Quarterly report pursuant to Section 13 or 15(d)

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

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1. Basis of Presentation, Consolidation, and Summary of Selected Significant Accounting Policies
6 Months Ended
Jun. 30, 2014
Notes to Financial Statements  
1. Basis of Presentation, Consolidation, and Summary of Selected Significant Accounting Policies

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, 2013 for Fusion Telecommunications International, Inc. (“Fusion”) 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 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 six months ended June 30, 2014 and 2013, 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.

 

Reverse split of common stock

On April 9, 2014, the Company’s Board of Directors approved amendments to the Company’s Certificate of Incorporation to (a) effect a reverse stock split of all of the outstanding shares of the Company’s common stock at a ratio (the “Reverse Split Ratio”) of one for fifty (the “Reverse Stock Split”) and (b) a corresponding reduction in the number of shares of common stock that the Company is authorized to issue from 900,000,000 to 18,000,000.  The Certificate of Amendment, which was approved by the Company’s stockholders on March 28, 2014, became effective on May 13, 2014, and at that time the Reverse Stock Split took place and each 50 shares of outstanding common stock of the Company was combined and automatically converted into one share of the Company’s common stock, with a par value of $0.01 per share.  In addition, the conversion and exercise prices of all of the Company’s outstanding preferred stock, common stock purchase warrants and options to purchase common stock were proportionately adjusted at the Reverse Split Ratio consistent with the terms of such instruments.  No fractional shares were issued as a result of the Reverse Stock Split, and any fractional share to which a stockholder may have been entitled as a result of the Reverse Stock Split was rounded up to the nearest whole share.

 

As a result of the Reverse Stock Split, all share and per share amounts as of December 31, 2013, as well as for the three and six months ended June 30, 2013, have been restated at the Reverse Split Ratio to give effect to the Reverse Stock Split.

 

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 June 30, 2014 and December 31, 2013.  The Company is subject to income tax examinations by major taxing authorities for all tax years since 2010 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, 2014 and December 31, 2013.  During the three and six month periods ended June 30, 2014 and 2013, the Company recognized no adjustments for uncertain tax positions.

 
Earnings 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 six months ended June 30, 2014, the diluted loss per share computation reflects a decrease in the loss attributable to common stockholders of approximately $688,000 for the gain on fair value of the Company’s derivative liability that was attributable to outstanding in-the-money warrants (see note 6).

 

For the three months ended June 30, 2013, the computation of diluted earnings per share was as follows:

 

Numerator:      
Income available to common stockholders   $ 1,585,424  
   Dividends on Series A-1, A-2 and A-4 Convertible Preferred Stock     100,349  
    $ 1,685,773  
         
Denominator:        
Weighted-average shares outstanding - basic     3,917,341  
Dilutive effect of employee stock options     192  
Dilutive effect of common stock purchase warrants     271,042  
Dilutive effect of Convertible Preferred Stock     1,404,971  
Weighted-average shares outstanding - diluted     5,593,546  

 

For the six months ended June 30, 2014 and 2013, the following securities were excluded in the calculation of diluted loss per share because their inclusion would be antidilutive:

 

    2014     2013  
Warrants     3,565,583       1,980,542  
Stock options     386,333       174,457  
Convertible preferred stock     4,726,572       1,404,971  
      8,678,488       3,559,970  

 

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 $100,000 for the three months ended June 30, 2014 and 2013, and approximately $200,000 for the six months ended June 30, 2014 and 2013.  As of June 30, 2014, the Board of Directors had not declared any dividends on the Company’s Series A Preferred Stock, and the Company had accumulated approximately $3,730,000 of preferred stock dividends.  The Board of Directors has declared dividends for the three and six months ended June 30, 2014 of $342,570 and $685,140, respectively, in connection with the Company’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 56,506 and 122,833 shares, respectively, of the Company’s common stock.

 

Sale of accounts receivable

The Company has an agreement to sell certain of its accounts receivable under an arrangement with a third party.  The Company records a loss on sale of accounts receivable at the time the receivables are sold for the difference between the book value of the receivables transferred and their respective purchase price.  During the year ended December 31, 2013, the Company accounted for the sales of its accounts receivable as sales of financial assets and derecognized them from its consolidated balance sheet as of the date of sale. In connection with the preparation of its June 30, 2014 consolidated financial statements, the Company determined that although the rights, title and interest of these receivables belong to the transferee, these transfers do not meet all of the criteria outlined in Accounting Standards Codification Topic (“ASC”) 860, Transfers and Servicing.  The Company had derecognized $0.9 million of such receivables as of December 31, 2013, and the Company believes this difference was not material to its consolidated balance sheet as of that date.  At June 30, 2014 the Company recorded accounts receivable and recognized a note payable to unrelated parties in the amount of $1.1 million (see note 6) for the amount of uncollected receivables that had been transferred.

 

The Company recognized losses on the sale of accounts receivable in the three and six months ended June 30, 2014 of approximately $53,000 and $94,000, respectively.  For the three and six months ended June 30, 2013, the Company recognized losses on the sale of accounts receivable of approximately $45,000 and $129,000, respectively.  These amounts are recorded in Other income (expenses) in the accompanying consolidated statements of operations.  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

Goodwill is the excess of the acquisition cost of businesses over the fair value of the identifiable net assets acquired, and consists of $2.6 million of goodwill recognized in the acquisition of Network Billing Systems, LLC (“NBS”) on October 29, 2012, with the remainder resulting from the Broadvox Transaction described more fully in note 2.  Goodwill at June 30, 2014 and December 31, 2013 was approximately $5.2 million and $5.1 million, respectively.  Goodwill is not amortized but is instead tested annually for impairment.  All of the Company’s goodwill is attributable to its Business Services business segment.  The following table presents the change in goodwill during the six months ended June 30, 2014.  There was no change in goodwill during the six months ended June 30, 2013:

 

Balance at

January 1, 2014

    Additions     Other (a)    

Balance at 

June 30, 2014

 
$ 5,124,130       -       97,958     $ 5,222,088  
                             

 

(a) - Amount relates to adjustments to the preliminary purchase price for acquisitions completed on December 31, 2013.

 

Impairment of Long-Lived Assets

The Company reviews long-lived assets, including intangible assets, for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be fully recoverable.  If an impairment indicator is present, the Company evaluates recoverability by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated by the assets.  If the carrying value of the asset exceeds the projected undiscounted cash flows, the Company is required to estimate the fair value of the asset and recognize an impairment charge to the extent that the carrying value of the asset exceeds its estimated fair value.  The Company did not record any impairment charges for the six months ended June 30, 2014 and 2013.

 

Impairment testing for goodwill is performed annually in the Company’s fourth fiscal quarter.  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.

 

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 six month ended June 30, 2014 and 2013 includes compensation expense for stock-based payment awards granted prior to June 30, 2014 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 operations for the three and six months ended June 30, 2014 was approximately $73,000 and $142,000, respectively.  Stock-based compensation expense for the three and six months ended June 30, 2013 was approximately $28,000 and $56,000, 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, 2014:

 

(unaudited)  
   

Number of

Options

    Weighted Average Exercise Price  
Balance at December 31, 2013     351,464     $ 16.29  
Shares granted during the period     37,450     $ 6.67  
Shares exercised during the period     -     $ -  
Shares forfeited during the period     (1,996 )   $ 6.23  
Shares expired during the period     (585 )   $ 9.72  
Shares outstanding at June 30, 2014     386,333     $ 15.42  
Shares exercisable at June 30, 2014     130,460     $ 36.31  

 

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)  
    Six Months Ended June 30,  
    2014     2013  
Dividend yield     0 %     0 %
Stock volatility     137.2 %     137.2 %
Average Risk-free interest rate     2.34 %     0.52 %
Average option term (years)     8.08       4  

 

As of June 30, 2014, there was approximately $647,000 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 2.14 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 $33,000 and $6,000 for the three months ended June 30, 2014 and 2013, and approximately $77,000 and $15,000 for the six months ended June 30, 2014 and 2013, 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 periods.  Actual results could be affected by the accuracy of those estimates.

 

Restricted cash

Restricted cash at June 30, 2014 and December 31, 2013 includes $1,000,000 of cash held in reserve as required by the terms of the Company’s senior lending agreement (see note 6), and certificates of deposit collateralizing a letter of credit in the aggregate amount of approximately $164,000.  The letter of credit is required as security for one of the Company’s non-cancelable operating leases for office facilities.