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 September 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: November 14, 2016.
 
Title of Each Class
Number of Shares Outstanding
Common Stock, $0.01 par value
18,062,879
 
 

 
 
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
TABLE OF CONTENTS
 
Part 1 Financial Information.
 3
Item 1. Financial Statements.
 3
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
24
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
 31
Item 4. Controls and Procedures.
 31
Part II Other Information.
 31
Item 1. Legal Proceedings.
 31
Item 1A. Risk Factors.
 32
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.
 32
Item 3. Defaults Upon Senior Securities.
 32
Item 4. Mine Safety Disclosures.
 32
Item 5. Other Information.
 32
Item 6. Exhibits.
 32
Signatures.
 33
Index to Exhibits
 34
 
 
 
 
2
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
PART 1 FINANCIAL INFORMATION
Item 1. Financial Statements.
 
Condensed Consolidated Balance Sheets
 
 
 
September 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
(unaudited)
 
 
 
 
ASSETS
 
 
 
 
 
 
Current assets:
 
 
 
 
 
 
Cash and cash equivalents
 $882,040 
 $7,540,543 
Accounts receivable, net of allowance for doubtful accounts of $366,422 and $308,813, respectively
  8,199,522 
  7,650,141 
Prepaid expenses and other current assets
  2,457,736 
  1,618,603 
Total current assets
  11,539,298 
  16,809,287 
Property and equipment, net
  12,929,148 
  14,055,493 
Other assets:
    
    
Security deposits
  548,288 
  575,038 
Restricted cash
  27,153 
  165,123 
Goodwill
  28,049,775 
  27,060,297 
Intangible assets, net
  42,727,552 
  45,824,399 
Other assets
  302,053 
  281,045 
Total other assets
  71,654,821 
  73,905,902 
TOTAL ASSETS
 $96,123,267 
 $104,770,682 
 
    
    
LIABILITIES AND STOCKHOLDERS' EQUITY
    
    
Current liabilities:
    
    
Notes payable - non-related parties
 $685,780 
 $685,780 
Due to RootAxcess seller
  333,334 
  300,000 
Due to TFB seller
  100,000 
  - 
Equipment financing obligations
  997,089 
  959,380 
Accounts payable and accrued expenses
  12,610,885 
  13,129,225 
Total current liabilities
  14,727,088 
  15,074,385 
Long-term liabilities:
    
    
Notes payable - non-related parties, net of discount
  30,672,580 
  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
  861,606 
  - 
Notes payable - related parties
  1,112,445 
  1,074,829 
Equipment financing obligations
  1,492,558 
  2,085,416 
Derivative liabilities
  233,934 
  953,005 
Total liabilities
  89,100,211 
  90,316,713 
Commitments and contingencies
    
    
Stockholders' equity (deficit):
    
    
Preferred stock, $0.01 par value, 10,000,000 shares authorized,
    
    
17,299 and 23,324 shares issued and outstanding
  173 
  233 
Common stock, $0.01 par value, 50,000,000 shares authorized,
    
    
15,064,953 and 12,788,971 shares issued and outstanding
  150,650 
  127,889 
Capital in excess of par value
  185,764,507 
  184,859,084 
Accumulated deficit
  (178,892,274)
  (170,533,237)
Total stockholders' equity
  7,023,056 
  14,453,969 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 $96,123,267 
 $104,770,682 
 
    
    
 
The accompanying notes are an integral part of the consolidated financial statements.
 
 
3
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(Unaudited)

 
 
Three Months Ended September 30,
 
 
Nine Months Ended September 30,
 
 
 
2016
 
 
2015
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 $29,497,129 
 $24,530,824 
 $93,101,835 
 $74,857,557 
Cost of revenues (exclusive of depreciation and amortization, shown separately below)
  16,769,587 
  13,533,647 
  53,936,078 
  41,359,955 
Gross profit
  12,727,542 
  10,997,177 
  39,165,757 
  33,497,602 
Depreciation and amortization
  2,998,628 
  3,140,427 
  8,946,781 
  9,183,632 
Selling, general and administrative expenses
  11,408,048 
  9,796,483 
  34,102,847 
  29,379,196 
Total operating expenses
  14,406,676 
  12,936,910 
  43,049,628 
  38,562,828 
Operating loss
  (1,679,134)
  (1,939,733)
  (3,883,871)
  (5,065,226)
Other (expenses) income:
    
    
    
    
Interest expense
  (1,625,195)
  (1,434,734)
  (4,877,828)
  (4,650,286)
Gain on change in fair value of derivative liability
  152,057 
  1,237,730 
  380,099 
  2,543,878 
Loss on extinguishment of debt
  - 
  (2,720,355)
  - 
  (2,720,355)
Other income (expense), net
  18,069 
  (2,399)
  33,514 
  56,369 
Total other expenses
  (1,455,069)
  (2,919,758)
  (4,464,215)
  (4,770,394)
Loss before income taxes
  (3,134,203)
  (4,859,491)
  (8,348,086)
  (9,835,620)
Provision for income taxes
  (10,951)
  - 
  (10,951)
  - 
Net loss
  (3,145,154)
  (4,859,491)
  (8,359,037)
  (9,835,620)
Preferred stock dividends
  (285,646)
  (379,740)
  (2,102,467)
  (1,186,826)
Net loss attributable to common stockholders
 $(3,430,800)
 $(5,239,231)
 $(10,461,504)
 $(11,022,446)
Basic and diluted loss per common share
 $(0.23)
 $(0.72)
 $(0.72)
 $(1.52)
Weighted average common shares outstanding:
    
    
    
    
Basic and diluted
  14,990,816 
  8,958,815 
  14,536,893 
  8,529,642 
 
See accompanying notes to the Condensed Consolidated Financial Statements.
 
 
4
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Condensed Consolidated Statement of Stockholders’ Equity
(Unaudited)
 
 
 
Preferred Stock
 
 
Common Stock
 
 
Capital in Excess of Par
 
 
Accumulated Deficit
 
 
Stockholders' Equity
 
 
 
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
    
    
    
    
    
  (8,359,037)
  (8,359,037)
Conversion of preferred stock into
    
    
    
    
    
    
    
   common stock, including dividends
  (6,025)
  (60)
  1,871,667 
  18,717 
  (18,657)
    
  - 
Dividends on preferred stock
    
    
  343,510 
  3,435 
  (3,435)
    
  - 
Adjustment for prior issuances and
    
    
    
    
    
    
  - 
   conversion of warrants
    
    
    
    
  338,972 
    
  338,972 
Adjustment for fractional shares
    
    
  685 
  8 
  (8)
    
  - 
Cancellation of common stock issued
    
    
    
    
    
    
    
   to PingTone sellers
    
    
  (51,380)
  (514)
  (179,830)
    
  (180,344)
Issuance of restricted stock
    
    
  55,000 
  550 
  99,000 
    
  99,550 
Issuance of common stock for services
    
    
    
    
    
    
    
   rendered
    
    
  56,500 
  565 
  96,385 
    
  96,950 
Stock-based compensation associated
    
    
    
    
    
    
    
   with stock incentive plans
    
    
    
    
  572,996 
    
  572,996 
Balance at September 30, 2016
  17,299 
 $173 
  15,064,953 
 $150,650 
 $185,764,507 
 $(178,892,274)
 $7,023,056 
 
See accompanying notes to the Condensed Consolidated Financial Statements.
 
 
5
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(Unaudited)
 
 
 
Nine Months Ended September 30,
 
 
 
2016
 
 
2015
 
Cash flows from operating activities:
 
 
 
 
 
 
Net loss
 $(8,359,037)
 $(9,835,620)
Adjustments to reconcile net loss to net cash provided by operating activities:
    
    
Depreciation and amortization
  8,946,781 
  9,183,632 
Loss on extinguishment on debt
  - 
  2,720,355 
Loss on accounts receivable settlement exchanged for equipment
  - 
  111,659 
Loss on disposal of property
  86,777 
  - 
Bad debt expense
  215,000 
  373,034 
Stock-based compensation
  572,996 
  392,676 
Stock based compensation issued for services rendered by third parties
  105,256 
  215,611 
Amortization of debt discount and deferred financing fees
  477,751 
  667,191 
Gain in the change in fair value of derivative liability
  (380,099)
  (2,543,878)
Changes in operating assets and liabilities:
    
    
Accounts receivable
  (625,771)
  (565,227)
Prepaid expenses and other current assets
  (1,373,378)
  (83,205)
Other assets
  (317,927)
  (203,414)
Accounts payable and accrued expenses
  (1,258,968)
  (297,079)
Net cash (used in) provided by operating activities
  (1,910,619)
  135,735 
 
    
    
Cash flows from investing activities:
    
    
Purchase of property and equipment
  (3,782,232)
  (2,479,335)
Proceeds from the sale of property and equipment
  28,736 
  - 
Net cash acquired through acqusition
  16,895 
  - 
Payments for acquisitions
  - 
  (500,000)
Returns of security deposits
  26,750 
  - 
Escrow refund - PingTone acquisition
  392,617 
  - 
Change in restricted cash
  137,970 
  1,000,000 
Net cash used in investing activities
  (3,179,264)
  (1,979,335)
 
    
    
Cash flows from financing activities:
    
    
Proceeds from notes payable - non-related parties
  - 
  9,000,000 
Proceeds from revolving debt
  - 
  12,500,000 
Proceeds from accounts receivable factoring arrangement
  - 
  1,630,045 
Repayments of borrowings to accounts receivable factoring arrangement
  - 
  (1,666,919)
Payments on equipment financing obligations
  (743,647)
  (592,514)
Repayments of notes payable
  (824,973)
  (20,835,022)
Payment of financing fees
  - 
  (680,828)
Net cash used in financing activities
  (1,568,620)
  (645,238)
Net change in cash and cash equivalents
  (6,658,503)
  (2,488,838)
Cash and cash equivalents, beginning of period
  7,540,543 
  6,444,683 
Cash and cash equivalents, end of period
 $882,040 
 $3,955,845 
 
See accompanying notes to the Condensed Consolidated Financial Statements.
 
 
6
 
 
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 nine months ended September 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 nine months ended September 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.
 
 
7
 
 
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 September 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 September 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 September 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 nine month periods ended September 30, 2016 or 2015, as there were no indicators of impairment.
 
 
8
 
 
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 September 30, 2016 and December 31, 2015, goodwill was approximately $28.0 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 nine months ended September 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 nine months ended September 30, 2016:
 
Balance at December 31, 2015
 $27,060,297 
Adjustment to the preliminary purchase price of Fidelity*
  (10,619)
Increase in goodwill - Technology for Business Corporation (“TFB”) acquisition
  1,000,097 
Balance at September 30, 2016
 $28,049,775 
 
*Acquisition of Fidelity Access Networks, LLC, Fidelity Connect LLC, Fidelity Voice Services, LLC and Fidelity Access Networks, Inc., (together with Fidelity Telecom, LLC hereinafter collectively referred to as “Fidelity”)
 
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 $154,000 and $145,000 for the three months ended September 30, 2016 and 2015, respectively, and approximately $508,000 and $390,000 for the nine months ended September 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.
 
 
9
 
 
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 September 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 September 30, 2016 and December 31, 2015. During the three and nine months ended September 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 March 2016, the Financial Accounting Standard Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2016-09, Compensation-Stock Compensation (Topic 718). The standard is intended to simplify several areas of accounting for share-based compensation arrangements, including the income tax impact, classification of the award as equity or as a liability, and classification on the statement of cash flows. ASU 2016-09 is effective for fiscal years and interim periods beginning after December 15, 2016, including interim periods within those reporting period. The Company does not expect this guidance to have a material impact on its consolidated financial statements.
 
In February 2016, FASB issued ASU No. 2016-02, Leases, which is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 with early adoption permitted. Under ASU 2016-02, lessees will be required to recognize for all leases at the commencement date a lease liability, which is a lessee’s obligation to make lease payments arising from a lease measured on a discounted basis, and a right-to-use asset, which is an asset that represents the lessee’s right to use or control the use of a specified asset for the lease term. The Company is currently evaluating the effect that the new guidance will have on its financial statements and related disclosures.
 
In November 2015, 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
 
 
10
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
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.
 
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. 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 $1.2 million gain on the fair value of the Company’s derivative liability for the three months ended September 30, 2015, and $1.9 million gain on the fair value of the Company’s derivative liability for the nine months ended September 30, 2015, which was attributable to 728,333 outstanding warrants issued by Fusion 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 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 nine months ended September 30, 2016 and 2015:
 
 
 
Three Months Ended September 30,
 
 
Nine Months Ended September 30,
 
 
 
2016
 
 
2015
 
 
2016
 
 
2015
 
Numerator
 
 
 
 
 
 
 
 
 
 
 
 
Net loss
 $(3,145,154)
 $(4,859,491)
 $(8,359,037)
 $(9,835,620)
Dividends on Series A-1, A-2 and A-4 Convertible Preferred Stock
  (101,729)
  (101,730)
  (302,976)
  (301,871)
Dividends declared on Series B-2 Convertible Preferred Stock
  (183,917)
  (278,010)
  (1,799,491)
  (884,955)
Gain on nominal warrants
  - 
  (1,187,183)
  - 
  (1,930,083)
Adjusted loss attributable to common stockholders
 $(3,430,800)
 $(6,426,414)
 $(10,461,504)
 $(12,952,529)
 
    
    
    
    
Denominator
    
    
    
    
Basic and diluted weighted average common shares outstanding
  14,990,816 
  8,958,815 
  14,536,893 
  8,529,642 
Loss per share
    
    
    
    
Basic and diluted
 $(0.23)
 $(0.72)
 $(0.72)
 $(1.52)
 
    
    
    
    
 
For the nine months ended September 30, 2016 and 2015, the following were excluded from the calculation of diluted earnings per common share because of their anti-dilutive effects:
 
 
 
Nine Months Ended September 30,
 
 
 
2016
 
 
2015
 
Warrants
  2,946,948 
  3,011,760 
Convertible preferred stock
  2,626,518 
  3,992,471 
Stock options
  1,157,512 
  677,126 
 
  6,730,978 
  7,681,357 
 
 
11
 
 
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 Fusion’s outstanding Series A-1, A-2 and A-4 preferred stock (the “Series A Preferred Stock”) of approximately $102,000 for the three months ended September 30, 2016 and 2015, and approximately $302,000 for the nine months ended September 30, 2016 and 2015. Through September 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 $4.6 million of accumulated preferred stock dividends. The Board of Directors has declared a dividend of $183,917 and $599,491 for the three and nine months ended September 30, 2016, respectively, on 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 122,601 and 343,510 shares, respectively, of Fusion’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 of Fusion’s common stock to a holder of 5,000 shares of Series B-2 Preferred Stock in connection with their agreement to convert all of their Series B-2 Preferred Stock holdings into shares of Fusion’s common stock.
 
Note 4. Intangible Assets
 
Intangible assets as of September 30, 2016 and December 31, 2015 are as follows:
 
 
 
September 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
  (20,965,072)
  (16,859,225)
   Intangible assets, net
 $42,727,552 
 $45,824,399 
 
Amortization expense was $1.4 million and $1.9 million for the three months ended September 30, 2016 and 2015, respectively, and for the nine months ended September 30, 2016 and 2015 was $4.1 million and $5.6 million, respectively. Estimated future aggregate amortization expense is expected to be as follows:
 
Year
 
 
Estimated Annual Amortization Expense
 
 
 
 
 
 
Remainder of  2016
 
 $2,038,362 
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
 
Fusion'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.
 
 
12
 
 
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 Fusion’s stock-based compensation plan using the Black-Scholes option-pricing model:
 
 
 
Nine months ended September 30,
 
 
 
2016
 
 
2015
 
Dividend yield (%)*
  0.0 
  0.0 
Expected volatility (%)
  92.4 
  125.4 
Average Risk-free interest rate (%)
  1.56 
  1.70 
Expected life of stock option term (years)
  8.0 
  7.6 
 
*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 $194,000 and $154,000 for the three months ended September 30, 2016 and 2015, respectively, and $573,000 and $393,000 for the nine months ended September 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 nine months ended September 30, 2016:
 
 
 
Number of Options
 
 
Weighted Average Exercise Price
 
Balance at December 31, 2015
  1,158,251 
 $4.96 
Shares granted during the period
  86,050 
  1.79 
Shares exercised during the period
  - 
  - 
Shares forfeited during the period
  (67,235)
  2.50 
Shares expired during the period
  (19,554)
  72.11 
Shares outstanding at September 30, 2016
  1,157,512 
  3.73 
Shares exercisable at September 30, 2016
  421,673 
 $5.77 
 
As of September 30, 2016, the Company had approximately $1.0 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 1.56 years.
 
Restricted Stock
 
During the nine months ended September 30, 2016, Fusion awarded 55,000 shares of its restricted common 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 three and nine months ended September 30, 2016, the Company recognized compensation expense of approximately $8,300 and $17,000, respectively, and has unamortized compensation of $82,960.
 
Note 6. Acquisition
 
On March 31, 2016, the Company completed the acquisition of certain assets from TFB, a provider of industry leading contact center solutions for an estimated purchase price of approximately $1.3 million consisting of $277,281 in cash and 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 estimated royalty fee of $1,011,606 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 the TFB acquisition. The aggregate purchase price has been allocated to the fair value of the assets acquired and liabilities assumed as follows:
 
 
13
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
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 liability
  (693,590)
Goodwill
  1,000,097 
Purchase price
 $1,288,887 
 
The amount of goodwill recognized is primarily attributable to the expected contributions of TFB to the overall corporate strategy in the cloud based call center solutions and synergies of the acquired business. None of the goodwill recognized is expected to be deductible for income tax purposes. The intangible assets subject to amortization consist of proprietary technology, customer relationships and non-compete agreements, with an estimated useful life of 8, 3 and 2 years, respectively.
 
Note 7. Supplemental Disclosure of Cash Flow Information
 
The following table summarizes the Company’s supplemental cash flows information:
 
 
 
Nine Months Ended September 30,
 
Supplemental Cash Flow Information
 
2016
 
 
2015
 
   Cash paid for interest
 $4,233,527 
 $3,961,498 
 
    
    
Supplemental Non-Cash Investing and Financing Activities
    
    
   Property and equipment acquired under capital leases
  188,497 
  1,440,816 
   Dividends on Series B-2 preferred stock paid with the issuance of common stock
  599,491 
  884,955 
   Due to Seller of RootAxcess
  - 
  700,000 
   Equipment received in exchange for settlement of accounts receivable
  - 
  105,570 
   Exercise of lenders warrants
  - 
  364,167 
   Assets acquired under earn-out liability
 $961,606 
 $- 
 
Note 8. Prepaid Expenses and Other Current Assets
 
The following table sets forth the items in prepaid expenses and other current assets:
 
 
 
September 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Insurance
 $380,359 
 $93,040 
Rent
  81,731 
  101,916 
Marketing
  140,397 
  109,455 
Software subscriptions
  670,614 
  498,078 
Due from seller of Fidelity
  - 
  425,963 
Due from factoring party
  - 
  26,018 
Commissions
  104,273 
  20,805 
Escrow receivable - Fidelity
  500,829 
  50,759 
Other
  579,533 
  292,569 
 
 $2,457,736 
 $1,618,603 
 
 
14
 
 
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:
 
 
 
September 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Trade accounts payable
 $3,699,791 
 $1,101,393 
Accrued bonus
  336,259 
  700,000 
Accrued professional and consulting fees
  225,878 
  274,205 
Accrued property and other taxes
  629,247 
  534,388 
Accrued network costs
  1,692,959 
  3,423,483 
Accrued rent
  117,252 
  82,894 
Accrued universal service fund fees
  730,205 
  494,852 
Customer deposits
  384,597 
  358,227 
Accrued credit card
  160,596 
  384,257 
Accrued payroll, employee benefits and vacation
  349,997 
  555,493 
Accrued sales and federal excise taxes
  1,686,636 
  2,204,098 
Accrued sales commissions
  789,322 
  981,121 
Accrued interest payable
  12,452 
  32,221 
Deferred revenue
  1,444,423 
  1,157,036 
Other
  351,271 
  845,557 
 
 $12,610,885 
 $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:
 
 
 
September 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
 
 
 
 
 
 
 
Equipment financing obligations
 $2,489,647 
 $3,044,796 
Less: current portion
  (997,089)
  (959,380)
Long-term portion
 $1,492,558 
 $2,085,416 
 
The Company’s payment obligations under the capital leases are as follows:
 
Year
 
 
Principal Payments
 
Remainder of 2016
 
 $247,693 
2017
  1,002,084 
2018
  958,846 
2019
  268,044 
2020
 $12,980 
 
 
15
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Note 11. Debt
 
As of September 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 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 September 30, 2016, the Company had borrowed $15.0 million under the revolver and $25.0 million under the term loan. For the three and nine months ended September 30, 2016, under the Opus Facility the Company recognized interest expense of approximately $0.5 million and $1.5 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 nine months ended September 30, 2016, the Company exceeded its leverage and senior leverage ratio covenants. On November 7, 2016, Opus Bank waived these covenants breaches. As a result of this waiver, we were in compliance with our obligations under this facility as of September 30, 2016.
 
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”). Under the Praesidian Facility, the Company is required to satisfy financial covenants similar to those required under the Opus Facility. For the three and nine months ended September 30, 2016, the Company was not in compliance with the leverage ratio covenant under this facility. On November 7, 2016, Praesidian waived our events of default with respect to non-compliance with the leverage ratio. As a result of this waiver, we were in compliance with our obligations under the Fourth Amended SPA as of September 30, 2016.
 
During the three and nine months ended September 30, 2016, the Company paid interest expense of approximately $0.9 million and $2.8 million, at an annual interest rate of 10.8%.
 
 
 
September 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
Subordinated Notes
 $33,645,865 
 $34,160,200 
Unamortized discount on Subordinated Notes
  (1,450,745)
  (1,697,091)
Unamortized debt issuance costs
  (836,760)
  (981,584)
Total notes payable - non-related parties
  31,358,360 
  31,481,525 
Less: current portion
  (685,780)
  (685,780)
Long-term portion
 $30,672,580 
 $30,795,745 
 
 
16
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
Related Party Note Payable
 
The note payable to Marvin Rosen, the Chairman of Fusion’s 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 amounts borrowed under the Opus Facility and the Fourth Amended SPA are paid in full.
 
 
 
September 30,
 
 
December 31,
 
 
 
2016
 
 
2015
 
Notes payable to Marvin Rosen
 $1,178,082 
 $1,178,082 
Discount on note
  (65,637)
  (103,253)
Total notes payable - related parties
 $1,112,445 
 $1,074,829 
 
For the nine months ended September 30, 2016, the Company recognized interest expense on the Rosen note of approximately $64,000 and amortization discount of approximately $38,000.
 
Note Payable to RootAxcess Seller
 
In connection with its 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 each of the three, six, nine, twelve, fifteen and eighteen month anniversary of the closing date. The remaining $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 RootAxcess 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 September 30, 2016, the Company made a payment of $127,306 net of an adjustment of $39,360 to the seller in connection with the terms of the asset purchase agreement. At September 30, 2016, the remaining balance due is $333,334.
 
Note Due to TFB Seller
 
In connection with the purchase of the assets of 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 payable to the sellers 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 the TFB 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 the sellers.
 
At September 30, 2016, the outstanding balance is $961,606, net of a salary advance of $50,000. There were no changes to the contingent liability based on the Company’s 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 such instruments as a liability at its fair value and adjusts the instrument to fair value at each reporting period. This liability is subject to re-measurement at each balance sheet date until the warrant is exercised or expires, and any change in fair value is recognized in the Company’s statement of operations. In this regard, Fusion has 584,834 outstanding warrants which provide for a downward adjustment of the exercise price if Fusion were to issue
 
 
17
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
common stock at an issuance price, or issue convertible debt or equity securities with an exercise price, that is less than the exercise price of these warrants. In addition, in connection with the sale of certain notes under the original Praesidian Facility, Fusion issued nominal warrants to the original lenders to purchase an aggregate of 728,333 shares of Fusion’s common stock. The nominal warrants were exercised in August 2015. The fair values of these warrants have been estimated using option pricing and other valuation models, and the quoted market price of Fusion’s common stock.
 
The following assumptions were used to determine the fair value of the warrants for the nine months ended September 30, 2016 and 2015:
 
 
 
Nine months ended September 30,
 
 
 
2016
 
 
2015
 
Stock price ($)
  1.65 
  1.88 
Exercise price ($)
  6.25 
  0 - 6.25 
Risk-free interest rate (%)
  1.56 
  1.75 - 2.06 
Expected volatility (%)
  92.4 
  125.4 
Time to maturity (years)
  2.25 
  7.08 - 8.25 
 
 
At September 30, 2016 and December 31, 2015, the fair value of the derivative was $233,934 and $953,005, respectively. For the three months ended September 30, 2016 and 2015, the Company recognized a gain on the change in the fair value of this derivative of approximately $152,000 and $1.2 million, respectively, and a gain of approximately $380,000 and $2.5 million for the nine months ended September 30, 2016 and 2015, respectively.
 
During the nine months ended September 30, 2016, the Company adjusted the valuation of its derivative liability for warrants issued in December 2013 and January 2014 and its valuation of certain warrants exercised during 2015. The amount of the adjustment was a net $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 an additional $338,972 impact to capital in excess of par and $433,050 increase in derivative liability 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
 
Fusion is authorized to issue 50,000,000 shares of its common stock. As of September 30, 2016 and December 31, 2015, 15,064,953 and 12,788,971 shares of its common stock, respectively, were issued and outstanding, respectively.
 
During the nine months ended September 30, 2016, Fusion issued 26,500 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 $96,950. In addition, the Fusion Board declared aggregate dividends of $599,491 on Fusion’s Series B-2 Preferred Stock, which, as permitted by the terms of the Series B-2 Preferred Stock, was paid in the form of 343,510 shares of common stock. In addition, during the nine months ended September 30, 2016, certain holders of the Series B-2 Preferred Stock elected to convert 6,025 shares into an aggregate of 1,871,667 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 these Series B-2 Preferred shares 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 the Company’s Series B Preferred Stock held by an affiliate of Unterberg in February 2016, caused the amount owned by Unterberg affiliates 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.
 
 
18
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
On July 19, 2016, Fusion entered into a Standstill Agreement with Unterberg, and notified Nasdaq of it plans to hold an annual stockholders meeting to obtain the requisite approval for the transactions. Consequently, Nasdaq granted the Company an extension of time to regain compliance with the Rule 5635(b). On October 28, 2016, Fusion’s shareholders approved the transaction with Unterberg and its affiliates and on November 2, 2016, Nasdaq notified Fusion that it has regained compliance with Rule 5635(b).
 
Restricted Stock
 
During the nine months ended September 30, 2016, the Company awarded 55,000 shares of restricted common stock to its Chief Financial Officer.
 
Preferred Stock
 
Fusion is authorized to issue up to 10,000,000 shares of preferred stock. As of September 30, 2016 and December 31, 2015 there was 5,045 shares of Series A Preferred Stock issued and outstanding. In addition, there were 12,254 and 18,279 shares of Series B-2 Preferred Stock issued and outstanding as of September 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, on January 1 of each year. As of September 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 $4.6 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, in cash or shares of Fusion common stock, at the option of the Company.
 
Since 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 September 30, 2016, the Company did not have any ongoing legal matters.
 
 
19
 
 
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 agents 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 assets from TFB completed in March 2016.
 
Carrier Services
 
Carrier Services includes the termination of domestic and international carrier traffic utilizing primarily VoIP technology. The Company currently interconnects with approximately 370 carriers and vendors, and is working to expand its interconnection relationships, particularly with carriers in emerging markets.
 
 
20
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
Operating segment information for the three and nine months ended September 30, 2016 and 2015 is summarized in the following tables:
 
 
Three months ended September 30, 2016
 
 
Carrier Services
 
 
Business Services
 
 
Corporate
 
 
Consolidated
 
Revenues
 $8,864,791 
 $20,632,338 
 $- 
 $29,497,129 
Cost of revenues (exclusive of depreciation and amortization)
  8,487,912 
  8,281,675 
  - 
  16,769,587 
Gross profit
  376,879 
  12,350,663 
  - 
  12,727,542 
Depreciation and amortization
  38,094 
  2,747,822 
  212,712 
  2,998,628 
Selling, general and administrative expenses
  653,462 
  9,547,547 
  1,207,039 
  11,408,048 
Interest expense
  - 
  1,551,534 
  73,661 
  1,625,195 
Gain on change in fair value of derivative liability
  - 
  - 
  (152,057)
  (152,057)
Other expenses (income)
  - 
  247,070 
  (265,139)
  (18,069)
Provision for income taxes
  - 
  10,951 
  - 
  10,951 
Net loss
 $(314,677)
 $(1,754,261)
 $(1,076,216)
 $(3,145,154)
Total assets
 $3,783,321 
 $90,027,291 
 $2,312,655 
 $96,123,267 
 
    
    
    
    
 
 
Nine months ended September 30, 2016
 
 
Carrier Services
 
 
Business Services
 
 
Corporate
 
 
Consolidated
 
Revenues
 $30,711,086 
  62,390,749 
 $- 
 $93,101,835 
Cost of revenues (exclusive of depreciation and amortization)
  29,341,982 
  24,594,096 
  - 
  53,936,078 
Gross profit
  1,369,104 
  37,796,653 
  - 
  39,165,757 
Depreciation and amortization
  116,102 
  8,128,378 
  702,301 
  8,946,781 
Selling, general and administrative expenses
  2,119,119 
  28,052,965 
  3,930,763 
  34,102,847 
Interest expense
  - 
  4,647,847 
  229,981 
  4,877,828 
Gain on change in fair value of derivative liability
  - 
  - 
  (380,099)
  (380,099)
Other expenses (income)
  - 
  764,308 
  (797,822)
  (33,514)
Provision for income taxes
    
  10,951 
    
  10,951 
Net loss
 $(866,117)
 $(3,807,796)
 $(3,685,124)
 $(8,359,037)
Capital expenditures
 $41,584 
 $3,740,648 
 $- 
 $3,782,232 
 
 
21
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
 
 
Three months ended September 30, 2015
 
 
Carrier Services
 
 
Business Services
 
 
Corporate
 
 
Consolidated
 
Revenues
 $8,269,529 
 $16,261,295 
 $- 
 $24,530,824 
Cost of revenues (exclusive of depreciation and amortization)
  7,642,008 
  5,891,639 
  - 
  13,533,647 
Gross profit
  627,521 
  10,369,656 
  - 
  10,997,177 
Depreciation and amortization
  48,022 
  2,898,068 
  194,337 
  3,140,427 
Selling, general and administrative expenses
  885,769 
  7,953,958 
  956,756 
  9,796,483 
Interest expense
  - 
  1,332,719 
  102,015 
  1,434,734 
Gain on change in fair value of derivative liability
  - 
  - 
  (1,237,730)
  (1,237,730)
Loss on extinguishment of debt
  - 
  2,538,272 
  182,083 
  2,720,355 
Other expenses (income)
  - 
  243,420 
  (241,021)
  2,399 
Net (loss) income
 $(306,270)
 $(4,596,781)
 $43,560 
 $(4,859,491)
Total assets
 $4,639,835 
 $59,128,769 
 $3,128,866 
 $66,897,470 
 
    
    
    
    
 
 
Nine months ended September 30, 2015
 
 
Carrier Services
 
 
Business Services
 
 
Corporate
 
 
Consolidated
 
Revenues
 $25,767,099 
 $49,090,458 
 $- 
 $74,857,557 
Cost of revenues (exclusive of depreciation and amortization)
  23,540,573 
  17,819,382 
  - 
  41,359,955 
Gross profit
  2,226,526 
  31,271,076 
  - 
  33,497,602 
Depreciation and amortization
  138,944 
  8,809,670 
  235,018 
  9,183,632 
Selling, general and administrative expenses
  2,619,818 
  23,684,671 
  3,074,707 
  29,379,196 
Interest expense
  - 
  4,457,080 
  193,206 
  4,650,286 
Gain on change in fair value of derivative liability
  - 
  - 
  (2,543,878)
  (2,543,878)
Loss on extinguishment of debt
  - 
  2,538,272 
  182,083 
  2,720,355 
Other expenses (income)
  - 
  591,691 
  (648,060)
  (56,369)
Net loss
 $(532,236)
 $(8,810,308)
 $(493,076)
 $(9,835,620)
Capital expenditures
 $69,905 
 $2,409,430 
 $- 
 $2,479,335 
 
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, is a Senior Advisor and a former partner of that company.
 
Since 2015, the Company has an operating agreement with XcomIP, LLC a telecommunications carrier in Hoboken, New Jersey, whose CEO Jay Adams is the brother of John Adams Vice President of our Carrier Services division. For the three and nine months ended September 30, 2016, we recognized revenues of approximately $0.5 million and $2.0 million, respectively. For the nine months ended September 30, 2016, the outstanding balance of accounts receivable from XcomIP and accounts payable owed to XcomIP was approximately $98,000 and $14,000, respectively.
 
 
22
 
 
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 September 30, 2016
 
 
 
 
 
 
 
 
 
 
 
 
Current liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Contingent liability (see note 11)
 $- 
 $- 
 $100,000 
  100,000 
Non-current liabilities:
    
    
    
    
Contingent liability (see note 11)
    
  - 
  861,606 
  861,606 
Derivative liability (see note 12)
  - 
  - 
  233,934 
  233,934 
   Total non-current liabilities
 $0 
 $- 
 $1,095,540 
 $1,095,540 
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 nine months ended September 30, 2016 are as follows:
 
Balance at December 31, 2015
 $953,005 
Gain for the period:
    
  Included in net loss
  (1,152,121)
  Adjustment for prior issuances and conversion of warrants (see note 12)
  433,050 
Balance at September 30, 2016
 $233,934 
 
    
 
Note 18. Subsequent Events
 
On November 14, 2016, the Company entered into a $70.0 million senior secured credit facility with East West Bank consisting of a $65.0 million, five-year term loan and a $5.0 million five-year revolver. The proceeds from the term loan were used to fund the acquisition of Apptix, Inc., pay in full the Opus Facility, and for general corporate purposes.  
 
On November 14, 2016, the Company completed the acquisition of Apptix, Inc. a cloud solutions provider based in Herndon, Virginia for a total purchase price of $28.0 million, consisting of approximately $23.0 million in cash and $5.0 million in Fusion’s restricted common stock.
 
On November 14, 2016, the Company completed an offering of $2.0 million of Fusion common stock in a private placement offering which is expected to fund on November 16, 2016. The proceeds will be used for general corporate purposes including working capital and capital expenditures.
 
 
23
 
 
 
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 as 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.
 
 
24
 
 
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 Months Ended September 30, 2016 Compared with Three Months Ended September 30, 2015
 
The following table summarizes the results of our consolidated operations for the three months ended September 30, 2016 and 2015:
 
 
 
Three Months Ended September 30,
 
 
 
2016
 
 % Revenues 
 
 2015
 
 
% Revenues
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 $29,497,129 
  100.0%
 $24,530,824 
  100.0%
Cost of revenues*
  16,769,587 
  56.9%
  13,533,647 
  55.2%
Gross profit
  12,727,542 
  43.1%
  10,997,177 
  44.8%
Depreciation and amortization
  2,998,628 
  10.2%
  3,140,427 
  12.8%
Selling, general and administrative expenses
  11,408,048 
  38.7%
  9,796,483 
  39.9%
Total operating expenses
  14,406,676 
  48.8%
  12,936,910 
  52.7%
Operating loss
  (1,679,134)
  (5.7%)
  (1,939,733)
  (7.9%)
Other (expenses) income:
    
    
    
    
Interest expense
  (1,625,195)
  (5.5%)
  (1,434,734)
  (5.8%)
Gain on change in fair value of derivative liability
  152,057 
  0.5%
  1,237,730 
  5.0%
Loss on extinguishment of debt
  - 
  0.0%
  (2,720,355)
  (11.1%)
Other income (expense), net
  18,069 
  0.1%
  (2,399)
  0.0%
Total other expenses
  (1,455,069)
  (4.9%)
  (2,919,758)
  (11.9%)
Loss before income taxes
  (3,134,203)
  (10.6%)
  (4,859,491)
  (19.8%)
Provision for income taxes
  (10,951)
  0%
  - 
  0.0%
Net loss
 $(3,145,154)
  (10.7%)
 $(4,859,491)
  (19.8%)
 
*Exclusive of depreciation and amortization, shown separately below.
 
Revenues
 
Consolidated revenues were $29.5 million during the three months ended September 30, 2016 compared to $24.5 million during the three months ended September 30, 2015, an increase of $5.0 million, or 20.2%.
 
Revenues from the Business Services segment were $20.6 million for the three months ended September 30, 2016 as compared to $16.3 million for the three months ended September 30, 2015. The increase is primarily attributable to revenue derived from new customers obtained from our acquisitions of RootAxcess in September 2015 and various Fidelity companies in December 2015.
 
Carrier Services revenue of approximately $8.9 million represents an increase of $0.6 million, or 7.2%, from the same period a year earlier. The increase was primarily due to an increase of 93% or $0.03 in the blended rate per minute of traffic terminated from the same period a year earlier, partially offset by a decrease of 44% in the number of minutes of traffic carried during the quarter.
 
 
25
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Cost of Revenues and Gross Margin
 
Consolidated cost of revenues was $16.8 million for the three months ended September 30, 2016 as compared to $13.5 million for the three months ended September 30, 2015. This increase was due to costs attributable to revenues derived from the RootAxcess and Fidelity acquisitions completed in the third and fourth quarter of 2015, and higher per minute rates for the cost of traffic terminated of 99.7% (or $0.03 per minute) in the Carrier Services segment.
 
Consolidated gross margin was 43.1% for the three months ended September 30, 2016 compared to 44.8% in the same period for 2015. The decrease is primarily due to approximately $0.8 million of additional costs of traffic terminated by our Carrier Services segment and an increase of approximately $2.4 million in our Business Services segment driven primarily by an increase in total customer services costs as a result of the RootAxcess and Fidelity acquisitions.
 
Gross margin for the Business Services segment was 59.9% for the three months ending September 30, 2016 as compared to 63.8% for the three months ending September 30, 2015. The decrease is due primarily to an increase in costs of revenue driven primarily by an increase in lower margin connectivity services associated with services offered by the acquired Fidelity companies.
 
Gross margin for the Carrier Services segment was 4.3% for the three months ended September 30, 2016 as compared to 7.6% in the three months ended September 30, 2015. The decrease was due to higher cost per minute of traffic terminated of $0.8 million, over the same period a year earlier.
 
Depreciation and Amortization
 
Depreciation and amortization expense was $3.0 million for the three months ended September 30, 2016 compared to $3.1 million in the same period of 2015. For the three months ended September 30, 2016, amortization expense of the intangible assets decreased by approximately $0.5 million from the same period in 2015 as a result of some of the intangible assets being fully amortized, and depreciation expense increased by approximately $0.4 million.
 
Selling, General and Administrative Expenses
 
Selling, general and administrative expenses (“SG&A”) for the three months ended September 30, 2016 was $11.4 million as compared to $9.8 million for the three months ended September 30, 2015. This increase is driven primarily by higher salaries and employee related benefits of approximately $1.6 million due to increased headcount resulting from our acquisitions of Fidelity, RootAxcess and TFB.
 
Interest Expense
 
Interest expense was approximately $1.6 million for the three months ended September 30, 2016 compared to $1.4 million in the same period of 2015. The increase in interest expense of $0.2 million is due to an increase in interest expense of approximately 0.4 million from the credit facility with Opus Bank offset by a decrease in interest expense of approximately $0.2 million from Praesidian as a result of the debt restructuring in August 2015 which lower the interest rate from 11.5% to 10.8%.
 
Change in Fair Value of Derivative Liability
 
During the three months ended September 30, 2016 and 2015, we recognized a gain on the change in fair value of our derivative liabilities in the amount of approximately $152,000 (see Notes 12 and 17) and $1.2 million, respectively. The gain and loss on the derivative are related to 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.
 
 
26
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES
 
Nine Months Ended September 30, 2016 Compared with Nine Months Ended September 30, 2015
 
The following table summarizes the results of our consolidated operations for the nine months ended September 30, 2016 and 2015:
 
 
 
  Nine Months Ended September 30,    
 
 
 
2016
 
 
% Sales
 
 
 2015
 
 
% Sales
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Revenues
 $93,101,835 
  100.0%
 $74,857,557 
  100.0%
Cost of revenues*
  53,936,078 
  57.9%
  41,359,955 
  55.3%
Gross profit
  39,165,757 
  42.1%
  33,497,602 
  44.7%
Depreciation and amortization
  8,946,781 
  9.6%
  9,183,632 
  12.3%
Selling, general and administrative expenses
  34,102,847 
  36.6%
  29,379,196 
  39.2%
Total operating expenses
  43,049,628 
  46.2%
  38,562,828 
  51.5%
Operating loss
  (3,883,871)
  (4.2%)
  (5,065,226)
  (6.8%)
Other (expenses) income:
    
    
    
    
Interest expense
  (4,877,828)
  (5.2%)
  (4,650,286)
  (6.2%)
Gain on change in fair value of derivative liability
  380,099 
  0.4%
  2,543,878 
  3.4%
Loss on extinguishment of debt
  - 
  0.0%
  (2,720,355)
  (3.6%)
Other income, net
  33,514 
  0.0%
  56,369 
  0.1%
Total other expenses
  (4,464,215)
  (4.8%)
  (4,770,394)
  (6.4%)
Loss before income taxes