UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One)
 
    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2016
 
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____ to _____
 
Commission File Number: 001-32421
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
(Exact name of registrant as specified in its charter)
 
Delaware
 
58-2342021
(State or other jurisdiction of incorporation or organization)
 
(IRS Employer Identification No.)
 
420 Lexington Avenue, Suite 1718, New York, New York   10170
   (Address of principal executive offices)    (Zip Code)
 
(212) 201-2400
 (Registrants telephone number, including area code)
 
Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
 
Yes   No
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  
 
Yes   No
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
 ☐
 
Accelerated filer
 ☐
Non-accelerated filer
 ☐
 
Smaller reporting company
 
(Do not check if smaller reporting company)
 
 
 
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      Yes  No  
 
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: August 8, 2016.
 
Title of Each Class
Number of Shares Outstanding
Common Stock, $0.01 par value
14,988,732
 
 
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
TABLE OF CONTENTS
 
Part 1 Financial Information.
 2
Item 1. Financial Statements.
 2
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 23
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
 30
Item 4. Controls and Procedures.
 30
Part II Other Information.
 30
Item 1. Legal Proceedings.
 30
Item 1A. Risk Factors.
 31
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 31
Item 3. Defaults Upon Senior Securities.
 31
Item 4. Mine Safety Disclosures.
 31
Item 5. Other Information.
 31
Item 6. Exhibits.
 31
Signatures.
 32
Index to Exhibits
 33
 
 
1
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
PART 1 FINANCIAL INFORMATION
 
Item 1. Financial Statements.
Condensed Consolidated Balance Sheets 
 
 
 
June 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
(unaudited)
 
 
 
 
ASSETS
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
  $3,798,911 
  $7,540,543 
Accounts receivable, net of allowance for doubtful accounts of $311,654 and $308,813, respectively
    7,881,031 
    7,650,141 
Prepaid expenses and other current assets
    2,627,478 
    1,618,603 
Total current assets
    14,307,420 
    16,809,287 
Property and equipment, net
    13,234,210 
    14,055,493 
Other assets:
       
       
Security deposits
    549,423 
    575,038 
Restricted cash
    27,153 
    165,123 
Goodwill
    27,772,494 
    27,060,297 
Intangible assets, net
    44,078,486 
    45,824,399 
Other assets
    530,732 
    281,045 
Total other assets
    72,958,288 
    73,905,902 
TOTAL ASSETS
  $100,499,918 
  $104,770,682 
 
       
       
LIABILITIES AND STOCKHOLDERS' EQUITY
       
       
Current liabilities:
       
       
Notes payable - non-related parties
  $685,780 
  $685,780 
Due to RootAxcess seller
    500,000 
    300,000 
Due to TFB seller
    100,000 
    - 
Equipment financing obligations
    991,681 
    959,380 
Accounts payable and accrued expenses
    13,263,707 
    13,129,225 
Total current liabilities
    15,541,168 
    15,074,385 
Long-term liabilities:
       
       
Notes payable - non-related parties, net of discount
    30,713,635 
    30,795,745 
Term Loan
    25,000,000 
    25,000,000 
Indebtedness under revolving credit facility
    15,000,000 
    15,000,000 
Due to RootAxcess seller
    - 
    333,333 
Due to TFB seller
    886,606 
    - 
Notes payable - related parties
    1,099,530 
    1,074,829 
Equipment financing obligations
    1,744,190 
    2,085,416 
Derivative liabilities
    385,990 
    953,005 
Total liabilities
    90,371,119 
    90,316,713 
Commitments and contingencies
       
       
Stockholders' equity (deficit):
       
       
Preferred stock, $0.01 par value, 10,000,000 shares authorized,
       
       
17,324 and 23,324 shares issued and outstanding
    173 
    233 
Common stock, $0.01 par value, 50,000,000 shares authorized,
       
       
14,975,482 and 12,788,971 shares issued and outstanding
    149,755 
    127,889 
Capital in excess of par value
    185,725,991 
    184,859,084 
Accumulated deficit
    (175,747,120)
    (170,533,237)
Total stockholders' equity
    10,128,799 
    14,453,969 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
  $100,499,918 
  $104,770,682 
 
See accompanying notes to the Condensed Consolidated Financial Statements.
 
2
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Condensed Consolidated Statements of Operations 
(Unaudited)
 
 
 
Three Months Ended June 30,
 
 
Six Months Ended June 30,
 
 
 
2016
 
 
2015
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
  $30,420,291 
  $25,063,695 
  $63,604,706 
  $50,326,733 
Cost of revenues (exclusive of depreciation and amortization, shown separately below)
    17,244,814 
    13,813,615 
    37,166,491 
    27,826,307 
Gross profit
    13,175,477 
    11,250,080 
    26,438,215 
    22,500,426 
Depreciation and amortization
    3,031,890 
    3,039,758 
    5,948,153 
    6,043,205 
Selling, general and administrative expenses
    11,270,013 
    9,851,735 
    22,694,799 
    19,582,713 
Total operating expenses
    14,301,903 
    12,891,493 
    28,642,952 
    25,625,918 
Operating loss
    (1,126,426)
    (1,641,413)
    (2,204,737)
    (3,125,492)
Other (expenses) income:
       
       
       
       
Interest expense
    (1,624,669)
    (1,608,709)
    (3,252,633)
    (3,215,552)
Gain on change in fair value of derivative liability
    45,642 
    2,510,950 
    228,042 
    1,306,148 
Other income, net
    25,115 
    26,765 
    15,445 
    58,767 
Total other expenses
    (1,553,912)
    929,006 
    (3,009,146)
    (1,850,637)
Loss before income taxes
    (2,680,338)
    (712,407)
    (5,213,883)
    (4,976,129)
Provision for income taxes
    - 
    - 
    - 
    - 
Net loss
    (2,680,338)
    (712,407)
    (5,213,883)
    (4,976,129)
Preferred stock dividends
    (284,839)
    (630,523)
    (1,816,821)
    (1,049,511)
Net loss attributable to common stockholders
  $(2,965,177)
  $(1,342,930)
  $(7,030,704)
  $(6,025,640)
Basic and diluted loss per common share
  $(0.20)
  $(0.33)
  $(0.49)
  $(0.81)
Weighted average common shares outstanding:
       
       
       
       
Basic and diluted
    14,864,768 
    8,461,794 
    14,306,170 
    8,311,499 
 
See accompanying notes to the Condensed Consolidated Financial Statements.

 
3
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Condensed Consolidated Statement of Stockholders’ Equity
(Unaudited)
 
 
 
Preferred Stock
 
 
Common Stock
 
 
Capital in Excess of Par
 
 
Accumulated Deficit
 
 
Stockholders' Equity (Deficit)
 
 
 
Shares
 
 
 $
 
 
Shares
 
 
$
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
    23,324 
  $233 
    12,788,971 
  $127,889 
  $184,859,084 
  $ (170,533,237)
  $14,453,969 
Net loss
       
       
       
       
       
    (5,213,883)
    (5,213,883)
Conversion of preferred stock into
       
       
       
       
       
       
       
   common stock
    (6,000)
    (60)
    1,866,667 
    18,667 
    (18,607)
       
    - 
Dividends on preferred stock
       
       
    220,909 
    2,209 
    (2,209)
       
    - 
Adjustment for prior issuances and
       
       
       
       
       
       
    - 
   conversion of warrants
       
       
       
       
    338,972 
       
    338,972 
Adjustment for fractional shares
       
       
    685 
    7 
    (7)
       
    - 
Issuance of restricted stock
       
       
    55,000 
    550 
    99,000 
       
    99,550 
Issuance of common stock for services
       
       
       
       
       
       
       
   rendered
       
       
    43,250 
    433 
    71,210 
       
    71,643 
Stock-based compensation associated
       
       
       
       
       
       
       
   with stock incentive plans
       
       
       
       
    378,548 
       
    378,548 
Balance at June 30, 2016
    17,324 
  $173 
    14,975,482 
  $149,755 
  $185,725,991 
  $(175,747,120)
  $10,128,799 
 
See accompanying notes to the Condensed Consolidated Financial Statements.
 
 
4
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
Six Months Ended June 30,
 
 
 
2016
 
 
2015
 
Cash flows from operating activities:
 
 
 
 
 
 
Net loss
  $(5,213,883)
  $(4,976,129)
Adjustments to reconcile net loss to net cash provided by operating activities:
       
       
Depreciation and amortization
    5,948,153 
    6,043,205 
Loss on disposal of property
    72,818 
    - 
Bad debt expense
    130,000 
    225,000 
Stock-based compensation
    378,548 
    238,768 
Stock based compensation issued for services rendered by third parties
    79,948 
    215,611 
Amortization of debt discount and deferred financing fees
    318,125 
    507,690 
Gain in the change in fair value of derivative liability
    (228,043)
    (1,306,148)
Changes in operating assets and liabilities:
       
       
Accounts receivable
    (254,925)
    (305,135)
Prepaid expenses and other current assets
    (1,230,504)
    (456,315)
Other assets
    (249,687)
    155,190 
Accounts payable and accrued expenses
    (691,178)
    156,308 
Net cash (used in) provided by operating activities
    (940,628)
    498,045 
 
       
       
Cash flows from investing activities:
       
       
Purchase of property and equipment
    (2,325,210)
    (1,859,265)
Proceeds from the sale of property and equipment
    23,961 
    - 
Net cash acquired through acqusition
    16,895 
    - 
Returns of security deposits
    25,615 
    - 
Escrow refund - PingTone acquisition
    318,409 
    - 
Change in restricted cash
    137,970 
    - 
Net cash used in investing activities
    (1,802,360)
    (1,859,265)
 
       
       
Cash flows from financing activities:
       
       
Payments on equipment financing obligations
    (497,422)
    (361,948)
Repayments of notes payable
    (501,222)
    (612,716)
Proceeds from the accounts receivable factoring arrangement
    - 
    1,078,576 
Repayments of borrowings related to the accounts receivable factoring arrangement
    - 
    (769,517)
Net cash used in financing activities
    (998,644)
    (665,605)
Net change in cash and cash equivalents
    (3,741,632)
    (2,026,825)
Cash and cash equivalents, beginning of period
    7,540,543 
    6,444,683 
Cash and cash equivalents, end of period
  $3,798,911 
  $4,417,858 
 
See accompanying notes to the Condensed Consolidated Financial Statements.
 
 
5
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 1.     Organization and Business
 
Fusion Telecommunications International, Inc. is a Delaware corporation incorporated in September 1997 (“Fusion” and together with its subsidiaries, the “Company,” “we,” “us” and “our”).  The Company is a provider of integrated cloud solutions, including cloud voice, cloud connectivity, cloud infrastructure, cloud computing, and managed cloud-based applications to businesses of all sizes, and voice over IP (“VoIP”) - based voice services to carriers.  The Company currently operates in two business segments: Business Services and Carrier Services.
 
Note 2.     Basis of Presentation and Summary of Significant Accounting Policies
 
Basis of Presentation
 
The accompanying unaudited condensed consolidated financial statements have been prepared in all material respects in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information. Pursuant to the rules and regulations of the U.S. Securities and Exchange Commission (the “SEC”), certain information and footnote disclosures normally included in annual consolidated financial statements prepared in accordance with U.S. GAAP have been condensed or omitted. The accompanying unaudited condensed consolidated interim financial statements have been prepared on the same basis as the financial statements for the fiscal year ended December 31, 2015.
 
Because certain information and footnote disclosures have been condensed or omitted, these unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes contained in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2015 (the “2015 Form 10-K”) as filed with the SEC.  In management’s opinion, all normal and recurring adjustments considered necessary for a fair presentation of the financial position, results of operations and cash flows for the periods presented have been included. Management believes that the disclosures made in these unaudited condensed consolidated interim financial statements are adequate to make the information not misleading. The results for the three and six months ended June 30, 2016 are not necessarily indicative of the results to be expected for the full year.
 
Significant Accounting Policies
 
For a detailed discussion of significant accounting policies, please refer to the 2015 Form 10-K. There have been no material changes in our accounting policies during the quarter ended June 30, 2016.
 
Principles of Consolidation
 
The condensed consolidated interim financial statements include the accounts of Fusion and each of its wholly-owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation.
 
Use of Estimates
 
The preparation of condensed consolidated interim financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported. Key estimates include: the recognition of revenue, allowance for doubtful accounts; asset lives used in computing depreciation and amortization; valuation of intangible assets; accounting for stock options and other equity awards particularly related to fair value estimates; accounting for income taxes; contingencies; and litigation. While management believes that such estimates are reasonable when considered in conjunction with the financial position and results of operations of the Company taken as a whole, actual results could differ from those estimates, and such differences could be material.
 
Reclassifications
 
Certain reclassifications have been made to the prior years’ financial statements in order to conform to the current year’s presentation. The reclassifications had no impact on net earnings previously reported.
 
6
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Cash and Cash Equivalents
 
Cash and cash equivalents include cash on deposit and short-term, highly-liquid investments with maturities of three months or less on the date of purchase. As of June 30, 2016 and December 31, 2015, the carrying value of cash and cash equivalents approximates fair value due to the short period to maturity.
 
Restricted Cash
 
Restricted cash consists primarily of cash held in reserve pursuant to the terms of financing arrangements and certificates of deposit that serve to collateralize outstanding letters of credit.  Restricted cash is recorded as current or non-current assets in the consolidated balance sheets depending on the duration of the restriction and the purpose for which the restriction exists.
 
At June 30, 2016 and December 31, 2015, the Company had certificates of deposit collateralizing a letter of credit in the aggregate amount of approximately $27,000 and $165,000, respectively. The letter of credit is required as security for one of the Company’s non-cancelable operating leases for office facilities.
 
Fair Value of Financial Instruments
 
At June 30, 2016 and December 31, 2015, the carrying value of the Company’s accounts receivable, accounts payable and accrued expenses approximates its fair value due to the short term nature of these financial instruments.
 
Long-Lived Asset Impairment
 
The Company periodically reviews long-lived assets, including intangible assets subject to amortization, for possible impairment when events or changes in circumstances indicate, in management’s judgment, that the carrying amount of an asset may not be recoverable.  Recoverability is measured by a comparison of the carrying amount of an asset or asset group to the estimated undiscounted future cash flows expected to be generated by such asset or asset group. If the undiscounted cash flows are less than the carrying amount of the asset or asset group, an impairment loss is recognized for the amount by which the carrying amount of the asset or asset group exceeds its fair value. The Company did not record any impairment charges during the six month periods ended June 30, 2016 or 2015, as there were no indicators of impairment.
 
7
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Goodwill
 
Goodwill represents the excess of consideration paid over the fair value of net assets acquired in business combinations. Goodwill is not amortized and is tested for impairment on an annual basis in the fourth quarter of each fiscal year and whenever events or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  A significant amount of judgment is involved in determining if an indicator of impairment has occurred. Such indicators include, but are not limited to, deterioration in general economic conditions, adverse changes in the markets in which a company operates, increases in input costs that have negative effects on earnings and cash flows, or a trend of negative or declining cash flows over multiple periods.
 
In testing goodwill for impairment, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not (more than 50%) that the estimated fair value of a reporting unit is less than its carrying amount. If the Company elects to perform a qualitative assessment and determines that an impairment is more likely than not, it is then required to perform a quantitative impairment test, otherwise no further analysis is required. The Company also may elect not to perform the qualitative assessment and, instead, proceed directly to the quantitative impairment test.
 
Under the goodwill two-step quantitative impairment test, the Company reviews for impairment the fair value of each reporting unit to its carrying value. The Company has determined that its reporting units are its operating segments (see Note 15).  The first step compares the fair value of a reporting unit with its carrying amount, including goodwill. If the carrying value of the reporting unit exceeds its fair value, the second step would be conducted; otherwise, no further steps are necessary as no potential impairment exists. The second step compares the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. Any excess of the reporting unit goodwill carrying value over the respective implied fair value is recognized as an impairment loss. At June 30, 2016 and December 31, 2015, goodwill was approximately $27.8 million and $27.0 million, respectively.  All of the Company’s goodwill is attributable to its Business Services segment.  There was no impairment charge recorded for goodwill during the six months ended June 30, 2016 or 2015, as there were no indicators of impairment.
 
The following table presents the changes in the carrying amounts of goodwill during the six months ended June 30, 2016:
 
Balance at December 31, 2015
  $27,060,297 
Adjustment to the preliminary purchase price of Fidelity
    (10,619)
Increase in goodwill - TFB acquisition
    722,816 
Balance at June 30, 2016
  $27,772,494 
 
Advertising and Marketing Costs
 
Costs related to advertising and marketing are expensed as incurred and included in selling, general and administrative expenses in the Company’s condensed consolidated statements of operations. Our advertising and marketing expense was approximately $183,600 and $130,000 for the three months ended June 30, 2016 and 2015, respectively, and approximately $353,200 and $245,000 for the six months ended June 30, 2016 and 2015, respectively.
 
Income Taxes
 
The Company complies with accounting and reporting requirements with respect to accounting for income taxes, which require an asset and liability approach to financial accounting and reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred income tax assets to the amount expected to be realized.
 
8
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES 
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
In accordance with U.S. GAAP, the Company is required to determine whether a tax position of the Company is more likely than not to be sustained upon examination by the applicable taxing authority, including resolution of any related appeals or litigation processes, based on the technical merits of the position. The tax benefit to be recognized is measured as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement. Derecognition of a tax benefit previously recognized could result in the Company recording a tax liability that would reduce net assets. Based on its analysis, the Company has determined that it has not incurred any liability for unrecognized tax benefits as of June 30, 2016 and December 31, 2015.  The Company is subject to income tax examinations by major taxing authorities for all tax years since 2011 and its tax returns may be subject to review and adjustment at a later date based on factors including, but not limited to, on-going analyses of and changes to tax laws, regulations and interpretations thereof.  No interest expense or penalties have been recognized as of June 30, 2016 and December 31, 2015.  During the three and six months ended June 30, 2016 and 2015, the Company recognized no adjustments for uncertain tax positions.
 
Stock-Based Compensation
 
The Company recognizes expense for its employee stock-based compensation based on the fair value of the awards that are granted. The fair values of stock options are estimated at the date of grant using the Black-Scholes option valuation model. The use of the Black-Scholes option valuation model requires the input of subjective assumptions. Measured compensation cost, net of estimated forfeitures, is recognized ratably over the vesting period of the related stock-based compensation award.  For transactions in which goods or services are the consideration received from non-employees in return for the issuance of equity instruments, the expense is recognized in the period when the goods and services are received at the fair value of the consideration received or the fair value of the equity instrument issued, whichever is determined to be a more reliable measurement.
 
New and Recently Adopted Accounting Pronouncements
 
In February 2016, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-02 (ASU 2016-02), Leases, which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 with early adoption permitted. Under ASU 2016-02, lessees will be required to recognize for all leases at the commencement date a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right –to-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures.
 
In November 2015, FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes (ASU 2015-17), which simplifies the presentation of deferred income taxes by requiring deferred tax assets and liabilities be classified as noncurrent on the balance sheet. The updated standard is effective beginning on January 1, 2017 with early application permitted as of the beginning of any interim or annual reporting period. The Company does not expect this guidance to have a material impact on its consolidated financial statements.
 
In September 2015, FASB issued guidance that eliminates the requirement for an acquirer in a business combination to account for measurement-period adjustments retrospectively. Instead, acquirers must recognize measurement-period adjustments during the period in which they determine the amounts, including the effect on earnings of any amounts they would have recorded in previous periods if the accounting had been completed at the acquisition date. This guidance is effective for interim and annual reporting periods beginning after December 15, 2015.  The adoption of this guidance did not have a material impact on the Company’s consolidated financial statements.
 
In April 2015, FASB issued guidance requiring an entity to present debt issuance costs related to a recognized debt liability as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. This guidance was effective for interim and annual reporting periods beginning after December 15, 2015.  The Company adopted this guidance as of January 1, 2016 and applied the provision retrospectively for fiscal 2015 (see Note 11). The adoption of this guidance by the Company resulted in an approximately $1.0 million decrease in other assets, and a decrease of $1.0 million in notes payable as of December 31, 2015.
 
9
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
In May 2014, FASB issued guidance that outlines a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and supersedes most recent current revenue recognition guidance, including industry-specific guidance. The core principle of the revenue model is that an entity recognizes revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The guidance also specifies the accounting for certain incremental costs of obtaining a contract and costs to fulfill a contract with a customer. Entities have the option of applying either a full retrospective approach to all periods presented or a modified approach that reflects differences prior to the date of adoption as an adjustment to equity. In April 2015, FASB deferred the effective date of this guidance until January 1, 2018 and the Company is currently assessing the impact of this guidance on its consolidated financial statements.
 
Note 3.     Loss per share
 
Basic and diluted loss per share is computed by dividing (i) loss available to common stockholders, adjusted by an approximately $0 million and $1.5 million gain on the fair value of the Company’s derivative liability for the three months ended June 30, 2016 and 2015, respectively, and $0 million and $0.7 million gain on the fair value of the Company’s derivative liability for the six months ended June 30, 2016 and 2015, respectively, which was attributable to 728,333 outstanding warrants with a nominal exercise price that were exercised in August 2015 and dividends paid on Fusion’s preferred stock, by (ii) the weighted-average number of common shares outstanding during the period, increased by the number of common shares underlying such warrants with a nominal exercise price as if such exercise had occurred at the beginning of the year.  
 
The following table sets forth the computation for basic and diluted net income per share for the three and six months ended June 30, 2016 and 2015:
 
 
 
Three Months Ended June 30,
 
 
Six Months Ended June 30,
 
 
 
2016
 
 
2015
 
 
2016
 
 
2015
 
Numerator
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
  $(2,680,338)
  $(712,408)
  $(5,213,883)
  $(4,976,129)
Dividends on Series A-1, A-2 and A-4 Convertible Preferred Stock
    (100,624)
    (100,623)
    (201,247)
    (200,141)
Dividends declared on Series B-2 Convertible Preferred Stock
    (184,215)
    (529,900)
    (1,615,574)
    (849,370)
Gain on nominal warrants
    - 
    (1,456,666)
    - 
    (742,900)
Adjusted loss attributable to common stockholders
  $(2,965,177)
  $(2,799,597)
  $(7,030,704)
  $(6,768,540)
 
       
       
       
       
Denominator
       
       
       
       
Basic and diluted weighted average common shares outstanding
    14,864,768 
    8,461,794 
    14,306,170 
    8,311,499 
Loss per share
       
       
       
       
Basic and diluted
  $(0.20)
  $(0.33)
  $(0.49)
  $(0.81)
 
For the six months ended June 30, 2016 and 2015, the following were excluded from the calculation of diluted earnings per common share because of their anti-dilutive effects:
 
 
 
Six Months Ended June 30,
 
 
 
2016
 
 
2015
 
Warrants
    2,971,685 
    3,391,324 
Convertible preferred stock
    2,629,645 
    4,424,147 
Stock options
    1,158,984 
    688,812 
 
    6,760,314 
    8,504,283 
 
 
10
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The net loss per common share calculation includes a provision for preferred stock dividends on the Company’s outstanding Series A-1, A-2 and A-4 preferred stock (the “Series A Preferred Stock”) of approximately $101,000 for the three months ended June 30, 2016 and 2015, and approximately $200,000 for the six months ended June 30, 2016 and 2015.  Through June 30, 2016, the Board of Directors of Fusion has never declared a dividend on any series of the Series A Preferred Stock, resulting in approximately $4.5 million of accumulated preferred stock dividends.  The Board of Directors has declared a dividend of $184,215 and $415,474 for the three and six months ended June 30, 2016, respectively, related to the Company’s Series B-2 preferred stock (the “Series B-2 Preferred Stock”), which, as permitted by the terms of the Series B-2 Preferred Stock, was paid in the form of 95,630 and 220,909 shares, respectively, of the Company’s common stock.   In addition, during the three months ended March 31, 2016, the Board of Directors paid an additional $1.2 million in dividends in the form of 666,667 shares in Fusion’s common stock to a holder of 5,000 shares of Series B-2 Preferred Stock for the conversion of their Series B-2 Preferred Stock holdings into Fusion’s common stock.
 
Note 4.     Intangible Assets
 
Intangible assets as of June 30, 2016 and December 31, 2015 are as follows:
 
 
 
June 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Trademarks and tradenames
  $1,093,400 
  $1,093,400 
Proprietary technology
    6,670,000 
    5,781,000 
Non-compete agreements
    10,711,043 
    10,703,043 
Customer relationships
    45,000,181 
    44,888,181 
Favorable lease intangible
    218,000 
    218,000 
 
    63,692,624 
    62,683,624 
   Less: accumulated amortization
    (19,614,138)
    (16,859,225)
   Intangible assets, net
  $44,078,486 
  $45,824,399 
 
.Amortization expense was $1.4 million and $1.9 million for the three months ended June 30, 2016 and 2015, respectively, and for the six months ended June 30, 2016 and 2015 was $2.8 million and $3.7 million, respectively.  Estimated future aggregate amortization expense is expected to be as follows:
 
                       Year
 
Estimated Annual Amortization Expense
 
   
 
 
 
Remainder of 2016
  $3,389,296 
                       2017
  $6,065,102 
                       2018
  $5,318,305 
                       2019
  $4,293,561 
                       2020
  $4,500,563 
                       and thereafter
  $20,511,659 
 
Note 5.     Stock–based compensation
 
The Company's stock-based compensation plan provides for the issuance of stock options to the Company’s employees, officers, and directors. The Compensation Committee of Fusion’s Board of Directors (the "Compensation Committee") approves all awards under Fusion's stock-based compensation plan.
 
11
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The following weighted average assumptions were used to determine the fair value of the stock options granted under the Company’s stock-based compensation plan using the Black-Scholes option-pricing model:
 
 
 
Six months ended June 30,
 
 
 
2016
 
 
2015
 
Dividend yield (%)*
    0.0 
    0.0 
Expected volatility (%)
    94.6 
    112.6 
Average Risk-free interest rate (%)
    1.58 
    1.69 
Expected life of stock option term (years)
    8.0 
    7.8 
 
       
       
*The dividend yield is zero as the Company has never paid and does not expect to pay dividends on its common stock.
 
The Company recognized compensation expense of approximately $180,000 and $116,000 for the three ended June 30, 2016 and 2015, respectively, and $379,000 and $239,000 for the six months ended June 30, 2016 and 2015, respectively.  These amounts are included in selling, general, and administrative expenses in the condensed consolidated interim statements of operations.
 
The following table summarizes the stock option activity for the six months ended June 30, 2016:
 
 
 
Number of Options
 
 
Weighted Average
Exercise Price
 
Balance at December 31, 2015
    1,158,251 
  $4.96 
Shares granted during the period
    81,300 
  $1.79 
Shares exercised during the period
    - 
  $- 
Shares forfeited during the period
    (63,224)
  $2.47 
Shares expired during the period
    (17,343)
  $80.82 
Shares outstanding at June 30, 2016
    1,158,984 
  $3.74 
Shares exercisable at June 30, 2016
    368,785 
  $5.99 
 
As of June 30, 2016, the Company had approximately $1.2 million of unrecognized compensation expense, net of estimated forfeitures, related to stock options granted under the Company’s stock-based compensation plan, which is expected to be recognized over a weighted-average period of 1.71 years.
 
Restricted Stock
 
In the quarter ended June 30, 2016, the Company awarded 55,000 shares of restricted stock to its Chief Financial Officer. The restricted stock granted was valued at the closing stock price on the day employment commenced and vests in three equal installments on the first, second and third anniversary of employment. For the quarter ended June 30, 2016, the Company recognized compensation expense of approximately $8,300 and has unamortized compensation of $91,245.
 
12
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 6.     Acquisition
 
On March 31, 2016, the Company completed the acquisition of Technology for Business Corporation (“TFB”), a provider of industry leading contact center solutions for an estimated purchase price of $1.0 million based on a royalty fee equal to ten percent of the collected monthly recurring revenues derived from sales of the cloud version of the proprietary call center software and maintenance services. The royalty fee was recognized as a ‘non-current liability’ in the condensed consolidated balance sheet and will be paid on a quarterly basis, commencing as of the first full calendar quarter following the second anniversary of the closing date of this acquisition.  The aggregate purchase price has initially been allocated to the fair value of the assets acquired as follows:
 
The allocation of the purchase price of TFB is as follows:
 
 
 
 
 
 
 
 
Covenant not to compete
  $8,000 
Customer contracts/relationships
    99,000 
Proprietary technology
    889,000 
Accounts receivable
    80,845 
Prepaid asset
    5,535 
Line of credit
    (100,000)
Deferred tax liability
    (693,590)
Goodwill
    722,816 
Purchase price
  $1,011,606 
 
Note 7.     Supplemental Disclosure of Cash Flow Information
 
The following table summarizes the Company’s supplemental cash flows information:
 
 
 
Six Months Ended June 30,
 
Supplemental Cash Flow Information
 
2016
 
 
2015
 
   Cash paid for interest
  $2,750,175 
  $2,680,029 
 
       
       
Supplemental Non-Cash Investing and Financing Activities
       
       
   Property and equipment acquired under capital leases
  $141,240 
  $764,991 
   Dividends on Series B-2 preferred stock paid with the issuance of common stock
  $415,574 
  $606,945 
   Assets acquired for earn-oout liability
  $986,606 
  $- 
 
Note 8.     Prepaid Expenses and Other Current Assets
 
The following table sets forth the items in prepaid expenses and other current assets:
 
 
 
June 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Insurance
  $411,299 
  $93,040 
Rent
    143,064 
    101,916 
Marketing
    136,694 
    109,455 
Sofware subscriptions
    799,045 
    498,078 
Due from seller of Fidelity
    425,963 
    425,963 
Due from factoring party
    - 
    26,018 
Commissions
    77,922 
    20,805 
Escrow receivable
    111,972 
    50,759 
Other
    521,519 
    292,569 
 
  $2,627,478 
  $1,618,603 
 
 
13
 
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 9.      Accounts Payable and Accrued Expenses
 
The following table sets forth the items in accounts payable and accrued expenses:
 
 
 
June 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Trade accounts payable
  $3,278,912 
  $1,101,393 
Accrued bonus
    421,078 
    700,000 
Accrued professional and consulting fees
    165,014 
    274,205 
Accrued property and other taxes
    221,815 
    534,388 
Accrued network costs
    2,697,957 
    3,423,483 
Accrued rent
    107,962 
    82,894 
Accrued universal service fund fees
    787,689 
    494,852 
Customer deposits
    372,391 
    358,227 
Accrued credit card
    79,918 
    384,257 
Accrued payroll and vacation
    367,140 
    555,493 
Accrued sales and federal excise taxes
    2,076,166 
    2,204,098 
Accrued sales commissions
    798,362 
    981,121 
Accrued interest payable
    20,739 
    32,221 
Deferred revenue
    1,473,983 
    1,157,036 
Other
    394,581 
    845,557 
 
  $13,263,707 
  $13,129,225 
 
Note 10.      Equipment Financing Obligations
 
From time to time, the Company enters into equipment financing or capital lease arrangements to finance the purchase of network hardware and software utilized in its operations.  These arrangements require monthly payments over a period of 24 to 48 months with interest rates ranging between 5.3% and 6.6%.  The Company’s equipment financing obligations are as follows:
 
 
 
June 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Equipment financing obligations
  $2,735,871 
  $3,044,796 
Less: current portion
    (991,681)
    (959,380)
Long-term portion
  $1,744,190 
  $2,085,416 
 
14
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 11.     Debt
 
As of June 30, 2016 and December 31, 2015, long-term debt was as follows:
 
Secured Credit Facility
 
In August 2015, the Company entered into a $40.0 million credit facility with Opus Bank, which facility was amended and restated by on December 8, 2015 (the “Opus Facility”).   The Opus Facility consists of a $15.0 million, revolving four-year credit facility, and a $25.0 million, five-year term loan. The maturity date of amounts borrowed under the revolving facility is August 28, 2019, and the maturity date of amounts borrowed under the term loan is August 28, 2020.
 
At June 30, 2016, the Company had outstanding $15.0 million under the revolver and $25.0 million under the term loan.  For the three and six months ended June 30, 2016, under the Opus Facility the Company recognized interest expense of approximately $0.5 million and $1.0 million, respectively, at a monthly interest rate of 4.75%.  The interest rate is calculated as the higher of (a) the rate of interest in effect for such day as publicly announced from time to time by the Wall Street Journal as its “prime rate” (or the average prime rate if a high and a low prime rate are therein reported) plus the Applicable Margin (as defined in the Opus Facility) in effect at such time, or (b) 3.25% plus the Applicable Margin.
 
Pursuant to the Opus Facility the Company must satisfy various customary financial covenants such as borrower leverage ratio, fixed charge coverage ratio, capital expenditures annual limit, minimum adjusted EBITDA, and maximum senior leverage ratio.  For the three and six months ended June 30, 2016, the Company was in compliance with the financial covenants under this facility.
 
Praesidian Facility
 
On December 8, 2015, the Company entered into the Fourth Amended and Restated Securities Purchase Agreement and Security Agreement (the “Fourth Amended SPA”) with the Company’s subordinated lenders (which, collectively with its prior versions is hereinafter referred to as the “Praesidian Facility”). As is the case under the Opus Facility, the Company is required to satisfy similar financial covenants. For the three and six months ended June 30, 2016, the Company was in compliance with the financial covenants under this facility. During the three and six months ended June 30, 2016, under the Fourth Amended SPA the Company paid interest expense of approximately $0.9 million and $1.8 million under the foregoing credit facilities, at an annual interest rate of 10.8%.
  
 
 
June 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Subordinated Notes
  $33,817,310 
  $34,160,200 
Unamortized discount on Subordinated Notes
    (1,532,860)
    (1,697,091)
Unamortized debt issuance costs
    (885,035)
    (981,584)
Total notes payable - non-related parties
    31,399,415 
    31,481,525 
Less: current portion
    (685,780)
    (685,780)
Long-term portion
  $30,713,635 
  $30,795,745 
 
 
15
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Related Party Note Payable
 
The note payable to Marvin Rosen, Fusion’s Chairman of the Board is subordinated to borrowings under the Opus Facility and the Fourth Amended SPA.  This note is unsecured, pays interest monthly at an annual rate of 7%, and matures 120 days after the Company’s obligations under the Opus Facility and the Fourth Amended SPA are paid in full.  
 
 
 
June 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Notes payable to Marvin Rosen
  $1,178,082 
  $1,178,082 
Discount on note
    (78,552)
    (103,253)
Total notes payable - related parties
  $1,099,530 
  $1,074,829 
 
For the six months ended June 30, 2016, the Company recognized interest expense on the Rosen note of approximately $43,000 and amortization discount of approximately $25,000.
 
Note Payable to RootAxcess Seller
 
In connection with the purchase of the assets of RootAxcess, LLC (“RootAxcess”) in September 2015, the Company held back $0.7 million against potential claims arising from breaches of representation and warranties. Of such amount, $0.4 million is to be paid to the seller in six equal installments of $66,667 on the three, six, nine, twelve, fifteen and eighteen month anniversary of the closing date.  In addition, the Company held back $0.3 million to be paid in three equal installments of $100,000 on each of the twelve, fifteen, and eighteen month anniversary of the closing date.  To the extent there is a unresolved claim notice pending (as defined in the asset purchase agreement), the monthly installment payable to seller immediately following the delivery of such claim notice may, at the Company’s reasonable discretion, be reduced by the amount in dispute under the claim notice and such amount will continue to be held by the Company until resolved, at which point, the Company will disburse the withheld amount in accordance with such resolution.
 
On June 30, 2016, the Company made a payment of $66,667 to the sellers in connection with the terms of the purchase agreement. At June 30, 2016, the remaining balance due is $500,000.
 
Note Due to TFB Seller
 
In connection with the purchase of the assets of Technology for Business Corporation (“TFB”) in March 2016, the Company recorded a contingent liability of $1,011,606 (see Note 6). The contingent liability was based on a royalty fee equal to ten percent of the collected monthly recurring revenues to be derived from the sale of the cloud version of the proprietary call center software and maintenance services. In accordance with the terms of the asset purchase agreement, the royalty fees will be paid on a quarterly basis, commencing as of the first full calendar quarter following the second anniversary of the closing date of this acquisition or March 31, 2018 and will continue for a period of 31 calendar quarters. In addition, a portion of the salary paid to the sellers for a period of two years following the acquisition date constitutes an advancement against any royalty fee owed to seller.
 
At June 30, 2016, the outstanding balance is $986,606 net of an advance of $25,000. There were no changes to the contingent liability based on our evaluation of the factors used to determine the fair value of the purchase price.
    
Note 12.    Derivative Liability
 
Fusion has issued warrants to purchase shares of its common stock in connection with certain debt and equity financing transactions. These warrants are accounted for in accordance with the guidance contained in ASC Topic 815, ‘Derivatives and Hedging’ (“ASC 815”).  For warrant instruments that do not meet an exclusion from derivative accounting, the Company classifies the warrant instrument as a liability at its fair value and adjusts the instrument to fair value at each reporting period. This liability is subject to re-measurement at each balance sheet date until the warrant is exercised or expires, and any change in fair value is recognized in the Company’s statement of operations.  In this regard, Fusion has 584,834 outstanding warrants which provide for a downward adjustment of the exercise price if Fusion were to issue common stock at an issuance price, or issue convertible debt or equity securities with an exercise price, that is less than the exercise price for these warrants. In addition, in connection with the sale of certain notes under the original version of the Praesidian Facility, Fusion issued nominal warrants to the original lenders to purchase an aggregate of 728,333 shares of its common stock.  The fair values of these warrants have been estimated using option pricing and other valuation models, and the quoted market price of Fusion’s common stock.
 
16
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
The following assumptions were used to determine the fair value of the warrants for the six months ended June 30, 2016 and 2015:
 
 
 
Six months ended June 30,
 
 
 
2016
 
 
2015
 
Stock price ($)
    1.84 
    2.13 
Exercise price ($)
    6.25 
    0 - 6.25 
Risk-free interest rate (%)
    1.58 
    2.07 - 2.35 
Expected volatility (%)
    94.6 
    112.6 
Time to maturity (years)
    2.75 
    7.30 - 8.50 
 
At June 30, 2016 and December 31, 2015, the fair value of the derivative was $385,990 and $953,005, respectively. For the three months ended June 30, 2016 and 2015, the Company recognized a gain on the change in the fair value of this derivative of approximately $46,000 and $2.5 million, respectively, and a gain of approximately $228,000 and $1.3 million for the six months ended June 30, 2016 and 2015, respectively.
 
During the six months ended June 30, 2016, the Company adjusted the valuation of its derivative liability for warrants issued in December 2013 and January 2014 and for changes to its valuation of warrants exercised during 2015. The amount of the adjustment was $772,022 impact on the condensed consolidated statements of operations resulting from the loss on the change in the fair value of the derivative and $338,972 impact to capital in excess of par in the condensed consolidated balance sheets (see Note 17). The Company has evaluated these adjustments in accordance with ASC 250-10-S99, SEC Materials (formerly SEC Staff Accounting Bulletin 99, Materiality) and concluded that both quantitatively and qualitatively the adjustments were not material. These adjustments were also evaluated by management in their assessment of internal controls over financial reporting.
 
Note 13.    Equity Transactions
 
Common Stock
 
The Company is authorized to issue 50,000,000 shares of its common stock. As of June 30, 2016 and December 31, 2015, 14,975,482 and 12,788,971 shares of its common stock were issued and outstanding, respectively.
 
During the six months ended June 30, 2015, the Company issued 13,250 shares of its common stock to a third party consultant for services rendered, and 30,000 shares of common stock to an employee in lieu of a cash bonus valued of $71,643. In addition, the Board of Directors declared aggregate dividends of $415,574 related to Fusion’s Series B-2 Preferred Stock, which, in accordance with the terms of the Series B-2 Preferred Stock, was paid in the form of 220,909 shares of common stock. In addition, during the three months ended March 31, 2016, certain holders of our Series B-2 Preferred Stock elected to convert their 6,000 shares of preferred stock into an aggregate of 1,866,667 shares of Fusion’s common stock, including 666,667 shares of common stock which were issued as a payment of additional dividends for the conversion of their Series B-2 Preferred Stock holdings into Fusion’s common stock. The additional shares issued were valued at the closing market price at the date of issuance of $1.80 per share or $1.2 million.
 
On May 9, 2016, the Company received a staff determination letter from Nasdaq stating that the Company was not in compliance with its rules for continued listing, Rule 5635(b), because it violated the shareholder approval requirement. The technical violation resulted from the purchase of 1,834,862 shares of the Company’s common stock by Unterberg Technology Partners, L.P. (“Unterberg”) in December 2015, which when aggregated with the common shares underlying of the Company’s Series B Preferred Stock held by Unterberg in February 2016, caused the amount owned by Unterberg to exceed the level allowed by Nasdaq without a prior shareholder vote.   The Nasdaq letter indicated that the Company had forty-five (45) calendar days to submit a plan to regain compliance. 
 
17
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
On July 19, 2016, the Company entered into a Standstill Agreement with Unterberg, and notified Nasdaq that it plans to hold a special meeting of its shareholders to obtain the requisite approval for the Transaction. Consequently, Nasdaq granted the Company an extension of time to regain compliance with the Rule 5635(b).  As such, on or before November 7, 2016, the Company must receive shareholder approval for the Transaction or convert a portion of Unterberg’s holdings into non-voting securities, such that Unterberg no longer has a 20% or greater voting position in the Company. The Company believes that resolution of this matter will not require a cash redemption.
 
Restricted Stock
 
In the quarter ended June 30, 2016, the Company awarded 55,000 shares of restricted stock to its Chief Financial Officer.
 
Preferred Stock
 
The Company is authorized to issue up to 10,000,000 shares of preferred stock. As of June 30, 2016 and December 31, 2015 there was 5,045 shares of Series A Preferred Stock issued and outstanding. In addition, there were 12,279 and 18,279 shares of Series B-2 Preferred Stock issued and outstanding as of June 30, 2016 and December 31, 2015, respectively.
 
The holders of the Series A Preferred Stock are entitled to receive cumulative dividends of 8% per annum payable in arrears, when and if declared by the Fusion’s Board of Directors, on January 1 of each year. As of June 30, 2016, no dividend had been declared by Fusion’s Board with respect to the Series A Preferred Stock, and the Company had accumulated approximately $4.5 million of preferred stock dividends. The holders of the shares of Series B-2 Preferred Stock are entitled to receive a cumulative 6% annual dividend payable quarterly in arrears when and if declared by the Fusion Board of Directors, in cash or shares of Fusion common stock, at the option of the Company.
 
Commencing January 1, 2016, Fusion has the right to force the conversion of the Series B-2 Preferred Stock into Fusion common stock at a conversion price of $5.00 per share; provided that the volume weighted average price for its common stock is at least $12.50 for ten consecutive trading days.
 
Note 14.    Commitments and Contingencies
 
Legal Matters
 
From time to time, the Company may be involved in a variety of claims, lawsuits, investigations and proceedings relating to contractual disputes, employment matters, regulatory and compliance matters, intellectual property rights and other litigation arising in the ordinary course of business.  Defending such proceedings can be costly and can impose a significant burden on management and employees. The Company does not expect that the outcome of any such claims or actions will have a material adverse effect on the Company’s liquidity, results of operations or financial condition. As of June 30, 2016, the Company did not have any significant ongoing legal matters.
 
18
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 15.    Segment Information
 
Operating segments are defined under U.S. GAAP as components of an enterprise for which separate financial information is available and evaluated regularly by a company's chief operating decision maker ("CODM") in deciding how to allocate resources and assess performance.
 
The Company has two reportable segments – “Business Services” and “Carrier Services.”  These segments are organized by the products and services that are sold and the customers that are served.  The Company measures and evaluates its reportable segments based on revenues and gross profit margins.  The Company’s measurement of segment profit exclude the Company’s executive, administrative and support costs.  The accounting policies of the segments are the same as those described in Note 2, Summary of Significant Accounting Policies, of the audited consolidated financial statements included in the 2015 Form 10-K.  The Company’s segments and their principal activities consist of the following:
 
Business Services
 
Through this operating segment, the Company provides cloud voice, cloud connectivity, cloud infrastructure, cloud computing and managed cloud-based applications to businesses of all sizes. These services are sold through the Company’s direct sales force and its partner sales channel, which utilizes the efforts of independent third-party distributors to sell the Company’s products and services. The Business Services segment includes the business acquired from RootAxcess in September 2015, its acquisition of the stock of various Fidelity companies in December, 2015, and its acquisition of TFB completed in March 2016.
 
Carrier Services
 
Carrier Services includes the termination of domestic and international carrier traffic utilizing primarily VoIP technology.  VoIP permits a less costly and more rapid interconnection between the Company and international telecommunications carriers, and generally provides better profit margins for the Company than other technologies.  The Company currently interconnects with approximately 370 carriers and vendors, and is working to expand its interconnection relationships, particularly with carriers in emerging markets.
 
19
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Operating segment information for the three and six months ended June 30, 2016 and 2015 is summarized in the following table:
 
 
Three months ended June 30, 2016      
 
 
Carrier Services
 
 
Business Services
 
 
Corporate
 
 
Consolidated
 
Revenues
  $9,614,629 
  $20,805,662 
  $- 
  $30,420,291 
Cost of revenues (exclusive of depreciation and amortization)
    9,154,522 
    8,090,292 
    - 
    17,244,814 
Gross profit
    460,107 
    12,715,370 
    - 
    13,175,477 
Depreciation and amortization
    46,697 
    2,705,035 
    280,158 
    3,031,890 
Selling, general and administrative expenses
    637,184 
    9,493,429 
    1,139,400 
    11,270,013 
Interest expense
    - 
    1,398,460 
    226,209 
    1,624,669 
Gain on change in fair value of derivative liability
    - 
    - 
    (45,642)
    (45,642)
Other expenses (income)
    - 
    374,932 
    (400,047)
    (25,115)
Net loss
  $(223,774)
  $(1,256,486)
  $(1,200,078)
  $(2,680,338)
Total assets
  $6,991,833 
  $91,846,337 
  $1,661,748 
  $100,499,918 
 
 
Six months ended June 30, 2016           
 
 
Carrier Services
 
 
Business Services
 
 
Corporate
 
 
Consolidated
 
Revenues
  $21,846,295 
    41,758,411 
  $- 
  $63,604,706 
Cost of revenues (exclusive of depreciation and amortization)
    20,854,069 
    16,312,422 
    - 
    37,166,491 
Gross profit
    992,226 
    25,445,989 
    - 
    26,438,215 
Depreciation and amortization
    78,008 
    5,380,556 
    489,589 
    5,948,153 
Selling, general and administrative expenses
    1,329,369 
    18,505,418 
    2,860,012 
    22,694,799 
Interest expense
    - 
    3,096,313 
    156,320 
    3,252,633 
Gain on change in fair value of derivative liability
    - 
    - 
    (228,042)
    (228,042)
Other expenses (income)
    - 
    517,238 
    (532,683)
    (15,445)
Net loss
  $(415,151)
  $(2,053,536)
  $(2,745,196)
  $(5,213,883)
 
       
       
       
       
Capital expenditures
  $41,584 
  $2,283,626 
  $- 
  $2,325,210 
 
 
20
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
 Three months ended June 30, 2015      
 
 
Carrier Services
 
 
Business Services
 
 
Corporate
 
 
Consolidated
 
Revenues
  $9,020,449 
  $16,043,246 
  $- 
  $25,063,695 
Cost of revenues (exclusive of depreciation and amortization)
    7,971,898 
    5,841,717 
    - 
    13,813,615 
Gross profit
    1,048,551 
    10,201,529 
    - 
    11,250,080 
Depreciation and amortization
    45,578 
    2,977,855 
    16,325 
    3,039,758 
Selling, general and administrative expenses
    1,010,593 
    7,728,973 
    1,112,169 
    9,851,735 
Interest expense
    - 
    1,562,134 
    46,575 
    1,608,709 
Gain on change in fair value of derivative liability
    - 
    - 
    (2,510,950)
    (2,510,950)
Other expenses (income)
    - 
    157,532 
    (184,297)
    (26,765)
Net (loss) income
  $(7,620)
  $(2,224,965)
  $1,520,178 
  $(712,407)
Total assets
  $1,719,940 
  $62,469,874 
  $4,781,983 
  $68,971,797 
 
 
 Six months ended June 30, 2015      
 
 
Carrier Services
 
 
Business Services
 
 
Corporate
 
 
Consolidated
 
Revenues
  $17,497,570 
  $32,829,163 
  $- 
  $50,326,733 
Cost of revenues (exclusive of depreciation and amortization)
    15,898,564 
    11,927,743 
    - 
    27,826,307 
Gross profit
    1,599,006 
    20,901,420 
    - 
    22,500,426 
Depreciation and amortization
    90,922 
    5,911,602 
    40,681 
    6,043,205 
Selling, general and administrative expenses
    1,734,049 
    15,731,077 
    2,117,587 
    19,582,713 
Interest expense
    - 
    3,124,361 
    91,191 
    3,215,552 
Gain on change in fair value of derivative liability
    - 
    - 
    (1,306,148)
    (1,306,148)
Other expenses (income)
    - 
    347,908 
    (406,675)
    (58,767)
Net loss
  $(225,965)
  $(4,213,528)
  $(536,636)
  $(4,976,129)
 
       
       
       
       
Capital expenditures
  $31,344 
  $1,827,921 
  $- 
  $1,859,265 
 
Note 16.    Related Party Transactions
 
Since March 6, 2014, the Company has engaged a third party to prepare its tax returns and to provide related tax advisory services. Larry Blum, a member of Fusion’s Board of Directors, is a Senior Advisor and a former partner of that company.
 
 
21
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 17.     Fair Value Disclosures
 
Fair value of financial and non-financial assets and liabilities is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The three-tier hierarchy for inputs used in measuring fair value, which prioritizes the inputs used in the methodologies of measuring fair value for assets and liabilities, is as follows:
 
Level 1—Quoted prices in active markets for identical assets or liabilities
Level 2—Observable inputs other than quoted prices in active markets for identical assets and liabilities
Level 3—No observable pricing inputs in the market
 
The following table represents the fair value of the liability measured at fair value on a recurring basis:
 
 
 
Level 1
 
 
Level 2
 
 
Level 3
 
 
Total
 
As of June 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Non-current liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liability (see note 12)
  $- 
  $- 
  $385,990 
  $385,990 
As of December 31, 2015
       
       
       
       
Non-current liabilities:
       
       
       
       
Derivative liability (see note 12)
  $- 
  $- 
  $953,005 
  $953,005 
 
Changes in the derivative warrant liability for the six months ended June 30, 2016 are as follows:
 
Balance at December 31, 2015
  $953,005 
Gain for the period:
       
  Included in net loss
    (1,000,065)
  Adjustment for prior issuances and conversion of warrants
    433,050(1)
Balance at June 30, 2016
  $385,990 
 
(1) See Note 12
 
22
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Item 2.  Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
The following discussion should be read in conjunction with the information contained in our unaudited consolidated financial statements and the notes thereto appearing elsewhere herein and in conjunction with the Management’s Discussion and Analysis set forth in the 2015 Form 10-K.
 
Certain statements and the discussion contained herein regarding the Company’s business and operations may include “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1996. Such statements consist of any statement other than a recitation of historical fact and can be identified by the use of forward-looking terminology such as “may,” “plans,” “expect,” “anticipate,” “intend,” “estimate” or “continue” or the negative thereof or other variations thereof or comparable terminology. The reader is cautioned that all forward-looking statements are speculative, and there are certain risks and uncertainties that could cause actual events or results to differ from those referred to in such forward-looking statements. The primary risk of the Company is its ability to attract new capital to execute its comprehensive business strategy. There may be additional risks associated with the integration of businesses following an acquisition, the Company’s ability to comply with its senior debt agreements, concentration of revenue from one source, competitors with broader product lines and greater resources, emergence into new markets, natural disasters, acts of war, terrorism or other events beyond the Company’s control and the other factors identified by the Company from time to time in its filings with the SEC.  However, the risks included should not be assumed to be the only risks that could affect future performance.
 
All forward-looking statements included are made as of the date hereof, based on information available to as of the date thereof, and the Company assumes no obligation to update any forward-looking statements.
 
Overview
 
Our Business
 
We offer a comprehensive suite of cloud voice, cloud connectivity, cloud infrastructure, cloud computing and managed cloud-based applications to businesses of all size, and offer domestic and international VoIP services to carriers worldwide.  Our advanced, proprietary cloud services platforms, as well as our state-of-the art switching systems, enable the integration of leading edge solutions in the cloud, increasing customer collaboration and productivity by seamlessly connecting employees, partners, customers and vendors.  We currently operate our business in two distinct business segments: Business Services and Carrier Services.
 
In the Business Services segment, we are focused on becoming our business customers’ single source for leveraging the increasing power of the cloud, providing a robust package of what we believe to be the essential services that form the foundation for their successful migration to, and efficient use of, the cloud.  Our core Business Services products and services include cloud voice and  unified communications as a service (UCaaS), improving communication and collaboration on virtually any device, virtually anywhere, and cloud connectivity services, securely and reliably connecting customers to the cloud with managed network solutions that are designed to increase quality and optimize network efficiency.  Our cloud computing and infrastructure as a service (IaaS) solutions, are designed to provide our larger enterprise customers with a platform on which additional cloud services can be layered.  Complemented by storage solutions, as well as software as a service (SaaS) solutions, such security and business continuity, our advanced cloud offerings allow our larger enterprise customers to experience the increased efficiencies and agility delivered by the cloud.  The Company’s cloud-based services are flexible, scalable and rapidly deployed, reducing our customers’ cost of ownership while increasing their productivity.
 
Through our Carrier Services segment, we have agreements with approximately 370 carrier customers and vendors, through which we sell domestic and international voice services to other carriers throughout the world.  Customers include U.S.-based carriers sending voice traffic to international destinations, and foreign carriers sending traffic to the U.S. and internationally.  We also purchase domestic and international voice services from many of our Carrier Services customers.  Our carrier-grade network, advanced switching platform and interconnections with global carriers on six continents also reduce the cost of global voice traffic and expand service delivery capabilities for our Business Services segment.
 
We manage our business segments based on gross profit and gross margin, which represents net revenue less the cost of revenue, and on net profitability after excluding certain non-cash and non-recurring items.  The majority of our operations, engineering, information systems and support personnel are assigned to either the Business Services or Carrier Services business segment for segment reporting purposes.
 
23
 
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
We continue to increasingly focus our sales and marketing efforts on developing vertically oriented solutions for targeted markets that require the kind of specialized solutions made possible by our state-of-the-art network and advanced services platforms.  Our vertically oriented solutions, which are currently focused on healthcare, legal, hospitality and real estate, offer a substantial opportunity to gain additional market share.   We intend to accelerate the growth of our Business Services segment with the goal of increasing the portion of our total revenue derived from this higher margin and more stable segment.   In addition to lowering the underlying costs of termination, we believe that our Carrier Services segment supports the growth of the Business Services segment by providing enhanced service offerings for business customers and by strengthening its relationships with major service providers throughout the world.
 
Results of Operations
 
Three and Six Months Ended June 30, 2016 Compared with Three and Six Months Ended June 30, 2015
 
The following table summarizes the results of our consolidated operations for the three months ended June 30, 2016 and 2015:
 
 
 
 Three Months Ended June 30,      
 
 
 
2016
 
 
% Revenues
 
 
 2015
 
 
% Revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
  $30,420,291 
    100.0%
  $25,063,695 
    100.0%
Cost of revenues*
    17,244,814 
    56.7%
    13,813,615 
    55.1%
Gross profit
    13,175,477 
    43.3%
    11,250,080 
    44.9%
Depreciation and amortization
    3,031,890 
    10.0%
    3,039,758 
    12.1%
Selling, general and administrative expenses
    11,270,013 
    37.0%
    9,851,735 
    39.3%
Total operating expenses
    14,301,903 
    47.0%
    12,891,493 
    51.4%
Operating loss
    (1,126,426)
    (3.7%)
    (1,641,413)
    (6.5%)
Other (expenses) income:
       
       
       
       
Interest expense
    (1,624,669)
    (5.3%)
    (1,608,709)
    (6.4%)
Gain on change in fair value of derivative liability
    45,642 
    0.2%
    2,510,950 
    10.0%
Other income, net
    25,115 
    0.1%
    26,765 
    0.1%
Total other expenses
    (1,553,912)
    (5.1%)
    929,006 
    3.7%
Loss before income taxes
    (2,680,338)
    (8.8%)
    (712,407)
    -2.8%
Provision for income taxes
    - 
    0%
    - 
    0.0%
Net loss
  $(2,680,338)
    (8.8%)
  $(712,407)
    -2.8%
 
*Exclusive of depreciation and amortization, shown separately below.
 
Three Months Ended June 30, 2016 Compared with Three Months Ended June 30, 2015
 
Revenues
 
Consolidated revenues were $30.4 million during the three months ended June 30, 2016 compared to $25.1 million during the three months ended June 30, 2015, an increase of $5.3 million, or 21.4%.  
 
Revenues from the Business Services segment were $20.8 million for the three months ended June 30, 2016 as compared to $16.0 million for the three months ended June 30, 2015.  The increase is primarily attributable to revenue derived from new customers from our acquisitions of RootAxcess in September 2015 and various Fidelity companies in December 2015.
 
Carrier Services revenue of approximately $9.6 million represents an increase of $0.6 million, or 6.6%, from the same period a year ago. The increase was primarily due to an increase of 45% in the blended rate per minute of traffic terminated, partially offset by a decrease of 26% in the number of minutes of traffic carried during the quarter.
 
24
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Cost of Revenues and Gross Margin
 
Consolidated cost of revenues was $17.2 million for the three months ended June 30, 2016 as compared to $13.8 million for the three months ended June 30, 2015.  The increase was due to costs attributable to revenues derived from the RootAxcess and Fidelity acquisitions during the fourth quarter of 2015, and higher per minute rates for the cost of traffic terminated of 55.8% in the Carrier Services segment.
 
Consolidated gross margin was 43.3% for the three months ended June 30, 2016 compared to 44.9% in the same period for 2015. The decrease is due primarily to approximately $1.2 million of additional costs of traffic terminated by our Carrier Services segment and an increase of approximately $2.2 million in our Business Services segment driven primarily by an increase in total customer services costs as a result of our RootAxcess and Fidelity acquisitions.
 
Gross margin for the Business Services segment was 61.1% for the three months ending June 30, 2016 as compared to 63.6% for the three months ending June 30, 2015. The decrease is due primarily to an increase in costs of revenue driven primarily by an increase in lower margin connectivity services obtained in the Fidelity acquisition.
 
Gross margin for the Carrier Services segment was 4.8% for the three months ended June 30, 2016 as compared to 11.6% in the three months ended June 30, 2015.  The decrease was due to higher cost per minute of traffic terminated of $1.2 million, or 55.8%, over the same period a year earlier.
 
Depreciation and Amortization
 
Depreciation and amortization expense was $3.0 million for the three months ended June 30, 2016 and 2015. For the three months ended June 30, 2016, amortization expense of the intangible assets decreased by approximately $0.5 million from the same period a year ago as a result of some of the intangible assets being fully amortized, and depreciation expense increased by approximately $0.5 million.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses (“SG&A”) for the three months ended June 30, 2016 was $11.3 million as compared to $9.9 million for the three months ended June 30, 2015.  This increase is the result of higher salaries and employee related benefits of approximately $1.3 million driven primarily by increased headcount associated with our acquisitions of Fidelity, RootAxcess and TFB.
 
Interest Expense
 
Interest expense was approximately $1.6 million for the three months ended June 30, 2016 and 2015. For the quarter ended June 30, 2016, we recognized interest expense of approximately $1.4 million related to senior secured borrowings, $21,300 of interest expense on a related party note, $44,000 in interest expense from our capital lease financing program, and approximately $159,000 in interest expense associated with debt discount and debt issuance costs amortization.
 
Change in Fair Value of Derivative Liability
 
During the three months ended June 30, 2016 and 2015, we recognized a gain on the change in fair value of our derivative liabilities in the amount of approximately $46,000 (see Notes 12 and 17) and $2.5 million, respectively. The gain and loss on the derivative are related to the warrants that we issued to our senior lenders in 2012 and 2013 and warrants issued to purchasers of our Series B-2 Preferred Stock, the terms of which cause them to be treated as liabilities and not as equity instruments.  The changes in their fair value are required to be recorded through the statement of operations at each accounting period.  These warrants are valued using an option pricing model and other valuation models, such that increases in Fusion’s stock price result in a higher valuation of the derivative and a charge to our income statement, and decreases in Fusion’s stock price result in a lower valuation and a gain being recorded in our income statement.
 
We may be subject to additional fluctuations in our income statement in 2016 and beyond based on changes in Fusion’s stock price and the corresponding changes in fair value of our derivative liabilities associated with the warrants issued in connection with our Series B-2 Preferred Stock.
 
25
 
  
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Six Months Ended June 30, 2016 Compared with Six Months Ended June 30, 2015
 
The following table summarizes the results of our consolidated operations for the six months ended June 30, 2016 and 2015:
 
 
 Six Months Ended June 30,      
 
 
2016
 
 
% Sales
 
 
2015
 
 
% Sales
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
  $63,604,706 
    100.0%
  $50,326,733 
    100.0%
Cost of revenues*
    37,166,491 
    58.4%
    27,826,307 
    55.3%
Gross profit
    26,438,215 
    41.6%
    22,500,426 
    44.7%
Depreciation and amortization
    5,948,153 
    9.4%
    6,043,205 
    12.0%
Selling, general and administrative expenses
    22,694,799 
    35.7%
    19,582,713 
    38.9%
Total operating expenses
    28,642,952 
    45.0%
    25,625,918 
    50.9%
Operating loss
    (2,204,737)
    (3.5%)
    (3,125,492)
    (6.2%)
Other (expenses) income:
       
       
       
       
Interest expense
    (3,252,633)
    -5.1%
    (3,215,552)
    (6.4%)
Gain on change in fair value of derivative liability
    228,042 
    0.4%
    1,306,148 
    2.6%
Other income, net
    15,445 
    0.0%
    58,767 
    0.1%
Total other expenses
    (3,009,146)
    (4.7%)
    (1,850,637)
    (3.7%)
Loss before income taxes
    (5,213,883)
    (8.2%)
    (4,976,129)
    (9.9%)
Provision for income taxes
    - 
    0%
    - 
    0.0%
Net loss
  $(5,213,883)
    (8.2%)
  $(4,976,129)
    (9.9%)
 
*Exclusive of depreciation and amortization, shown separately below.
 
Revenues
 
Consolidated revenues were $63.6 million for the six months ended June 30, 2016 compared to $50.3 million for the six months ended June 30, 2015, an increase of $13.3 million, or 26.4%.  
 
Revenues from the Business Services segment increased by $9.0 million for the first six months of 2016 to $41.8 million from $32.8 million for the first six months of 2015. The increase is due primarily as the result of new customers from the RootAxcess and Fidelity acquisitions which were completed in the third and fourth quarter of 2015.
 
Carrier Services revenue of $21.8 million represents an increase of $4.3 million, or 24.9%, from a year ago. The increase is the result of a 42.5% increase in the blended rate per minute of traffic terminated offset by a decrease of 12.4% in overall traffic volume of traffic terminated.
 
Cost of Revenues and Gross Margin
 
Consolidated cost of revenues was $37.2 million for the six months ended June 30, 2016 compared to $27.8 million for the six months ended June 30, 2015.  The increase is due to costs attributable to revenues resulting from the RootAxcess and Fidelity acquisitions during the fourth quarter of 2015, and higher per minute rates for the cost of traffic terminated of 49.8% in the Carrier Services segment.
 
Consolidated gross margin was 41.6% in the six months ended June 30, 2016 compared to 44.7% in the six months ended June 30, 2015. The decrease is due primarily to an increase in costs of revenue driven primarily by the inclusion of the Fidelity acquisition and an increase in costs in our Carrier Services segment of $4.9 million as a result of higher per minute rates of the cost of traffic terminated.
 
26
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Gross margin for the Business Services segment was 60.9% for the first six months of 2016 compared to 63.7% for the first six months of 2015. The decrease is due primarily to an increase in costs of revenue driven primarily by an increase in lower margin connectivity services obtained in the Fidelity acquisition.
 
Gross margin for the Carrier Services business segment was 4.5% for the six months ended June 30, 2016 compared to 9.1% in the six months ended June 30, 2015. The decrease was due to higher cost per minute of traffic terminated of $4.9 million, or 49.8%, over the same period a year earlier.
 
Depreciation and Amortization
 
Depreciation and amortization expense was $5.9 million and $6.0 million for the six months ended June 30, 2016 and 2015, respectively. For the six months ended June 30, 2016, amortization expense of the intangible assets decreased by approximately $0.9 million from the same period a year ago as a result of some of the intangible assets being fully amortized, and depreciation expense increased by approximately $0.8 million from the same period a year ago.
 
Selling, General and Administrative Expenses
 
SG&A expenses increased by $3.1 million to $22.7 million for the six months ended June 30, 2016 from $19.6 million for the six months ended June 30, 2015.  This increase is primarily the result of higher salaries and employee related benefits of approximately $3.2 million driven by increased headcount associated with our acquisitions of Fidelity, RootAxcess and TFB.
 
Interest Expense
 
Interest expense was approximately $3.3 million for the six months ended June 30, 2016 and $3.2 million for the same period in 2015. For the six months ended June 30, 2016, we recognized interest expense of approximately $2.8 million related to senior secured borrowings, $42,531 of interest expense on a related party note, $89,000 in interest expense from our capital lease financing program, and approximately $318,000 in interest expense associated with debt discount and debt issuance costs amortization.
 
Change in Fair Value of Derivative Liability
 
The change in fair value of the derivative was a gain of $228,000 in the six months ended June 30, 2016 compared to a gain of $1.3 million the six months ended June 30, 2015.  This change is due to the decrease in Fusion's stock price during these periods, which decreases the value of our derivative liability.
 
Liquidity and Capital Resources
 
Since our inception, we have incurred significant net losses. At June 30, 2016, we had working capital deficit of approximately $1.2 million and stockholders’ equity of $10.1 million.  At December 31, 2015, we had working capital of $1.7 million and stockholders’ equity of approximately $14.5 million.  Our consolidated cash balance at June 30, 2016 was $3.8 million as compared to $7.5 million at December 31, 2015.  While we believe we have sufficient cash to fund our operations and meet our operating and debt obligations for the next twelve months, we may be required to raise additional capital to support our business plan. There can be no assurances that such funds will be available to the Company as and when needed or on terms deemed by us to be acceptable.  
 
We have never paid cash dividends on our common stock, and we do not anticipate paying cash dividends on our common stock in the foreseeable future. We intend to retain all of our earnings, if any, for general corporate purposes, and, if appropriate, to finance the expansion of our business. Subject to the rights of holders of our outstanding preferred stock, any future determination to pay dividends is at the discretion of Fusion’s Board of Directors, and will be dependent upon our financial condition, operating results, capital requirements, general business conditions, the terms of our credit facilities, limitations under Delaware law and other factors that Fusion’s Board of Directors and senior management consider appropriate.
 
The holders of our Series A Preferred Stock are entitled to receive cumulative dividends of 8% per annum payable in arrears, as and if declared by Fusion’s Board of Directors. The holders of our Series B-2 Preferred Stock are entitled to receive quarterly dividends at an annual rate of 6%.  These dividends can be paid, at the Company’s option, either in cash or, under certain circumstances, in shares of Fusion’s common stock.
 
27
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Through June 30, 2016, Fusion’s Board had never declared dividends on any series of the Series A Preferred Stock, and, as a result, the Company had accumulated approximately $4.5 million of preferred stock dividends. The Fusion Board of Directors declared a dividend of $184,215 for the three months ended June 30, 2016 on the Series B-2 Preferred Stock, which, as permitted by the terms of the Series B-2 Preferred Stock, was paid in the form of 95,630 shares of Fusion’s common stock.
 
Secured Credit Facility
 
In December 2015, the Company entered into the Opus Facility, which facility amended and restated, in its entirety, the $40.0 million credit facility originally entered into by the Company with Opus Bank in August 2015.  The Opus Facility consists of a $15.0 million revolving credit facility and a $25.0 million term loan.  All borrowings under the Opus Facility bear interest at a rate equal to the higher of (a) the rate of interest in effect for such day as publicly announced from time to time by the Wall Street Journal as its “prime rate” (or the average prime rate if a high and a low prime rate are therein reported) plus the Applicable Margin then in effect at such time, or (b) 3.25% plus the Applicable Margin and are secured by a first priority security interest in all of the assets of Fusion and its subsidiaries, including the capital stock of each such subsidiary. Under the Opus Facility, “Applicable Margin” is calculated based on the ratio of Senior Indebtedness to Adjusted EBITDA (each as defined in the Opus Facility) and ranges from 1.25% to 2.00% based on the ratio level.  In addition, subject to certain limitations, Fusion and certain of its subsidiaries have guaranteed the obligations of the borrower (“Fusion NBS Acquisition Corp.”) under the Opus Facility, including its obligations to repay all borrowings. The maturity date of amounts borrowed under the credit facility is four years or August 28, 2019, and the maturity date of any amounts borrowed under the term loan is August 28, 2020.  The Opus Facility contains a number of affirmative and negative covenants, including but not limited to, restrictions on paying indebtedness subordinate to borrowings under the Opus Facility, incurring additional indebtedness, making capital expenditures, dividend payments and cash distributions by subsidiaries. The Opus Facility also requires on-going compliance with various financial covenants, including a maximum senior leverage ratio, fixed charge coverage ratio and minimum levels of earnings before interest, taxes, depreciation and amortization. Effective December 31, 2015, the Company’s obligation to maintain a minimum unencumbered cash bank balance of no less than $1.0 million at all times was eliminated.
 
At June 30, 2016, we have outstanding $15.0 million under the Opus Facility and $25.0 million under the term loan.  The Company paid monthly interest at a rate of 4.75%, and paid interest expense of $480,278 and $960,556 during the three and six months ended June 30, 2016, respectively.  As of June 30, 2016, we were in compliance with all the financial covenants in the Opus Facility.
 
Praesidian Facility
 
Simultaneous with the execution of the Opus Facility, the Company executed the Fourth Amended SPA which forms a part of the Praesidian Facility. The Fourth Amended SPA amended and restated the terms of the Third Amended and Restated Securities Purchase Agreement and Security Agreement (the “Third Amendment”).   Specifically, the Fourth Amended SPA amended the Third Amendment to (i) provide the consent of the continuing lenders to the acquisition of Fidelity (ii) add Fidelity as a guarantor and credit party under the Praesidian Facility, and (iii) modify or eliminate certain of the financial covenants contained in the Third Amendment, including the requirement to maintain a minimum unencumbered cash bank balance of $1.0 million at all times. As of June 30, 2016, we were in compliance with all the financial covenants in the Fourth Amended SPA.
 
 The following notes have been issued by us under the Praesidian Facility:
 
Series A and B Notes.  The Company sold $6.5 million aggregate principal amount of Series A notes, and $10.0 million aggregate principal amount of Series B notes in October 2012, the proceeds of which were used to finance our acquisition of Network Billing Systems, LLC.
 
Series C and D Notes. The Company sold $0.5 million aggregate principal amount of Series C notes and $25.0 million aggregate principal amount of Series D notes in December 2013, to finance our acquisition of certain assets of Broadvox.
 
Series E Notes. The Company sold $5.0 million aggregate principal amount of Series E notes in October 2014 to fund our acquisition of PingTone Communications Inc.
 
Series F Notes.  The Company sold $9.0 million aggregate principal amount of Series F notes in August 2015 to retire a portion of the approximately $20.0 million of notes held by one of the original lenders.
 
 
28
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
At June 30, 2016, we had approximately $34.0 million principal amount of notes outstanding under the Fourth Amended SPA. In accordance with the terms of the Fourth Amended SPA, the notes bear interest at an annual rate of 10.8%, with monthly principal payments of approximately $57,148 with the outstanding principal balance on all the notes payable at maturity on February 28, 2021.
 
For the three months ended June 30, 2016 and 2015, we paid interest expense on the notes of approximately $1.0 million and $1.3 million, respectively, and $1.8 million and $2.6 million for the six months ended June 30, 2016 and 2015, respectively.
 
Related Party Note Payable
 
We have a note payable outstanding of approximately $1.2 million to Marvin Rosen, the Chairman of Fusion’s Board of Directors.  This note is subordinated to all amounts borrowed under the Opus Facility and the Fourth Amended SPA.  This note is unsecured, pays interest monthly at an annual rate of 7%, and matures 120 days after all borrowings under the Opus Facility and the Fourth Amended SPA are paid in full. For the quarter ended June 30, 2016, the Company recognized interest expense on this note of approximately $21,300.
 
We have entered into various capital lease agreements to finance the purchase of property and equipment, at interest rates generally ranging from 5.3% to 6.6%.   During the six months ended June 30, 2016, we paid $497,422 scheduled principal payments under these leases and approximately $89,000 in interest expense.
 
The following table sets forth a summary of our cash flows for the periods indicated:
 
 
 
Six Months Ended June 30,
 
 
  2016 
 
2015
 
 
 
 
 
 
 
 
Net cash (used in) provided by operating activities
  $(940,628)
  $498,045 
Net cash used in investing activities
    (1,802,360)
    (1,859,265)
Net cash used in financing activities
    (998,644)
    (665,605)
Net decrease in cash and cash equivalents
    (3,741,632)
    (2,026,825)
Cash and cash equivalents, beginning of period
    7,540,543 
    6,444,683 
Cash and cash equivalents, end of period
  $3,798,911 
  $4,417,858 
 
Cash used in operating activities was $0.9 million for the six months ended June 30, 2016, compared to cash provided by operating activities of $0.5 million during the six months ended June 30, 2015.  
 
The following table illustrates the primary components of our cash flows from operations:
 
 
 
Six Months Ended June 30,
 
 
 
2016
 
 
2015
 
Net loss
  $(5,213,883)
  $(4,976,129)
Non-cash expenses, gains and losses
    6,699,549 
    5,924,126 
Accounts receivable
    (254,925)
    (305,135)
Accounts payable and accrued expenses
    (691,178)
    156,308