UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
______________
 
FORM 10-K
______________
 
ý      ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2006
 
Commission file number 000-32421
______________
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
(Exact name of registrant as specified in 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
(Registrant’s telephone number, including area code)
______________
 
Securities registered pursuant to Section 12(b) of the Act:
 
Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
American Stock Exchange
Redeemable Common Stock Purchase Warrants
American Stock Exchange
 
Securities registered pursuant to Section 12(g) of the Act: None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
Yes ¨  No ý
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.
Yes ¨  No ý
Indicate by a check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý  No ¨
Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨
Indicate by check mark whether the registrant is a large accelerated filer, accelerated filer, or non-accelerated filer. See Definition of “accelerated filer and large accelerated filer” as defined in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ¨ Accelerated Filer ¨ Non-Accelerated Filer ý
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ¨  No ý
The aggregate market value of the voting Common Stock held by non-affiliates of the Registrant based upon the closing price of the common stock as reported by the American Stock Exchange on March 26, 2007, was $12,703,670. Solely for purposes of this calculation, shares beneficially owned by directors and officers of the Registrant and persons owning 5% or more of the Registrant’s common stock have been excluded, in that such persons may be deemed to be affiliates of the Registrant. Such exclusion should not be deemed a determination or admission by the Registrant that such individuals or entities are, in fact, affiliates of the Registrant.
The number of shares outstanding of the Registrant’s capital stock as of March 26, 2007, is as follows:
 
Title of Each Class
Number of Shares Outstanding
Common Stock, $0.01 par value
26,971,465
Redeemable Common Stock Purchase Warrants
7,641,838
 
DOCUMENTS INCORPORATED BY REFERENCE
 
The following documents (or parts thereof) are incorporated by reference into the following parts of this Form 10-K. Certain information required in Part III of this Annual Report on Form 10-K is incorporated from the Registrant’s Proxy Statement for the 2007 Annual Meeting of Stockholders to be held in 2007
 


 
 
2006 FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
ANNUAL REPORT ON FORM 10-K
 
TABLE OF CONTENTS
 
 
 
 
 
Page
         
Part I
 
 
   
         
Item 1.
 
Business
     
3
Item 1A
 
Risk Factors
 
14
Item 2.
 
Properties
 
20
Item 3.
 
Legal Proceedings
 
21
Item 4.
 
Submission of Matters to a Vote of Security Holders
 
21
   
 
   
Part II
 
 
   
         
Item 5.
 
Market for Registrant’s Common Equity and Related Stockholder Matters
 
22
Item 6.
 
Selected Financial Data
 
24
Item 7.
 
Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
25
Item 7A.
 
Quantitative and Qualitative Disclosures About Market Risk
 
35
Item 8.
 
Financial Statements and Supplementary Data
 
36
Item 9.
 
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
36
Item 9A.
 
Controls and Procedures
 
36
 
 
 
   
Part III
 
 
   
         
Item 10.
 
Directors, Executive Officers and Corporate Governance
 
37
Item 11.
 
Executive Compensation
 
37
Item 12.
 
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
37
Item 13.
 
Certain Relationships and Related Transactions, and Director Independence
 
37
Item 14.
 
Principal Accounting Fees and Services
 
37
 
 
 
   
Part IV
 
 
   
         
Item 15.
 
Exhibits and Financial Statement Schedules
 
38
 
 
 
   
 
 
Index to Consolidated Financial Statements 
 
F1
 
 
2

 
 
PART 1
 
Item 1. Business
 
Overview
 
Fusion Telecommunications International, Inc. (the terms “Company”, “us”, and/or “we” and other similar terms as used herein refer collectively to the Company together with its principal operating subsidiaries) provides Voice over Internet Protocol telecommunications services (VoIP) to, from, in and between emerging markets in Asia, the Middle East, Africa, the Caribbean, and Latin America. We currently market VoIP services to consumers, corporations, Internet service providers, distribution partners and telecommunications carriers.
 
Through our key assets of market knowledge, technical expertise and strategic relationships, we believe we are poised to:
 
 
·
Capitalize upon the growth in VoIP telecommunications, a market that Insight Research Corporation expects to grow from $82 billion in 2005 to nearly $197 billion by 2007 and expand our international penetration of VoIP applications to consumers and corporations;
 
 
·
Deliver customized VoIP services designed to meet the needs of the emerging markets and communities of interest worldwide;
 
 
·
Deliver a complete suite of VoIP service offerings for corporations and consumers;
 
 
·
Establish our company as a global telecommunications service provider;
 
 
·
Continue to expand the number of partnerships globally to facilitate the distribution of our VoIP services; and
 
 
·
Bridge the migration from traditional telephony to VoIP through the introduction of the Worldwide Internet Area Code.
 
We target markets that we believe have: (i) barriers to entry, (ii) substantial growth prospects, (iii) an increasing number of corporations operating within them, (iv) high cost of telecommunications services, and (v) a substantial quantity of voice and data traffic between the developed world (e.g., the United States and United Kingdom) and other countries within our target markets. In select emerging markets, we will deploy network facilities in order to connect that country to the United States.
 
We currently provide services to customers in over 100 countries. We believe that by using local partners in select markets, we can best distribute our services while providing a high level of local customer support.
 
Services
 
To date, we derive a significant portion of our revenues primarily from U.S.-based carriers requiring VoIP connectivity to emerging markets. As we continue to execute our strategy, we anticipate a larger number of non-U.S. based customers. We are currently seeking to expand our retail VoIP revenue stream to consumers and corporations by providing our services to, from, in and between emerging markets, which to date, have not generated material revenues for us. We deliver our VoIP services directly to end-users and through partnerships with companies that distribute and support our services locally. We also deliver our services through joint ventures.
 
We have service contracts with our customers, including carriers, corporations and consumers. Our contracts with carriers typically have a one-year renewable term, with no minimum volume per month, and allow the customer to terminate without penalty. Our contracts with corporate customers are typically for a one-year term, and have an early cancellation penalty. For the years ended December 31, 2006, 2005, and 2004, the Telco Group accounted for 16.2%, 11.3%, and 13.3%, respectively, of our total revenues. In addition, for the years ended December 31, 2006 and 2005, Qwest accounted for 23.2% and 15.7% of our total revenues, respectively.
 
Our voice services to carriers accounted for the majority of our revenues in 2006 and 2005. Our retail VoIP service enables customers, typically for a lower cost than traditional telephony, to place voice calls anywhere in the world using their personal computers, Internet protocol phones or regular telephones when accompanied by a hardware device. VoIP services utilize the Internet as opposed to circuit switching (traditional telephony technology), thereby offering cost savings to customers. These services are primarily offered under our retail brand Efonica directly to consumers, corporations, distribution partners, or Internet Service Providers around the world. In select cases, we will also provide co-branded and private label solutions. Our services are offered to customers located in Asia, the Middle East, Africa, and Latin America.
 
 
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Additionally, we enter into interconnection agreements with telecommunications carriers worldwide. These agreements enable us to terminate traffic into a country and in some cases receive traffic from that country. We use the capacity obtained through these interconnection agreements to carry our own retail traffic in addition to selling capacity to other carriers desiring voice termination to those destinations. As we grow, we expect to use an increasing percentage of our capacity for higher margin retail traffic. We offer facility co-location services to other communication service providers, enabling them to co-locate their equipment within our facility, or lease a portion of our equipment. Often, we provide wholesale services to the parties who co-locate with us.
 
In the second quarter of 2007, we will begin marketing Corporate Retail Services within the United States. We will offer hosted IP-PBX services for those companies wishing to outsource the management of their telecommunications facilities. We will also offer IP trunking solutions for companies wishing to retain their existing telecommunications infrastructures, but still reap the benefits of VoIP telephony. We will also offer our corporate customers Internet access, toll free services, conference calling, and a premium version of our Mobilink service. On a selective basis, we will offer corporate customers certain advanced solutions, including virtual private networks, private line services, and managed network services.
 
Our segments and their principal activities consist of the following:
 
Voice Services to Carriers - Voice services to carriers includes VoIP to carriers, which is the termination of voice telephony minutes by the Internet rather than older circuit-switched technology. VoIP permits a less costly and more rapid interconnection between our network and international telecommunications carriers. This segment also includes Traditional Voice (the termination of voice telephony minutes from or to the countries we serve, utilizing traditional Time Division Multiplexing (TDM) or “circuit-switched” technology. Typically, this will include interconnection with traditional telecommunications carriers either located internationally or those carriers that interconnect with us at their U.S. Points of Presence (POP) and provide service to other destinations. These minutes are sold to carriers on a wholesale basis.
 
Consumers, Corporations and Other - We provide VoIP services targeted to consumers and corporations. We offer services that permit our customers to originate calls via IP telephones or telephone systems and use the Internet to complete those calls to standard telephone lines anywhere in the world. We also provide PC-to-Phone services that allow consumers to use their personal computers to place calls to the telephone of the called party. For corporate customers, we offer fully hosted IP-PBX services, as well as IP trunking solutions and Internet access. In addition, we selectively offer point-to-point private lines, virtual private networking, and call center services to certain customers within our target markets.
 
Growth Strategy
 
Strategy: Our strategy is to provide a full suite of VoIP services to consumers and corporations in the emerging markets and to the international communities of interest around the world. We look to create local partnerships to facilitate distribution of our services within our target countries. We also look to create global partnerships to facilitate global distribution of our services.
 
The details of our strategy include:
 
 
·
Market Customized VoIP Calling Plans to Consumers and Corporations
 
Our key service offering is VoIP, which allows us to offer feature-rich, prepaid and monthly subscription Internet-based telephone services at competitive prices to any consumer or business with broadband or dial-up Internet access. Quality levels, which had once been a significant issue, are fast approaching those associated with traditional voice transmission. We typically market our VoIP services to corporations and consumers through an in-country distribution partner. Many of our target markets have different cultures, calling patterns, and payment options requirements. Our marketing strategy focuses on delivering customized VoIP calling plans, feature packages and payment option to meet the needs of the target market and communities of interest around the world. We intend to build upon our market position in the international VoIP business to selectively market our VoIP services to the enterprise market. We believe that the ability to deliver global Internet access and managed private networks and other Internet-based services to multinational businesses are important capabilities in allowing us to address this market segment.
 
 
4

 
 
 
·
Establish Local Partners for In-Country Distribution and Support
 
We believe that working with strong partners allows us to best distribute services and attract, retain and support customers. We seek to develop partnership arrangements in each of our markets. Local partners offer advantages since their existing infrastructure, sales distribution channels, and technical support can be utilized, while simultaneously reducing capital needed to enter the market. We seek to partner with companies that have access to a customer base, whether online or otherwise, such as Internet service providers, wireless Internet access providers, licensed carriers, online retailers, electronics outlets, and hardware manufacturers. We intend to work with our partners to enable them to distribute and support our products and services. In select cases, we offer a co-branded or private label option. Our private label alternative enables our partners to market our products, technology platform and global reach under their own brand. This alternative is ideal for partners that do not have the capital, expertise and technology platform required to deliver our services but want to build their own brand. Local partners also offer critical insights into the regulatory environment and are familiar with the specific cultural nuances of their region. Additionally, we anticipate that prior to the rollout of any new services, our partners will work with us in contributing market intelligence to ensure a successful introduction of new products.
 
 
·
Deploy a Carrier Grade Network Infrastructure
 
We have built a highly scalable network and back office infrastructure to deliver our services. We utilize the latest Softswitch technology for routing VoIP and TDM calls to off-net customers.
 
We are developing and deploying back-office systems and service platforms that will enable us to offer our customers a wide array of services and features, including comprehensive feature packages, pre-paid subscription-based calling plans, and free on-net calling. The development of this extensive scalable back office will also serve to reduce our dependence on other communication carriers. We believe our focus on being a carrier grade VoIP service provider enables us to deliver the quality of service required by our customers.
 
 
·
Develop International Interconnections to Carriers
 
We seek to enter into relationships with in-country carriers to transport voice traffic to and/or from that country. We believe that we have established our presence in the voice markets due to (i) direct interconnections to postal telephone and telegraph companies and other licensed carriers, which typically provide higher quality transmission than the services offered by “gray market” operators, and (ii) competitive pricing. We believe that carriers seeking to access these markets will increasingly want to work with companies that have established relationships with postal telephone and telegraph companies and other licensed carriers, as opposed to quasi-legal operators who divert long distance traffic and revenue from those carriers. We believe gray market operators generally provide poorer quality and reliability. In several markets, we receive inbound traffic from the postal telephone and telegraph company and other licensed carriers that tend to produce higher margins than our outbound carrier voice services. We believe this inbound traffic from postal telephone and telegraph companies and other licensed carriers, strengthens our ability to ensure favorable contractual arrangements. We will use capacity on our international voice networks to carry our own retail traffic in addition to selling capacity to other carriers desiring termination to those specific destinations. Although there are significant peaks and valleys in the carrier revenue stream, we believe it is important to our success in the retail market to keep our cost basis low and our quality high. As we progress in the execution of our business plan, we intend to use a greater percentage of our network capacity to carry higher margin retail traffic.
 
 
·
Exploit Communication Patterns Among and Between our Markets
 
We look to provide connectivity to, from, in and between our emerging markets. We seek to create international interconnections with global carriers to carry our international traffic. We are targeting customers in synergistic markets to leverage the communities of interest by providing customized calling and feature service plans designed to meet the needs of ethnic communities around the world. Our regional marketing plan is focused on the emerging market communities of interest around the world. We are also seeing demand from business customers for multi-country connectivity such as a U.S. corporation seeking connectivity to India, China, and the Philippines from one provider. We also believe that traffic among emerging markets is less susceptible to price and margin erosion than traffic among developed countries.
 
 
5

 
 
Marketing
 
Our VoIP marketing strategy focuses on delivering customized calling plans, feature packages and payment options to meet the needs of emerging markets and ethnic communities around the world. Our VoIP service works with a broadband or a dial-up connection to the Internet; a capability that we believe has been ignored by many VoIP service providers. We believe this service delivery flexibility is very important, since approximately 70% of the world’s Internet users still connect through dial-up.
 
We market VoIP services to consumers, corporations, Internet Service Providers and carriers through direct sales or distribution partners. Internet access and private network solutions are marketed through direct and alternate distribution channels.
 
We market our services via a variety of distribution channels, including:
 
 
·
Direct Sales and Regional Management - We have a direct sales force that sells our products and services to corporations and carriers. We also have regional sales management that focuses on Latin America, Asia, Africa, the Middle East and the Caribbean. The regional executives manage and grow existing revenue streams from partners and defined strategic accounts, identify and develop new partnerships, develop strategies for market penetration, identify new market opportunities, and coordinate internal support activities.
 
 
·
Agents - We use independent sales agents to sell our services. Our sales agents are compensated on a commission-based structure. We typically control the product, pricing, branding, technical and secondary level customer support, billing and collections.
 
 
·
Partnerships - We seek to develop partnership arrangements in each of our markets with companies that are able to distribute and support our services. These partners can be ISPs, retail store chains, carriers, cable operators and other distribution companies. In addition to local distribution and support, our partners may provide or arrange for last mile connectivity required for the delivery of local Internet access and private networks. We also focus on the development of global partnerships that have multi-country distribution capabilities.
 
 
·
Strategic Ventures - We enter into agreements with other companies to market and distribute each other’s products and services to the customer and prospect base of the other. The providing party usually will support and bill its own products. Depending on the strategic venture, we may pay or receive a commission or share revenue and/or profits with each other.
 
Efonica
 
Efonica was incorporated in the Technology, Electronic Commerce and Media Free Zone in Dubai, United Arab Emirates and entered into a joint venture agreement with us in 2002.
 
In January 2005, we entered into an agreement to acquire the remaining 49.8% minority interest in Efonica from Karamco, Inc., which was contingent upon the successful completion of our initial public offering by March 1, 2005. As our IPO was completed by this date, the Efonica transaction closed on February 18, 2005. The purchase price was $9,785,700 representing Karamco’s portion of Efonica’s debt owed to us as of the closing date and the $500,000, which was paid in cash in February 2005 to Karamco with the balance paid in shares of common stock. The number of shares issued to Karamco was determined by the $6.45 per share initial price of the common stock at the date of the IPO.
 
Approximately $4.4 million worth of such common stock (675,581 shares) issued to Karamco was being held in escrow (the “Escrow Shares”). In March 2006, the Escrow Shares were released to Karamco subject to a lock-up period until February 15, 2007.
 
Out of the shares issued to Karamco, we registered for resale 150,000 shares of common stock and a registration statement covering such shares was declared effective on June 21, 2005 (the “Registered Shares”). If the sale of the 150,000 shares that were registered results in less than $1 million of gross proceeds within 635 days of the effectiveness of the registration statement, we are required to pay Karamco the difference between the aggregate gross proceeds of Karamco’s sale of the Registered Shares and $1,000,000. At December 31, 2006, the Company has paid Karamco $430,000 towards the difference payment (“Difference Payment”). In the event the Difference Payment is less than $430,000, Karamco is obligated to reimburse for such excess and this obligation is secured by 50,387 shares held in escrow.
 
 
6

 
 
Roger Karam, who became our President of VoIP Services upon the effective date of the IPO, owns Karamco.
 
Efonica F-Z, LLC is presently integrated with the rest of our organization and Efonica is presently serving as our consumer services brand.
 
Joint Ventures
 
We enter into formal joint venture agreements with certain partners and have established four joint ventures to market and provide our services. The profits of each joint venture agreement are typically allocated according to percentage of equity ownership.
 
The terms of each non-joint venture partnership or distribution agreement are different by partner but in general provide for a revenue or profit sharing arrangement.
 
India
 
In March 2000, we entered into a joint venture agreement with Communications Ventures India Pvt. Ltd. to form an entity named Estel Communication Pvt. Ltd. Estel is organized and existing under the laws of India and has its office in New Delhi, India. We own 49% of the joint venture and have voting rights in another 1.01%, which in turn gives us an indirect 50.01% voting control in the joint venture. Estel is in the business of selling and supporting VoIP, private networks and Internet access in India. Primarily we have funded the joint venture. Our joint venture partner has had a lack of resources necessary to make investments to grow our operations or fund its commitments to us. As of December 31, 2006 and 2005, the amounts due from Estel were approximately $431,000 and $29,000, which is net of an allowance of approximately $414,000 and $834,000, respectively.
 
Jamaica
 
In January 2005, we concluded an agreement to acquire 51% of the common stock of a Jamaican telecommunications company in exchange for $150,000. The company currently holds international and domestic carrier license agreements with the Jamaican government, which enable it to operate as an international carrier through 2013 and as a domestic carrier through 2018.
 
In October 2006, we executed an agreement accepting an offer from a third party to purchase certain assets and liabilities of our holdings in Jamaica. The contract associated with that offer was subsequently defaulted on, and the Company is vigorously pursuing legal action associated with this default. Although the Company intends to do business in Jamaica in the future, we have reviewed the assets associated with that subsidiary, and as a result of the changes in the Company’s business plan, we have impaired approximately $277,000 associated with the assets of this entity during the year ended December 31, 2006.
 
Turkey
 
On March 8, 2005, through a wholly owned subsidiary, Fusion Turkey, LLC, we entered into a Stock Purchase Agreement to acquire 75% of the shares of LDTS Uzak Mesafe Telekomikasyon ve Iletisim Hizmetleri San.Tic.A.S. (“LDTS”) from the existing shareholders. The transaction closed on May 6, 2005 following receipt of approval from the Turkish Telecom Authority. Fusion acquired the shares for approximately $131,000 cash and the posting of a bank guarantee of $251,000. LDTS possesses a Type 2 telecommunications license approved by the Turkish Telecom Authority. This license permitted Fusion to offer VoIP services under its Efonica brand and other Internet services to corporations and consumers in Turkey.

During the year ended December 31, 2006, we decided to begin winding up and liquidating our Turkey joint venture. This decision was a result of various challenges we encountered from an increasingly complicated and constantly changing regulatory environment in Turkey, which made it very difficult to enter the market. These regulatory difficulties included an unstable environment as well as the selling of Turk-Telecom, which was a government owned entity, to a private company. As a result of this decision, the operations of this subsidiary are being treated as a discontinued operation.
 
 
7

 
 
Network Strategy
 
Our network strategy incorporates a packet switched platform capable of interfacing with Internet protocols and other platforms including Time Division Multiplexing (“TDM”). This is key to providing the flexibility needed to accommodate the many protocols used to transport voice and data today. We continually evaluate, and where appropriate, deploy additional communications technologies such as Multi-Protocol Label Switching (“MPLS”) and Any Transport over MPLS (“ATOM”), which handle information transport in a more efficient fashion than other earlier technologies such as frame relay and ATM.
 
The core of our network design is a packet-based switching system that accommodates VoIP and traditional voice, Internet, data and video services. Packet-based networking is considerably more efficient than circuit-switched systems because it can disperse packets (information) in many directions and then reassemble them at the destination. This makes much more efficient use of available facilities when compared to circuit-based systems. We believe that this design offers an extensible platform to support envisioned growth. The network design is intended to embrace emerging technologies as they become available. The network architecture is highly distributable and supports geographical expansion outside of the United States and, if necessary, can deliver packet technology to every part of the network.
 
We are currently using a Veraz “Softswitch”, Cisco and Nuera Orca media gateways, and carrier class Cisco routers and switches on a fiber-based gigabit Ethernet backbone to transport voice and data traffic. Softswitch is a generic term that refers to a new generation of telecommunications switching equipment that is entirely computerized and based on software processes that execute entirely on off-the-shelf servers. This provides us with call control and routing capabilities to further enhance service and performance available to our clients.
 
We have deployed back-office systems and services platforms that will enable us to offer our customers a wide-array of VoIP services and features, including subscription-based calling plans, free on-net calling, advanced feature packages, conferencing, and unified messaging. This development of an extensive scalable back-office will also serve to reduce our dependence on other communication carriers.
 
Benefits of the Fusion Distributed Network Architecture
 
Historically, most large international communications networks required investment and implementation of self-contained switching hardware that, in turn, could then be connected with other comparable equipment nodes via leased lines or other forms of networking. Examples of these would include equipment such as large traditional carrier switching equipment. All of the intelligence and functionality had to be replicated in each major location.
 
We, however, have implemented an environment that we believe is far more flexible, adaptable, and less costly than the legacy systems in use by some of our competition. Our Softswitch environment permits us to centrally control our network and service offerings from one location yet deploy gateways that interface with customers and vendors in remote locations. Each remote gateway is able to deliver our service suite even though the intelligence is centrally located in our New York facility. Instead of needing duplicative and expensive infrastructure in every location, we economize by allowing multiple disparate network equipment to be centrally managed. We believe that we can capitalize on market opportunities that would previously have been unadvisable due to the expense of deployment and associated marketplace risks.
 
Capacity
 
In traditional telecommunications systems, capacity is a function of equipment and software. Because of its modular architecture, Softswitch capacity is much less dependent on hardware. We believe that our Softswitch environment will enable us to expand our capacity to handle traffic and our geographic reach with greater ease in the future.
 
Ease of Modular Service Creation
 
Traditional telecommunications switching systems are not easily modified to incorporate new features and functionality. Because our Softswitch environment is entirely computer driven, our systems are flexible and designed for the addition of features. We intend to expand our service offerings by integrating additional hardware and software systems.
 
 
8

 
 
Our distributed architecture and flexible technology platform allows us to roll out new services in a shorter period of time than many traditional telecommunication companies.
 
Ease of Deployment
 
As we continue to penetrate emerging retail markets, or as we establish interconnect agreements with additional foreign carriers, we will seek to establish regional points of presence that are connected back to our New York switching center. These regional points of presence will enable our VoIP services to be offered and delivered from remote locations, while the network intelligence and management of the services reside in our New York facility. This modular approach will also allow us to quickly respond to new market opportunities and deploy our new services rapidly.
 
Competition
 
The international telecommunications industry is highly competitive and significantly affected by regulatory changes, technology evolution, marketing strategies, and pricing decisions of the larger industry participants. In addition, companies offering Internet, data and communications services are, in some circumstances, consolidating. We believe that service providers compete on the basis of price, customer service, product quality, brand recognition and breadth of services offered. Additionally, carriers may compete on the basis of technology. Recently, we have seen carriers competing on their ability to carry VoIP. As technology evolves and legacy systems become an encumbrance, we expect carriers to compete on the basis of technological agility, their ability to adapt to, and adopt, new technologies.
 
In the area of VoIP we compete with companies such as Vonage, 8X8, Deltathree, Net2Phone, Skype and Mediaring. This business segment is marketing-intensive and does not have high barriers to entry. While we believe our distribution relationships and marketing skills provide us with a competitive advantage, our competitors generally have more resources and more widely recognized brand names.
 
We compete with several emerging international carriers, many of whom are in or entering the VoIP market, among which are Primus Telecommunications Group, VSNL, and IDT Corporation. We also compete with non-U.S. based emerging carriers. For example, in India, we compete with Bharti Tele-Ventures, Reliance Telecom and Data Access, all of which are larger, better capitalized and have broader name recognition than Fusion. Many of these competitors are becoming increasingly focused on emerging markets, as they seek to find higher margin opportunities. Many of these carriers are also focused on voice carriage, but may become increasingly focused on providing private networks and other Internet protocol services.
 
We also compete within the “Free Service” segment of the VoIP market, which is also a rapidly growing market segment. The current market leader in this segment is Skype. Other major players moving into this segment include Yahoo, Google, and MSN. Each of these companies offers an instant messenger (IM) service that incorporates the ability to make free computer-to-computer voice calls between registered users. By comparison, we are targeting individuals who are more focused on telephony applications than enhanced IM applications, and will offer the ability to make calls between any combination of computer, IP phones, and analog phones connected to an ATA device. In fact, there is no need to have a computer turned on, or even own a computer, to use our free service. We believe that this service will not only generate significant interest among users, but that it will also generate customers interested in upgrading to enhanced capabilities (e.g. voice mail or off-net calling) or to our subscription service offerings.
 
In each country where we operate, there are numerous competitors, including VoIP service providers, wireline, wireless and cable competitors. We believe that as international telecommunications markets continue to deregulate, competition in these markets will increase, similar to the competitive environment that has developed in the United States following the AT&T divestiture in 1984 and the Telecommunications Act of 1996. Prices for long distance voice calls in the markets in which we compete have been declining and are likely to continue to decrease. In addition, many of our competitors are significantly larger, control larger networks, and have substantially greater financial, technical and marketing resources.
 
 
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We compete with business-oriented Internet access providers, including AT&T, Verizon, Qwest, and Cable & Wireless. These providers may offer both wholesale and retail Internet connectivity and are considerably larger than us and have greater brand recognition.
 
We have been unable to identify any direct and comprehensive competitors that deliver the same suite of services to the same markets with the same marketing strategy as we do. We compete with many different providers in various aspects of our Business Plan, but have found none that directly offer the same breadth of services focused on emerging markets. Some of our competitive advantages include:
 
 
·
A full suite of services that complement our VoIP service offerings as opposed to a single offering;
 
 
·
The ability to offer prepaid, monthly recurring service plans and free service to customers using broadband or dial-up Internet access;
 
 
·
Connectivity with over 150 carriers worldwide;
 
 
·
Worldwide Internet Area Code;
 
 
·
A bundled product offering VoIP service and Internet access to corporate users;
 
 
·
Our focus on emerging markets in Latin America, Asia, the Middle East, Africa, and the Caribbean;
 
 
·
The ability to make calls between any combination of computers, Internet connected telephones, wireless devices, and other SIP-enabled hardware;
 
 
·
An international partnership and distribution model, which provides for faster service deployment, reduced capital requirements and cost-efficient service delivery; and
 
 
·
A strategy of using local partners to enable us to access new markets, secure or obtain communication licenses, enhance distribution and provide local customer support.
 
At this time, we are unable to provide quantified disclosure regarding our market share in the markets in which we operate. As is common with emerging markets, the aggregate market for our products and services is usually not known until feasibility studies containing a wide range of demographic variables are conducted. We are not aware of any studies that presently exist which provide sufficient data for us to determine our market share.
 
Government Regulation
 
Generally, in the United States, we are subject to varying degrees of federal, state and local regulation and licensing, including that of the Federal Communications Commission. Internationally we also encounter similar regulations from foreign governments and their telecommunications/regulatory agencies. At each of these levels, there are significant regulations, fees and taxes imposed on the provision of telecommunications services.
 
We cannot assure that the applicable U.S. and foreign regulatory agencies will grant required authority or refrain from taking action against us if we are found to have provided services without obtaining the necessary authorizations or pursuant to applicable regulations. If authority is not obtained or if our pricing, and/or terms or conditions of service, or required filings are not filed, or are not updated, or otherwise do not fully comply with the rules of these agencies, third parties or regulators could challenge these actions and we could be subject to forfeiture of our license, penalties, fines, fees and/or costs.
 
The U.S. Federal Government and state authorities have the power to revoke our regulatory approval to operate internationally, interstate, or intrastate, or to impose financial penalties, statutory interest and require us to pay back taxes or fees if we fail to pay, or are delinquent in paying, telecommunications taxes or regulatory fees or fail to file necessary tariffs or mandatory reports. We have been delinquent in such financial, filing and reporting obligations and required filings in the past including, but not limited to, Federal Communications Commission and Universal Service Fund reports and payments.
 
During July 2004, the United States Senate continued to consider how it might apply regulations to VoIP. The VoIP Regulatory Freedom Act of 2004 exempts VoIP service from state taxes and regulations and defines it as a lightly regulated information service for U.S. government regulators. This does not, however, remove the uncertainty of regulatory impact within the United States. For example, the bill reserves the ability for states to require VoIP to provide 911 services, to require VoIP providers to contribute to state universal service programs, and to pay intrastate access charges to other telecom providers.
 
 
10

 
 
On April 24, 2004, the FCC rendered a decision on the AT&T Petition for Declaratory Ruling (WC Docket No. 02-361) pending before them. The FCC determined that where 1+ calls were made from regular telephones, converted into an Internet protocol format, transported over the AT&T Internet backbone, and then converted back from IP format and delivered to the called party through the local exchange carriers’ local business lines (not Feature Group D trunks), the service was a “telecommunications service” for which terminating access charges were due the local exchange carrier. In its decision, the Commission stated that, under the current rules, the service provided by AT&T is a “telecommunications service” upon which interstate access charges may be assessed against AT&T. The FCC limited its decision to the specific facts of the AT&T case where the type of service involved ordinary Customer Premise Equipment (CPE) with no enhanced functionality, the calls originated and terminated on the public switched telephone network, and the calls underwent no net protocol conversion and provided no enhanced functionality to the end user due to the provider’s use of Internet protocol technology. In fact, in the AT&T case the customer was completely unaware of AT&T’s use of IP technology in transporting the call.
 
Although the FCC determined the services provided by AT&T to be a telecommunications service subject to interstate access charges rather than information services not subject to such charges, they did not make a determination regarding the regulatory status of phone-to-phone VoIP or its exposure to Universal Service Fund (USF), 911, Communications Assistance for Law Enforcement Act (CALEA) or any other public policy issues. The FCC further qualified the decision by stating that they “in no way intend to preclude the Commission from adopting a different approach when it resolves the IP-Enabled Services rulemaking proceeding or the Intercarrier Compensation rule making proceeding.” (Developing a Unified Intercarrier Compensation Regime, CC Docket No. 01-92, Notice of Proposed Rulemaking, 16 FCC Rcd 9610 (2001) (Intercarrier Compensation)).
 
In June 2005, the FCC imposed 911 obligations on providers of “interconnected” VoIP services.
 
In addition, the FCC requires interconnected VoIP providers to register with the FCC, comply with the Communications Assistance for Law Enforcement Act of 1994 (CALEA) and to contribute to the Universal Service Fund.
 
We do not believe that we are an “interconnected” VoIP service provider under the FCC definition and, therefore, do not fall under the regulatory requirements set forth above. If the FCC determines we are an “interconnected” VoIP service provider and have not registered as such, or are not compliant under the regulations, third parties or regulators could challenge these actions and we could be subject to penalties, fines, fees and/or costs. In addition, emerging technology could cause us to change our product and service configuration or the FCC definition could be changed, and we may become an “interconnected” VoIP provider under the FCC definition in the future. Should this occur, we will be required to comply with the regulations set forth above.
 
Some states have tried to directly regulate VoIP services on an intrastate basis, but these attempts have, so far, not held up to court challenges. Many states are holding forums to research the issues surrounding VoIP. Some are encouraging or even requesting that VoIP providers subject themselves to public service commission jurisdiction and obtain certification as telephone companies. Most are hesitant to act until a final determination is made by the FCC, but some have voluntarily done so.
 
We believe VoIP may be subject to additional regulation in the future, it is uncertain when or how the effects of such regulation would affect us, nor is it understood if other countries will seek to follow suit. If additional regulation does occur, the FCC, any state or any country may impose surcharges, taxes or additional regulations upon providers of VoIP. The imposition of any such additional fees, charges, taxes and regulations on Internet protocol service providers could materially increase our costs and may limit or eliminate the competitive pricing we currently enjoy.
 
Intellectual Property and Trademarks
 
We have several trademarks and service marks, all of which are of material importance to us.
 
The following trademarks and service marks are registered with the United States Patent Trademark Office:
 
1. Fusion Telecommunications International
 
 
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2. FTI
 
3. Diamond / Block Logo
 
4. Diamond Logo
 
5. Fusion
 
6. Fusion Telecom
 
7. efonica (logo)
 
8. Efonica
 
The following trademarks and service marks are filed with the United States Patent Trademark Office and are currently in registration process:
 
1. Fusion (logo)

2. Hear the Difference

3. Efocash

4. Efostore

5. Efofax

6. Efobridge

7. Efolink

8. Efogate

9. Efonicash

10. Efo in

11. Efonifax

12. Efonicall

13. Efo out

14. Efonica (softphone design)

15. The Area Code of the Internet

16. Worldwide Internet Area Code

17. Internet Area Code

18. Efo

19. Fusion Softphone

20. Efonica Softphone

21. Invite a Friend
 
 
12


 
22. Members Area

23. Callgate

24. Freefonica

25. Enumber

26. Ecash

27. Estore

28. Internet Phone Number

The following trademark application was abandoned by the company because it was no longer used in commerce.
 
Fusion Tel
 
The telecommunications and VoIP markets have been characterized by substantial litigation regarding patent and other intellectual property rights. Litigation, which could result in substantial cost to and diversion of our efforts, may be necessary to enforce trademarks issued to us or to determine the enforceability, scope and validity of the proprietary rights of others. Adverse determinations in any litigation or interference proceeding could subject us to costs related to changing names and a loss of established brand recognition. Recently, a competitor of ours, Vonage, was sued by Verizon, for a violation of a number of VoIP related patents. Verizon was awarded substantial monetary damages.
 
Employees
 
As of December 31, 2006, we had 86 employees in Fusion Telecommunications International, Inc., and none of our employees are represented by a labor union. We consider our employee relations to be good, and we have never experienced a work stoppage.
 
Confidentiality Agreements
 
All our employees have signed confidentiality agreements, and it is our standard practice to require newly hired employees and, when appropriate, independent consultants, to execute confidentiality agreements. These agreements provide that the employee or consultant may not use or disclose confidential information except in the performance of his or her duties for the company, or in other limited circumstances. The steps taken by us may not, however, be adequate to prevent the misappropriation of our proprietary rights or technology.
 
Revenues and Assets by Geographic Area
 
During the years ended December 31, 2006 and 2005, 90.4% and 89.5%, respectively, of our revenue was derived from customers in the United States and 9.6% and 10.5%, respectively, from international customers. As of December 31, 2006 and 2005, 2.0% and 5.4%, respectively, of our long-lived assets were located outside of the United States. For more information concerning our geographic concentration, see Note 21 of the Notes to Consolidated Financial Statements included elsewhere in this report.
 
Available Information
 
We are subject to the informational requirements of the Securities Exchange Commission and in accordance with those requirements file reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy the reports, proxy statements and other information that we file with the Commission under the informational requirements of the Securities Exchange Act at the Commission’s Public Reference Room at 450 Fifth Street N.W., Washington, DC 20549. Please call 1-800-SEC-0339 for information about the Commission’s Public Reference Room. The Commission also maintains a web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of the commission’s web site is http://www.sec.gov. Our web site is http://www.fusiontel.com. We make available through our web site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q. Current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Commission. Information contained on our web site is not a part of this report.
 
 
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Item 1A. Risk Factors

The discussion in this annual report regarding our business and operations includes “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,” “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. This disclosure highlights some of the important risks regarding our business. The number one risk of the Company is its ability to attract fresh and continued capital to execute its comprehensive business strategy. In addition, the risks included should not be assumed to be the only things that could affect future performance. Additional risks and uncertainties include the potential loss of contractual relationships, changes in the reimbursement rates for those services as well as uncertainty about the ability to collect the appropriate fees for services provided by us. Also, the Company faces challenges in technology development and use. We may also be subject to disruptions, delays in collections, or facilities closures caused by potential or actual acts of terrorism or government security concerns.
 
Risks Related to Business
 
We have a history of operating losses and, prior to our IPO, a working capital deficit and stockholders’ deficit. There can be no assurance that we will ever achieve profitability or have sufficient funds to execute our business strategy.
 
There can be no assurance that any of our business strategies will be successful or that we will ever achieve profitability. At December 31, 2006, we had a working capital deficit of approximately ($2.7) million and stockholders’ equity of approximately $13.4 million. We have continued to sustain losses from operations and for the years ended December 31, 2006, 2005 and 2004, we have incurred a net loss applicable to common stockholders of approximately $13.4 million, $9.4 million, and $5.4 million, respectively. In addition, we have not generated positive cash flow from operations for the years ended December 31, 2006, 2005 and 2004. We may not be able to generate future profits and may not be able to support our operations, or otherwise establish a return on invested capital. In addition, we may not have sufficient funds to execute our business strategy, requiring us to raise funds from capital markets, consequently, diluting our common stock.
 
If we are unable to manage our growth or implement our expansion strategy, we may increase our costs without maximizing our revenues.
 
We may not be able to expand our product offerings, our client base and markets, or implement the other features of our business strategy at the rate or to the extent presently planned. Our projected growth will place a significant strain on our administrative, operational and financial resources and may increase our costs. If we are unable to successfully manage our future growth, establish and continue to upgrade our operating and financial control systems, recruit and hire necessary personnel or effectively manage unexpected expansion difficulties, we may not be able to maximize revenues or profitability.
 
The success of our planned expansion is dependent upon market developments and traffic patterns, which will lead us to make expenditures that may not result in increased revenues.
 
Our purchase of network equipment and software will be based in part on our expectations concerning future revenue growth and market developments. As we expand our network, we will be required to make significant capital expenditures, including the purchase of additional network equipment and software, and to add additional employees. To a lesser extent our fixed costs will also increase from the ownership and maintenance of a greater amount of network equipment including our Softswitch, gateways, routers, satellite equipment, and other related systems. If our traffic volume were to decrease, or fail to increase to the extent expected or necessary to make efficient use of our network, our costs as a percentage of revenues would increase significantly.
 
 
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We may be unable to adapt to rapid technology trends and evolving industry standards, which could lead to our products becoming obsolete.
 
The communications industry is subject to rapid and significant changes due to technology innovation, evolving industry standards, and frequent new service and product introductions. New services and products based on new technologies or new industry standards expose us to risks of technical or product obsolescence. We will need to use technologies effectively, continue to develop our technical expertise and enhance our existing products and services in a timely manner to compete successfully in this industry. We may not be successful in using new technologies effectively, developing new products or enhancing existing products and services in a timely manner or that any new technologies or enhancements used by us or offered to our customers will achieve market acceptance.
 
We are pursuing new lines of business, and introducing new services. In some cases, the technology for these services and/or the market for those services are untested. There can be no assurance of our ability to introduce future services on a timely basis or our ability to derive significant revenues from them.
 
Our ability to deploy new products and services may be hampered by technical and operational issues which could delay our ability to derive profitable revenue from these service offerings. Additionally, our ability to market these services may prove more difficult than anticipated, including factors such as our ability to competitively price such services. There can be no assurance that we will be able to introduce our planned future services, or that we will be able to derive significant revenue from them.
 
Our new services are dependent upon multiple service platforms, network elements, and back-office systems, as well as the successful integration of these items. There can be no assurance of the success of this development and integration.
 
We have completed the initial infrastructure build out of our major network elements and are currently integrating and testing our new services. We cannot ensure that these services will perform as expected. Our ability to effectuate our business plan is dependent on the successful rollout of our services.
 
We are also developing and deploying back-office systems and services platforms that will enable us to offer our customers a wide-array of new services and features including subscription-based calling plans, conferencing, and unified messaging. There can be no assurance that these developmental efforts will be completed on time or produce the desire results.
 
There can be no assurance that the planned migration of existing VoIP service customers onto our new infrastructure will be successful.
 
We will be moving existing VoIP service customers onto our new infrastructure. We cannot ensure that we will be successful in moving these customers to the new infrastructure. The failure to successfully transition these customers onto our new infrastructure could result in the loss of those existing customers and negatively impact our ability to acquire new customers.
 
If our information and processing systems for billing and client service are not properly implemented, it could harm our ability to bill and provide services effectively.
 
Sophisticated back office information and processing systems are vital to our growth and our ability to monitor costs, bill clients, provision client orders, and achieve operating efficiencies. Our plans for the development and implementation of these systems rely, for the most part, on having the capital to purchase and maintain required software, choosing products and services offered by third party vendors, and integrating such products and services with existing systems. We also may require customized systems in order to meet our requirements, which may delay implementation and increase expenses. These systems must also integrate with our network infrastructure. In the event that these systems do not integrate with our network infrastructure, our ability to manage our operational or financial systems will be inhibited. We cannot ensure that they will be implemented at all, or that, once implemented, they will perform as expected. Furthermore, our right to use some of these systems is dependent upon license agreements with third party vendors.
 
 
15

 
 
These third-party vendors may cancel or refuse to renew some of these agreements, and the cancellation or non-renewal of these agreements may harm our ability to bill and provide services efficiently.
 
If we do not operate our Softswitch technology effectively, many of the potential benefits of the new technology may not be realized.
 
We made a fundamental change in our business operations when we migrated to Softswitch technology. There are inherent risks associated with using such a relatively new technology. We may be required to spend additional time or money on this technology, which could otherwise be spent on developing our services. We have previously experienced problems in the operation of our Softswitch. If we do not operate the technology effectively or if our technical staff and we spend too much time on operational issues, it could result in increased costs without the corresponding benefits.
 
We may be impacted by current litigation regarding patent infringement.
 
On March 8, 2007, a jury in the U.S. District Court for the Eastern District of Virginia ruled that Vonage Holdings had infringed on three patents held by Verizon Communications, and ordered Vonage to pay Verizon $58 million plus possible future royalties. The details of the patent infringement are not yet clear, however, the patents related in part to technologies used to connect Internet telephone use to the traditional telephone network. Vonage has appealed the decision. At this point, it is not known what will happen on appeal, or whether there may be a future impact to other VoIP service providers, including us. If we were restricted from using certain VoIP technologies, it could increase our cost of service or preclude us from offering certain current or future services
 
Breaches in our network security systems may hurt our ability to deliver services and our reputation, and result in liability.
 
We could lose clients and expose ourselves to liability if there are any breaches to our network security systems, which could jeopardize the security of confidential information stored in our computer systems. In the last four years we experienced two known breaches of network security, which resulted in a temporary failure of network operations. Any network failure could harm our ability to deliver certain services, our reputation and subject us to liability.
 
Our growth is dependent upon our ability to build new distribution relationships, and to bring on new customers, of which there can be no assurance.
 
Our ability to grow through quick and cost effective deployment of our VoIP services is dependent upon our ability to identify and contract with local entities that will assist in the distribution of our products. This will include local sales agents that sell our retail, Efonica-branded services, resellers that private label and sell our wholesale VoIP services, and referral entities such as web portals that refer potential customers to us. If we are unable to identify or contract for such distribution relationships, we may not generate the customers or revenues currently envisioned.
 
Our entry into new markets will rely upon our ability to obtain licenses to operate in those countries, and our ability to establish good working relationships with postal telephone and telegraph companies in order to interconnect to the telephone networks. There can be no assurance of our ability to accomplish either.
 
The rapid growth of our network and the growth of our international distribution capabilities are dependent upon our ability to apply for and receive licenses to operate in the foreign markets we intend to enter. They are also dependent upon our ability to establish positive working relationships with foreign postal telephone and telegraph companies, and other licensed carriers, and to negotiate and execute the agreements necessary for us to interconnect with their local networks. While we will diligently pursue these relationships, we might not be able to obtain the necessary licenses and interconnections within the time frame envisioned or not at all.
 
The communications services industry is highly competitive and we may be unable to compete effectively.
 
The communications industry, including Internet and data services, is highly competitive, rapidly evolving, and subject to constant technological change and intense marketing by providers with similar products and services. We expect that new competitors, as well as gray market operators (operators who arrange call termination in a manner that bypasses the postal telephone and telegraph company, resulting in high margins for the gray market operator and substantially lower revenues for the postal telephone and telegraph company), are likely to join existing competitors in the communications industry, including the market for VoIP, Internet and data services. Many of our current competitors are significantly larger and have substantially greater market presence as well as greater financial, technical, operational, marketing and other resources and experience than we do. In the event that such a competitor expends significant sales and marketing resources in one or several markets we may not be able to compete successfully in such markets. We believe that competition will continue to increase, placing downward pressure on prices. Such pressure could adversely affect our gross margins if we are not able to reduce our costs commensurate with such price reductions. In addition, the pace of technological change makes it impossible for us to predict whether we will face new competitors using different technologies to provide the same or similar services offered or proposed to be offered by us. If our competitors were to provide better and more cost effective services than ours, we may not be able to increase our revenues or capture any significant market share.
 
 
16

 
 
Industry consolidation could make it more difficult for us to compete.
 
Companies offering Internet, data and communications services are, in some circumstances, consolidating. We may not be able to compete successfully with businesses that have combined, or will combine, to produce companies with substantially greater financial, sales and marketing resources, larger client bases, extended networks and infrastructures and more established relationships with vendors, distributors and partners than we have. With these heightened competitive pressures, there is a risk that our revenues may not grow as expected and the value of our common stock could decline.
 
Our ability to provide services is often dependent on our suppliers and other service providers who may not prove to be effective.
 
A majority of the voice calls made by our clients are connected through other communication carriers, which provide us with transmission capacity through a variety of arrangements. Our ability to terminate voice traffic in our targeted markets is an essential component of our ongoing operations. If we do not secure or maintain operating and termination arrangements, our ability to increase services to our existing markets, and gain entry into new markets, will be limited. Therefore, our ability to maintain and expand our business is dependent, in part, upon our ability to maintain satisfactory relationships with incumbent and other licensed carriers, Internet service providers, international exchange carriers, satellite providers, fiber optic cable providers and other service providers, many of which are our competitors, and upon our ability to obtain their services on a cost effective basis, as well as the ability of such carriers to carry the traffic we route to their networks or provide network capacity. If a carrier does not carry traffic routed to it, or provide required capacity, we may be forced to route our traffic to, or buy capacity from, a different carrier on less advantageous terms, which could reduce our profit margins or degrade our network service quality. In the event network service is degraded it may result in a loss of customers. To the extent that any of these carriers raise their rates, change their pricing structure, or reduce the amount of capacity they will make available to us, our revenues and profitability may be adversely affected.
 
We rely on third party equipment suppliers who may not be able to provide us the equipment necessary to deliver the services that we seek to provide.
 
We are dependent on third party equipment suppliers for equipment, software and hardware components, including Cisco, Nextone and Veraz. If these suppliers fail to continue product development and research and development or fail to deliver quality products or support services on a timely basis, or we are unable to develop alternative sources, if and as required, it could result in our inability to deliver the services that we currently and intend to provide.
 
We rely on the cooperation of postal telephone and telegraph companies who may hinder our operations in certain markets.
 
In some cases we will require the cooperation of the postal telephone and telegraph company or another carrier in order to provide services under a license or partnership agreement. In the event the postal telephone and telegraph company or another carrier does not cooperate, our service rollout may be delayed, or the services we offer could be negatively affected. If we acquire a license for a market and the postal telephone and telegraph company or incumbent carrier desires to negatively affect our business in the area, they may be in a position to significantly delay our ability to provide services in that market and ultimately make it not worth pursuing.
 
 
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If we are unable to develop and maintain successful relationships with our joint venture partners, we could fail in an important market.
 
We are engaged in certain joint ventures where we share control or management with a joint venture partner. If we are unable to maintain a successful relationship with a joint venture partner, the joint venture’s ability to move quickly and respond to changes in market conditions or respond to financial issues can erode and reduce the potential for value creation and return on investment. Further, the joint ventures may restrict or delay our ability to make important financial decisions, such as repatriating cash to us from such joint ventures. This uncertainty with our joint ventures could result in a failure in an important market.
 
Service interruptions could result in a loss of revenues and harm our reputation.
 
Portions of our network may be shut down from time to time as a result of disputes with vendors or other issues. Any future network shut downs can have a significant negative impact on revenue and cash flows, as well as hurting our reputation. In addition, there is no assurance that we will be able to quickly resolve disputes, if ever, which could result in a permanent loss of revenues.
 
Because we do business on an international level we are subject to an increased risk of tariffs, sanctions and other uncertainties that may hurt our revenues.
 
There are certain risks inherent in doing business internationally, especially in emerging markets, such as unexpected changes in regulatory requirements, the imposition of tariffs or sanctions, licenses, customs, duties, other trade barriers, political risks, currency devaluations, high inflation, corporate law requirements, and even civil unrest. Many of the economies of these emerging markets are weak and volatile. We may not be able to mitigate the effect of inflation on our operations in these countries by price increases, even over the long-term. Further, expropriation of private businesses in such jurisdictions remains a possibility, whether by outright seizure by a foreign government or by confiscatory tax or other policies. Deregulation of the communications markets in developing countries may not continue. Incumbent providers, trade unions and others may resist legislation directed toward deregulation and may resist allowing us to interconnect to their network switches. The legal systems in emerging markets frequently have insufficient experience with commercial transactions between private parties. Consequently, we may not be able to protect or enforce our rights in any emerging market countries. Governments and regulations may change resulting in availability of licenses and/or cancellations or suspensions of operating licenses, confiscation of equipment and/or rate increases. The instability of the laws and regulations applicable to our businesses and their interpretation and enforcement in these markets could materially and adversely affect our business, financial condition, or results of operations.
 
Regulatory treatment of VoIP outside the United States varies from country to country. Some countries including the U.S. are considering subjecting VoIP services to the regulations applied to traditional telephone companies and they may assert that we are required to register as a telecommunications carrier in that country or impose other regulations. In such cases, our failure to register could subject us to fines, penalties, or forfeiture. Regulatory developments such as these could have a material adverse effect on our international operations.
 
The success of our business depends on the acceptance of the Internet in emerging markets that may be slowed by limited bandwidth, high bandwidth costs, and other technical obstacles.
 
The ratio of telephone lines per population, or teledensity, in most emerging countries is low when compared to developed countries. Bandwidth, the measurement of the volume of data capable of being transported in a communications system in a given amount of time, remains very expensive in these regions, especially when compared to bandwidth costs in the United States. Prices for bandwidth capacity are generally set by the government or incumbent telephone company and remain high due to capacity constraints among other things. While this trend tends to diminish as competitors roll out new bypass services, these rollouts may be slow to occur. Further, constraints in network architecture limit Internet connection speeds on conventional dial-up telephone lines, and are significantly less than the up to 1.5 megabits per second connection speed on direct satellite link or digital subscriber lines and cable modems in the United States. These speed and cost constraints may severely limit the quality and desirability of using the Internet in emerging countries and can be an obstacle to us entering emerging markets.
 
 
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Additional taxation and the regulation of the communications industry may slow our growth, resulting in decreased demand for our products and services and increased costs of doing business.
 
We could have to pay additional taxes because our operations are subject to various taxes. We structure our operations based on assumptions about various tax laws, U.S. and international tax treaty developments, international currency exchange, capital repatriation laws, and other relevant laws by a variety of non-U.S. jurisdictions. Taxation or other authorities might not reach the same conclusions we reach. We could suffer adverse tax and other financial consequences if our assumptions about these matters are incorrect or the relevant laws are changed or modified.
 
We are subject to varying degrees of international, federal, state, and local regulation. Significant regulations imposed at each of these levels govern the provision of some or all of our services and affect our business. We cannot assure you that our joint venture partners, or we have, or, will receive the international, United States Federal Communications Commission (“FCC”), or state regulatory approvals they or we require. Nor can we provide you with any assurance that international, FCC or state regulatory authorities will not raise material issues with respect to our compliance with applicable regulations or that the cost of our compliance will not have a materially adverse effect on our revenues and profitability.
 
The U.S. Federal Government and state authorities have the power to revoke our regulatory approval to operate internationally, interstate, or intrastate, or to impose financial penalties if we fail to pay, or are delinquent in paying, telecommunications taxes or regulatory fees or fail to file necessary tariffs or mandatory reports. We are currently, and have been, delinquent in such financial obligations and required filings in the past. Furthermore, delays in receiving required regulatory approvals or the enactment of new and adverse legislation, regulations or regulatory requirements could also have a materially adverse affect on our condition. In addition, future legislative, judicial and regulatory agency actions could alter competitive conditions in the markets in which we intend to operate, to our detriment.
 
In addition to new regulations being adopted, existing laws may be applied to the Internet, which could hamper our growth.
 
New and existing laws may cover issues that include: sales and other taxes; user privacy; pricing controls; characteristics and quality of products and services; consumer protection; cross-border commerce; copyright, trademark and patent infringement; and other claims based on the nature and content of Internet materials. This could delay growth in demand for our products and services and limit the growth of our revenue.
 
Risks Related to our Common Stock
 
Voting Control by Principal Stockholders
 
As of March 31, 2007, our executive officers and directors collectively control approximately 33.2% of our outstanding common stock and, therefore are able to significantly influence the vote on matters requiring stockholder approval, including the election of directors.
 
We Do Not Intend to Pay Dividends on Common Stock.
 
We have never declared or paid any cash dividends on our common stock. We intend to retain any future earnings to finance our operations and to expand our business and, therefore, do not expect to pay any cash dividends in the foreseeable future.
 
 
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Item 2. Properties
 
We are headquartered in New York, New York and lease offices and space in a number of locations. Below is a list of our leased offices and space as of March 31, 2007.
 
Location
 
Lease Expiration
 
Annual Rent
 
Purpose
 
Approx. Sq. Ft
 
                                                               
                   
420 Lexington Avenue,
Suite 1718
New York, New York 10170
     
October 2015
     
$
440,000
(1)    
Lease of principal executive offices
     
9,000
 
                     
75 Broad Street
New York, New York 10007
 
March 2010
 
$
634,000
(2)
Lease of network facilities
 
15,000
 
                     
1475 W. Cypress Creek Road
Suite 204
Fort Lauderdale, Florida 33309
 
May 2014
 
$
171,000
(3)
Lease of network facilities and office space
 
13,100
 
                     
Premises GO2- GO3
Building No. 9
Dubai Internet City
Dubai, United Arab Emirates
 
December 2007
 
$
87,000
 
Lease of office space
 
1,300
 
                     
——————
(1)
This lease is subject to gradual increase to $509,000 from years 2008 to 2015.
 
(2)
This lease is subject to gradual increase to $673,000 from years 2008 to 2010.
 
(3)
This lease is subject to gradual increase to $215,000 from years 2008 to 2014.
 
 
We believe that our leased facilities are adequate to meet our current needs and that additional facilities are available to meet our development and expansion needs in existing and projected target markets.
 
 
 
20

 
 
Item 3. Legal Proceedings
 
On May 28, 2003, Jack Grynberg, et al., an investor in one of our private offerings, filed a complaint with the Denver District Court, State of Colorado (Jack Grynberg, et al v. Fusion Telecommunications International, Inc., et al, 03-CV-3912) seeking damages in the amount of $400,000 for the purchase of an interest in Fusion’s 1999 private placement offering of subordinated convertible notes through Joseph Stevens & Company, Inc., a registered broker dealer. This complaint asserted the following claims for relief against us: Breach of Fiduciary Duty, Civil Theft, Deceptive Trade Practices, Negligent Misrepresentation, Deceit Based on Fraud, Conversion, Exemplary Damages and Prejudgment Interest. On June 25, 2004, we filed with the Court our Motion to Dismiss, which was granted. The Company was awarded attorneys’ fees by the court. A written order of Judgment in favor of the Company and against the plaintiff in the amount of approximately $40,000 was recorded on January 24, 2006. The plaintiffs have filed an appeal of the motion, which is still pending as of the date of this filing.
 
On March 30, 2006, an equipment vendor filed a complaint with the Circuit Court in Broward County, State of Florida, seeking damages in the amount of approximately $1,380,000 allegedly due on two promissory notes plus accrued interest through March 1, 2006 and attorney costs. Management asserted a counterclaim against the vendor, which was settled subsequent to year end resulting in the amendment of an existing contract with the vendor. Our legal counsel has advised that, at this stage, they cannot accurately predict the likelihood of an unfavorable outcome or quantify the amount or range of potential loss, if any. Accordingly, with the exception of amounts previously accrued by us under the capital lease arrangement, no adjustment that may result from resolution of these uncertainties has been made in our accompanying financial statements.
 
The Company is currently undergoing an audit by New York State for franchise and excise taxes, which has not yet been concluded and may result in an indeterminate amount of tax liability, not previously accrued for.
 
On or about February 9, 2007, we filed a complaint against Patrick S. Dallas, InfoTel Holdings, Ltd., Phil Walton and John Does 1-5 in the Supreme Court of the State of New York (Fusion Telecommunications International, Inc. vs. Patrick S. Dallas, et al., Index No. 2007001836) seeking damages associated with Mr. Dallas’ sale of Convergent Technologies Ltd. Stock to us and InfoTel’s breach of its October 2006 agreement to purchase Fusion Jamaica Limited’s equipment in Jamaica and assume the real property lease in Jamaica. We believe Mr. Dallas owns or controls InfoTel. This complaint asserted the following claims for relief: Breach of Contract (the Stock Purchase Agreement); Breach of Mr. Dallas’ Employment Agreement; Breach of Mr. Dallas’ Non-Solicitation and Non-Compete Agreement; Breach of Contract (the InfoTel Agreement); Diversion and Waste of Corporate Assets; Conversion: Scheme to Defraud and Deceive and Demand for Accounting; Fraudulent Misconduct with Intent to Defraud (the Stock Purchase Agreement); Fraudulent Misconduct with Intent to Defraud (the InfoTel Agreement); Indemnification (the Stock Purchase Agreement); and Indemnification (the InfoTel Agreement). Our legal counsel has advised that, at this state, they cannot accurately predict the likelihood of an unfavorable outcome, or quantify the amount or range of damages we would be entitled to receive if we prevail.
 
The Company is involved in other claims and legal actions arising in the normal course of business. Management does not expect that the outcome of these cases will have a material effect of the Company’s financial position.
 
Due to the regulatory nature of the industry, the Company is periodically involved in various correspondence and inquiries from state and federal regulatory agencies. Management does not expect the outcome on these inquiries to have a material impact on our operations or financial condition.
 
Item 4. Submission of Matters to a Vote of Security Holders
 
There were no matters submitted to a vote of security holders in the fourth quarter of the fiscal year ended December 31, 2006.
 
 
21

 
 
PART II
 
Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters
 
Market Information
 
Our common stock is currently listed on the American Stock Exchange under the symbol “FSN”, and our redeemable common stock purchase warrants are listed on the American Stock Exchange under the symbol “FSN.WS”.
 
Prior to February 15, 2005, there was no established trading market for our common stock and redeemable common stock warrants.
 
Common Stock
 
Year Ended December 31, 2006
 
High
 
Low
 
                                            
 
 
 
  
 
First Quarter
 
$
3.40
 
$
2.45
 
Second Quarter
 
$
3.47
 
$
1.99
 
Third Quarter
 
$
2.52
 
$
1.45
 
Fourth Quarter
 
$
1.90
 
$
1.01
 

 
Year Ended December 31, 2005
 
High
 
Low
 
                                            
 
 
 
  
 
First Quarter
 
$
7.70
 
$
4.90
 
Second Quarter
 
$
5.11
 
$
4.05
 
Third Quarter
 
$
4.70
 
$
3.51
 
Fourth Quarter
 
$
3.70
 
$
2.30
 


Redeemable Common Stock Purchase Warrants

Year Ended December 31, 2006
 
High
 
Low
 
                                            
 
 
 
  
 
First Quarter
 
$
0.65
 
$
0.30
 
Second Quarter
 
$
0.50
 
$
0.22
 
Third Quarter
 
$
0.41
 
$
0.16
 
Fourth Quarter
 
$
0.35
 
$
0.07
 


Year Ended December 31, 2005
 
High
 
Low
 
                                            
 
 
 
  
 
First Quarter
 
$
1.42
 
$
0.85
 
Second Quarter
 
$
0.95
 
$
0.45
 
Third Quarter
 
$
0.64
 
$
0.40
 
Fourth Quarter
 
$
0.53
 
$
0.23
 
 
 
On March 26, 2007, the last reported sale price for our common stock on the American Stock Exchange was $0.64 per share and the last reported sale price for our redeemable common stock purchase warrants were $0.07 per warrant. The market price for our stock and warrants is highly volatile and fluctuates in response to a wide variety of factors.
 
 
22

 
 
Holders
 
As of March 26, 2007, we had approximately 2,158 holders of record of our common stock and 1,476 holders of record of our redeemable common stock purchase warrants. This does not reflect persons or entities that hold their stock in nominee or “street” name through various brokerage firms.
 
Dividend Policy
 
We have never declared or paid any cash dividends on our common stock. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to finance our operations and to expand our business. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon our financial condition, operating results, capital requirements and other factors that our board of directors considers appropriate.
 
Issuer Purchases of Equity Securities
 
There have been no purchases of equity securities by the Company required to be disclosed herein.
 
Use of Proceeds
 
In December 2006, the Company completed the first phase of a private placement for the purpose of raising working capital for the Company’s operations. The private placement provided for the issuance of a maximum of 10,000 shares of the Company’s newly designated Preferred Stock, Series A-1 at $1,000 per share. The total number of shares of Preferred Stock Series A-1 issued in this private placement was 3,875 shares, for which net proceeds of approximately $3.8 million were received and are being used for working capital. As of December 31, 2006, approximately $1.1 million of the net proceeds received by the Company had been used to fund operations.
 
Equity Compensation Plans
 
The following table provides certain aggregate information with respect to all of our equity compensation plans in effect for year ended December 31, 2006:
 
Plan Category
 
Number of Securities to
Be Issued Upon
Exercise of
Outstanding Options,
Warrants and
Rights
 
Weighted
Average
Exercise Price
of Outstanding
Options,
Warrants and Rights
 
Number of Securities
Remaining Available
for Future Issuance
 
                                                                       
 
 
 
 
 
 
 
Equity compensation plans approved by security holders
   
2,832,546
 
$
3.54
   
1,167,454
 
Total
   
2,832,546
 
$
3.54
   
1,167,454
 
 
 
 
23

 
 
Item 6. Selected Financial Data
 
The following table sets forth selected historical financial data as of and for each of the periods ended December 31, 2006, 2005, 2004, 2003 and 2002. The selected financial data are derived from the audited consolidated financial statements of Fusion Telecommunications International, Inc. The consolidated financial statements, and the report thereon, as of December 31, 2006 and 2005, and for the three year period ended December 31, 2006 which are included elsewhere in this Annual Report on Form 10-K. The following financial information should be read in conjunction with “Management’s Discussion and Analysis and Results of Operations” and our consolidated financial statements and related notes appearing elsewhere in this Annual Report.
 
 
 
Years Ended December 31,
 
   
2006
 
2005
 
2004
 
2003
 
2002
 
                            
Revenues
 
$
47,087,064
 
$
49,364,542
 
$
49,557,973
 
$
32,018,471
 
$
25,537,163
 
Operating expenses:
                         
Cost of revenues
   
42,463,724
   
45,048,917
   
42,927,994
   
27,855,508
   
23,638,447
 
Depreciation and amortization
   
1,397,094
   
1,510,172
   
1,804,184
   
1,981,805
   
2,361,495
 
Loss on impairment
   
867,212
   
   
   
375,000
   
467,765
 
Selling, general and administrative expenses
   
14,803,062
   
11,633,713
   
9,722,719
   
8,543,664
   
9,607,160
 
Advertising and marketing
   
1,335,745
   
175,725
   
81,686
   
32,143
   
19,000
 
Total Operating Expenses
   
60,866,837
   
58,368,527
   
54,536,583
   
38,788,120
   
36,093,867
 
Operating loss
   
(13,779,773
)
 
(9,003,985
)
 
(4,978,610
)
 
(6,769,649
)
 
(10,556,704
)
Other income (expense):
                         
Interest income
   
318,333
   
474,109
   
26,428
   
12,227
   
(21,501
)
Interest expense
   
(114,006
)
 
(434,749
)
 
(2,254,488
)
 
(859,123
)
 
(1,036,844
)
Gain (loss) on settlements of debt
   
465,854
   
(75,927
)
 
2,174,530
   
3,918,295
   
1,812,092
 
Loss from investment in Estel
   
(185,234
)
 
(541,876
)
 
(519,728
)
 
(746,792
)
 
326,367
 
Other
   
44,801
   
(195,006
)
 
(15,965
)
 
(97,766
)
 
98,626
 
Minority interests
   
67,694
   
175,353
   
(7,654
)
 
157,617
   
19,440
 
Total other income (expense)
   
597,442
   
(598,096
)
 
(596,877
)
 
2,384,458
   
1,198,180
 
Loss from continuing operations
   
(13,182,331
)
 
(9,602,081
)
 
(5,575,487
)
 
(4,385,191
)
 
(9,358,524
)
Discontinued operations:
                       
Income (loss) from discontinued operations
   
(168,871
)
 
207,007
   
545,215
   
208,620
   
 
Net loss
 
$
(13,351,202
)
$
(9,395,074
)
$
(5,030,272
)
$
(4,176,571
)
$
(9,358,524
)
Losses applicable to common stockholders:
                       
Loss from continuing operations
 
$
(13,182,331
)
$
(9,602,081
)
$
(5,575,487
)
$
(4,385,191
)
$
(9,358,524
)
Preferred stock dividends
   
   
   
(385,918
)
 
(635,254
)
 
(642,552
)
Net loss applicable to common stockholders from continuing operations:
   
(13,182,331
)
 
(9,602,081
)
 
(5,961,405
)
 
(5,020,445
)
 
(10,001,076
)
Income (loss) from discontinued operations
   
(168,871
)
 
207,007
   
545,215
   
208,620
   
 
Net loss applicable to common stockholders
 
$
(13,351,202
)
$
(9,395,074
)
$
(5,416,190
)
$
(4,811,825
)
$
(10,001,076
)
Basic and diluted net loss per common share:
                               
Loss from continuing operations
 
$
(0.49
)
$
(0.39
)
$
(0.35
)
$
(0.37
)
$
(1.01
)
Income (loss) from discontinued operations
   
(0.01
)
 
0.01
   
0.03
   
0.02
   
 
Net loss applicable to common stockholders
 
$
(0.50
)
$
(0.38
)
$
(0.32
)
$
(0.35
)
$
(1.01
)
Weighted average shares outstanding
                       
Basic and diluted
   
26,737,083
   
24,965,080
   
16,707,114
   
13,616,803
   
9,885,901
 

 
 
24

 

 
 
 
Years Ended December 31,
 
 
 
2006
 
2005
 
2004
 
2003
 
2002
 
   
                   
                 
Operating data:
                     
Capital expenditures
 
$
(3,299,198
)
$
(1,877,252
)
$
(627,219
)
$
(582,149
)
$
(427,057
)
                                 
Summary Cash Flow Data:
                       
Net cash used in operating activities
   
(11,343,665
)
 
(7,980,651
)
 
(4,874,834
)
 
(4,884,543
)
 
(4,265,500
)
Net cash used in investing activities
   
(3,693,097
)
 
(2,396,445
)
 
(250,460
)
 
(744,071
)
 
(983,453
)
Net cash provided by financing activities
   
2,989,413
   
20,798,874
   
6,288,375
   
8,097,832
   
5,985,380
 
 
                       
Balance Sheet Data (at period end):
                               
Cash
 
$
2,743,155
 
$
14,790,504
 
$
4,368,726
 
$
3,205,645
 
$
736,427
 
Restricted cash
   
781,566
   
218,176
   
380,276
   
736,626
   
1,051,182
 
Property and equipment
   
14,262,669
   
12,214,290
   
11,022,330
   
10,078,806
   
10,623,109
 
Property and equipment, net
   
6,422,016
   
4,270,966
   
3,271,474
   
3,743,293
   
5,649,787
 
Total assets
   
27,573,300
   
34,385,779
   
13,662,117
   
11,681,625
   
10,992,016
 
Total debt
   
1,216,746
   
1,577,615
   
5,687,631
   
4,644,904
   
9,151,925
 
Redeemable preferred stock
   
   
   
9,716,026
   
3,466,538
   
 
Total stockholders’ equity (deficit)
 
$
13,445,958
 
$
17,721,641
 
$
(13,290,029
)
$
(9,866,927
)
$
(14,867,407
)
 
 
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion of our financial condition and results of operations should be read together with our consolidated financial statements and the related notes thereto included in another part of this Annual Report. This discussion contains certain forward-looking statements, within the meaning of the Private Securities Litigation Reform Act of 1995, that involve substantial risks and uncertainties. When used in this report the words “anticipate,” “believe,” “estimate,” “expect” and similar expressions as they relate to our management or us are intended to identify such forward-looking statements. Our actual results, performance or achievements could differ materially from those expressed in, or implied by, these forward-looking statements. Historical operating results are not necessarily indicative of the trends in operating results for any future period.
 
Overview
 
We are an international telecommunications carrier delivering VoIP services, private network, Internet access, and other advanced services to, from, in and between emerging markets in Asia, the Middle East, Africa, Latin America, and the Caribbean. Our corporate strategy focuses our resources on customizing VoIP services to meet the demands of international communities of interest in emerging markets around the world. We seek to gain early entry in high growth emerging markets, often in partnership with local organizations that have strong distribution channels, regulatory experience, market intelligence, the ability to deliver local loops and the capability of providing customer service support. This approach enables us to introduce our Internet protocol telecommunications services in these markets, thereby benefiting from the time-to-market advantages, expanded geographic reach and reduced capital requirements that local partnerships afford. Additionally, we have built a carrier grade retail infrastructure to expand our VoIP service and feature options and to better support the growth of our VoIP services to consumers and corporations.
 
 
25

 

The following table summarizes our results of operations for the periods indicated:
 
 
 
Years Ended December 31,
 
 
 
2006
 
2005
 
2004
 
                  
Revenues
 
$
47,087,064
 
$
49,364,542
 
$
49,557,973
 
Operating expenses:
               
    Cost of revenues
   
42,463,724
   
45,048,917
   
42,927,994
 
    Depreciation and amortization
   
1,397,094
   
1,510,172
   
1,804,184
 
    Loss on impairment
   
867,212
   
   
 
    Selling, general and administrative
   
14,803,062
   
11,633,713
   
9,722,719
 
    Advertising and marketing
   
1,335,745
   
175,725
   
81,686
 
    Total operating expenses
   
60,866,837
   
58,368,527
   
54,536,583
 
        Operating loss
   
(13,779,773
)
 
(9,003,985
)
 
(4,978,610
)
 
                 
Other income (expense):
                   
    Interest income
   
318,333
   
474,109
   
26,428
 
    Interest expense
   
(114,006
)
 
(434,749
)
 
(2,254,488
)
    Gain (loss) on settlements of debt
   
465,854
   
(75,927
)
 
2,174,530
 
    Loss from investment in Estel
   
(185,234
)
 
(541,876
)
 
(519,728
)
    Other
   
44,801
   
(195,006
)
 
(15,965
)
    Minority interests
   
67,694
   
175,353
   
(7,654
)
    Total other income (expense)
   
597,442
   
(598,096
)
 
(596,877
)
Loss from continuing operations
   
(13,182,331
)
 
(9,602,081
)
 
(5,575,487
)
    Loss from discontinued operations
   
(168,871
)
 
207,007
   
545,215
 
Net loss
 
$
(13,351,202
)
$
(9,395,074
)
$
(5,030,272
)
 
 
The following table presents our historical operating results as a percentage of revenues for the periods indicated:
 
   
Years Ended December 31,
 
 
 
2006
 
2005
 
2004
 
 
                
Revenues
   
100.0
%
 
100.0
%
 
100.0
%
Operating expenses:
                 
Cost of revenues
   
90.2
%
 
91.3
%
 
86.6
%
Depreciation and amortization
   
3.0
%
 
3.1
%
 
3.6
%
Loss on impairment
   
1.8
%
 
0.0
%
 
0.0
%
Selling, general and administrative                                                                   
   
31.4
%
 
23.6
%
 
19.6
%
Advertising and marketing
   
2.8
%
 
0.4
%
 
0.2
%
Total operating expenses
   
129.2
%
 
118.4
%
 
110.0
%
Operating loss
   
(29.2
)%
 
(18.4
)%
 
(10.0
)%
                     
Other income (expense):
                   
Interest income
   
0.7
%
 
1.0
%
 
0.1
%
Interest expense
   
(0.2
)%
 
(0.9
)%
 
(4.5
)%
Gain (loss) on settlement of debt
   
1.0
%
 
(0.2
)%
 
4.4
%
Loss from investment in Estel
   
(0.4
)%
 
(1.1
)%
 
(1.0
)%
Other
   
0.1
%
 
(0.4
)%
 
0.0
%
Minority interests
   
0.1
%
 
0.4
%
 
0.0
%
                     
Total other income (expense)
   
1.3
%
 
(1.2
)%
 
(1.2
)%
Loss from continuing operations
   
(27.9
)%
 
(19.6
)%
 
(11.3
)%
Loss from discontinued operations
   
(0.4
)%
 
0.4
%
 
1.1
%
Net loss
   
(28.3
)%
 
(19.2
)%
 
(10.2
)%
 
 
Revenues
 
Historically, we have generated the majority of our revenues from voice traffic sold to other carriers, with a primary focus in the last several years on VoIP terminations to the emerging markets. We focus on growing our existing customer base, which is primarily U.S. based, as well as the addition of new customers, and the establishment of direct VoIP terminating arrangements with telecommunication carriers in emerging markets and around the world. Although we believe that this business continues to be of value to our strategy, ongoing competitive and pricing pressures have caused us to increase our focus on higher margin, value-added services (primarily VoIP to consumers and corporations), and market them to, or in conjunction with, distribution partners on a direct, co-branded or private label basis.
 
 
26

 
 
In an effort to further increase margins, expand our retail customer base, and develop more stable revenue streams, we have begun to focus significant effort and resources to build our VoIP business to consumers and corporations. While this does not yet represent a significant portion of our revenue base, we expect to continue to increase our emphasis in this area. We believe that this will complement our carrier business with a higher margin and more stable customer base.
 
In 2002, we established Efonica F-Z, LLC, as a retail services company marketing VoIP products to consumer and corporate customers in emerging markets. Beginning in the Middle East, Asia and Africa, then extending into Latin America, Efonica’s services are primarily sold through distribution channels on a pre-paid basis. Efonica’s customers can place calls from anywhere in the world to any destination using a personal computer, Internet protocol telephone or regular telephone when accompanied by a hardware device that may be purchased through Efonica. We believe that the introduction of advanced features such as voicemail, call waiting and call forwarding will enhance this value-added offering. In February 2005, we closed on the purchase of the 49.8% minority interest in Efonica.
 
We manage our revenues by product and customer. We manage our costs by provider (vendor). We track total revenue at the customer level because our sales force has to manage the revenue generation at the customer level, and invoices are billed to and collected at the customer level. We also have to track the same revenues by product, because different products have different billing and payment terms, and individual customers may have multiple billing and payment terms if they purchase multiple products from us.
 
We manage our revenue segments based on gross margin, which is net revenues less cost of revenues, rather than on net profitability, due to the fact that our infrastructure is built to support all products, rather than individual products. This applies both to the capital investments made (such as switching and transmission equipment), and to Selling, General and Administrative resources. The majority of our sales and operations personnel support all product lines within their market segment, i.e. carrier, and are not separately hired to support individual product segments. For segment reporting purposes, all expenses below cost of revenues are allocated based on percentage of utilization of resources unless the items can be specifically identified to one of the product segments.
 
Operating Expenses
 
Our operating expenses are categorized as cost of revenues, depreciation and amortization, loss on impairment, selling, general and administrative expenses, and advertising and marketing.
 
Cost of revenues includes costs incurred with the operation of our leased network facilities, and the purchase of voice termination and Internet protocol services from other telecommunications carriers and Internet service providers. We continue to work to lower the variable component of the cost of revenue through the use of least cost routing, and continual negotiation of usage-based and fixed costs with domestic and international service providers.
 
Depreciation and amortization includes depreciation of our communications network equipment, amortization of leasehold improvements of our switch locations and administrative facilities, and the depreciation of our office equipment and fixtures. In 2006, it also includes amortization of the Efonica customer list.
 
Selling, general and administrative expenses include salaries and benefits, commissions, occupancy costs, sales, professional fees and other administrative expenses.
 
Advertising and marketing expense includes cost for promotional materials for the marketing of our retail products and services, as well as for public relations.
 
 
27

 
 
Company Highlights
 
The following summary of significant events during the two years ended December 31, 2006, highlights the accomplishments and events that have influenced our performance during that time period.
 
2006

·  
Licensed Market-Leading Technology - Licensed Global IP Sound’s market-leading technology to power its VoIP softphone;
   
·  
Filed Patent Application - Filed patent application for our proprietary VoIP technology for SIP peer-to-peer VoIP communication;
   
·  
Completion of Softphone Development - Completed development of our proprietary PC-based VoIP softphone, which allows us to differentiate our Efonica® VoIP offering;
   
·  
Launched Free Internet Service - Launched new free Internet phone service, which allows Efonica® subscribers worldwide to make free calls without computers. We also created the Worldwide Internet Area Code™ which allows subscribers to use their existing telephone numbers preceded by a “10”;
   
·  
Filed for Patent for Worldwide Internet Area Code - Filed patent application for Worldwide Internet Area Code™;
   
·  
Introduction of EFO Out - We introduced one of our new paid services, EFO Out, which allows users to call any landline or mobile telephone number in the world at extremely competitive prices;
   
·  
Jinti Partnership - Entered into a strategic partnership with Jinti, a rapidly growing Chinese community services site that currently attracts in excess of 3 million unique visitors from China each month;
   
·  
Marketing Alliance with MasterCard worldwide - We entered into a retail marketing alliance with MasterCard Worldwide to offer our suite of premium paid VoIP communication services to MasterCard cardholders;
   
·  
Efonica subscribers exceed 1,000,000 - Since launching our new Efonica VoIP service on June 19, 2006, we have registered more than one million subscribers;
   
·  
Efonica Services in Jordan - Introduction of our Efonica VoIP services in Jordan to allow us to continue to connect communities worldwide, due to our securing exclusive rights to a Jordanian Telecommunications License;
   
·  
Introduction of Mobilink - Launched revolutionary new Mobilink Service, which offers U.S. consumers access to VoIP services from their mobile phones, without Internet access or special software; and
   
·  
Consummation of Private Placement - In December 2006, we consummated a $3.875 million private placement of a newly designated class of convertible preferred stock. Participating were a group of investors including Fusion’s Chairman, its CEO and each of the other nine members of the Board of Directors.
 
2005

 
·
Capital Fund-Raising - In February 2005, we closed on our initial public offering of securities of 3,600,000 shares of common stock at a price of $6.45 per share and 3,600,000 redeemable common stock purchase warrants at $.05 per warrant. Net proceeds of the offering were approximately $20.4 million. On March 30, 2005, our underwriters exercised their over-allotment option and purchased an additional 480,000 shares of common stock and 540,000 purchase warrants. We received an additional $2.9 million in net proceeds from the closing on the over-allotment option;
     
 
·
Debt Reduction - Upon completion of our IPO we repaid approximately $1.5 million in outstanding debt. In addition, $2.5 million of convertible debt was converted into 651,515 shares of common stock. During May 2005, we repaid an additional $0.2 million of debt;
     
 
·
Conversion of Series C Preferred Stock - The $10.0 million liability related to the 109,962 shares of outstanding Series C Preferred Stock was converted into equity (3,141,838 shares of common stock);
 
 
28

 
 
 
·
VoIP to Consumers and Corporations Revenue Growth - Revenue in our retail VoIP to consumers and corporations segment grew 8% during 2005 over 2004. This segment’s revenue is expected to increase significantly once our paid VoIP products and services are rolled out; and
     
 
·
Purchase of Efonica - In February 2005, we acquired the remaining 49.8% interest in our Efonica joint venture.
 
Year Ended December 31, 2006 Compared with Year Ended December 31, 2005.
 
Revenues
 
Consolidated revenues were $47.1 million for 2006 compared to $49.4 million for 2005, a decrease of 4.6%.
 
Revenues for voice services sold to carriers remained relatively constant year over year, at $43.6 million for both 2006 and 2005. Although there was no increase in the year over year comparison, there had been an unusually high peak in the second quarter of 2005 that was an anomaly. Carrier revenues have consistently increased quarter over quarter since that peak period.
 
Revenues for consumers, corporations and other decreased from $5.8 million in 2005 to $3.4 million in 2006. The decrease was mainly due to technical difficulties encountered in the development of our Efonica retail services platform, which held back the growth of this segment, and also due to the cancellations of government contracts. We expect the technical issues with the new retail VoIP platform to be resolved during this year, and we expect this segment’s revenues to grow significantly during the next few years.
 
Cost of Revenues
 
Consolidated cost of revenues improved by $2.6 million, or 5.7%, decreasing from $45.0 million in 2005 to $42.5 million in 2006. Approximately $1.0 million of this decrease was attributable to an improvement in efficiencies of route management for voice services to carriers. The remaining decrease in cost of revenues was attributable to a decrease in revenues for consumers, corporations and other.
 
Consolidated gross margin increased $0.3 million for 2006 over 2005. Gross margin for voice services to carriers increased by $1.1 million, but was partially offset by a decrease in the gross margin for consumers, corporations and other.
 
Operating Expenses
 
Depreciation and Amortization. Depreciation and amortization decreased to $1.4 million during the year ended 2006 from $1.5 million, or 7.5%, during the year ended 2005. Our depreciation decreased as a result of many our assets being fully depreciated during all or a part of 2006.
 
Selling, General and Administrative. Selling, general and administrative expenses increased $3.2 million or 27.2% to $14.8 million during 2006, from $11.6 million during 2005. This increase is primarily attributed to increased salaries and benefits, as more personnel have been required to support the growth and expansion of our infrastructure. In addition, contributing to the 2006 increase is approximately $0.7 million of compensation expense recorded in connection with our adoption of SFAS123(R) on January 1, 2006. Our professional fees have also increased as a result of our growth and our becoming a public company in February 2005, including expenses associated with Sarbanes Oxley, travel related expenses, occupancy costs, and insurance expenses. However, we are taking strong measures to reduce our expenses, and believe that as we execute our business strategies, selling, general and administrative expenses as a percentage of revenues will begin to decline.
 
Advertising and Marketing. Advertising and marketing increased from $0.2 million in 2005 to $1.3 million in 2006, associated with the promotional campaign for the launch of our new retail products and services.
 
Operating Loss. Our operating loss increased $4.8 million or 53% to a loss of $13.8 million during 2006, from a loss of $9.0 million during 2005. The increase in operating loss was attributable to the items mentioned above, including the decrease in gross margin, the increase in selling, general and administrative expenses associated with our retail infrastructure growth, the increase in advertising and marketing for our new retail services, and the increased costs associated with regulatory compliance requirements.
 
 
29

 
 
Other Income (Expense). Total other income (expense) changed from a net loss of $0.6 million in 2005 to a net gain of $0.6 million during 2006. During 2006, we had interest expense of $0.1 million in contrast to interest expense of $0.4 million during 2005. The $0.4 million interest expense for 2005 included $0.3 million of accretion since all the Series C Preferred Stock was converted to common stock in connection with our February 2005 IPO. Consequently, accretion ceased and 2005 interest expense only includes accretion for the period between January 1, 2005 and February 17, 2005. A significant portion of this debt was repaid during February 2005 in connection with our IPO. We also had decreased interest income during 2006 of $0.3 million versus $0.5 million during 2005, as cash was used in operating activities. Gain (loss) on debt settlements changed from a net loss of $0.1 million in 2005 to a net gain of $0.5 million during 2006. The 2006 gain on debt forgiveness was attributed to the settlements of vendor obligation. The loss from investment in Estel decreased $0.3 million or 65.8%, from $0.5 million in 2005 to $0.2 million during 2006. Minority interest decreased approximately $0.1 million during 2006 from $0.2 million during 2005. The 2005 minority interests balance is attributed to the losses incurred in connection with our Turkey joint venture.
 
Discontinued Operations. In 2006 Fusion incurred $0.2 million in loss from discontinued operations associated with its Turkey subsidiary. In 2005 the Company had income of $0.2 million associated with the resolution of certain liabilities associated with previous discontinued operations.
 
Net Loss. The net loss for 2006 was $13.4 million compared to $9.4 million for 2005. The factors noted above that impacted the net operating loss were partially reduced by the positive other income.
 
Year Ended December 31, 2005 Compared with Year Ended December 31, 2004.
 
Revenues
 
Consolidated revenues remained fairly constant between the two years ($49.4 million during 2005 compared to $49.6 million during 2004). An increase in our revenues for consumers, corporations and other was net with a decrease in our voice to carriers revenues.
 
Revenues for consumers, corporations and other represented 11.7% of our consolidated revenues during 2005 compared to 10.8% during 2004. This increase from $5.3 million in 2004, to $5.8 million in 2005, was mainly due to the growth of our Efonica branded retail services.
 
Revenues for voice services sold to carriers decreased $0.6 million or 1.4% in 2005 versus 2004. During the year ended 2005, these revenues were impacted by a combination of technical difficulties associated with the migration to the new Softswitch, and the peaks and valleys of the carrier business, downward pricing pressure on average rate per minute.
 
Cost of Revenues
 
Consolidated cost of revenues increased $2.1 million or 4.9% to $45.0 million in 2005, from $42.9 million in 2004. Approximately $2.1 million of this increase was attributable to an increase in voice services to carriers.
 
The cost of revenues for consumers, corporations and other grew $0.1 million or 3.7% from $3.8 million in 2004 to $4.0 million in 2005, due primarily to the growth in that revenue base.
 
Consolidated gross margin decreased $2.3 million for 2005 over 2004. Gross margin for total voice services to carriers decreased by $2.6 million, which was partially offset by an improvement in the gross margin for consumers, corporations and other of $0.3 million.
 
The decline in gross margin for voice services to carriers was primarily related to a more competitive wholesale market, slightly higher network costs as a percentage of revenue, and technical difficulties associated with the migration to the Softswitch technology. The migration difficulties adversely impacted our ability to route traffic to the least cost provider, specifically for the first quarter of 2005.
 
Operating Expenses
 
Depreciation and Amortization. Depreciation and amortization decreased by $0.3 million or 16.3% to $1.5 million during the year ended 2005, from $1.8 million during 2004. Although our fixed assets increased significantly as a result of assets added during 2005, including the new Softswitch and our new retail infrastructure currently in process, our depreciation decreased as a result of many our assets being fully depreciated during all or a part of 2005.
 
 
30

 
 
Selling, General and Administrative. Selling, general and administrative expenses increased $1.9 million or 19.7% to $11.6 million during 2005, from $9.7 million during 2004. This increase is primarily attributed to increased salaries and benefits, as more personnel have been required to support the growth and expansion of our infrastructure. Also, increasing as a result of our growth and our becoming a public company in February 2005, have been our legal and professional fees (including expenses associated with Sarbanes Oxley), travel related expenses, occupancy costs, and insurance expense. As a percentage of revenues, selling, general and administrative expenses increased from 19.6% during 2004, to 23.6% during 2005. We believe that as we execute our business strategies, selling, general and administrative expenses as a percentage of revenues will begin to decline.
 
Advertising and Marketing. Advertising and marketing increased from $0.1 million in 2004 to $0.2 million in 2005, associated with the preparation of marketing materials for the launch of our new retail products and services.
 
Operating Loss. Our operating loss increased $4.0 million or 80.9% to a loss of $9.0 million during 2005, from a loss of $5.0 million during 2004. The increase in operating loss was primarily attributable to both the decrease in gross margin and the increase in selling, general and administrative expenses associated with infrastructure growth and public company compliance requirements.
 
Other Income (Expense). Total other income (expense) remained consistent at a net expense of $0.6 million during both years. During 2005, we had interest expense of $0.4 million in contrast to interest expense of $2.2 million during 2004. The $2.2 million of interest expense during 2004, included accretion of $1.7 million (in accordance with SFAS 150) related to the then outstanding Series C Preferred Stock. The $0.4 million interest expense for 2005 included only $0.3 million of accretion since all the Series C Preferred Stock was converted to common stock in connection with our February 2005 IPO. Consequently, accretion ceased and 2005 interest expense only includes accretion for the period between January 1, 2005 and February 17, 2005. In addition, interest expense was higher during 2004, as the Company had significant outstanding debt throughout all of 2004. A significant portion of this debt was repaid during February 2005 in connection with our IPO. We also had increased interest income during 2005 of $0.5 million versus $26,000 during 2004, as a result of the investment of the IPO proceeds. Gain (loss) on debt settlements changed from a net gain of $2.2 million in 2004 to a net loss of $0.1 million during 2005. The 2004 gain on debt forgiveness was attributed to $0.2 million of settlements of capital lease obligations, $0.4 million of settlement of general obligations and $1.6 million of settlements of network obligations. The loss from investment in Estel remained consistent at $0.5 million. Minority interest increased approximately $183,000 to $175,000 during the 2005 from $(7,000) during 2004. The 2005 minority interests balance is attributed to the losses incurred in connection with our Jamaica and Turkey joint ventures.
 
Discontinued Operations. In 2005 the Company had income of $0.2 million associated with the resolution of certain liabilities associated with previous discontinued operations.
 
Net Loss. The primary factors impacting our net loss for the year ended December 31, 2005, were a decrease in gross margin, an increase in selling, general and administrative expenses, and the reduction in forgiveness of debt net with a decrease in interest expense and an increase in interest income.
 
Liquidity and Capital Resources
 
Since our inception, we have incurred significant operating and net losses. In addition, we are not generating positive cash flows from operations. As of December 31, 2006, we had stockholders’ equity of approximately $13.4 million in comparison to $17.7 million at December 31, 2005, and a working capital deficit of approximately $2.7 million in comparison to working capital of $7 million at December 31, 2005. The proceeds have been and will continue to be used for working capital and general corporate purposes, international deployment, and to fund the development of our retail service offerings. We may seek further financing through the sale of debt or equity securities, although we have no commitments to do so.
 
Below is a summary of our cash flows for the periods indicated. These cash flow results are consistent with prior years in that we continued to use significant cash in connection with our operating and investing activities and had significant cash provided by financing activities.
 
 
31

 
 
A summary of our cash flows for the periods indicated is as follows:
 
 
 
Year Ended
December 31, 2006
 
Year Ended
December 31, 2005
 
Year Ended
December 31, 2004(1)
 
                                                                                                          
                
Cash used in operating activities
 
$
(11,343,665
)
$
(7,980,651
)
$
(4,874,834
)
Cash used in investing activities
   
(3,693,097
)
 
(2,396,445
)
 
(250,460
)
Cash provided by financing activities
   
2,989,413
   
20,798,874
   
6,288,375
 
Increase (decrease) in cash and cash equivalents
   
(12,047,349
)
 
10,421,778
   
1,163,081
 
Cash and cash equivalents, beginning of period
   
14,790,504
   
4,368,726
   
3,205,645
 
Cash and cash equivalents, end of period
 
$
2,743,155
 
$
14,790,504
 
$
4,368,726
 
——————
(1)
These figures include an aggregate of approximately $2.2 million that was paid during the period to satisfy past obligations.
 
Source of Liquidity
 
As of December 31, 2006, we had cash and cash equivalents of approximately $2.7 million. In addition, as of December 31, 2006, we had approximately $0.8 million of cash restricted from withdrawal and held by banks as certificates of deposits securing letters of credit.
 
From our inception through December 31, 2006, we financed our operations from cash provided from financing activities. These activities were primarily through net proceeds of approximately $23.3 million from our IPO, and the private placement of approximately $54.6 million of equity securities, $1.6 million from the exercise of stock options and warrants, and $22.0 million from the issuance of notes. In addition, since inception we have financed the acquisition of $8.2 million of fixed assets through capital leases.
 
Our long-term liquidity is dependent on our ability to attain future profitable operations. We cannot predict if and when we will be able to attain future profitability.
 
Uses of Liquidity
 
Our short-term and long-term liquidity needs arise primarily from interest and principal payments related to our capital lease obligations, capital expenditures, working capital requirements as may be needed to support the growth of our business, and any additional funds that may be required for business expansion opportunities.
 
Our cash capital expenditures were approximately, $3.3 million during 2006, $1.9 million during 2005 and $0.6 million in 2004. We expect our cash capital expenditures to be approximately $1.0 million for the year ending December 31, 2007. The 2007 estimated capital expenditures primarily consist of the completion of our retail infrastructure buildout, purchase of additional software for expanded product offerings, and international deployment.
 
Cash used in operations was approximately $11.3 million during 2006, $8.0 million during 2005, and $4.9 million during 2004. The cash used in our operations has historically been a function of our net losses, gains on forgiveness of debt, and changes in working capital as a result of the timing of receipts and disbursements. Our net cash used in operating activities increased significantly during 2006, primarily attributed to the initial build-out of our retail infrastructure and the initial launch of our new products and services. As we transition our existing customers to our new infrastructure and continue to build that revenue base, we expect our net cash used in operating activities to improve during future periods.
 
In some situations, we may be required to guarantee payment or performance under agreements, and in these circumstances we would need to secure letters of credit or bonds to do so.
 
Debt Service Requirements
 
At December 31, 2006 we had approximately $1.2 million of current and long-term debt. This balance is current and relates to our capital leases. Our interest expense decreased significantly during 2006 compared to 2005 due to the following factor:
 
 
32

 
 
1.  
We recorded $0.3 million of accretion to interest expense related to our Series C Preferred Stock during 2005, which ceased as of February 2005 when the Series C Preferred Stock was converted to common stock. Although the accretion represented a non-cash charge to interest expense during a portion of 2005, approximately $0.7 million in cash dividends were paid during January 2005, in connection with the Series C Preferred Stock.
 
Capital Instruments
 
In December 2006, the Company completed the first phase of a private placement for the purpose of raising working capital to fund the Company’s operations. The private placement provided for the issuance of a maximum of 10,000 shares of the Company’s newly designated Preferred Stock, Series A-1 at $1,000 per share. The total number of shares of Preferred Stock Series A-1 issued in this private placement was 3,875 shares, for which net proceeds of approximately $3.8 million were received. In addition, the Company issued warrants to purchase 1,160,204 shares of common stock exercisable at $1.67 per share. The terms of the Series A-1 Preferred Stock will pay dividends at 8% and are convertible into Fusion’s common stock at a fixed conversion price of $1.67 per share.
 
Summary of Contractual Obligations
 
As of December 31, 2006
 
 
 
Less than
1 Year
 
1-3
Years
 
3-5
Years
 
More than
5 Years
 
Total
 
                                                                     
                     
Contractual obligations:
                     
Debt maturing within one year
 
$
150,000
 
$
 
$
 
$
 
$
150,000
 
Capital leases
   
1,066,746
   
   
   
   
1,066,746
 
Operating leases
   
1,369,000
   
2,683,000
   
1,505,000
   
2,407,000
   
7,964,000
 
Minimum purchase commitments
   
101,574
   
   
   
   
101,574
 
Total contractual cash obligations
 
$
2,687,320
 
$
2,683,000
 
$
1,505,000
 
$
2,407,000
 
$
9,282,320
 
 
Critical Accounting Policies and Estimates
 
We have identified the policies and significant estimation processes below as critical to our business operations and the understanding of our results of operations. The listing is not intended to be a comprehensive list. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for management’s judgment in their application. In other cases, management is required to exercise judgment in the application of accounting principles with respect to particular transactions. The impact and any associated risks related to these policies on our business operations is discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations” where such policies affect reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 2 in the Notes to Consolidated Financial Statements for the year ended December 31, 2006, included in this Annual Report on Form 10-K. Our preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amounts of revenue and expenses during the reporting periods. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. There can be no assurance that actual results will not differ from those estimates and such differences could be significant.
 
Revenue Recognition - Our revenue is primarily derived from fees charged to terminate voice services over our network, retail sales to consumers and corporations through our Efonica brand, and from monthly recurring charges associated with Internet and private line services.
 
Variable revenue is earned based on the number of minutes during a call and is recognized upon completion of a call, adjusted for allowance for doubtful accounts receivable and billing adjustments. Revenue for each customer is calculated from information received through our network switches. Customized software has been designed to track the information from the switch and analyze the call detail records against stored detailed information about revenue rates. This software provides us the ability to do a timely and accurate analysis of revenue earned in a period. Consequently, the recorded amounts are generally accurate and the recorded amounts are unlikely to be revised in the future.
 
 
33

 
 
Fixed revenue is earned from monthly recurring services provided to the customer that are fixed and recurring in nature, and are contracted for over a specified period of time. The initial start of revenue recognition is after the provisioning, testing and acceptance of the service by the customer. The charges continue to bill until the expiration of the contract, or until cancellation of the service by the customer.
 
Additionally, the majority of our VoIP services to consumers and corporations are prepaid. The revenue received from the prepayments that is related to VoIP termination services in the current month is booked to the current month’s revenue, and the remainder of the prepayments is booked to deferred revenue, until usage occurs.
 
Accounts Receivable - Accounts receivable are recorded net of an allowance for doubtful accounts. On a periodic basis, we evaluate our accounts receivable and record an 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 and payments are not expected to be received.
 
Cost of Revenues and Cost of Revenues Accrual - Cost of revenues is comprised primarily of costs incurred from other domestic and international communications carriers to originate, transport and terminate calls. The majority of our cost of revenue is variable, based upon the number of minutes of use, with transmission and termination costs being the most significant expense. Call activity is tracked and analyzed with customized software that analyzes the traffic flowing through our network switches. Each period the activity is analyzed and an accrual is recorded for minutes not invoiced. This cost accrual is calculated using minutes from the system and the variable cost of revenue based upon predetermined contractual rates.
 
In addition to the variable cost of revenue, there are also fixed expenses. One category of fixed expenses are those associated with the network backbone connectivity to our switch facilities. These would consist of hubbing charges at our New York switch facility that allow other carriers to send traffic to our switch, satellite or cable charges to connect to our international network, or Internet connectivity charges to connect customers or vendors to Fusion’s switch via the public Internet, a portion of which are variable costs. The other category of fixed expenses is associated with charges that are dedicated point-to-point connections to specific customers (both private line and Internet access).
 
Intangible Assets and Goodwill Impairment Testing - Absent any circumstances that warrant testing at another time, we test for goodwill and non-amortizing intangible asset impairment as part of our year-end closing process. Impairment losses are recorded when indicators of impairment are present based primarily upon estimated future cash flows.
 
Income Taxes - We account for income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). SFAS 109 requires companies to recognize deferred tax liabilities and assets for the expected future income tax consequences of events that have been recognized in our consolidated financial statements. Deferred tax liabilities and assets are determined based on the temporary differences between the consolidated financial statements carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in the years in which the temporary differences are expected to reverse. In assessing the likelihood of utilization of existing deferred tax assets and recording a full valuation allowance, we have considered historical results of operations and the current operating environment.

Recently Issued Accounting Pronouncements

In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments - an amendment of FASB Statements No. 133 and 140,” which simplifies accounting for certain hybrid financial instruments by permitting fair value re-measurement for any hybrid instrument that contains an embedded derivative that otherwise would require bifurcation and eliminates a restriction on the passive derivative instruments that a qualifying special-purpose entity may hold. SFAS No. 155 is effective for all financial instruments acquired, issued or subject to a re-measurement (new basis) event occurring after the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 155 is not expected to have an impact on our results of operations or financial position.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets - an amendment of FASB Statement No. 140,” which establishes, among other things, the accounting for all separately recognized servicing assets and servicing liabilities by requiring that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. The adoption of SFAS No. 156 is not expected to have an impact on our results of operations or financial position.
 
 
34

 
 
In June 2006, the FASB issued Financial Interpretation No. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASB Statement No. 109” (“FIN No. 48”). Fin No. 48 clarifies the accounting for uncertainty in income taxes recognized in the financial statements in accordance with SFAS No. 109, “Accounting of Income Taxes”. The interpretation is effective for fiscal years beginning after December 15, 2006. The Company does not expect the adoption of this FIN will have a material impact on its financial statements.

In September 2006, the Financial Accounting Standard Board issued “Statement of Financial Accounting Standard 157, Fair Value Measurements” (“SFAS 157”) that provides enhanced guidance for using fair value to measure assets and liabilities. The standard applies whenever other standards require (or permit) assets or liabilities to be measured at fair value. The standard does not expand the use of fair value in any new circumstances. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. Earlier application is encouraged, provided that the reporting entity has not yet issued financial statements for that fiscal year, including financial statements for an interim period within that fiscal year.

In September 2006, the Securities and Exchange Commission published Staff Accounting Bulletin (“SAB”) No. 108 (Topic IN), “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements”. SAB No. 108 requires registrants to quantify misstatements using both the balance sheet and income statement approaches, with adjustment required if either method results in a material error. The provisions of SAB No. 108 are effective for financial statements for the first fiscal year ending after November 15, 2006. The Company is currently evaluating the effect, if any, SAB No. 108 may have on its financial statements, but it does not expect the adoption of SAB 108 to have an impact on its financial position or results of operations.
 
Inflation
 
We do not believe inflation has a significant effect on our operations at this time.
 
Forward Looking Statements
 
Certain statements contained herein may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because such statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, risks associated with the integration of businesses following an acquisition, concentration of revenue from one source, competitors with broader product lines and greater resources, emergence into new markets, the termination of any of the Company’s significant contracts or partnerships, the Company’s inability to maintain working capital requirements to fund future operations or the Company’s inability to attract and retain highly qualified management, technical and sales personnel.
 
Item 7A. Quantitative and Qualitative Disclosures About Market Risks
 
Quantitative and Qualitative Disclosures About Market Risk
 
We are exposed to certain market risks that are inherent in our financial instruments. These instruments arise from transactions in the normal course of business.
 
As of December 31, 2006, the majority of our cash balances were held primarily in the form of a short-term highly liquid investment grade money market fund in a major financial institution. Due to the short-term nature of our investments, we believe that we are not subject to any material interest or market rate risks.
 
At December 31, 2006, all of our outstanding debt has fixed interest rates. As such, we are not subject to interest rate risk on any of our debt. As such, we currently believe that our interest rate risk is very low.
 
We currently do not conduct any significant amount of business in currencies other than the United States dollar. The reporting and functional currency for our Dubai international subsidiary is the United States dollar. Our other international subsidiaries currently do not have any significant operations that would provide foreign currency risk. However, in the future, we likely will conduct a larger percentage of our business in other foreign currencies that could have an adverse impact on our future results of operations.
 
 
35

 
 
Item 8. Consolidated Financial Statements and Supplementary Data
 
Our Consolidated Financial Statements required by this Item are included in Item 15 of this report on pages F-1 through F-32.
 
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
 
None.
 
Item 9A. Controls and Procedure
 
(a) Evaluation of Disclosure Controls and Procedures. Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and effective to ensure that material information relating to us, including our consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this Annual Report on Form 10-K was being prepared.
 
(b) Changes in Internal Controls. There were no changes in our internal control over financial reporting, identified in connection with the evaluation of such internal control that occurred during our last fiscal year, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
(c) Limitations. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurances that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with its policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We periodically evaluate our internal controls and make changes to improve them.
 
 
36

 
 
PART III
 
Item 10. Directors and Executive Officers of the Registrant
 
The information required by this Item is incorporated herein by reference to the sections entitled “Management” and “Principal Stockholders” in the proxy statement for our 2007 Annual Meeting of Stockholders.
 
On November 1, 2004, we adopted a Corporate Code of Conduct and Ethics applicable to all employees and directors of Fusion, including our principal executive officer and principal financial and accounting officer. A copy of the Code of Conduct and Ethics is posted on our website at www.fusiontel.com. We intend to post on our website any amendments to, or waivers from, our Code of Conduct and Ethics that apply to our principal executive officer and principal financial and accounting officer.
 
Item 11. Executive Compensation
 
The information required by this Item is incorporated herein by reference to the section entitled “Executive Compensation” in the proxy statement for our 2007 Annual Meeting of Stockholders.
 
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
 
The information required by this Item is incorporated herein by reference to the section entitled “Principal Stockholders” in the proxy statement for our 2007 Annual Meeting of Stockholders.
 
Item 13. Certain Relationships and Related Transactions
 
The information required by this Item is incorporated herein by reference to the section entitled “Related Party Transactions” in the proxy statement for our 2007 Annual Meeting of Stockholders.
 
Item 14. Principal Accounting Fees and Services
 
The information required by this Item is incorporated herein by reference to the section entitled “Principal Accounting Fees and Services” in the proxy statement for our 2007 Annual Meeting of Stockholders.
 
 
37

 
 
PART IV
 
Item 15. Exhibits and Financial Statement Schedules
 
(a)(1) Financial Statements.
 
The Consolidated Financial Statements filed as part of this Annual Report on Form 10-K are identified in the Index to Consolidated Financial Statements on page F-1 hereto.
 
(a)(2) Financial Statement Schedules.
 
Schedule II - Valuation and Qualifying Accounts is included on page F-32 hereto. All other financial statement schedules have been omitted because the information required to be set forth therein is not applicable or is shown on the financial statements or notes thereto.
 
(a)(3) Exhibits.
 
The following exhibits are filed herewith or are incorporated by reference to exhibits previously filed with the Securities and Exchange Commission.
 
Exhibit No.
 
Description
                          
   
3.1
     
Certificate of Incorporation, as amended(*)
3.1
 
(a) Certificate of Designation of Series C Convertible Redeemable Preferred Stock(*)
3.2
 
Bylaws(*)
10.1
 
1998 Stock Option Plan(*)
10.2
 
Employment Agreement between registrant and Matthew Rosen(*)
10.2.1
 
Amended and Restated Employment Agreement between registrant and Matthew Rosen(3)
10.3
 
Master Service Agreement between registrant and Terremark Worldwide, Inc., dated May 29, 2003(*)
10.5
 
Joint Venture Agreement between registrant and Karamco, Inc., dated December 12, 2002(*)
10.6
 
Agreement between Fusion registrant and Communications Ventures PVT. LTD, dated May 13, 2004(*)
10.7
 
Form of Warrant to Purchase Common Stock(*)
10.8
 
Lease Agreement between registrant and SLG Graybar Sublease, LLC for the 420 Lexington Avenue, New York, NY office(*)
10.8.1
 
Lease Modification Agreement dated November 1, 2005, between registrant and SLG Graybar Sublease, LLC for the 420 Lexington Avenue, New York, NY office(4)
10.8.2
 
Lease Modification Agreement dated November 1, 2005, between registrant and SLG Graybar Sublease, LLC for the 420 Lexington Avenue, New York, NY office(4)
10.8.3
 
Lease Agreement dated November 1, 2005, between registrant and SLG Graybar Sublease, LLC for the 420 Lexington Avenue, New York, NY office(4)
10.9
 
Lease Agreement between registrant and 67 Broad Street LLC for the 75 Broad Street, New York, NY office(*)
10.10
 
Lease Agreement between registrant and Fort Lauderdale Crown Center, Inc. for the Fort Lauderdale, Florida office, as amended(*)
10.10.11
 
Amendment dated February 10, 2006, to Lease Agreement between registrant and Fort Lauderdale Crown Center, Inc., for the Fort Lauderdale, Florida office, as amended(4)
10.11
 
Lease Agreement between Efonica FZ- LLC and Dubai Internet City for Dubai offices(4)
10.13
 
Shareholders Joint Venture Agreement between registrant and Communications Ventures Index Pvt. Ltd., dated March 11, 2000(*)
10.19
 
Warrant to Purchase Common Stock issued by registrant to Marvin Rosen, dated July 31, 2002(*)
10.28
 
Non-Competition Agreement between registrant and Marvin Rosen(*)
10.29
 
Stock Purchase Agreement between registrant, Convergent Technologies, Ltd. And the stockholders listed on Schedule 1 Attached thereto, dated December 16, 2004, as amended and restated, dated January 11, 2005(*)
10.30
 
Employment Agreement between registrant and Roger Karam(*)
10.31.1
 
Stock Purchase Agreement between registrant, Efonica FZ-LLC and Karamco, Inc., dated January 11, 2005 and the amendment thereto(*)
10.31.2
 
Amendment to Stock Purchase Agreement between registrant, Efonica FZ-LLC and Karamco, Inc., dated March 24, 2006(4)
10.32
 
Carrier Service Agreement for International Terminating Traffic between the registrant and Qwest Communications Corporation, dated May 17, 2000(*)
 
 
38

 
 
Exhibit No.
 
Description
                          
   
10.33
 
Carrier Service Agreement between registrant and Telco Group, Inc. dated April 3, 2001, as amended(*)
10.34
 
Colocation License Agreement between the registrant and Telco Group, dated January 28, 2002.(*)
10.35
 
International VoIP Agreement, dated April 25, 2002, as amended(*)
10.36.1
 
Stock Purchase Agreement dated March 8, 2005 between FUSION TURKEY, L.L.C., LDTS UZAK MESAFE TELEKOMÜNIKASYON VE .ILETIS,IM HIZMETLERI SAN.TIC.A.S. and Bayram Ali BAYRAMOGLU; Mecit BAYRAMOGLU Mehmet; Musa BAYSAN; Yahya BAYRAMOGLU and Özlem BAYSAN.(1)
10.37
 
Lease Agreement dated April 28, 2005, between Convergent Technologies Limited and Oceanic Digital Jamaica Limited **
10.38
 
Promissory Note issued by iFreedom Communications International Holdings, Limited; iFreedom Communications Corporation; iFreedom Communications (Malaysia) Sdn. Bhd.; iFreedom Communications, Inc.; iFreedom Communications Hong Kong Limited and iFreedom UK, Ltd., jointly and severally, to Registrant.(4)
10.39
 
Form of Subscription Agreement (5)
10.40
 
Form of Warrant (5)
10.41
 
Certificate of Designation of the Rights and Preferences of the Series A-1 Preferred Stock (5)
14
 
Code of Ethics of Registrant(4)
21.1
 
List of Subsidiaries(4)
31.1
 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(4)
31.2
 
Certification of Chief Financial Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002(4)
32.1
 
Certification of Chief Executive Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (4)
32.2
 
Certification of the Chief Financial Officer Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002(4)
——————
*
Originally filed with our Registration Statement no. 33-120412 and incorporated herein by reference.
 
**
Originally filed with our Registration Statement no. 33-120206 and incorporated herein by reference.
 
(1)
Filed as Exhibit to our Current Report on Form 8-K filed on March 14, 2005 and incorporated herein by reference.
 
(2)
Filed as Exhibit to or Annual Report on Form 10-K filed March 31, 2005 and incorporated herein by reference.
 
(3)
Filed as Exhibit to our Current Report on Form 8-K filed on March 17, 2006, and incorporated herein by reference.
 
(4)
Filed herewith.
 
(5)  
Files as Exhibit to our Current Report on Form 8-K filed on December 15, 2006, and incorporated herein by reference.
 
 
39

 
 
 
SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
 
 
 
 
 Fusion Telecommunications International, Inc.
 
Date: April 2, 2007 By:   /s/ Matthew D. Rosen
 
Name: Matthew D. Rosen
  Title: President and Chief Executive Officer
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report.
 
Name
 
Title
 
Date
                                          
     
                                          
/s/ Marvin S. Rosen
     
Chairman of the Board
     
April 2, 2007
Marvin S. Rosen
         
/s/ Matthew D. Rosen
 
President and Chief Executive Officer
 
April 2, 2007
Matthew D. Rosen
         
/s/ Barbara Hughes
 
Chief Financial Officer and Principal Accounting and Financial Officer
 
April 2, 2007
Barbara Hughes
         
/s/ Philip Turits
 
Secretary, Treasurer, and Director
 
April 2, 2007
Philip Turits
         
/s/ E. Alan Brumberger
 
Director
 
April 2, 2007
E. Alan Brumberger
         
/s/ Michael Del Giudice
 
Director
 
April 2, 2007
Michael Del Giudice
         
/s/ Julius Erving
 
Director
 
April 2, 2007
Julius Erving
         
/s/ Evelyn Langlieb Greer
 
Director
 
April 2, 2007
Evelyn Langlieb Greer
         
/s/ Fred P. Hochberg
 
Director
 
April 2, 2007
Fred P. Hochberg
         
/s/ Raymond E. Mabus
 
Director
 
April 2, 2007
Raymond E. Mabus
         
/s/ Dennis Mehiel
 
Director
 
April 2, 2007
Dennis Mehiel
         
/s/ Paul C. O’Brien
 
Director
 
April 2, 2007
Paul C. O’Brien
         
 
 
40

 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
 
CONSOLIDATED FINANCIAL STATEMENTS
 
Table of Contents
 
   
Page
     
Report of Independent Registered Public Accounting Firm
     
F-2
Consolidated Balance Sheets as of December 31, 2006 and 2005
 
F-3
Consolidated Statements of Operations for the years ended December 31, 2006, 2005 and 2004
 
F-4
Consolidated Statements of Changes in Stockholders’ Equity (Deficit) for the years ended December 31, 2006, 2005 and 2004
 
F-5
Consolidated Statements of Cash Flows for the years ended December 31, 2006, 2005 and 2004
 
F-6
Notes to Consolidated Financial Statements
 
F-8
Valuation and Qualifying Accounts for the years ended December 31, 2006, 2005 and 2004
 
F-32
 
 
F-1

 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
To the Board of Directors and Stockholders of
Fusion Telecommunications International, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Fusion Telecommunications International, Inc. and Subsidiaries (the “Company”) as of December 31, 2006 and 2005, and the related consolidated statements of operations, stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fusion Telecommunications International, Inc. and Subsidiaries as of December 31, 2006 and 2005, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2006, in conformity with accounting principles generally accepted in the United States of America.

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 3 to the consolidated financial statements, the Company has incurred negative cash flow from operations and net losses since inception and has limited capital to fund future operations that raise substantial doubt about their ability to continue as a going concern. Management’s plans in regard to this matter are also described in Note 3. The consolidated financial statements do not include any adjustment that might result from this uncertainty.

In connection with our audits of the financial statements referred to above, we audited the financial statement schedule on page F-32. In our opinion, the financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information stated therein.


                                             /s/ Rothstein, Kass & Company, P.C.

Roseland, New Jersey
March 9, 2007
 
F-2

 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
 
CONSOLIDATED BALANCE SHEETS
 
   
December 31,
 
 
 
2006
 
2005
 
             
ASSETS
           
Current assets
             
Cash and cash equivalents
 
$
2,743,155
 
$
14,790,504
 
Accounts receivable, net of allowance for doubtful accounts of approximately $694,000 and $414,000 in 2006 and 2005, respectively
   
6,743,753
   
2,952,760
 
Restricted cash
   
365,000
   
 
Prepaid expenses and other current assets
   
622,207
   
1,242,266
 
Assets held for sale
   
129,231
   
245,305
 
Total current assets
   
10,603,346
   
19,230,835
 
Property and equipment, net
   
6,422,016
   
4,270,966
 
Other assets
             
Security deposits
   
141,868
   
331,891
 
Restricted cash
   
416,566
   
218,176
 
Goodwill
   
4,971,221
   
5,118,640
 
Intangible assets, net
   
4,913,360
   
4,861,012
 
Other assets
   
104,923
   
354,259
 
Total other assets
   
10,547,938
   
10,883,978
 
TOTAL ASSETS
 
$
27,573,300
 
$
34,385,779
 
 
           
LIABILITIES AND STOCKHOLDERS’ EQUITY
             
Current liabilities
             
Long-term debt, current portion
 
$
150,000
 
$
150,000
 
Capital lease/equipment financing obligations, current portion
   
1,066,746
   
1,419,965
 
Accounts payable and accrued expenses
   
11,461,112
   
9,269,341
 
Investment in Estel
   
554,286
   
771,182
 
Liabilities of discontinued operations
   
95,085
   
620,809
 
Total current liabilities
   
13,327,229
   
12,231,297
 
Long-term liabilities
             
Capital lease/equipment financing obligations, net of current portion
   
   
7,650
 
Other long-term liabilities
   
800,113
   
4,357,497
 
Total long-term liabilities
   
800,113
   
4,365,147
 
Commitments and contingencies
           
Minority interests
   
   
67,694
 
Stockholders’ Equity
             
    Preferred stock, Series A-1, $0.01 par value, 10,000 shares authorized, 3,875 and 0 shares issued and outstanding in 2006 and 2005, respectively
   
39
   
 
Common stock, $0.01 par value, 105,000,000 shares authorized, 26,971,465 and 11,114,962 shares issued and 26,958,965 and 10,439,381 shares outstanding in 2006 and 2005, respectively
   
269,590
   
104,394
 
Common stock, Class A, $0.01 par value, 21,000,000 shares authorized, 0 and 15,739,963 shares issued and outstanding in 2006 and 2005, respectively
   
   
157,400
 
Capital in excess of par value
   
114,514,725
   
105,447,041
 
Accumulated deficit
   
(101,338,396
)
 
(87,987,194
)
Total stockholders’ equity
   
13,445,958
   
17,721,641
 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
 
$
27,573,300
 
$
34,385,779
 
 
See accompanying notes to consolidated financial statements.
 
 
F-3

 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
 
CONSOLIDATED STATEMENTS OF OPERATIONS
 
 
 
Years Ended December 31,
 
 
 
 2006
 
2005
 
2004
 
 
 
  
 
 
 
 
 
Revenues
 
$
47,087,064
 
$
49,364,542
 
$
49,557,973
 
Operating expenses:
                   
Cost of revenues, exclusive of depreciation and amortization, shown separately below
   
42,463,724
   
45,048,917
   
42,927,994
 
Depreciation and amortization