds of $99,500 to the Company for future payment to Sveltoz Solutions for the development of the data management software. Given the nature and status of the software development, no equipment costs have been capitalized.	47,602	–
On August 10, 2012, the Company purchased $13,870 of equipment with a three year equipment finance loan. The loan bears interest at an effective interest rate of 31.55%, along with monthly principal and interest payments of $585. The loan is collateralized with the purchased equipment. Matures on August 9, 2015.	11,963	13,448
On April 1, 2012, the Company purchased $129,747 of equipment with a three year equipment finance loan. The loan bears interest at an effective interest rate of 8.3%, along with monthly principal and interest payments of $4,078. The loan is collateralized with the purchased equipment. Matures on April 1, 2015.	98,396	104,129
Consideration for the MS Health acquisition included partial proceeds obtained from a $360,800 Small Business Association (“SBA”) loan, bearing interest at fixed and variable rates. The initial interest rate is 5.5% per year for three (3) years, consisting of the Prime Rate in effect on the first business day of the month in which the SBA loan application was received, plus 2.25%. The loan terms then transition to a variable interest rate over the remaining seven (7) years of the ten (10) year maturity term, calculated at 2.25% above the Prime Rate, as adjusted quarterly. The Company must pay principal and interest payments of $3,916 monthly. The SBA Loan is guaranteed by PRMI, K9 Bytes, Desk Flex, Inc., MS Health and the Company, and secured by the assets of MS Health and the Company.	327,591	343,060
Consideration for the MS Health acquisition included an unsecured $100,000 seller financed note payable (“MSHSC Note”), bearing interest at 6% per annum, a ten (10) year amortization, a right of offset, no payments of either principal or interest for two (2) years and equal payments of principal and interest commencing in year three (3), no prepayment penalty, and full payment of all amounts due after five (5) years. Pursuant to an amendment to a consulting agreement with the seller on March 23, 2012, the Company agreed to begin to repay principal of $1,000 per month, and had repaid a total of $6,000 during the year ended December 31, 2012. The MSHSC Note is secured by a security interest over the assets of MS Health. We did not purchase and MSHSC agreed to retain and be responsible for any and all liabilities of MSHSC.	94,000	94,000
On Deck Capital Loan – DeskFlex, Inc.:   On November 7, 2011, DeskFlex entered into a four month $20,000 note payable agreement with On Deck Capital. Payments of $183 were originally due daily on the loan. Origination fees of $500 were added to the initial loan, agreed to pay additional fees of $387 per month in servicing fees during the term of the loan and to repay the loan via daily payments of $183. The total payments due on the loan equate to an annual interest rate of 18%.   On February 15, 2012, we amended this loan agreement to increase the loan balance to $35,400, consisting of additional proceeds of $19,200, a rolled over loan balance of $10,050, an origination fee of $750 and interest amount of $5,400 to be paid over the restarted four month term of the loan via daily payments of $274.   On July 23, 2012, we amended this loan agreement again to increase the remaining unpaid loan balance to $35,400 again, consisting of additional proceeds of $23,883, a rolled over loan balance of $5,367, an origination fee of $750 and interest amount of $5,400 to be paid over the restarted four month term of the loan via daily payments of $274.   On October 30, 2012, we amended this loan agreement again to increase the remaining unpaid loan balance to $41,300, consisting of additional proceeds of $18,085, a rolled over loan balance of $16,040, an origination fee of $875 and interest amount of $6,300 to be paid over the restarted four month term of the loan via daily payments of $320.   On February 8, 2013, we again amended this loan agreement again to increase the remaining unpaid loan balance to $41,300, consisting of additional proceeds of $17,541, a rolled over loan balance of $16,584, an origination fee of $875 and interest amount of $6,300 to be paid over the restarted four month term of the loan via daily payments of $320.   The proceeds of all refinancing loans were received with substantially the same terms as the original debt.	12,806	28,173

20

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On Deck Capital Loan – Epazz, Inc.:   On January 3, 2012, Epazz entered into a nine month $55,800 note payable agreement with On Deck Capital. Payments of $289 were originally due daily on the loan. Proceeds of $43,875 were received on the loan, origination fees of $1,125 were added to the initial loan, along with interest of $10,800. The total payments due on the loan equate to an annual interest rate of 18%.   On May 25, 2012, we amended this loan agreement to increase the loan balance to $63,000, consisting of additional proceeds of $25,043, a rolled over loan balance of $24,957 and interest of $13,000 to be paid over the restarted nine month term of the loan via daily payments of $326.   On September 10, 2012, we again amended this loan agreement to increase the loan balance to $76,800, consisting of additional proceeds of $22,613, a rolled over loan balance of $35,887, an origination fee of $1,500 and interest of $16,800 to be paid over the revised twelve month term of the loan via daily payments of $299.   The proceeds of all refinancing loans were received with substantially the same terms as the original debt.	–	54,088
On March 20, 2012, DeskFlex entered into a $25,000 three year promissory note bearing interest at 11%. The promissory note is payable in monthly installments of $843 per month, maturing on March 20, 2015 (the “Maturity Date”).	15,358	19,483
Pursuant to an asset purchase agreement entered into on October 26, 2011, the Company granted K9 Bytes, Inc., a Florida corporation, a subordinated secured $30,750 promissory note carrying a 6% interest rate, payable in monthly installments of $333 per month starting in November 2011 and ending on October 26, 2014, at which time the then remaining balance of the promissory note ($23,017, assuming no additional payments other than those scheduled) is due. The promissory note is secured by a secondary lien on all of the assets of Epazz’s subsidiary, K9 Bytes, Inc., an Illinois corporation formed to house the purchased assets. The promissory note is also personally guaranteed by Shaun Passley, our Chief Executive Officer.	4,400	6,234
Unsecured $50,000 promissory note originated on September 15, 2010 between Intellisys and Paul Prahl, payable in monthly installments of $970 carries a 6% interest rate, maturing on September 18, 2015.The Company also agreed to provide Mr. Prahl earn-out rights, which provide that he will receive up to a maximum of $13,350 per year for the three calendar years following the Closing (with the first such calendar year beginning on January 1, 2011), based on the revenues generated by IntelliSys during such applicable year, whereas $6,675 is earned if revenues are between $350,000 and $380,000, $10,012 is earned if revenues are between $380,000 and $395,000, or $13,350 is earned if revenues are greater than $395,000 during each relevant year.	9,846	10,520
Unsecured term loan between Epazz and Bank of America, originating on June 15, 2011 bearing interest at 9.5% matures on June 17, 2016. Payments of $1,559 are due monthly.	66,917	68,436
Unsecured promissory note between Epazz and Newtek Finance for $185,000 originating on September 30, 2010 bearing interest at 6% matures on September 30, 2020. Payments of $2,054 are due monthly.	145,377	153,377

21

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The Company raised funds paid pursuant to an asset purchase agreement with K9 Bytes, Inc., a Florida corporation, on October 26, 2011, through a $235,000 Small Business Association (“SBA”) loan from a third party lender (the “Third Party Lender” and the “SBA Loan”). The SBA Loan has a term of ten (10) years; maturing on October 26, 2021, bearing interest at the prime rate plus 2.75% per annum, adjusted quarterly; is payable in monthly installments (beginning in December 2011) of $2,609 per month; is guaranteed by the Company and personally guaranteed by Shaun Passley, the Company’s Chief Executive Officer; and is secured by all of the assets of K9 Bytes, Inc., the Illinois corporation and wholly-owned subsidiary formed to house the acquired assets and the Company, 100% of the outstanding capital of the K9 subsidiary, and a life insurance policy on Mr. Passley’s life in the amount of $235,000. A total of approximately $10,000 of the amount borrowed under the SBA Loan was used to pay closing fees in connection with the loan, $169,250 was used to pay K9 Bytes the cash amount due pursuant to the terms of the Purchase Contract and the remainder of such loan amount was made available for working capital for the Company and the wholly-owned subsidiary, K9 Bytes, Inc.		207,107			216,214
Total long term debt		1,229,724			1,111,162
Less: current portion		(312,864	)		(218,699	)
Long term debt, less current portion	$	916,860		$	892,463

The Company recorded interest expense on long term debts, credit lines and capital leases in the amount of $100,160 and $65,040 for the six months ended June 30, 2013 and 2012, respectively.

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

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

Convertible Preferred Stock, Series A

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

Convertible Preferred Stock, Series B

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

22

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Declaration of Dividends

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

Beneficial Conversion Feature

On June 12, 2013, the Company entered into a convertible promissory note with JMJ Financial Note. The beneficial conversion feature discount resulting from the conversion price that was $0.00518 below the market price of $0.0017 on the June 12, 2013 origination date resulted in a debt discount value of $33,000 that was recognized as additional paid in capital and is being amortized on a straight line basis over the life of the loan.

Common Stock, Class A

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

Debt Conversions into Class A Common Stock

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

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

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

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

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

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

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

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

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

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

23

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On April 24, 2013, the Company issued 15,873,016 shares of Class A Common Stock pursuant to the conversion of $10,000 of convertible debt, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

On June 24, 2013, the Company issued 40,857,143 shares of Class A Common Stock pursuant to the conversion of $17,160 of convertible debt, consisting of $16,500 of principal and $660 of accrued and unpaid interest. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

Loss on Convertible Debt Modification to Related Party

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

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

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

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

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

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

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

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

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

Convertible Common Stock, Class B

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

On Mary 16, 2013, the Company issued 5,000,000 shares of Convertible Class B Common Stock to the Company’s CEO in consideration for providing product development services. The total fair value of the common stock was $9,500 based on the closing price of the Company’s common stock on the date of grant.

24

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 14 – Subsequent Events

Debt Conversions into Class A Common Stock

On July 9, 2013, the Company issued 80,000,000 shares of Class A Common Stock pursuant to the conversion of $26,400 of convertible debt owed to a related party, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

On July 10, 2013, the Company issued 22,222,222 shares of Class A Common Stock pursuant to the conversion of $8,000 of convertible debt, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

On July 30, 2013, the Company issued 15,476,190 shares of Class A Common Stock pursuant to the conversion of $13,000 of convertible debt, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

On August 7, 2013, the Company issued 40,000,000 shares of Class A Common Stock pursuant to the conversion of $32,000 of convertible debt owed to a related party, which consisted entirely of principal. The note was converted in accordance with the conversion terms; therefore no gain or loss has been recognized.

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

On July 5, 2013, the Company issued 25,000,000 shares of Class A Common Stock to Vivienne Passley, a related party, for providing human resource services. The total fair value of the common stock was $15,000 based on the closing price of the Company’s common stock on the date of grant.

On July 8, 2013, the Company issued 710,526,316 shares of Class A Common Stock to the Company’s CEO in consideration for providing product development services, of which 200,000,000 shares vested immediately and the remaining 510,526,316 shares will be vested once the Company reports revenue of $10 million in a calendar year. The total fair value of the common stock was $497,368 based on the closing price of the Company’s common stock on the date of grant, of which $140,000 is being expensed and $357,368 is presented as a deduction against additional paid in capital in the equity section of the balance sheet until the terms of the vesting periods are satisfied.

Shares of Class A Common Stock Issued as Loan Origination Fees to Related Parties

On July 19, 2013, the Company issued 2,500,000 shares of Class A Common Stock to Vivienne Passley, a related party, as a loan origination fee. The total fair value of the common stock was $4,250 based on the closing price of the Company’s common stock on the date of grant.

On July 31, 2013, the Company issued 3,000,000 shares of Class A Common Stock to Star Financial Corporation, a related party, as a loan origination fee. The total fair value of the common stock was $4,200 based on the closing price of the Company’s common stock on the date of grant.

On August 2, 2013, the Company issued 3,000,000 shares of Class A Common Stock to Star Financial Corporation, a related party, as a loan origination fee. The total fair value of the common stock was $5,100 based on the closing price of the Company’s common stock on the date of grant.

On August 12, 2013, the Company issued 5,000,000 shares of Class A Common Stock to Vivienne Passley, a related party, as a loan origination fee. The total fair value of the common stock was $7,000 based on the closing price of the Company’s common stock on the date of grant.

Debt Financing, Related Party

On July 31, 2013, the Company received an unsecured loan of $27,000 from Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 15, 2014. In addition, a loan origination fee of $5,000 and 3,000,000 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.

On August 2, 2013, the Company received an unsecured loan of $27,000 from Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 17, 2014. In addition, a loan origination fee of $5,000 and 3,000,000 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.

25

EPAZZ, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On August 7, 2013, the Company received an unsecured loan of $24,000 from Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 20, 2014. In addition, a loan origination fee of $4,000 and 2,500,000 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.

On August 12, 2013, the Company received an unsecured loan of $51,000 from 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 February 15, 2014. In addition, a loan origination fee of $6,000 and 5,000,000 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.

Debt Repayments

On August 12, 2013, the Company repaid $33,333 in complete satisfaction of the First JMJ note, consisting of $33,000 of principal and $333 of accrued and unpaid interest.

Amendment to Employment Agreement

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

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

ALL STATEMENTS IN THIS DISCUSSION THAT ARE NOT HISTORICAL ARE FORWARD-LOOKING STATEMENTS. STATEMENTS PRECEDED BY, FOLLOWED BY OR THAT OTHERWISE INCLUDE THE WORDS "BELIEVES", "EXPECTS", "ANTICIPATES", "INTENDS", "PROJECTS", "ESTIMATES", "PLANS", "MAY INCREASE", "MAY FLUCTUATE" AND SIMILAR EXPRESSIONS OR FUTURE OR CONDITIONAL VERBS SUCH AS "SHOULD", "WOULD", "MAY" AND "COULD" ARE GENERALLY FORWARD-LOOKING IN NATURE AND NOT HISTORICAL FACTS. THESE FORWARD-LOOKING STATEMENTS WERE BASED ON VARIOUS FACTORS AND WERE DERIVED UTILIZING NUMEROUS IMPORTANT ASSUMPTIONS AND OTHER IMPORTANT FACTORS THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROM THOSE IN THE FORWARD-LOOKING STATEMENTS. FORWARD-LOOKING STATEMENTS INCLUDE THE INFORMATION CONCERNING OUR FUTURE FINANCIAL PERFORMANCE, BUSINESS STRATEGY, PROJECTED PLANS AND OBJECTIVES. THESE FACTORS INCLUDE, AMONG OTHERS, THE FACTORS SET FORTH BELOW UNDER THE HEADING "RISK FACTORS." ALTHOUGH WE BELIEVE THAT THE EXPECTATIONS REFLECTED IN THE FORWARD-LOOKING STATEMENTS ARE REASONABLE, WE CANNOT GUARANTEE FUTURE RESULTS, LEVELS OF ACTIVITY, PERFORMANCE OR ACHIEVEMENTS. MOST OF THESE FACTORS ARE DIFFICULT TO PREDICT ACCURATELY AND ARE GENERALLY BEYOND OUR CONTROL. WE ARE UNDER NO OBLIGATION TO PUBLICLY UPDATE ANY OF THE FORWARD-LOOKING STATEMENTS TO REFLECT EVENTS OR CIRCUMSTANCES AFTER THE DATE HEREOF OR TO REFLECT THE OCCURRENCE OF UNANTICIPATED EVENTS, EXCEPT AS PROVIDED BY LAW. READERS ARE CAUTIONED NOT TO PLACE UNDUE RELIANCE ON THESE FORWARD-LOOKING STATEMENTS. REFERENCES IN THIS FORM 10-Q, UNLESS ANOTHER DATE IS STATED, ARE TO JUNE 30, 2013. AS USED HEREIN, THE “COMPANY,” “EPAZZ,” “WE,” “US,” “OUR” AND WORDS OF SIMILAR MEANING REFER TO EPAZZ, INC., AND INCLUDE EPAZZ’S WHOLLY OWNED SUBSIDIARIES, DESK FLEX, INC., AN ILLINOIS CORPORATION (“DFI”), PROFESSIONAL RESOURCE MANAGEMENT, INC., AN ILLINOIS CORPORATION, INTELLISYS, INC., A WISCONSIN CORPORATION ("INTELLISYS"), K9 BYTES, INC., AN ILLINOIS CORPORATION (“K9 BYTES”), MS HEALTH, INC., AN ILLINOIS CORPORATION (“MS HEALTH”) ANDCOOLING TECHNOLOGY SOLUTIONS, INC., AN ILLINOIS CORPORATION (“CST”), UNLESS OTHERWISE STATED, OR THE CONTEXT SUGGESTS OTHERWISE.

BUSINESS OVERVIEW

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

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

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

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

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

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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.

Cooling Technology Solutions, Inc.

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

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PLAN OF OPERATION

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

RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED JUNE 30, 2013, AS COMPARED TO THE THREE MONTHS ENDED JUNE 30, 2012:

	For the Three Months Ended
	June 30,						Increase /
	2013			2012			(Decrease)
Revenues	$	279,119		$	432,890		$	(153,771	)
General and Administrative		166,403			192,131			(25,728	)
Salaries and Wages		1,555,081			67,697			1,487,384
Depreciation and Amortization		67,385			75,167			(7,782	)
Bad Debts (Recoveries)		45			(42,847	)		42,892
Total Operating Expenses		1,788,914			292,148			1,496,766
Net Operating Loss		(1,509,795	)		140,742			1,650,537
Total Other Income (Expense)		(157,783	)		(42,821	)		114,962
Net Loss	$	(1,667,578	)	$	97,921		$	1,765,499

Revenues:

For the three months ended June 30, 2013 we had revenue of $279,119 compared to revenue of $432,890 for the three months ended June 30, 2012, a decrease of $153,771, or 36% from the comparative period. The decrease in revenues was evenly distributed across our subsidiaries.

General and Administrative:

General and administrative expenses decreased by $25,728, or 13% to $166,403 for the three months ended June 30, 2013 compared to general and administrative expense of $192,131 for the three months ended June 30, 2012. The decrease in general and administrative expense is due primarily to decreased professional fees as a result of not having to pay for the preparation of restatements for the year ended December 31, 2011 and acquisition costs during the three months ending June 30, 2013 that were necessary during the three months ending June 30, 2012.

Salaries and Wages:

Salaries and wages increased by $1,487,384 or 2,197% to $1,555,081 for the three months ended June 30, 2013 compared to salaries and wages of $67,697 for the three months ended June 30, 2012. The increase in salaries and wages is due primarily to the increase in stock based compensation of $1,430,500 pursuant to 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, in addition to increased cash compensation to our officers and employees. No shares were issued for services during the three months ending June 30, 2012.

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Depreciation and Amortization:

We had depreciation and amortization expense of $67,385 for the three months ended June 30, 2013 as compared to $75,167 for the three months ended June 30, 2012, a decrease of $7,782, or 10% from the comparative period. This decrease is principally due to certain assets reaching the end of their depreciable life cycle. We anticipate the replacement of these assets as resources become available.

Bad Debts (Recoveries):

We had bad debts expense of $45 for the three months ended June 30, 2013 as compared to bad debts (recoveries) of $(42,847) for the three months ended June 30, 2012, a decrease in bad debts (recoveries) of $42,892, or 100% 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.

Net Operating Loss:

Total operating expenses for the three months ended June 30, 2013 were $1,788,914, compared to $292,148 for the three months ended June 30, 2012, an increase of $1,496,766 or 512% from the comparative period. We had net operating losses of $1,509,795 for the three months ended June 30, 2013 compared to net operating income of $140,742 for the three months ended June 30, 2012, an increase in operating loss of $1,650,537, or 1,173% from the comparative period. The increase in operating loss was primarily due the increase in stock based compensation to related parties and decreased revenues.

Other Income (Expense):

Loss on debt conversions related to a modification of a related party debt was $14,240 for the three months ended June 30, 2013 compared to $-0- for the three months ended June 30, 2012, an increase of $14,240 from the comparative period. The current 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.

Interest expense was $143,543 for the three months ended June 30, 2013 compared to $42,854 for the three months ended June 30, 2012, an increase of $100,689 or 235% from the comparative period. Interest expense increased due to increased borrowings to finance our acquisitions, as well as an increase of $54,461 of finance costs related to the amortized discount on beneficial conversion features and another $20,645 in excess of the carrying value of Asher Note 5 paid to satisfy the convertible note with Asher Enterprises over the $-0- of amortized discounts and finance costs recognized during the three months ended June 30, 2012.

Net Loss:

We had a net loss of $1,667,578 for the three months ended June 30, 2013 compared to net income of $97,921 for the three months ended June 30, 2012, an increased net loss of $1,765,499, or 1,803%, from the comparative period. The increased net loss was primarily due to increased stock based compensation and a loss on convertible debt modification issued to related parties in the combined amount of $1,444,740, additional debt servicing costs and the recognition of associated amortization costs on debt discounts related to beneficial conversion features, along with our decreased revenues.

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RESULTS OF OPERATIONS FOR THE SIX MONTHS ENDED JUNE 30, 2013, AS COMPARED TO THE SIX MONTHS ENDED JUNE 30, 2012:

	For the Six Months Ended
	June 30,						Increase /
	2013			2012			(Decrease)
Revenues	$	487,129		$	547,367		$	(60,238	)
General and Administrative		287,634			322,881			(35,247	)
Salaries and Wages		1,771,234			161,212			1,610,022
Depreciation and Amortization		144,160			122,641			21,519
Bad Debts (Recoveries)		(8,740	)		(35,072	)		26,332
Total Operating Expenses		2,194,288			571,662			1,622,626
Net Operating Loss		(1,707,159	)		(24,295	)		1,682,864
Total Other Income (Expense)		(358,990	)		(83,891	)		275,099
Net Loss	$	(2,066,149	)	$	(108,186	)	$	1,957,963

Revenues:

For the six months ended June 30, 2013 we had revenue of $487,129 compared to revenue of $547,367 for the six months ended June 30, 2012, a decrease of $60,238, or 11% from the comparative period. The decrease in revenues was evenly distributed across our subsidiaries.

General and Administrative:

General and administrative expenses decreased by $35,247, or 13% to $287,634 for the six months ended June 30, 2013 compared to general and administrative expense of $322,881 for the six months ended June 30, 2012. The decrease in general and administrative expense is due primarily to decreased professional fees as a result of not having to pay for the preparation of restatements for the year ended December 31, 2011 and acquisition costs during the six months ending June 30, 2013 that were necessary during the six months ending June 30, 2012.

Salaries and Wages:

Salaries and wages increased by $1,610,022, or 999% to $1,771,234 for the six months ended June 30, 2013 compared to salaries and wages of $161,212 for the six months ended June 30, 2012. The increase in salaries and wages is due primarily to the increase in 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. No shares were issued for services during the six months ending June 30, 2012.

Depreciation and Amortization:

We had depreciation and amortization expense of $144,160 for the six months ended June 30, 2013 as compared to $122,641 for the six months ended June 30, 2012, an increase of $21,519, or 18% from the comparative period. This increase is due to having a greater depreciable asset base as a result of our acquisition of K9 Bytes on March 28, 2012.

Bad Debts (Recoveries):

We had bad debts (recoveries) of $8,785 for the six months ended June 30, 2013 as compared to bad debts (recoveries) of $(35,072) for the six months ended June 30, 2012, a decrease in bad debts (recoveries) of $26,332, or 75% 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.

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Net Operating Loss:

Total operating expenses for the six months ended June 30, 2013 were $2,194,288, compared to $571,662 for the six months ended June 30, 2012, an increase of $1,622,626, or 284% from the comparative period. We had net operating losses of $1,707,159 for the six months ended June 30, 2013 compared to $24,295 for the six months ended June 30, 2012, an increase in operating loss of $1,682,864, or 6,927%, from the comparative period. The increase in operating loss was primarily due the increase in stock based compensation to related parties and decreased revenues.

Other Income (Expense):

Loss on convertible debt modification, related party was $96,032 for the six months ended June 30, 2013 compared to $-0- for the six months ended June 30, 2012, an increase of $96,032 or 100% from the comparative period. The current period loss on debt modification was due to an amended convertible promissory note with Star Financial Corporation, which at the time of modification carried a balance of $190,849, and 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 Star Financial convertible promissory note to revise the conversion terms from a $0.005 floor and 75% discount to market to conversion terms consisting of, "equal to the greater of, (a) 50% of the Market Price, or (b) the fixed conversion price of $0.00075 per share". The Company compared the fair value of the debt immediately preceding the modification to the fair value after the modification to determine the loss on modification of $81,792. We also amended the Vivienne Passley 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.

Interest expense was $262,958 for the six months ended June 30, 2013 compared to $83,929 for the six months ended June 30, 2012, an increase of $179,029, or 213% from the comparative period. Interest expense increased due to increased borrowings to finance our acquisitions, as well as an increase of $113,634 of finance costs related to the amortized discount on beneficial conversion features over the $14,978 of amortized discounts recognized during the six months ended June 30, 2012, in addition to another $20,645 in excess of the carrying value of Asher Note 5 paid to satisfy the convertible note with Asher Enterprises during the six months ended June 30, 2013 that was not present in the comparative six months ended June 30, 2012.

Net Loss:

We had a net loss of $2,066,149 for the six months ended June 30, 2013 compared to $108,186 for the six months ended June 30, 2012, an increased net loss of $1,957,963, or 1,810%, from the comparative period. The increased net loss was primarily due to increased stock based compensation, losses on convertible debt modification issued to related parties and increased debt servicing costs in the combined amount of $1,618,032, and the recognition of an additional $113,634 of associated amortization costs on debt discounts related to beneficial conversion features and decreased revenues of $60,238 during the six months ended June 30, 2013, compared to the six months ended June 30, 2012.

LIQUIDITY AND CAPITAL RESOURCES

The following table summarizes total assets, accumulated deficit, stockholders’ equity (deficit) and working capital at June 30, 2013 compared to December 31, 2012.

	June 30,			December 31,
	2013			2012
Total Assets	$	1,285,579		$	1,378,030
Total Liabilities	$	1,969,808		$	1,849,541
Accumulated (Deficit)	$	(6,198,905	)	$	(4,114,756	)
Stockholders’ Equity (Deficit)	$	(684,229	)	$	(471,511	)
Working Capital (Deficit)	$	(754,125	)	$	(681,561	)

We had total current assets of $155,136 as of June 30, 2013, consisting of cash of $47,187, net accounts receivable of $75,494, and other current assets of $32,455.

We had non-current assets of $1,130,443 as of June 30, 2013, consisting of $141,157 of property and equipment, net, including accumulated depreciation and amortization of $383,788, intangible assets of $733,826, net, including $436,894 of accumulated amortization and goodwill of $255,460 related to the purchase of our subsidiaries.

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We had total current liabilities of $909,261 as of June 30, 2013, consisting of $18,000 of dividends payable in stock or cash at the election of management, $193,241 of accounts payable and accrued expenses, $189,338 of deferred revenues, current portion of outstanding balances on lines of credit of $74,937, current portion of capitalized leases in the amount of $25,247, current maturities of notes payable, related parties of $7,868, current maturities on convertible debentures of $87,766, net of discounts of $35,534, and current maturities on long term debts in the amount of $312,864.

We had negative working capital of $754,125 and a total accumulated deficit of $6,198,905 as of June 30, 2013.

We had total liabilities of $1,969,808 as of June 30, 2013, which included total current liabilities of $909,261, long-term portion of capitalized leases of $8,160, long term portion of notes payable, related parties of $100,000, long-term convertible debentures of $35,527, net of discounts of $10,922 and long-term debts of $916,860, net of current portion.

We had net cash used in operating activities of $173,163 for the six months ended June 30, 2013, which was primarily due to our net loss of $164,179 after adjustments for non-cash operating expenses, an increase of $29,759 in accounts receivable, a decrease of $1,743 of other current assets, and an increase of $49,284 in accounts payable and accrued expenses, and a decrease of $30,252 in deferred revenues.

We had $1,697 of net cash used in investing activities for the six months ended June 30, 2013, which consisted of $1,697 of cash paid for the purchase of equipment.

We had $175,946 of net cash provided in financing activities during the six months ended June 30, 2013, which represented proceeds from notes payable and convertible debts of $505,045, repayments on long term debts of $319,386 and principal payments on capital leases of $9,713.

Declaration of Dividends

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

Recent Financing Activities

Second quarter of 2013:

On various dates the Company’s CEO advanced and repaid funds to the Company at a 15% interest rate, due on demand. A total of $76,350 was advanced and repaid by the CEO during the six months ended June 30, 2013.

On various dates between April 1, 2013 and June 12, 2013, related parties advanced net proceeds of $86,000 in exchange for unsecured promissory notes bearing interest at 10% and additional loan origination costs of $14,000.

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

On May 1, 2013, the Company purchased licenses to develop data management software in the total amount of $51,250 from Igenti, Inc., bearing an effective interest rate of 11%, consisting of 36 monthly payments of $1,674, maturing on April 30, 2016. The loan is collateralized with the data management software. Igenti retained a total of $4,615 of financing fees and paid the remaining proceeds of $46,615 to the Company for future payment to Sveltoz Solutions for the development of the data management software.

On June 12, 2013, we received net proceeds of $30,000 in exchange for an unsecured $33,000 convertible promissory note, including an Original Issue Discount (“OID”) of $3,000, carrying a 12% interest rate (“First JMJ Note”), matures on June 11, 2014. The principal was 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 $0.0018 per share, whichever is less than, but not below $0.00009 per share. The note was subsequently repaid in full on August 12, 2013 & thus the 12% interest was not assessed per the terms of the note. The debt holder was limited to owning 4.99% of the Company’s issued and outstanding shares.

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On June 24, 2013, the Company received a loan of $15,000 from WebBank, c/o NewLogic Business Loans, Inc., (“NewLogic”) bearing an effective interest rate of 5.71%, consisting of 176 daily week day payments of $106, maturing on February 19, 2014. The loan is collateralized with MS Health’s receivables. The promissory note is also personally guaranteed by Shaun Passley, our Chief Executive Officer.

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

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

Third quarter of 2013:

On July 31, 2013, the Company received an unsecured loan of $27,000 from Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 15, 2014. In addition, a loan origination fee of $5,000 and 3,000,000 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.

On August 2, 2013, the Company received an unsecured loan of $27,000 from Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 17, 2014. In addition, a loan origination fee of $5,000 and 3,000,000 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.

On August 7, 2013, the Company received an unsecured loan of $24,000 from Star Financial Corporation, Inc., a corporation owned by an immediate family member of the Company’s CEO. The note carries a 15% interest rate, matures on January 20, 2014. In addition, a loan origination fee of $4,000 and 2,500,000 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.

On August 12, 2013, the Company received an unsecured loan of $51,000 from 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 February 15, 2014. In addition, a loan origination fee of $6,000 and 5,000,000 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.

Recent Debt Conversions

Second quarter of 2013:

During the three months ended June 30, 2013, we issued a total of 136,121,174 shares of common stock pursuant to debt conversions of a total of $89,500 of principal and $1,899 of accrued interest, and a loss on conversion of $14,240, during the six months ended June 30, 2013, of which, 50,000,000 shares of common stock were issued in conversion of $40,000 of outstanding principal on a related party note owed to Star Financial Corporation and another 14,239,500 shares valued at $28,479 were issued in settlement of $14,239 of outstanding principal and interest on a debt owed to Vivienne Passley, resulting in a loss on debt modification of $14,240 during the three months ended June 30, 2013.

Third quarter of 2013:

On various dates between July 9, 2013 and August 7, 2013, we issued a total of 157,698,412 shares of common stock pursuant to debt conversions of a total of $79,400 of principal, of which, 120,000,000 shares of common stock were issued in conversion of $58,400 of outstanding principal on a related party note owed to Star Financial Corporation.

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A total of $57,349 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 pricesbelow the most recent market price of $0.0014 per share
	Conversion	Principal		100%	75%	50%	25%
Lender / Origination	Terms	Borrowed		$0.0014	$0.0011	$0.0007	$0.0004
Star Financial   (Related Party)   July 2, 2012	As amended on March 5, 2013, convertible into the greater of (a) 50% of the average of the closing market price over the 5 days prior to the conversion request, and (b) the fixed conversion price of $0.00075 per share. Interest rate of 10%.	$	46,449	33,177,857	44,237,143	66,355,714	132,711,429
Tonaquint, Inc.   (First Tonaquint Note)   September 10, 2012	Convertible into 60% of the average of the two lowest trading prices over the 10 days prior to the conversion request, or $0.00009, whichever is greater. Interest rate of 8% with a 22% default rate.	$	10,900	7,785,714	10,380,952	15,571,429	31,142,857
		$	57,349	40,963,571	54,618,095	81,927,143	163,854,286

Recent Shares of Common Stock Issued for Services

Second quarter of 2013:

To conserve on the Company's capital requirements, the Company has issued shares in lieu of cash payments to related parties, and the Company expects to continue this practice. In the three months ended June 30, 2013, the Company granted a total of 746,026,316 shares of Class A Common Stock, and 500,000,000 shares of Convertible Class B Common Stock valued at $9,500 in lieu of cash payments to employees and related parties. No shares were issued for services during the three months ending June 30, 2012.

Third quarter of 2013:

On July 5, 2013, the Company issued 25,000,000 shares of Class A Common Stock to Vivienne Passley, a related party, for providing human resource services. The total fair value of the common stock was $15,000 based on the closing price of the Company’s common stock on the date of grant.

On July 8, 2013, the Company issued 710,526,316 shares of Class A Common Stock to the Company’s CEO in consideration for providing product development services. The total fair value of the common stock was $497,368 based on the closing price of the Company’s common stock on the date of grant, consisting of 200,000,000 shares valued at $140,000 that vest immediately and 510,526,316 shares valued at $357,368 issued tothe Company’s CEO in consideration for providing product development services that will vest once the Company reports revenue of $10 million in a calendar year. The unvested shares are presented as a deduction against additional paid in capital in the equity section of the balance sheet until the terms of the vesting periods are satisfied.

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

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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

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

Inherent Limitations of Internal Controls

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

Changes in Internal Control over Financial Reporting

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

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PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

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

ITEM 1A. RISK FACTORS

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

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

The following sales of equity securities by the Company occurred during the three month period ended June 30, 2013:

Debt Conversion Issuances

On April 2, 2013, the Company issued 15,151,515 shares of Class A Common Stock pursuant to the conversion of $10,000 of convertible debt, which consisted entirely of principal.

On April 10, 2013, the Company issued 50,000,000 shares of Class A Common Stock pursuant to the conversion of $40,000 of convertible debt owed to a related party, which consisted entirely of principal.

On May 27, 2013, the Company modified a related party debt and issued 14,239,500 shares of Class A Common Stock in settlement of $14,239 of related party debt owed to Vivienne Passley, which consisted of $13,000 of principal and $1,239 of accrued and unpaid interest.

On April 24, 2013, the Company issued 15,873,016 shares of Class A Common Stock pursuant to the conversion of $10,000 of convertible debt, which consisted entirely of principal.

On June 24, 2013, the Company issued 40,857,143 shares of Class A Common Stock pursuant to the conversion of $17,160 of convertible debt, consisting of $16,500 of principal and $660 of accrued and unpaid interest.

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

Shares Issued for Services

On Mary 16, 2013, the Company issued 5,000,000 shares of Convertible Class B Common Stock to the Company’s CEO in consideration for providing product development services.

On May 16, 2013, the Company issued 710,526,316 shares of Class A Common Stock to the Company’s CEO in consideration for providing product development services.

On May 24, 2013, the Company issued 35,500,000 shares of Class A Common Stock to Fay Passley, a related party, for providing collateral on acquisition loans that originated on September 30, 2010 and October 26, 2011.

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

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable.

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ITEM 5. OTHER INFORMATION

Amendment to Employment Agreement

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

Item 6. Exhibits

			Incorporated by reference
Exhibit	Exhibit Description	Filed herewith	Form	Period ending	Exhibit	Filing date
3.1	Articles of Incorporation		SB-2	12/04/06	X	12/04/06
3.2	Articles of Amendment		SB-2	12/04/06	X	12/04/06
3.3	Articles of Amendment		SB-2	12/04/06	X	12/04/06
3.4	Articles of Amendment		SB-2	12/04/06	X	12/04/06
3.5	Statement of Change of Registered Agent		SB-2	12/04/06	X	12/04/06
3.6	Articles of Amendment		SB-2	12/04/06	X	12/04/06
3.7	Amended and Restated By-Laws		SB-2	12/04/06	X	12/04/06
3.8	Articles of Amendment		10-Q	09/30/12	X	12/18/12
3.9	Articles of Amendment		10-K	12/31/12	X	06/03/13
4.1	Form of Stock Certificate		SB-2	12/04/06	X	12/04/06
10.1	Promissory Note with Star Financial Corporation, April 1, 2013	X
10.2	Promissory Note with Star Financial Corporation, April 12, 2013	X
10.3	Promissory Note with Star Financial Corporation, May 16, 2013	X
10.4	Promissory Note with Star Financial Corporation, June 12, 2013	X
10.5	First JMJ Financial Convertible Promissory Note, June 12, 2013	X
10.6	Software Finance Agreement with CIT Finance, LLC, May 1, 2013	X
10.7	Loan and Security Agreement with Small Business Financial Solutions, LLC, April 5, 2013	X
10.8	Merchant Agreement with Horizon Business Funding, LLC, June 11, 2013	X
10.9	Business Loan Agreement with WebBank, June 19, 2013	X
10.10	First Amendment to Executive Employment Agreement, August 16, 2013	X
21.1	Subsidiaries	X
31.1	Certifications pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934, as amended, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002	X
32.1	Certifications pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002	X
99.1	Temporary Hardship Exemption
101.INS*	XBRL Instance Document
101.SCH*	XBRL Schema Document
101.CAL*	XBRL Calculation Linkbase Document
101.DEF*	XBRL Definition Linkbase Document
101.LAB*	XBRL Labels Linkbase Document
101.PRE*	XBRL Presentation Linkbase Document

* To be furnished by amendment per Temporary Hardship Exemption under Regulation S-T.

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SIGNATURES

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

	EPAZZ, INC.
DATED: August 19, 2013	By: /s/ Shaun Passley
	Shaun Passley
	Chief Executive Officer (Principal Executive Officer), President, Chief Financial Officer (Principal Accounting Officer), and Director

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