UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
 
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2017
 
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____ to _____
 
Commission File Number: 001-32421
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
58-2342021
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
 
420 Lexington Avenue, Suite 1718, New York, New York   10170
   (Address of principal executive offices)    (Zip Code)
 
(212) 201-2400
 (Registrants telephone number, including area code)
 
Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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   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   No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer”, “accelerated filer”, “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filler
Accelerated filer
Non-accelerated filler
Smaller reporting company
(do not check if a smaller reporting company)
Emerging growth company 
☐ 
 
If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by checkmark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes No  
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: August 7, 2017.
 
Title of Each Class
Number of Shares Outstanding
Common Stock, $0.01 par value
22,505,365
 

 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
TABLE OF CONTENTS
 
Part 1 Financial Information.
 
Item 1. Financial Statements.
3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
22
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
32
Item 4. Controls and Procedures.
32
Part II Other Information.
32
Item 1. Legal Proceedings.
32
Item 1A. Risk Factors.
32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
33
Item 3. Defaults Upon Senior Securities.
33
Item 4. Mine Safety Disclosures.
33
Item 5. Other Information.
33
Item 6. Exhibits.
33
Signatures.
34
Index to Exhibits
35
 
 
 
 
2
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
PART 1 FINANCIAL INFORMATION
 
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets 
 
 
 
June 30,
2017
 
 
December 31,
2016
 
ASSETS
 
(unaudited)
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 $2,407,317 
 $7,221,910 
Accounts receivable, net of allowance for doubtful accounts of
    
    
approximately $702,000 and $427,000, respectively
  9,486,904 
  9,359,876 
Prepaid expenses and other current assets
  1,707,268 
  1,084,209 
Total current assets
  13,601,489 
  17,665,995 
Property and equipment, net
  13,850,574 
  14,248,915 
Security deposits
  612,299 
  630,373 
Restricted cash
  27,153 
  27,153 
Goodwill
  35,286,629 
  35,689,215 
Intangible assets, net
  60,975,789 
  63,617,471 
Other assets
  60,527 
  77,117 
TOTAL ASSETS
 $124,414,460 
 $131,956,239 
 
    
    
LIABILITIES AND STOCKHOLDERS' EQUITY
    
    
Current liabilities:
    
    
Term loan - current portion
 $4,875,000 
 $2,979,167 
Obligations under asset purchase agreements - current portion
  911,370 
  546,488 
Equipment financing obligations
  1,238,986 
  1,002,578 
Accounts payable and accrued expenses
  20,692,741 
  19,722,838 
Total current liabilities
  27,718,097 
  24,251,071 
Long-term liabilities:
    
    
Notes payable - non-related parties, net of discount
  31,692,383 
  31,431,602 
Notes payable - related parties
  903,583 
  875,750 
Term loan
  57,341,519 
  60,731,204 
Indebtedness under revolving credit facility
  - 
  3,000,000 
Obligations under asset purchase agreements
  1,290,811 
  890,811 
Equipment financing obligations
  983,364 
  1,237,083 
Derivative liabilities
  262,542 
  348,650 
Total liabilities
  120,192,299 
  122,766,171 
Commitments and contingencies
    
    
Stockholders' equity:
    
    
Preferred stock, $0.01 par value, 10,000,000 shares authorized,
    
    
14,341 and 17,299 shares issued and outstanding
  143 
  174 
Common stock, $0.01 par value, 90,000,000 shares authorized,
    
    
22,505,365 and 20,642,028 shares issued and outstanding
  225,054 
  206,422 
Capital in excess of par value
  193,605,847 
  192,233,032 
Accumulated deficit
  (189,608,883)
  (183,249,560)
Total stockholders' equity
  4,222,161 
  9,190,068 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 $124,414,460 
 $131,956,239 
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
 
 
3
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Condensed Consolidated Statements of Operations 
(unaudited)
 
 
 
For the Three Months Ended
June 30,
 
 
For the Six Months Ended
June 30,
 
 
 
2017
 
 
2016
 
 
2017
 
 
2016
 
Revenues
 $38,089,006 
 $31,041,047 
 $73,900,882 
 $64,835,296 
Cost of revenues, exclusive of depreciation and
    
    
    
    
amortization, shown separately below
  20,901,548 
  17,865,570 
  40,172,461 
  38,397,081 
Gross profit
  17,187,458 
  13,175,477 
  33,728,421 
  26,438,215 
Depreciation and amortization
  3,600,609 
  3,031,890 
  7,437,757 
  5,948,153 
Selling, general and administrative expenses
  14,330,934 
  11,270,013 
  28,465,809 
  22,694,799 
Total operating expenses
  17,931,543 
  14,301,903 
  35,903,566 
  28,642,952 
Operating loss
  (744,085)
  (1,126,426)
  (2,175,145)
  (2,204,737)
Other (expenses) income:
    
    
    
    
Interest expense
  (2,172,084)
  (1,624,669)
  (4,264,396)
  (3,252,633)
Gain on change in fair value of derivative liabilities
  113,779 
  45,642 
  73,334 
  228,042 
Loss on disposal of property and equipment
  (65,250)
  (11,996)
  (92,050)
  (72,818)
Other income, net
  13,365 
  37,111 
  129,845 
  88,263 
Total other expenses
  (2,110,190)
  (1,553,912)
  (4,153,267)
  (3,009,146)
Loss before income taxes
  (2,854,275)
  (2,680,338)
  (6,328,412)
  (5,213,883)
Provision for income taxes
  (23,100)
  - 
  (30,911)
  - 
Net loss
  (2,877,375)
  (2,680,338)
  (6,359,323)
  (5,213,883)
Preferred stock dividends
  (240,498)
  (284,839)
  (1,494,607)
  (1,816,821)
Net loss attributable to common stockholders
  (3,117,873)
  (2,965,177)
  (7,853,930)
  (7,030,704)
 
    
    
    
    
Basic and diluted loss per common share:
 $(0.14)
 $(0.20)
 $(0.36)
 $(0.49)
Weighted average common shares outstanding:
    
    
    
    
Basic and diluted
  22,408,335 
  14,864,768 
  21,562,714 
  14,306,170 
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
 
 
4
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Condensed Consolidated Statement of Stockholders’ Equity
(unaudited)
 
 
 Preferred Stock 
 
Common Stock
 
 Capital in Excess
of Par Value
 
 Accumulated Deficit 
 Stockholders' Equity 
 
 
Shares
 
 
$
 
 
Shares
 
 
$
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2016
  17,299 
 $174 
  20,642,028 
 $206,422 
 $192,233,032 
 $(183,249,560)
 $9,190,068 
Net loss
  - 
  - 
  - 
  - 
  - 
  (6,359,323)
  (6,359,323)
Conversion of preferred stock into common stock
  (2,958)
  (31)
  986,665 
  9,866 
  (9,835)
  - 
  - 
Dividends on preferred stock
  - 
  - 
  205,776 
  2,058 
  (2,058)
  - 
  - 
Proceeds from the exercise of common stock
 
    
    
    
    
    
    
purchase warrants
  - 
  - 
  561,834 
  5,617 
  775,334 
  - 
  780,951 
Issuance of common stock for services rendered
  - 
  - 
  115,000 
  1,150 
  163,300 
  - 
  164,450 
Reclassification of derivative liability
  - 
  - 
  - 
  - 
  12,774 
  - 
  12,774 
Forfeiture of common stock award by employee
  - 
  - 
  (5,938)
  (59)
  (8,552)
  - 
  (8,611)
Stock-based compensation associated with
 
    
    
    
    
    
    
stock incentive plans
  - 
  - 
  - 
  - 
  441,852 
  - 
  441,852 
Balance at June 30, 2017
  14,341 
 $143 
  22,505,365 
 $225,054 
 $193,605,847 
 $(189,608,883)
 $4,222,161 
 
The accompanying notes are an integral part of these Condensed Consolidated Financial Statements.
 
5
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Condensed Consolidated Statements of Cash Flows
(unaudited)
 
 
 
Six Months Ended June 30,
 
 
 
2017
 
 
2016
 
Cash flows from operating activities:
 
 
 
 
 
 
Net loss
 $(6,359,323)
 $(5,213,883)
 
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
Depreciation and amortization
  7,437,757 
  5,948,153 
Loss on disposal of property and equipment
  92,050 
  72,818 
Stock-based compensation
  441,852 
  378,548 
Stock issued for services rendered or in settlement of liabilities
  164,450 
  79,948 
Amortization of debt discount and deferred financing fees
  419,762 
  318,125 
Gain on the change in fair value of derivative liability
  (73,335)
  (228,043)
Changes in operating assets and liabilities:
    
    
Accounts receivable
  426,301 
  (124,925)
Prepaid expenses and other current assets
  (991,509)
  (1,230,504)
Other assets
  16,590 
  (249,687)
Accounts payable and accrued expenses
  953,879 
  (691,178)
Net cash provided by (used in) operating activities
  2,528,474 
  (940,628)
 
    
    
Cash flows from investing activities:
    
    
Purchase of property and equipment
  (2,341,272)
  (2,325,210)
Proceeds from the sale of property and equipment
  73,962 
  23,961 
(Payment) for acquisitions, net of cash acquired
  (558,329)
  16,895 
Escrow refund - PingTone acquisition
  - 
  318,409 
Return of security deposits
  18,074 
  25,615 
Net cash used in investing activities
  (2,807,565)
  (1,940,330)
 
    
    
Cash flows from financing activities:
    
    
Proceeds from the exercise of common stock purchase warrants
  780,951 
  - 
Repayments of term loan
  (1,625,000)
  (501,222)
Repayments of revolving debt, net
  (3,000,000)
    
Payments for obligations under asset purchase agreements
  (216,668)
    
Payments on equipment financing obligations
  (474,785)
  (497,422)
Net cash used in financing activities
  (4,535,502)
  (998,644)
Net change in cash and cash equivalents
  (4,814,593)
  (3,879,602)
Cash and cash equivalents, including restricted cash, beginning of period
  7,249,063 
  7,705,666 
Cash and cash equivalents, including restricted cash, end of period
 $2,434,470 
 $3,826,064 
 
See accompanying notes to the Condensed Consolidated Financial Statements.
 
6
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Note 1. Organization and Business
 
Fusion Telecommunications International, Inc. is a Delaware corporation incorporated in September 1997 (“Fusion” and together with its subsidiaries, the “Company,” “we,” “us” and “our”).  The Company is a provider of integrated cloud solutions, including cloud voice, cloud connectivity, cloud infrastructure, cloud computing, and managed cloud-based applications to businesses of all sizes, and voice over IP (“VoIP”) - based voice services to other carriers.  The Company currently operates in two business segments, Business Services and Carrier Services.
 
Note 2. Basis of Presentation and Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in all material respects in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information. Pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”), certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted.
 
Because certain information and footnote disclosures have been condensed or omitted, these unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2016, as amended (the “2016 Form 10-K”) as filed with the SEC. In management’s opinion, all normal and recurring adjustments considered necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented have been included. Management believes that the disclosures made in these unaudited condensed consolidated interim financial statements are adequate to make the information not misleading. The results of operations for the interim periods presented are not necessarily indicative of the results for the entire year.
 
Effective January 1, 2017, the Company changed the manner in which it accounts for federal and state universal service fees and surcharges in its consolidated statement of operations. The Company now includes the amounts collected in revenues, and reports the associated costs in cost of revenues, and this change has been applied retrospectively in the Company’s consolidated financial statements for all periods presented. As a result, both the Company’s revenues and cost of revenues for the three and six months ended June 30, 2017 include $0.7 million and $1.4 million, respectively, of federal and state universal service fees and surcharges. Revenues and cost of revenues for the three and six months ended June 30, 2016 include $0.6 million and $1.2 million, respectively, of federal and state universal service fees and surcharges.
 
During the three and six months ended June 30, 2017 and 2016, comprehensive loss was equal to the net loss amounts presented for the respective periods in the accompanying condensed consolidated interim statements of operations. Also, as discussed further below, effective January 1, 2017 the Company early adopted Accounting Standards Update (“ASU”) 2016-18, Restricted Cash.
 
Liquidity
 
Since inception, the Company has incurred significant net losses. At June 30, 2017, the Company had a working capital deficit of $14.1 million and stockholders’ equity of $4.2 million. At December 31, 2016, the Company had a working capital deficit of $6.6 million and stockholders’ equity of $9.2 million. The Company’s consolidated cash balance at June 30, 2017 was $2.4 million. While the Company projects that it has sufficient cash to fund its operations and meet its operating and debt obligations for the next twelve months, it may be required to either raise additional capital, limit its discretionary capital expenditures or borrow amounts available under its revolving credit facility to support its business plan. There is currently no commitment for any additional funding and there can be no assurances that funds will be available on terms that are acceptable to the Company, or at all.
 
Principles of Consolidation
 
The condensed consolidated interim financial statements include the accounts of Fusion and each of its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
 
 
7
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Use of Estimates
 
The preparation of condensed consolidated interim financial statements in conformity with U.S. GAAP 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 condensed consolidated interim financial statements and the reported amounts of revenues and expenses during the reporting periods. On an on-going basis, the Company evaluates its estimates, including, but not limited to, those related to recognition of revenue, allowance for doubtful accounts; fair value measurements of its financial instruments; useful lives of its long-lived assets used in computing depreciation and amortization; impairment assessment of goodwill and intangible assets; accounting for stock options and other equity awards, particularly related to fair value estimates, accounting for income taxes, contingencies and litigation. Changes in the facts or circumstances underlying these estimates could result in material changes and actual results could differ from those estimates.
 
Cash Equivalents
 
Cash and cash equivalents include cash on deposit and short-term, highly-liquid investments with maturities of three months or less on the date of purchase. As of June 30, 2017 and December 31, 2016, the carrying value of cash and cash equivalents approximates fair value due to the short period to maturity.
 
Fair Value of Financial Instruments
 
At June 30, 2017 and December 31, 2016, the carrying value of the Company’s accounts receivable, accounts payable and accrued expenses approximates its fair value due to the short term nature of these financial instruments.
 
Impairment of Long-Lived Assets
 
The Company periodically reviews long-lived assets, including intangible assets, for possible impairment when events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If an impairment indicator is present, the Company evaluates recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets.  If the carrying value of the asset exceeds the projected undiscounted cash flows, the Company is required to estimate the fair value of the asset and recognize an impairment charge to the extent that the carrying value of the asset exceeds its estimated fair value. The Company did not record any impairment charges during the three and six months ended June 30, 2017 and 2016, as there were no indicators of impairment.
 
Goodwill
 
Goodwill is the excess of the acquisition cost of a business combination over the fair value of the identifiable net assets acquired. Goodwill at June 30, 2017 and December 31, 2016 was $35.3 million and $35.7 million, respectively.  All of the Company’s goodwill is attributable to its Business Services segment.  
 
The following table presents the changes in the carrying amounts of goodwill during the six months ended June 30, 2017:
 
Balance at December 31, 2016
 $35,689,215 
Increase in goodwill associated with a 2016 acquisition
  7,414 
Adjustment to goodwill associated with acquisition of customer bases (see note 3)
  (410,000)
Balance at June 30, 2017
 $35,286,629 
 
Goodwill is not amortized and is tested for impairment on an annual basis in the fourth quarter of each fiscal year and whenever events or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
 
The impairment test for goodwill uses a two-step approach, which is performed at the reporting unit level.  The Company has determined that its reporting units are its operating segments (see note 15) since that is the lowest level at which discrete, reliable financial and cash flow information is available.  Step one compares the fair value of the reporting unit (calculated using a market approach and/or a discounted cash flow method) to its carrying value.  If the carrying value exceeds the fair value, there is a potential impairment and step two must be performed.  Step two compares the carrying value of the reporting unit’s goodwill to its implied fair value, which is the fair value of the reporting unit less the fair value of the unit’s assets and liabilities, including identifiable intangible assets.  If the implied fair value of goodwill is less than its carrying amount, an impairment is recognized.
 
In testing goodwill for impairment, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (more than 50%) that the estimated fair value of a reporting unit is less than its carrying amount. If the Company elects to perform a qualitative assessment and determines that an impairment is more likely than not, it is then required to perform a quantitative impairment test. The Company also may elect not to perform the qualitative assessment and, instead, proceed directly to the quantitative impairment test. The Company did not record any impairment charges related to goodwill during the three and six months ended June 30, 2017 and 2016.
 
 
8
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Advertising and Marketing Costs
 
Advertising and marketing expenses includes cost for promotional materials and trade show expenses for the marketing of the Company’s products and services.  Advertising and marketing expenses were $0.3 million and $0.2 million for the three months ended June 30, 2017 and 2016, respectively, and $0.5 million and $0.4 million for the six months ended June 30, 2017 and 2016, respectively. Advertising and marketing expenses are reflected in selling, general and administrative expenses in the Company’s condensed consolidated statements of operations.
 
Income Taxes
 
The accounting and reporting requirements with respect to accounting for income taxes require an asset and liability approach. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred income tax assets to the amount expected to be realized.
 
In accordance with U.S. GAAP, the Company is required to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Derecognition of a tax benefit previously recognized could result in the Company recording a tax liability that would reduce net assets. Based on its analysis, the Company has determined that it has not incurred any liability for unrecognized tax benefits as of June 30, 2017 and December 31, 2016. The Company is subject to income tax examinations by major taxing authorities for all tax years since 2013 and its tax returns may be subject to review and adjustment at a later date based on factors including, but not limited to, on-going analyses of and changes to tax laws, regulations and interpretations thereof. No interest expense or penalties have been recognized as of June 30, 2017 and December 31, 2016. During the three and six months ended June 30, 2017 and 2016, the Company recognized no adjustments for uncertain tax positions.
 
Stock-Based Compensation
 
The Company recognizes expense for its employee stock-based compensation based on the fair value of the awards at the date of grant. The fair values of stock options are estimated at the date of grant using the Black-Scholes option valuation model. The use of the Black-Scholes option valuation model requires the input of subjective assumptions. Compensation cost, net of estimated forfeitures, is recognized ratably over the vesting period of the related stock-based compensation award. For transactions in which goods or services are received from non-employees in return for the issuance of equity instruments, the expense is recognized in the period when the goods and services are received at the fair value of the consideration received or the fair value of the equity instrument issued, whichever is more readily determinable.
 
New and Recently Adopted Accounting Pronouncements
 
In July 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). The amendments in Part I of this update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. This standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures.
 
In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, which clarifies guidance and presentation related to restricted cash in the statement of cash flows, including stating that restricted cash should be included within cash and cash equivalents in the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, with early adoption permitted, and is to be applied retrospectively. The Company early adopted ASU 2016-18 effective January 1, 2017. Adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
 
 
9
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
In February 2016, the FASB issued ASU No. 2016-02, Leases, which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 with early adoption permitted. Under ASU 2016-02, lessees will be required to recognize for all leases at the commencement date a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right to-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures.
 
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which simplifies the presentation of deferred income taxes by requiring that deferred tax assets and liabilities be classified as noncurrent on the balance sheet. The updated standard became effective as of January 1, 2017. Adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
 
In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation, which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Under ASU 2016-09, all excess tax benefits and tax deficiencies related to share-based payment awards are to be recognized as income tax expense or income tax benefit in the statement of operations. In addition, the tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur and excess tax benefits should be recognized regardless of whether the benefit reduces taxes payable in the current period. Adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
 
In May 2014, the FASB issued guidance that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most recent current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also specifies the accounting for certain incremental costs of obtaining a contract and costs to fulfill a contract with a customer. Entities have the option of applying either a full retrospective approach to all periods presented or a modified approach that reflects differences prior to the date of adoption as an adjustment to equity. In April 2015, the FASB deferred the effective date of this guidance until January 1, 2018 and the Company is currently assessing the impact of this guidance on its consolidated financial statements.
 
Note 3. Acquisitions
 
On November 18, 2016, the Company entered into an asset purchase agreement pursuant to which the Company assumed obligations to provide services to a customer base. In connection with that transaction, the Company recognized goodwill and a corresponding obligation to the seller in the amount of $0.4 million. In such agreement, the Company also agreed to pay additional consideration to the seller if it was able to facilitate the assignment of certain additional customers to the Company.
 
On March 1, 2017, the Company entered into an additional asset purchase agreement with another party pursuant to which the Company assumed obligations to provide services to a customer base and also purchased the outstanding accounts receivables associated with that customer base of approximately $0.6 million. As this customer base was included in the November 2016 agreement, the Company is required to pay consideration to the counterparty to that agreement in the estimated aggregate amount of $1.7 million (included in customer base acquisitions in note 11).  The March 2017 agreement also provides for a management period during which the Company will be responsible for all aspects of the customer relationship with respect to the acquired customer base until such time as all regulatory approvals have been obtained, and the Company’s consolidated statement of operations includes the revenue associated with the customer base acquisition effective March 1, 2017.  The March 2017 agreement also provides for a transition period during which the seller thereunder will provide certain services and assistance to the Company.
 
The aggregate amount for the November 2016 and March 2017 agreements totaled $2.3 million, comprised of the $0.6 million paid for the accounts receivable and the $1.7 million of contingent consideration related to the customer base which was valued at a multiple of monthly revenue and that will be paid over a period of 18 months.  The March 2017 agreement resulted in a reduction to the goodwill in the amount of $0.4 million. These agreements did not have a material effect on the Company’s results of operations or financial condition.
 
Note 4. Loss per share
 
Basic and diluted loss per share is computed by dividing the loss attributable to common stockholders by the weighted-average number of common shares outstanding during the period.
 
 
10
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
The following table sets forth the computation of basic and diluted net income per share for the three and six months ended June 30, 2017 and 2016:
 
 
 
Three Months Ended June 30,
 
 
Six Months Ended June 30,
 
 
 
2017
 
 
2016
 
 
2017
 
 
2016
 
Numerator
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
  (2,877,375)
  (2,680,338)
 $(6,359,323)
 $(5,213,883)
Undeclared dividends on Series A-1, A-2 and A-4 Convertible Preferred Stock
  (100,624)
  (100,624)
  (200,141)
  (201,247)
Conversion price reduction on Series B-2 Preferred Stock (see note 13)
  - 
  - 
  (623,574)
  - 
Series B-2 warrant exchange (see note 13)
  - 
  - 
  (347,191)
  - 
Dividends declared on Series B-2 Convertible Preferred Stock
  (139,874)
  (184,215)
  (323,701)
  (1,615,574)
Net loss attributable to common stockholders
 $(3,117,873)
 $(2,965,177)
 $(7,853,930)
 $(7,030,704)
 
    
    
    
    
Denominator
    
    
    
    
Basic and diluted weighted average common shares outstanding
  22,408,335 
  14,864,768 
  21,562,714 
  14,306,170 
 
    
    
    
    
Loss per share
    
    
    
    
Basic and diluted
 $(0.14)
 $(0.20)
 $(0.36)
 $(0.49)
 
For the six months ended June 30, 2017 and 2016, the following were excluded from the calculation of diluted earnings per common share because of their anti-dilutive effects:
 
 
 
For the Six Months Ended June 30,
 
 
 
2017
 
 
2016
 
Warrants
  2,657,900 
  2,971,685 
Convertible preferred stock
  2,065,230 
  2,629,645 
Stock options
  2,160,525 
  1,158,984 
 
  6,883,655 
  6,760,314 
 
The net loss per common share calculation includes a provision for preferred stock dividends on Fusion’s outstanding Series A-1, A-2 and A-4 preferred stock (collectively, the “Series A Preferred Stock”) for the three and six months ended June 30, 2017 of $0.1 million and $0.2 million, respectively. The provision for dividends on the Series A Preferred Stock for the three and six months ended June 30, 2016 was $0.1 million and $0.2 million, respectively.. Through June 30, 2017, the Board of Directors of Fusion has never declared a dividend on any series of the Series A Preferred Stock, resulting in approximately $4.9 million of accumulated preferred stock dividends.
 
The Fusion Board declared dividends on the Company’s Series B-2 Cumulative Convertible Preferred Stock (the “Series B-2 Preferred Stock”) of $0.1 million and $0.2 million for the three months ended June 30, 2017 and 2016, respectively, and $0.3 million and $1.6 million for the six months ended June 30, 2017 and 2016, respectively. As permitted by the terms of the Series B-2 Preferred Stock, dividends were paid in the form of 205,776 and 887,576 shares of Fusion’s common stock for the six months ended June 30, 2017 and 2016, respectively.
 
 
11
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Note 5. Intangible Assets
 
Intangible assets as of June 30, 2017 and December 31, 2016 are as follows:
 
 
 
June 30, 2017
 
 
December 31, 2016
 
 
 
Gross Carrying Amount
 
 
Accumulated Amortization
 
 
Total
 
 
Gross Carrying Amount
 
 
Accumulated Amortization
 
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Trademarks and tradename
 $1,093,400 
 $(587,148)
 $506,252 
 $1,093,400 
 $(501,982)
 $591,418 
Proprietary technology
  6,670,000 
  (4,697,869)
  1,972,131 
  6,670,000 
  (4,036,915)
  2,633,085 
Non-compete agreement
  12,128,043 
  (10,890,367)
  1,237,676 
  12,128,043 
  (9,891,892)
  2,236,151 
Customer relationships
  67,713,181 
  (10,467,985)
  57,245,196 
  65,948,181 
  (7,827,697)
  58,120,484 
Favorable lease intangible
  218,000 
  (203,466)
  14,534 
  218,000 
  (181,667)
  36,333 
Total acquired intangibles
 $87,822,624 
 $(26,846,835)
 $60,975,789 
 $86,057,624 
 $(22,440,153)
 $63,617,471 
 
Amortization expense was $2.2 million and $1.4 million for the three months ended June 30, 2017 and 2016, respectively, and $4.4 million and $2.8 million for the six months ended June 30, 2017 and 2016, respectively. Estimated future aggregate amortization expense is expected to be as follows:
 
Year
 
 
Amortization Expense
 
remainder of 2017
 
 $4,177,862 
2018
 
  6,561,232 
2019
 
  5,577,500 
2020
 
  5,537,117 
2021
 
  5,362,750 
 
Note 6. Supplemental Disclosure of Cash Flow Information
 
Supplemental cash flow information for the six months ended June 30, 2017 and 2016 is as follows:
 
 
 
Six Months Ended June 30,
 
Supplemental Cash Flow Information
 
2017
 
 
2016
 
   Cash paid for interest
 $4,139,659 
 $2,750,175 
   Cash paid for income taxes
 $- 
 $- 
 
    
    
Supplemental Non-Cash Investing and Financing Activities
    
    
   Property and equipment acquired under capital leases or equipment financing obligations
 $457,475 
 $141,240 
Conversion of preferred stock into common stock
 $2,958,000 
 $- 
   Dividend on Series B-2 preferred stock paid with the issuance of Fusion common stock
 $323,701 
 $415,574 
   Obligations under asset purchase agreements
 $1,350,000 
 $1,011,606 
 
Note 7. Prepaid Expenses and Other Current Assets
 
Prepaid expenses and other current assets at June 30, 2017 and December 31, 2016 are as follows:
 
 
 
June 30,
2017
 
 
December 31,
2016
 
Insurance
 $170,830 
 $160,262 
Rent
  80,091 
  5,389 
Marketing
  36,351 
  74,665 
Software subscriptions
  881,799 
  419,431 
Comisssions
  115,564 
  159,146 
Other
  422,633 
  265,316 
Total
 $1,707,268 
 $1,084,209 
 
 
12
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Note 8. Accounts Payable and Accrued Expenses
 
Accounts payable and accrued expenses at June 30, 2017 and December 31, 2016 are as follows:
 
 
 
June 30,
2017
 
 
December 31,
2016
 
Trade accounts payable
 $4,940,015 
 $6,358,548 
Accrued license fees
  2,881,331 
  2,881,331 
Accrued sales and federal excise taxes
  2,777,928 
  2,863,363 
Deferred revenue
  1,633,739 
  1,874,641 
Accrued network costs
  3,469,076 
  1,416,000 
Accrued sales commissions
  872,616 
  819,106 
Property and other taxes
  818,732 
  581,956 
Accrued payroll and vacation
  472,670 
  421,733 
Customer deposits
  377,631 
  365,249 
Interest payable
  9,383 
  304,409 
Credit card payable
  22,873 
  265,985 
Accrued USF fees
  205,984 
  249,825 
Accrued bonus
  516,395 
  249,361 
Professional and consulting fees
  195,650 
  164,878 
Rent
  130,077 
  127,781 
Other
  1,368,641 
  778,672 
Total
 $20,692,741 
 $19,722,838 
 
Note 9. Equipment Financing Obligations
 
From time to time, the Company enters into equipment financing or capital lease arrangements to finance the purchase of network hardware and software utilized in its operations. These arrangements require monthly payments over a period of 24 to 48 months with interest rates ranging between 5.3% and 6.6%. The Company’s equipment financing obligations are as follows:
 
 
 
June 30,
 
 
December 31,
 
 
 
2017
 
 
2016
 
Equipment financing obligations
 $2,222,350 
 $2,239,661 
Less: current portion
  (1,238,986)
  (1,002,578)
Long-term portion
 $983,364 
 $1,237,083 
 
The Company’s payment obligations under its capital leases are as follows:
 
Year ending December 31:
 
 
Principal
 
remainder of 2017
 
 $642,084 
2018
 
  1,140,586 
2019
 
  429,486 
2020
 
  10,194 
 
 
 $2,222,350 
 
 
13
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Note 10. Long-Term Debt
 
Secured Credit Facilities
 
As of June 30, 2017 and December 31, 2016, secured credit facilities consists of the following:
 
 
 
June 30,
 
 
December 31,
 
 
 
2017
 
 
2016
 
Term loan
 $63,375,000 
 $65,000,000 
Less:
    
    
Deferred financing fees
  (1,158,481)
  (1,289,629)
Current portion
  (4,875,000)
  (2,979,167)
Term loan - long-term portion
 $57,341,519 
 $60,731,204 
 
    
    
Indebtedness under revolving credit facility
 $- 
 $3,000,000 
 
On November 14, 2016, Fusion NBS Acquisition Corp. (“FNAC”), a wholly-owned subsidiary of Fusion, entered into a new credit agreement (the “East West Credit Agreement”) with East West Bank, as administrative agent and the lenders identified therein (collectively with East West Bank, the “East West Lenders”). Under the East West Credit Agreement, the East West Lenders extended FNAC (i) a $65.0 million term loan and (ii) a $5.0 million revolving credit facility (which includes up to $4 million in “swingline” loans that may be accessed on a short-term basis). The proceeds of the term loan were used to retire the $40 million outstanding under a previously existing credit facility, and to fund the cash portion of the purchase price of FNAC’s acquisition of the issued and outstanding capital stock (the “Apptix Acquisition”) of Apptix, Inc., a wholly-owned subsidiary of Apptix, ASA (“Apptix”).
 
Borrowings under the East West Credit Agreement are evidenced by notes bearing interest at rates computed based upon either the then current “prime” rate of interest or “LIBOR” rate of interest, as selected by FNAC. Interest on borrowings that FNAC designates as “base rate” loans bear interest at the greater of the prime rate published by the Wall Street Journal or 3.25% per annum, in each case plus 2% per annum. Interest on borrowings that FNAC designates as “LIBOR rate” loans bear interest at the LIBOR rate of interest published by the Wall Street Journal, plus 5% per annum. The current interest rate is 6.25% per annum.
 
The Company is required to repay the term loan in equal monthly payments of $270,833 from January 1, 2017 through January 1, 2018, when monthly payments increase to $541,667, until the maturity date of the term loan on November 12, 2021, when the remaining $36.8 million of principal is due. Borrowings under the revolving credit facility are also payable on the November 12, 2021 maturity date of the facility. At June 30, 2017 and December 31, 2016, $0 and $3.0 million, respectively, was outstanding under the revolving credit facility.
 
In conjunction with the execution of the East West Credit Agreement, the Company and the East West Lenders also entered into (i) an IP security agreement under which the Company has pledged intellectual property to the East West Lenders to secure payment of the East West Credit Agreement, (ii) subordination agreements under which certain creditors of the Company and the East West Lenders have established priorities among them and reached certain agreements as to enforcing their respective rights against the Company, and (iii) a pledge and security agreement under which Fusion and FNAC have each pledged its equity interest in its subsidiaries to the East West Lenders.
 
Under the East West Credit Agreement: 
The Company is subject to a number of affirmative and negative covenants, including but not limited to, restrictions on paying indebtedness subordinate to its obligations to the East West Lenders, incurring additional indebtedness, making capital expenditures, dividend payments and cash distributions by subsidiaries.
The Company is required to comply with various financial covenants, including leverage ratio, fixed charge coverage ratio and minimum levels of earnings before interest, taxes, depreciation and amortization; and its failure to comply with any of the restrictive or financial covenants could result in an event of default and accelerated demand for repayment of amounts outstanding.
The Company granted the lenders security interests on all of its assets, as well as the capital stock of FNAC and each of its subsidiaries.
Fusion and its subsidiaries (and future subsidiaries of both) other than FNAC have guaranteed FNAC’s obligations, including FNAC’s repayment obligations thereunder.
 
At June 30, 2017 and December 31, 2016, the Company was in compliance with all of the financial covenants contained in the East West Credit Agreement.
 
 
14
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Notes Payable – Non-Related Parties
 
At June 30, 2017 and December 31, 2016, notes payable – non-related parties consists of the following: 
 
 
 
June 30,
 
 
December 31,
 
 
 
2017
 
 
2016
 
Subordinated notes
 $33,588,717 
 $33,588,717 
Discount on subordinated notes
  (1,204,398)
  (1,368,629)
Deferred financing fees
  (691,936)
  (788,486)
Total notes payable - non-related parties
  31,692,383 
  31,431,602 
Less: current portion
  - 
  - 
Long-term portion
 $31,692,383 
 $31,431,602 
 
On November 14, 2016, FNAC, Fusion and Fusion’s other subsidiaries entered into the Fifth Amended and Restated Securities Purchase Agreement (the “Praesidian Facility”) with Praesidian Capital Opportunity Fund III, L.P., Praesidian Capital Opportunity Fund III-A, LP and United Insurance Company of America (collectively, the “Praesidian Lenders”). The Praesidian Facility amends and restates a prior facility, pursuant to which FNAC previously sold its Series A, Series B, Series C, Series D, Series E and Series F senior notes in an aggregate principal amount of $33.6 million (the “SPA Notes”). These notes require interest payments in the amount of $0.3 million per month.  The current interest rate is 10.8% per annum.
 
Under the terms of the Praesidian Facility, the maturity date of the SPA Notes is May 12, 2022, no payments of principal are due until the maturity date, and the financial covenants contained in the Praesidian Facility are substantially similar to those contained in the East West Credit Agreement. In connection with the execution of the Praesidian Facility, the Praesidian Lenders entered into a subordination agreement with the East West Lenders pursuant to which the Praesidian Lenders have subordinated their right to payment under the Restated Purchase Agreement and the SPA Notes to repayment of the Company’s obligations under the East West Credit Agreement. At June 30, 2017 and December 31, 2016, the Company was in compliance with all of the financial covenants contained in the Praesidian Facility.
 
Notes Payable – Related Parties
 
At June 30, 2017 and December 31, 2016, notes payable – related parties consists of the following: 
 
 
 
June 30,
 
 
December 31,
 
 
 
2017
 
 
2016
 
Notes payable to Marvin Rosen
 $928,081 
 $928,081 
Discount on notes
  (24,498)
  (52,331)
Total notes payable - related parties
 $903,583 
 $875,750 
 
The notes payable to Marvin Rosen, Fusion’s Chairman of the Board, are subordinated to borrowings under the East West Credit Agreement and the Praesidian Facility. These notes are unsecured, pays interest monthly at an annual rate of 7%, and matures 120 days after the Company’s obligations under the East West Credit Agreement and the Praesidian Facility are paid in full. 
 
 
15
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
 
Note 11. Obligations Under Asset Purchase Agreements
 
In connection with certain acquisitions and asset purchases completed by the Company during 2015, 2016 and 2017, the Company has various obligations to the sellers, mainly for payments of portions of the purchase price that have been deferred under the terms of the respective purchase and sale agreements. Such obligations to sellers or other parties associated with these transactions as of June 30, 2017 and December 31, 2016 are as follows:
 
 
 
June 30, 2017
 
 
December 31,
 
 
 
2017
 
 
2016
 
Root Axcess
 $- 
 $166,668 
Customer base acquisitions
  1,315,575 
  334,025 
Technology For Business, Inc.
  886,606 
  936,606 
 
  2,202,181 
  1,437,299 
Less: current portion
  (911,370)
  (546,488)
Long-term portion
 $1,290,811 
 $890,811 
 
Note 12. Derivative Liability
 
Fusion has issued warrants to purchase shares of its common stock in connection with certain debt and equity financing transactions. These warrants are accounted for in accordance with the guidance contained in ASC Topic 815, Derivatives and Hedging. For warrant instruments that are not deemed to be indexed to Fusion’s own stock, the Company classifies such instruments as a liability at its fair value and adjusts the instrument to fair value at each reporting period. This liability is subject to re-measurement at each balance sheet date until the warrant is exercised or expires, and any change in fair value is recognized in the Company’s statement of operations. At June 30, 2017, Fusion had 549,634 warrants outstanding which provide for a downward adjustment of the exercise price if Fusion were to issue common stock at an issuance price, or issue convertible debt or warrants with a conversion or exercise price, that is less than the exercise price of these warrants. During the six months ended June 30, 2017, 35,200 of such warrants were exercised and, as a result, approximately $13,000 was reclassified from the Company’s derivative liability into equity.
 
The fair values of these warrants have been estimated using option pricing and other valuation models, and the quoted market price of Fusion’s common stock. The following assumptions were used to determine the fair value of the warrants for the six months ended June 30, 2017 and 2016:
 
 
 
Six months ended June 30,
 
 
 
2017
 
 
2016
 
Stock price ($)
  1.45-1.58 
  1.79-1.84 
Adjusted Exercise price ($)
  1.54-1.55 
  6.25 
Risk-free interest rate (%)
  2.23 
  1.58-1.78 
Expected volatility (%)
  64.3-74.4 
  94.6-96.7 
Time to maturity (years)
  1.5-1.75 
  2.75-3.00 
 
At June 30, 2017 and December 31, 2016, the fair value of the derivative was $0.3 million. For the three months ended June 30, 2017 and 2016, the Company recognized a gain on the change in fair value of the derivative of $0.1 million and approximately $46,000, respectively, and for the six months ended June 30, 2017 and 2016, the Company recognized a gain on the change in the fair value of this derivative of $0.1 million and $0.2 million, respectively.
 
Note 13. Equity Transactions
 
Common Stock
 
Fusion is authorized to issue 90,000,000 shares of its common stock. As of June 30, 2017 and December 31, 2016, 22,505,365 and 20,642,028 shares of its common stock, respectively, were issued and outstanding.
 
During the six months ended June 30, 2017, the Company entered into exchange agreements with certain holders of Fusion’s outstanding warrants whereby the outstanding warrants were exchanged for new warrants (the “2017 Warrants”), which warrants permitted the holders to exercise and purchase, for a limited period of 60 days, unregistered shares of Fusion’s common stock at a discount of up to 10% below the closing bid price of the common stock at the time of exercise but in no event at a price of less than $1.30 per share. In connection with these exchange agreements, the warrant holders exercised 2017 Warrants to purchase 561,834 shares of common stock on March 31, 2017 at an exercise price of $1.39 per share. The Company received proceeds from the exercise of the 2017 Warrants in the amount of $0.8 million, which were used for general corporate purposes. In connection with the exchange agreements, all of the 2017 Warrants were immediately exercised and none remained outstanding as of June 30, 2017. As a result of the exchange, the Company recorded a preferred stock dividend in the amount of $0.3 million for the difference in fair value of the warrants that were exchanged (see note 4).
 
 
16
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
On February 23, 2017, Fusion issued 115,000 shares of its common stock valued at approximately $0.2 million for services rendered. During the six months ended June 30, 2017, Fusion’s Board of Directors declared dividends on the Series B-2 Preferred Stock that were paid in the form of 205,776 shares of Fusion common stock (see note 4).
 
Preferred Stock
 
Fusion is authorized to issue up to 10,000,000 shares of preferred stock. As of June 30, 2017 and December 31, 2016, there were 5,045 shares of Series A Preferred Stock issued and outstanding. In addition, there were 9,296 and 12,254 shares of Series B-2 Preferred Stock issued and outstanding as of June 30, 2017 and December 31, 2016, respectively.
 
On March 31, 2017, the Company agreed with certain holders of its Series B-2 Preferred Stock to convert their shares of Series B-2 Preferred Stock into shares of Fusion common stock at a conversion price of $3.00 per share (the conversion price for such preferred stock otherwise being $5.00 per share). As a result, 2,958 shares of Series B-2 Preferred Stock were converted into a total of 986,665 shares of Fusion common stock, and the Company recorded a preferred stock dividend of $0.6 million for the value of the incremental number of common shares issued in connection with the reduction in the conversion price of the Series B-2 Preferred Stock (see note 4).
 
The holders of the Series A Preferred Stock are entitled to receive cumulative dividends of 8% per annum payable in arrears, when and if declared by the Fusion’s Board, on January 1 of each year. As of June 30, 2017, no dividends have been declared with respect to the Series A Preferred Stock (see note 4). The holders of the Series B-2 Preferred Stock are entitled to receive a cumulative 6% annual dividend payable quarterly in arrears when and if declared by the Fusion Board, in cash or shares of Fusion common stock, at the option of the Company (see note 4). As of June 30, 2017, all required quarterly dividends have been paid.
 
Stock Options
 
Fusion's 2016 equity incentive plan reserves a number of shares of common stock equal to 10% of Fusion’s common stock outstanding from time to time on a fully diluted basis, adjusted upward for the number of shares not granted under Fusion’s 2009 stock option plan and for shares covered by options granted thereunder that expire without being exercised. The 2016 equity incentive plan provides for the grant of incentive stock options, stock appreciation rights, restricted stock, restricted stock units, stock grants, stock units, performance shares and performance share units to employees, officers, non-employee directors of, and consultants to the Company. Options issued under the various Fusion plans typically vest in annual increments over a three or four year period, expire ten years from the date of grant and are issued at exercise prices no less than 100% of the fair market value at the time of grant.
 
The following assumptions were used to determine the fair value of the stock options granted under Fusion’s stock-based compensation plans using the Black-Scholes option-pricing model:
 
 
 
Six Months Ended June 30,
 
 
 
2017
 
 
2016
 
Dividend yield
  0.0%
  0.0%
Expected volatility
  92.40%
  94.6-96.7%
Average Risk-free interest rate
  2.22%
  1.58%
Expected life of stock option term (years)
  8.00 
  8.00 
 
The Company recognized compensation expense of $0.2 million for the three months ended June 30, 2017 and 2016, and $0.4 million for the six months ended June 30, 2017 and 2016. These amounts are included in selling, general and administrative expenses in the condensed consolidated interim statements of operations.
 
 
17
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
The following table summarizes stock option activity for the six months ended June 30, 2017:
 
 
 
Number of Options
 
 
Weighted Average Exercise Price
 
Weighted Average Remaining Contract Term
Outstanding at December 31, 2016
  2,183,723 
 $2.56 
8.56 years
Granted
  59,450 
  1.55 
 
Exercised
  - 
  - 
 
Forfeited
  (57,138)
  1.59 
 
Expired
  (25,510)
  19.28 
 
Outstanding at June 30, 2017
  2,160,525 
  2.36 
8.15 years
Exercisable at June 30, 2017
  712,240 
  3.89 
6.60 years
 
As of June 30, 2017, the Company had approximately $1.4 million of unrecognized compensation expense, net of estimated forfeitures, related to stock options granted under the Company’s stock-based compensation plans, which is expected to be recognized over a weighted-average period of 2.0 years.
 
Note 14. Commitments and Contingencies
 
From time to time, the Company may be involved in a variety of claims, lawsuits, investigations and proceedings relating to contractual disputes, employment matters, regulatory and compliance matters, intellectual property rights and other litigation arising in the ordinary course of business. Defending such proceedings can be costly and can impose a significant burden on management and employees. The Company does not expect that the outcome of any such claims or actions will have a material adverse effect on the Company’s liquidity, results of operations or financial condition. As of June 30, 2017, the Company did not have any ongoing legal matters that would have a material adverse effect on its liquidity, results of operations or financial condition.
 
In May 2017, FNAC commenced an action in the United States District Court for the Southern District of New York against Apptix, ASA, and certain of its and Apptix’s former officers and employees, arising from an estimated $2.9 million underpayment of license fees to a software vendor (see note 8). In August 2017, FNAC settled this litigation. As consideration for terminating the litigation, FNAC will be paid $150,000 in cash and the sellers will return 300,000 shares of Fusion common stock valued at $363,000 to the Company.
 
Note 15. Segment Information
 
Operating segments are defined under U.S. GAAP as components of an enterprise for which discrete financial information is available and evaluated regularly by a company's chief operating decision maker in deciding how to allocate resources and assess performance.
 
The Company has two reportable segments – Business Services and Carrier Services. These segments are organized by the products and services that are sold and the customers that are served. The Company measures and evaluates its reportable segments based on revenues and gross profit margins. The Company’s measurement of segment profit exclude the Company’s executive, administrative and support costs. The accounting policies of the segments are the same as those described in Note 2, Summary of Significant Accounting Policies, of the audited consolidated financial statements included in the 2016 Form 10-K. The Company’s segments and their principal activities consist of the following:
 
 
18
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Business Services
 
Through this operating segment, the Company provides a comprehensive suite of cloud communications, cloud connectivity, cloud computing and managed cloud-based applications to small, medium and large businesses. These services are sold through both the Company’s direct sales force and its partner sales channel, which utilizes the efforts of independent third-party distributors to sell the Company’s products and services. 
 
Carrier Services
 
Carrier Services includes the termination of domestic and international carrier traffic utilizing primarily VoIP technology.  VoIP permits a less costly and more rapid interconnection between the Company and international telecommunications carriers, and generally provides better profit margins for the Company than other technologies.  The Company currently interconnects with approximately 370 carrier customers and vendors, and is working to expand its interconnection relationships, particularly with carriers in emerging markets. See note 18 for a discussion regarding the Company’s future plans relating to this business segment.
 
Operating segment information for the three and six months ended June 30, 2017 and 2016 is summarized in the following tables:
 
 
 
Three Months Ended June 30, 2017
 
 
 
Carrier Services
 
 
Business Services
 
 
Corporate and Unallocated
 
 
Consolidated
 
Revenues
 $8,107,985 
 $29,981,021 
 $- 
 $38,089,006 
Cost of revenues (exclusive of depreciation and amortization)
  7,912,535 
  12,989,013 
  - 
  20,901,548 
Gross profit
  195,450 
  16,992,008 
  - 
  17,187,458 
Depreciation and amortization
  255,113 
  3,351,262 
  (5,766)
  3,600,609 
Selling, general and administrative expenses
  570,153 
  12,535,452 
  1,225,329 
  14,330,934 
Interest expense
  - 
  (2,113,396)
  (58,688)
  (2,172,084)
Gain on change in fair value of derivative liability
  - 
  - 
  113,779 
  113,779 
Other expenses, net
  (44)
  (6,990)
  (44,851)
  (51,885)
Income tax provision
  - 
  (23,100)
  - 
  (23,100)
Net loss
 $(629,860)
 $(1,038,192)
 $(1,209,323)
 $(2,877,375)
Total assets
 $1,571,274 
 $121,286,610 
 $1,556,576 
 $124,414,460 
 
 
 
Six Months Ended June 30, 2017
 
 
 
Carrier Services
 
 
Business Services
 
 
Corporate and Unallocated
 
 
Consolidated
 
Revenues
 $15,438,821 
 $58,462,061 
 $- 
 $73,900,882 
Cost of revenues (exclusive of depreciation and amortization)
  15,042,742 
  25,129,719 
  - 
  40,172,461 
Gross profit
  396,079 
  33,332,342 
  - 
  33,728,421 
Depreciation and amortization
  294,366 
  6,938,241 
  205,150 
  7,437,757 
Selling, general and administrative expenses
  1,091,366 
  24,726,626 
  2,647,817 
  28,465,809 
Interest expense
  - 
  (4,136,948)
  (127,448)
  (4,264,396)
Gain on change in fair value of derivative liability
  - 
  - 
  73,334 
  73,334 
Other (expenses) income, net
  (83)
  163,334 
  (125,456)
  37,795 
Income tax provision
  - 
  (30,911)
  - 
  (30,911)
Net loss
 $(989,736)
 $(2,337,050)
 $(3,032,537)
 $(6,359,323)
Capital expenditures
 $21,443 
 $2,319,829 
 $- 
 $2,341,272 
 
 
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FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
 
 
Three Months Ended June 30, 2016
 
 
 
Carrier Services
 
 
Business
Services
 
 
Corporate
and
Unallocated
 
 
Consolidated
 
Revenues
 $9,614,629 
 $21,426,418 
 $- 
 $31,041,047 
Cost of revenues (exclusive of depreciation and amortization)
  9,154,522 
  8,711,048 
  - 
  17,865,570 
Gross profit
  460,107 
  12,715,370 
  - 
  13,175,477 
Depreciation and amortization
  46,697 
  2,705,035 
  280,158 
  3,031,890 
Selling, general and administrative expenses
  637,184 
  9,493,429 
  1,139,400 
  11,270,013 
Interest expense
  - 
  (1,398,460)
  (226,209)
  (1,624,669)
Gain on change in fair value of derivative liability
  - 
  - 
  45,642 
  45,642 
Other (expenses) income, net
  - 
  (374,932)
  400,047 
  25,115 
Net loss
 $(223,774)
 $(1,256,486)
 $(1,200,078)
 $(2,680,338)
Total assets
 $6,991,833 
 $91,846,337 
 $1,661,748 
 $100,499,918 
 
    
    
    
    
 
 
 
Six Months Ended June 30, 2016
 
 
 
Carrier Services
 
 
Business
Services
 
 
Corporate
and
Unallocated
 
 
Consolidated
 
Revenues
 $21,846,295 
 $42,989,001 
 $- 
 $64,835,296 
Cost of revenues (exclusive of depreciation and amortization)
  20,854,069 
  17,543,012 
  - 
  38,397,081 
Gross profit
  992,226 
  25,445,989 
  - 
  26,438,215 
Depreciation and amortization
  78,008 
  5,380,556 
  489,589 
  5,948,153 
Selling, general and administrative expenses
  1,329,369 
  18,505,418 
  2,860,012 
  22,694,799 
Interest expense
  - 
  (3,096,313)
  (156,320)
  (3,252,633)
Gain on change in fair value of derivative liability
  - 
  - 
  228,042 
  228,042 
Other (expenses) income, net
  - 
  (517,238)
  532,683 
  15,445 
Net loss
 $(415,151)
 $(2,053,536)
 $(2,745,196)
 $(5,213,883)
Capital expenditures
 $41,584 
 $2,283,626 
 $- 
 $2,325,210 
 
Note 16. Related Party Transactions
 
Since March 6, 2014, the Company has engaged a tax advisor to prepare its tax returns and to provide related tax advisory services. The Company was billed $0.1 million and approximately $60,000 for the six months ended June 30, 2017 and 2016, respectively, by this firm. Larry Blum, a member of Fusion’s Board of Directors, is a Senior Advisor to and a former partner of this firm.
 
The Company also has notes payable to Marvin Rosen (see note 10).
 
Note 17. Fair Value Disclosures
 
Fair value of financial and non-financial assets and liabilities is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The three-tier hierarchy for inputs used in measuring fair value, which prioritizes the inputs used in the methodologies of measuring fair value for assets and liabilities, is as follows:
 
Level 1—Quoted prices in active markets for identical assets or liabilities
Level 2—Observable inputs other than quoted prices in active markets for identical assets and liabilities
Level 3—No observable pricing inputs in the market
 
The following table represents the liabilities measured at fair value on a recurring basis:
 
 
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FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
Total
 
As of June 30, 2017
 
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Contingent purchase price liability
  - 
  - 
 $911,370 
 $911,370 
Non-current liabilities:
    
    
    
    
Contingent purchase price liability
  - 
  - 
 $1,290,811 
 $1,290,811 
Derivative liability (see note 12)
  - 
  - 
 $262,542 
 $262,542 
As of December 31, 2016
    
    
    
    
Current liabilities:
    
    
    
    
Contingent purchase price liability
  - 
  - 
 $546,488 
 $546,488 
Non-current liabilities:
    
    
    
    
Contingent purchase price liability
  - 
  - 
 $890,811 
 $890,811 
Derivative liability (see note 12)
  - 
  - 
 $348,650 
 $348,650 
 
Changes in the derivative warrant liability for the six months ended June 30, 2017 are as follows:
 
Balance at December 31, 2016
 $348,650 
Change for the period:
    
Change in fair value included in net loss
  (73,334)
Warrant exchange (see note 12)
  (12,774)
Balance at June 30, 2017
 $262,542 
 
Changes in the contingent purchase price liability for the six months ended June 30, 2017 are as follows:
 
Balance at December 31, 2016
 $1,437,299 
Change for the period:
    
Acquired customer base
  1,350,000 
Increase in amounts due from Technology Opportunity Group
  (368,450)
Payments made
  (216,668)
Balance at June 30, 2017
 $2,202,181 
 
Note 18. Subsequent Events
 
On July 20, 2017, Fusion entered into a contribution agreement with its newly formed wholly-owned subsidiary Fusion Global Services LLC (‘FGS”) under the terms of which, Fusion contributed certain assets from its Carrier Services Business segment to FGS. Simultaneously with the execution of the foregoing contribution agreement, FGS also entered into an agreement with XcomIP, LLC, (“XcomIP”), under which XcomIP agreed to contribute its carrier business to FGS subject to satisfaction of certain conditions precedent. If these conditions are satisfied, FGS and XcomIP will execute a contribution agreement, and Fusion and XcomIP will execute a shareholder agreement under which Fusion will agree to provide up to $750,000 in working capital. Following XcomIP’s contribution of assets, Fusion will hold a 60% membership interest in FGS assets, liabilities and results of operations that will then be consolidated in the financial statements of the Company. The Company expects to complete the foregoing transactions prior to the end of August 2017.
 
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FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read in conjunction with the information contained in our unaudited consolidated financial statements and the notes thereto appearing elsewhere herein and in conjunction with the Management’s Discussion and Analysis set forth in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016, as amended, originally filed with the SEC on March 21, 2017 (the “2016 Form 10-K”).
 
Certain statements and the discussion contained herein regarding the Company’s business and operations may include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1996. Such statements consist of any statement other than a recitation of historical fact and can be identified by the use of forward-looking terminology such as “may,” “plans,” “expect,” “anticipate,” “intend,” “estimate” or “continue” or the negative thereof or other variations thereof or comparable terminology. The reader is cautioned that all forward-looking statements are speculative, and there are certain risks and uncertainties that could cause actual events or results to differ from those referred to in such forward-looking statements. The primary risk of the Company is its ability to attract new capital to execute its comprehensive business strategy. There may be additional risks associated with the integration of businesses following an acquisition, the Company’s ability to comply with the terms of its credit facilities, competitors with broader product lines and greater resources, emergence into new markets, natural disasters, acts of war, terrorism or other events beyond the Company’s control and the other factors identified by the Company from time to time in its filings with the SEC. However, the risks included should not be assumed to be the only risks that could affect future performance. All forward-looking statements included are made as of the date hereof, based on information available to the Company as of the date thereof, and the Company assumes no obligation to update any forward-looking statements.
 
OVERVIEW
 
Our Business
 
We offer a comprehensive suite of cloud communications, cloud connectivity, cloud computing and managed cloud-based applications to small, medium and large businesses, and offer domestic and international VoIP services to telecommunications carriers worldwide.  Our advanced, proprietary cloud services platforms, as well as our state-of-the art switching systems, enable the integration of leading edge solutions in the cloud, increasing customer collaboration and productivity by seamlessly connecting employees, partners, customers and vendors.  We currently operate our business in two distinct business segments: Business Services and Carrier Services.
 
In the Business Services segment, we are focused on becoming our business customers’ single source for leveraging the increasing power of the cloud, providing a robust package of what we believe to be the essential services that form the foundation for their successful migration to, and efficient use of, the cloud.  Our core Business Services products and services include cloud voice and Unified Communications as a Service, improving communication and collaboration on virtually any device, virtually anywhere, cloud connectivity services, securely and reliably connecting customers to the cloud with managed network solutions that are designed to increase quality and optimize network efficiency and contact center solutions.  Our cloud computing and Infrastructure as a Service solutions are designed to provide our larger enterprise customers with a platform on which additional cloud services can be layered.  Complemented by our Software as a Service solutions, such as security and business continuity, our advanced cloud offerings include private and hybrid cloud, storage, backup and recovery and secure file sharing that allow our customers to experience the increased efficiencies and agility delivered by the cloud. The Company’s cloud-based services are flexible, scalable and rapidly deployed, reducing our customers’ cost of ownership while increasing their productivity.
 
Through our Carrier Services segment, we have agreements with approximately 370 carrier customers and vendors, through which we sell domestic and international voice services to other carriers throughout the world.  Customers include U.S.-based carriers sending voice traffic to international destinations and foreign carriers sending traffic to the U.S. and internationally.  We also purchase domestic and international voice services from many of our Carrier Services customers.  Our carrier-grade network, advanced switching platform and interconnections with global carriers on six continents also reduce the cost of global voice traffic and expand service delivery capabilities for our Business Services segment.
 
We manage our business segments based on gross profit and gross margin, which represents net revenue less the cost of revenue, and on net profitability after excluding certain non-cash and non-recurring items.  The majority of our operations, engineering, information systems and support personnel are assigned to either the Business Services or Carrier Services business segment for segment reporting purposes.
 
 
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FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
We continue to focus our sales and marketing efforts on developing vertically oriented solutions for targeted markets that require the kind of specialized solutions made possible by our state-of-the-art network and advanced services platforms.  Our vertically oriented solutions, which are currently focused on healthcare, legal, hospitality and real estate, offer a substantial opportunity to gain additional market share.   We intend to accelerate the growth of our Business Services segment with the goal of increasing the portion of our total revenue derived from this higher margin and more stable segment.   In addition to lowering the underlying costs of termination, we believe that our Carrier Services segment supports the growth of the Business Services segment by providing enhanced service offerings for business customers and by strengthening its relationships with major service providers throughout the world.
 
Recent Events
 
On July 20, 2017, we entered into a contribution agreement with our newly formed wholly-owned subsidiary Fusion Global Services LLC (‘FGS”) under the terms of which, we contributed certain assets from our Carrier Services Business segment to FGS. Simultaneously with the execution of the foregoing contribution agreement, FGS also entered into an agreement with XcomIP, LLC, (“XcomIP”), under which XcomIP agreed to contribute its carrier business to FGS subject to satisfaction of certain conditions precedent. If these conditions are satisfied, FGS and XcomIP will execute a contribution agreement, and Fusion and XcomIP will execute a shareholder agreement under which Fusion will agree to provide up to $750,000 in working capital. Following XcomIP’s contribution of assets, Fusion will hold a 60% membership interest in FGS assets, liabilities and results of operations that will then be consolidated in the financial statements of the Company. We expect to complete the foregoing transactions prior to the end of August 2017.
 
On November 14, 2016, we acquired certain assets (the “Apptix Acquisition”) of Apptix, Inc. (“Apptix”), for a purchase price of $26.7 million, consisting of approximately $23.0 million in cash and 2,997,926 shares of Fusion’s common stock. Apptix provides cloud-based communications, collaboration, virtual desktop, compliance, security and cloud computing solutions to approximately 1,500 business customers throughout the U.S. 
 
In November 2016 and March 2017, we acquired customer bases and recorded corresponding intangible assets (see note 3 to the accompanying Consolidated Financial Statements) of approximately $2.3 million.
 
Our Performance
 
Revenues for the three months ended June 30, 2017 were $38.1 million, an increase of $7.7 million, or 25%, compared to the three months ended June 30, 2016. Our operating loss for the three months ending June 30, 2017 was $0.7 million, as compared with $1.1 million for the three months ended June 30, 2016. Our net loss for the three months ended June 30, 2017 was $2.9 million, as compared to $2.7 million for the three months ended June 30, 2016.
 
Revenues for the six months ended June 30, 2017 were $73.9 million, an increase of $10.3 million, or 16%, compared to the six months ended June 30, 2016. Our operating loss for the six months ending June 30, 2017 and June 30, 2016 was $2.2 million. Our net loss for the six months ended June 30, 2017 was $6.4 million, as compared to $5.2 million for the six months ended June 30, 2016.
 
Our Outlook
 
Our ability to achieve positive cash flows from operations and net profitability is substantially dependent upon our ability to increase revenue and/or on our ability to achieve further cost savings and operational efficiencies in our operations.
  
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
 
Our discussion and analysis of financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and the related disclosure of contingent liabilities.  We base these estimates on our historical experience and on various other assumptions that we believe to be reasonable under the circumstances, and these estimates form the basis for our judgments concerning the carrying values of assets and liabilities that are not readily apparent from other sources.  We periodically evaluate these estimates and judgments based on available information and experience. Actual results could differ from our estimates under different assumptions and conditions.  If actual results significantly differ from our estimates, our financial condition and results of operations could be materially impacted.
 
We have identified the policies and significant estimation processes discussed below as critical to our operations and to an understanding of our results of operations.  For a detailed discussion on the application of these and other accounting policies, see Note 2 to the Consolidated Financial Statements included in the 2016 Form 10-K.
 
 
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FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Effective January 1, 2017, we changed the manner in which we account for federal and state universal service fees and surcharges in our consolidated statement of operations. We now include the amounts collected in revenues, and reports the associated costs in cost of revenues, and this change has been applied retrospectively in the accompanying consolidated financial statements for all periods presented. As a result, both our revenues and cost of revenues for the three and six months ended June 30, 2017 include $0.7 million and $1.4 million, respectively, of federal and state universal service fees and surcharges, and revenues and cost of revenues for the three and six months and June 30, 2016 include $0.6 million, and $1.2 million, respectively, of federal and state universal service fees and surcharges.
 
Revenue Recognition
 
We recognize revenue when persuasive evidence of a sale arrangement exists, delivery has occurred or services have been rendered, the sales price is fixed and determinable and collectability is reasonably assured.  We record provisions against revenue for billing adjustments, which are based upon estimates derived from factors that include, but are not limited to, historical results, analysis of credits issued and current economic trends.  The provisions for revenue adjustments are recorded as a reduction of revenue at the time revenue is recognized.
 
Our Business Services revenue includes monthly recurring charges (“MRC”) to customers for whom services are contracted over a specified period of time, and variable usage fees charged to customers that purchase our business products and services.  Revenue recognition commences after the provisioning, testing and acceptance of the service by the customer.  MRC continues until the expiration of the contract, or until cancellation of the service by the customer.  To the extent that payments received from a customer are related to a future period, the payment is recorded as deferred revenue until the service is provided or the usage occurs.
 
Our Carrier Services revenue is primarily derived from usage fees charged to other carriers that terminate VoIP traffic over our network.  Variable revenue is earned based on the length of a call, as measured by the number of minutes of duration.  It is recognized upon completion of the call, and is adjusted to reflect the allowance for billing adjustments.  Revenue for each customer is calculated from information received through our network switches.  Our customized software tracks the information from the switches and analyzes the call detail records against stored detailed information about revenue rates.  This software provides us with the ability to complete a timely and accurate analysis of revenue earned in a period.  We believe that the nature of this process is such that recorded revenues are unlikely to be revised in future periods.
 
Cost of Revenues
 
For our Business Services segment, cost of revenues include the MRC associated with certain platform services purchased from other service providers, the MRC associated with private line services and the cost of broadband Internet access used to provide service to these business customers.
 
Cost of revenues for our Carrier Services segment consists primarily of costs incurred from other carriers to originate, transport, and terminate voice calls for our carrier customers.  Thus, the majority of our cost of revenues for this segment is variable, based upon the number of minutes actually used by our customers and the destinations they are calling.  Call activity is tracked and analyzed with customized software that analyzes the traffic flowing through our network switch.  During each period, the call activity is analyzed and an accrual is recorded for the costs associated with minutes not yet invoiced.  This cost accrual is calculated using minutes from the system and the variable cost of revenue based upon predetermined contractual rates.  Fixed expenses reflect the costs associated with connectivity between our network infrastructure, including our New Jersey switching facility, and certain large carrier customers and vendors.
 
Fair Value of Financial Instruments
 
The carrying value of certain financial instruments such as accounts receivable, accounts payable and accrued expenses, approximates their fair values due to their short term nature.  Some of the warrants issued in conjunction with the issuance of our debt and equity securities are accounted for in accordance with the guidance contained in Accounting Standards Codification (“ASC”) Topic 815, Derivatives and Hedging.  For these warrant instruments that are not deemed to be indexed to Fusion’s stock, we classify the warrant instrument as a liability at its fair value and adjust the instrument to fair value at each reporting period. This liability is subject to re-measurement at each balance sheet date until the underlying warrants are exercised or as they expire, and any change in fair value is recognized in our statement of operations.  The fair values of these warrants have been estimated using option pricing and other valuation models, and the quoted market price of Fusion’s common stock.
 
 
24
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Accounts Receivable
 
Accounts receivable is recorded net of an allowance for doubtful accounts.  On a periodic basis, we evaluate our accounts receivable and adjust the allowance for doubtful accounts based on our history of past write-offs and collections and current credit conditions.  Specific customer accounts are written off as uncollectible if the probability of a future loss has been established, collection efforts have been exhausted and payment is not expected to be received.
 
Impairment of Long-Lived Assets
 
We periodically review long-lived assets, including intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.  If an impairment indicator is present, we evaluate recoverability by a comparison of the carrying amount of the asset to future undiscounted net cash flows expected to be generated by the asset.  If the carrying value of the asset exceeds the projected undiscounted cash flows, we are required to estimate the fair value of the asset and recognize an impairment charge to the extent that the carrying value of the asset exceeds its estimated fair value.  
 
Impairment testing for goodwill is performed in the fourth fiscal quarter of each year.  The impairment test for goodwill uses a two-step approach, which is performed at the reporting unit level.  We have determined that our reporting units are our operating segments since that is the lowest level at which discrete, reliable financial and cash flow information is available.  The authoritative guidance provides entities with an option to perform a qualitative assessment to determine whether a quantitative analysis is necessary.  We did not record any impairment charges for goodwill or long-lived assets for the six months ended June 30, 2017 and 2016.
 
Income Taxes
 
We account for income taxes in accordance with U.S. GAAP, which requires the recognition of deferred tax liabilities and assets for the expected future income tax consequences of events that have been recognized in our financial statements.  Deferred income tax assets and liabilities are computed for temporary differences between the financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income.  Valuation allowances are established to reduce deferred income tax assets when we determine that it is more likely than not that we will fail to generate sufficient taxable income to be able to utilize the deferred tax assets.
 
Recently Issued Accounting Pronouncements
 
In July 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). The amendments in Part I of this update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity’s own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. As a result, a freestanding equity-linked financial instrument (or embedded conversion option) no longer would be accounted for as a derivative liability at fair value as a result of the existence of a down round feature. This standard is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018, with early adoption permitted. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures.
 
In November 2016, the FASB issued ASU No. 2016-18, Restricted Cash, which clarifies guidance and presentation related to restricted cash in the statement of cash flows, including stating that restricted cash should be included within cash and cash equivalents in the statement of cash flows. The standard is effective for fiscal years beginning after December 15, 2017, with early adoption permitted, and is to be applied retrospectively. We early adopted ASU 2016-18 effective January 1, 2017. Adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
 
In February 2016, the FASB issued ASU No. 2016-02, Leases, which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 with early adoption permitted. Under ASU 2016-02, lessees will be required to recognize for all leases at the commencement date a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right to-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures.
 
 
25
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
In March 2016, the FASB issued ASU No. 2016-09, Compensation – Stock Compensation, which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016. Under ASU 2016-09, all excess tax benefits and tax deficiencies related to share-based payment awards are to be recognized as income tax expense or income tax benefit in the statement of operations. In addition, the tax effects of exercised or vested awards should be treated as discrete items in the reporting period in which they occur and excess tax benefits should be recognized regardless of whether the benefit reduces taxes payable in the current period. Adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
 
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes, which simplifies the presentation of deferred income taxes by requiring deferred tax assets and liabilities be classified as noncurrent on the balance sheet. The updated standard became effective as of January 1, 2017. Adoption of this standard did not have a material impact on our consolidated financial statements.
 
In May 2014, the FASB issued guidance that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most recent current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also specifies the accounting for certain incremental costs of obtaining a contract and costs to fulfill a contract with a customer. Entities have the option of applying either a full retrospective approach to all periods presented or a modified approach that reflects differences prior to the date of adoption as an adjustment to equity. In April 2015, the FASB deferred the effective date of this guidance until January 1, 2018 and the Company is currently assessing the impact of this guidance on its consolidated financial statements.
 
 RESULTS OF OPERATIONS
 
Three Months Ended June 30, 2017 Compared with Three Months Ended June 30, 2016
 
The following table summarizes the results of our consolidated operations for the three months ended June 30, 2017 and 2016:
 
 
 
2017
 
 
2016  
 
 
  $
 
  %
 
  $
 
  %
 
Revenues
 $38,089,006 
  100.0 
 $31,041,047 
  100.0 
Cost of revenues *
  20,901,548 
  54.9 
  17,865,570 
  57.6 
Gross profit
  17,187,458 
  45.1 
  13,175,477 
  42.4 
Depreciation and amortization
  3,600,609 
  9.5 
  3,031,890 
  9.8 
Selling, general and administrative expenses
  14,330,934 
  37.6 
  11,270,013 
  36.3 
Total operating expenses
  17,931,543 
  47.1 
  14,301,903 
  46.1 
Operating loss
  ( 744,085)
  (2.0)
  ( 1,126,426)
  (3.6)
Other (expenses) income:
    
    
    
    
Interest expense
  ( 2,172,084)
  (5.7)
  ( 1,624,669)
  (5.2)
Gain on change in fair value of derivative liability
  113,779 
  0.3 
  45,642 
  0.1 
Loss on disposal of property and equipment
  ( 65,250)
  (0.2)
  (11,996)
  (0.0)
Other income, net
  13,365 
  0.0 
  37,111 
  0.1 
Total other expenses
  ( 2,110,190)
  (5.5)
  ( 1,553,912)
  (5.0)
Loss before income taxes
  ( 2,854,275)
  (7.5)
  ( 2,680,338)
  (8.6)
Provision for income taxes
  (23,100)
  (0.1)
  - 
  - 
Net loss
 $(2,877,375)
  (7.6)
 $(2,680,338)
  (8.6)
 
*Exclusive of depreciation and amortization, shown separately.
 
Revenues
 
Consolidated revenues were $38.1 million for the three months ended June 30, 2017, as compared to $31.0 million for the three months ended June 30, 2016, an increase of $7.0 million, or 23%.
 
Revenues from the Business Services segment were $30.0 million for the three months ended June 30, 2017 as compared to $21.4 million for the three months ended June 30, 2016. The increase is primarily attributable to revenue derived from new customers acquired in the Apptix Acquisition in November 2016, and to the customer base acquired in November 2016 and March 2017.
 
 
26
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Revenues from the Carrier Services segment were $8.1 million for the three months ended June 30, 2017 as compared to $9.6 million for the three months ended June 30, 2016. The decrease in Carrier Services revenue was primarily due to a reduction in the number of minutes transmitted over our network in the second quarter of 2017, partially offset by an increase in the blended rate per minute of traffic terminated.
 
Effective January 1, 2017, we changed the manner in which we account for federal and state universal service fees and surcharges in our consolidated statement of operations. We now include the amounts in net revenues, and report the associated costs in cost of revenues, and this change has been applied retrospectively in the Company’s consolidated financial statements for all periods presented. As a result, our Business Services revenues and cost of revenues for the three months ended June 30, 2017 and 2016 include $0.7 million and $0.6 million, respectively, of federal and state universal service fees and surcharges
 
Cost of Revenues and Gross Margin
 
Consolidated cost of revenues was $20.9 million for the three months ended June 30, 2017, as compared to $17.9 million for the three months ended June 30, 2016. The increase is largely due to a $4.3 million increase in costs resulting from higher revenues in our Business Services segment, partially offset by a $1.2 million decline in costs in our Carrier Services segment resulting from a decline in call colume serviced.
 
Consolidated gross margin was 45.1% for the three months ended June 30, 2017, as compared to 42.4% for the three months ended June 30, 2016. The increase is due to a higher mix of Business Services revenue, which generates a substantially higher margin than our Carrier Services revenue in 2017 as compared to 2016.
 
Gross margin for the Business Services segment was 56.7% for the three months ending June 30, 2017, as compared to 59.3% for the three months ending June 30, 2016. The decrease is due primarily to lower margins associated with revenues from the acquired customer bases.
 
Gross margin for the Carrier Services segment was 2.4% for the three months ended June 30, 2017, as compared to 4.8% for the three months ended June 30, 2016. The decrease in gross margin was mainly due to an increase in the cost per minute of traffic terminated in the second quarter of 2017 as compared to the same period of a year ago.
 
Depreciation and Amortization
 
Depreciation and amortization expense was $3.6 million for the three months June 30, 2017, as compared to $3.0 million in the same period of 2016. The increase is primarily due to amortization expense related to the intangible assets recognized in the Apptix Acquisition, primarily customer contracts.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses (“SG&A”) for the three months ended June 30, 2017 was $14.3 million, as compared to $11.3 million for the three months ended June 30, 2016. This increase is driven primarily by higher salaries and employee related costs, as well as other expenses resulting from the Apptix Acquisition in November 2016.
 
Operating Loss
 
Our operating loss of $0.7 million for the three months ended June 30, 2017 represents a decrease of $0.4 million from the operating loss for the three months ended June 30, 2016. The decrease is due to the $4.0 million increase in consolidated gross profit in 2017 resulting from increased business services revenues, largely offset by the $3.6 million increase in operating expenses.
 
Other Expenses
 
Other expenses, which includes interest expense, gains on the change in fair value of the Company’s derivative liability, loss on the disposal of property and equipment and miscellaneous income and expense, was $2.1 million for the three months ended June 30, 2017, as compared to $1.6 million for the three months ended June 30, 2016. The increase is due to higher interest expense in the amount of $0.5 million related to the increase in outstanding indebtedness incurred in November 2016 to finance the Apptix Acquisition. This new financing increased our outstanding debt by approximately $25 million.
 
Net Loss
 
Our net loss for the three months ended June 30, 2017 was $2.9 million, as compared to $2.7 million for the three months ended June 30, 2016, as the improvement in operating loss of $0.4 million for the quarter was more than offset by the increase in other expenses.
 
 
27
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
 
Six Months Ended June 30, 2017 Compared with Six Months Ended June 30, 2016
 
The following table summarizes the results of our consolidated operations for the six months ended June 30, 2017 and 2016:
 
 
 
2017    
 
 
2016
 
 
  $ 
  % 
  $ 
  % 
Revenues
 $73,900,882 
  100.0 
 $64,835,296 
  100.0 
Cost of revenues *
  40,172,461 
  54.4 
  38,397,081 
  59.2 
Gross profit
  33,728,421 
  45.6 
  26,438,215 
  40.8 
Depreciation and amortization
  7,437,757 
  10.1 
  5,948,153 
  9.2 
Selling, general and administrative expenses
  28,465,809 
  38.5 
  22,694,799 
  35.0 
Total operating expenses
  35,903,566 
  48.6 
  28,642,952 
  44.2 
Operating loss
  (2,175,145)
  (2.9)
  (2,204,737)
  (3.4)
Other (expenses) income: