Quarterly report pursuant to sections 13 or 15(d)

1. Basis of Presentation, Consolidation, and Summary of Selected Significant Accounting Policies (Policies)

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1. Basis of Presentation, Consolidation, and Summary of Selected Significant Accounting Policies (Policies)
9 Months Ended
Sep. 30, 2013
Notes to Financial Statements  
Basis of Presentation, Consolidation

The accompanying unaudited condensed consolidated interim financial statements and notes thereto should be read in conjunction with the audited consolidated financial statements included in the Annual Report on Form 10-K for the fiscal year ended December 31, 2012 for Fusion Telecommunications International, Inc. and its Subsidiaries (collectively, the “Company”).  These condensed consolidated interim financial statements have been prepared in accordance with the instructions to Form 10-Q and Article 8 of Regulation S-X of the United States Securities and Exchange Commission (the “SEC”) and therefore omit or condense certain footnotes and other information normally included in condensed consolidated interim financial statements prepared in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”).  All material intercompany balances and transactions have been eliminated in consolidation.  In the opinion of the Company’s management, all adjustments (consisting of normal recurring accruals) considered necessary for the fair presentation of the condensed consolidated interim financial statements have been made. The results of operations for an interim period are not necessarily indicative of the results for the entire year.

 

During the three and nine months ended September 30, 2013 and 2012, comprehensive loss was equal to the net loss amounts presented for the respective periods in the accompanying condensed consolidated interim statements of operations.  In addition, certain prior year balances have been reclassified to conform to the current presentation.

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.

 

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 September 30, 2013 and December 31, 2012.  The Company is subject to income tax examinations by major taxing authorities for all tax years since 2009 and 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 September 30, 2013 and December 31, 2012.  During the three month periods ended September 30, 2013 and 2012, the Company recognized no adjustments for uncertain tax positions.

Earnings per share

The Company complies with the accounting and disclosure requirements regarding earnings (loss) per share. Basic earnings per share excludes dilution and is computed by dividing earnings attributable to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income of the Company.

 

For the three and nine months ending September 30, 2013 and 2012, the following securities were excluded in the calculation of diluted loss per share because their inclusion would be antidilutive:

 

    2013     2012  
Warrants     114,495,924       51,372,711  
Stock options     17,662,583       6,418,261  
Convertible preferred stock     7,669,838       7,299,510  
      139,828,345       65,090,482  

 

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 in the approximate amount of $101,000 for the three months ended September 30, 2013 and 2012, and approximately $301,000 and $302,000 for the nine months ended September 30, 2013 and 2012, respectively.  As of September 30, 2013, the Board of Directors had not declared any dividends on the Company’s preferred stock, and the Company had accumulated approximately $3,428,000 of preferred stock dividends.

Sale of accounts receivable

The Company has an agreement to sell certain of its accounts receivable under an arrangement with a third party.  These transactions qualify as sales of financial assets under the criteria outlined in Accounting Standards Codification Topic (“ASC”) 860, Transfers and Servicing, in that the rights, title and interest to the receivables are transferred.  As a result, the Company accounts for the sales of its accounts receivable by derecognizing them from its consolidated balance sheet as of the date of sale and recording a loss on sale at the time the receivables are sold for the difference between the book value of the receivables sold and their respective purchase price.

 

The Company recognized a loss on the sale of accounts receivable in the three and nine months ended September 30, 2013 of approximately $47,000 and $176,000, respectively.  For the three and nine months ended September 30, 2012 the Company recognized a loss on the sale of accounts receivable of approximately $66,000 and $235,000, respectively, and approximately $0.9 million and $2.4 million of the Company’s outstanding accounts receivable have been derecognized from the Company’s consolidated balance sheet as of September 30, 2013 and December 31, 2012, respectively.   The Company’s obligations to the purchaser of the receivables under the agreement are secured by a first priority lien on the accounts receivable of the Company’s Carrier Services business segment, and by a subordinated security interest on the other assets of the Company’s Carrier Services business segment.  Based on the Company’s evaluation of the creditworthiness of the customers whose receivables the Company sells under this arrangement, the Company does not believe that there is any significant credit risk related to those receivables.

Goodwill

At September 30, 2013 and December 31, 2012, the Company had goodwill in the amount of $2.6 million and $2.4 million, respectively, consisting of the excess of the acquisition cost over the fair value of the identifiable net assets acquired in connection with the Company’s acquisition of Network Billing Systems, LLC (“NBS”) on October 29, 2012.  Impairment testing for goodwill is performed annually in the Company’s fourth fiscal quarter or when indications of an impairment exist.  The Company has the option to perform a qualitative assessment to determine if the fair value of the entity is less than its carrying value. The impairment test for goodwill uses a two-step approach, which is performed at the reporting unit level. The Company has determined that its reporting units are its operating segments since that is the lowest level at which discrete, reliable financial and cash flow information is available. Step one compares the fair value of the reporting unit (calculated using a market approach and/or a discounted cash flow method) to its carrying value. If the carrying value exceeds the fair value, there is a potential impairment and step two must be performed. Step two compares the carrying value of the reporting unit’s goodwill to its implied fair value, which is the fair value of the reporting unit less the fair value of the unit’s assets and liabilities, including identifiable intangible assets. If the implied fair value of goodwill is less than its carrying amount, an impairment is recognized.  The Company did not record any impairment charges during the nine months ended September 30, 2013.

 

During the nine months ending September 30, 2013, the Company recorded an adjustment to the fair value of the accounts receivable of NBS as of the date of acquisition, with a corresponding increase to goodwill, in the amount of $0.2 million.

Stock based compensation

The Company accounts for stock-based compensation by recognizing the fair value of the compensation cost for all stock awards over their respective service periods, which are generally equal to the vesting period.  This compensation cost is determined using option pricing models intended to estimate the fair value of the awards at the date of grant using the Black-Scholes option-pricing model.  An offsetting increase to stockholders' equity is recorded equal to the amount of the compensation expense charge.

 

Stock-based compensation expense recognized in the condensed consolidated interim statements of operations for the three and nine months ended September 30, 2013 and 2012 includes compensation expense for stock-based payment awards granted prior to September 30, 2013 but not yet vested, based on the estimated grant date fair value.  As stock-based compensation expense recognized in the condensed consolidated statements of operations is based on awards ultimately expected to vest, it has been reduced for estimated forfeitures. When estimating forfeitures, the Company considers historical forfeiture rates as well as ongoing trends for actual option forfeiture.

 

The impact of stock-based compensation expense on the Company’s results of continuing operations was approximately $51,000 and $32,000 for the three months ended September 30, 2013 and 2012, respectively, and approximately $107,000 and $101,000 for the nine months ended September 30, 2013 and 2012, 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 nine months ended September 30, 2013:

 

Activity  

(unaudited)

Number of Options

   

Weighted Average Exercise

Price

 
Outstanding at December 31, 2012     8,864,261     $ 0.58  
Granted     9,043,610     $ 0.08  
Forfeitures in 2013     (152,625 )   $ 0.11  
Expirations in 2013     (92,663 )   $ 1.03  
Outstanding at September 30, 2013     17,662,583     $ 0.33  
Exercisable at September 30, 2013     5,295,100     $ 0.89  

 

The Company calculated the fair value of each common stock option grant on the date of grant using the Black-Scholes option-pricing model method with the following assumptions:

 

    (unaudited)  
    Nine Months Ended September 30,  
    2013     2012  
Dividend yield     0.00 %     0.00 %
Stock volatility     137.2 %     111.2-148.7 %
Average Risk-free interest rate     0.68 %     0.25-0.28 %
Average option term (years)     3       4  

 

As of September 30, 2013, there was approximately $631,000 of total unrecognized compensation cost, net of estimated forfeitures, related to stock options granted under the Company’s Stock Incentive Plans, which is expected to be recognized over a weighted-average period of 2.57 years.

Advertising and Marketing

Advertising and marketing expense includes cost for promotional materials and trade show expenses for the marketing of the Company’s business products and services. Advertising and marketing expenses were approximately $9,000 and $0 for the three months ended September 30, 2013 and 2012, respectively, and approximately $25,000 and $8,000 for the nine months ended September 30, 2013 and 2012, respectively.

Fair value of financial instruments

The carrying amounts of the Company’s assets and liabilities approximate the fair value presented in the accompanying Condensed Consolidated Balance Sheets, due to their short-term maturities.

Use of estimates

The preparation of condensed consolidated interim financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the condensed consolidated interim financial statements and the reported amounts of revenues and expenses during the period.  Actual results could be affected by the accuracy of those estimates.

Restricted cash

Restricted cash at September 30, 2013 and December 31, 2012 includes $232,325 and $1,000,000 of cash held in reserve as required by the terms of the Company’s senior lending agreement (see notes 2 and 7), and certificates of deposit collateralizing a letter of credit in the aggregate amount of $163,711 and $26,326 at September 30, 2013 and December 31, 2012, respectively.  The letter of credit is required as security for one of the Company’s non-cancelable operating leases for office facilities.  The restricted cash balance at September 30, 2013 includes $122,500 of cash held in escrow from private placement efforts for which shares of the Company’s equity securities have not been issued.  The consolidated balance sheet at September 30, 2013 includes a corresponding escrow payable representing the Company’s obligation to issue such securities.