UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
|X| ANNUAL REPORT PURSUANT TO SECTION 13 OR
15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2004
Commission file Number: 000-[1-]32421
FUSION TELECOMMUNICATIONS,
INTERNATIONAL,
INC.
(Exact name of registrant as specified in charter)
| Delaware | 58-2342021 |
| (State or other jurisdiction of | (I.R.S. employer |
| incorporation or organization) | identification no.) |
| 420 Lexington Avenue, Suite 518 | 10170 |
| New York, New York 10170 | (Zip code) |
| (Address of principal executive offices) |
Registrant’s telephone number, including area code: (212) 972-2000
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class | Name of Each Exchange on Which Registered |
| Common Stock, | American Stock Exchange |
| par value $0.01 per share | |
| Redeemable Common Stock Purchase Warrants | American Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act: None.
Indicate by a check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ x ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
The aggregate market value of the Common Stock held by non-affiliates of the Registrant based upon the closing price of the common stock as reported by the American Stock Exchange on March 24, 2005 was $105,968,123. Solely for purposes of this calculation, shares beneficially owned by directors and officers of the Registrant and persons owning 5% or more of the Registrant’s common stock have been excluded, in that such persons may be deemed to be affiliates of the Registrant. Such exclusion should not be deemed a determination or admission by the Registrant that such individuals or entities are, in fact, affiliates of the Registrant.
The number of shares outstanding of the Registrant’s capital stock as of March 24, 2005 is as follows:
| Number of Shares Outstanding | ||
| Title of each Class | at March 24, 2005 | |
| Class A Common Stock, $0.01 | 17,501,422 | |
| Common Stock, $0.01 par value | 8,832,996 | |
| Redeemable Common Stock Purchase Warrants | 6,741,838 | |
DOCUMENTS INCORPORATED BY REFERENCE
The following documents (or parts thereof) are incorporated by reference into the following parts of this Form 10-K. Certain information required in Part III of this Annual Report on Form 10-K is incorporated from the Registrant’s Proxy Statement for the 2005 Annual Meeting of Stockholders to be held in 2005.
FUSION
TELECOMMUNICATIONS INTERNATIONAL, INC. TABLE OF CONTENTS
PART I
PART II
PART III
PART IV
PART 1
ITEM 1. BUSINESS
Overview
We seek to become a leading provider of
VoIP and other Internet services to, from and within emerging markets in Asia, the
Middle East, Africa, the Caribbean, and Latin America. With our lead product, VoIP,
we currently provide a full suite of communications services to corporations, postal
telephone and telegraph companies, other licensed carriers, Internet service providers,
government entities, and consumers. Our packet based network infrastructure includes
the latest Softswitch technology which technology allows us to deliver Internet
protocol services around the world with quality and reliability.
Through our key assets of market knowledge,
technical expertise and strategic relationships, we believe we are poised to:
We target markets that we believe have: (i) barriers
to entry, (ii) substantial growth prospects, (iii) an increasing number of corporations
operating within them, and (iv) a substantial quantity of voice and data traffic
between the developed world (e.g., the United States and United Kingdom) and other
countries within our network. In select emerging markets, we will deploy network
facilities in order to connect that country to the United States.
We currently provide services to customers
in over 45 countries. We believe that by using local partners in select markets,
we can best distribute our services while providing a high level of local customer
support.
Services
To date, we derive a significant portion
of our revenues primarily from U.S.-based customers requiring voice and data connectivity
to emerging markets. As we continue to execute our strategy, we anticipate a larger
number of non-U.S. based customers. We are currently seeking to expand our revenue
stream by providing our services from, in and between emerging markets, which to
date, have not generated material revenues for us. We deliver our services directly
to end users and through partnerships with companies that distribute and support
our services locally. We also deliver our services through joint ventures.
We have service contracts with several
customers, including government agencies. Our contracts with carriers typically
have a one year renewable term, with no minimum volume per month, and allow the
customer to terminate without penalty. Our contracts with corporate customers are
typically for a one year term, and have an early cancellation penalty. Our government
contracts range from one year to five year terms, and are terminable at the government’s
option without penalty. For the years ended December 31, 2004, 2003 and 2002, the
Telco Group accounted for 13.3%, 13.7% and 13.8%, respectively, of our total revenues.
1
We have tailored our service offerings to meet the needs of our target
customers requiring services to, from, in and between emerging markets.
Our segments and their principal activities consist
of the following:
Traditional Voice—we terminate voice
telephony minutes to countries served by us, utilizing traditional Time Division
Multiplexing (TDM) and “circuit-switched” technology. Typically, this
will include interconnection with tradi- 2
tional telecommunications carriers either located internationally
or those carriers that interconnect with us at our US Points of Presence (POP) and
provide service to other destinations.
VoIP (Voice over Internet Protocol) to
Carriers—VoIP includes the termination of voice telephony minutes through the
internet rather than traditional circuit-switched technology. This permits less
costly and more rapid interconnection between us and international telecommunications
carriers.
VoIP (Voice over Internet Protocol) to
Consumers and Corporations—Primarily through our Efonica and Estel entities,
we provide VoIP services targeted to end-users and corporations.We offer services
that permit consumers or corporations to originate calls via IP telephones or telephone
systems that use the Internet for completion to standard telephone lines anywhere
in the world. We also provide PC-to-Phone service that utilizes the Internet to
allow consumers to use their personal computers to place calls to the telephone
of their destination party.
Internet, Private Networks & Other—We
provide Internet connectivity to telecommunications carriers, Internet service providers,
government entities, and multinational customers via our POPs in the US, India and
through our partners elsewhere. We also offer point-to-point private lines, virtual
private networking, and call center communications services to customers in our
target markets. Lastly, we offer an Internet video conferencing service to customers
anywhere in the world.
Growth Strategy
Strategy: Our strategy is
to gain early entry in an emerging country and then market advanced communication
services such as VoIP, private networks, Internet access, Internet protocol video
conferencing, and other Internet services. In many cases, we will establish a foothold
within an emerging market through a partnership with a local organization. We believe
that working in conjunction with local partners enables us to offer global services
with local support.
• Establish Local Partners
for In-Country Distribution and Support.
We believe that working with strong partners
allows us to best distribute services and attract, retain and support customers.
We seek to develop partnership arrangements in each of our markets. Local partners
offer time to market advantages as their existing infrastructure, sales distribution
channels, and technical support can be utilized, while simultaneously reducing capital
needed to enter the market. Additionally, these partners typically provide last
mile connectivity in their country required for the delivery of local Internet access
and private networks. This last mile connectivity, which is the connection between
the in-country telecommunications facility and the customer’s physical location,
in combination with local support, expands the geographic coverage of our global
service offering and helps differentiate us from our competitors.
We intend to work with our partners to
enable them to distribute and support our products and services (either co-branded
or private labeled). Our private label alternative enables our partners to market
our products, technology platform and global reach under their own brand. This alternative
is ideal for partners that do not have the capital, expertise and technology platform
required to deliver our services but want to build their own brand. Local partners
also offer critical insights into the regulatory environment and are familiar with
the specific cultural nuances of their region. Additionally, we anticipate that
prior to the rollout of any new services, our partners will work with us, contributing
market intelligence, to ensure a successful introduction of new products. This partnering
approach allows the local infrastructure to progress to a more technologically advanced
platform while positioning us to benefit from the rapid growth that these technologies
enable.
• Deploy Internet
Protocol Infrastructure.
We deliver a broad array of Internet protocol
based communication services, primarily VoIP, which require a lower capital investment
than traditional strategies. This approach allows us to accomplish what we believe
many of our partners in emerging markets are seeking a way to enhance existing in-country
technology and service offerings at minimal 3
cost. This allows the local infrastructure to progress to a more
technologically advanced platform while positioning us to benefit from the rapid
growth that these new technologies and under penetrated markets enable.
• Establish Market
Position in VoIP Business.
One of our key service offerings is VoIP,
which allows us to offer Internet-based long distance services at competitive prices
to any business, consumer or carrier with broadband or dial-up Internet access.
Quality levels, which had once been a significant issue, are fast approaching those
associated with traditional voice transmission. We typically market our VoIP services
to corporations and consumers through an in-country distribution partner. Additionally,
we seek to enter into relationships with in-country carriers to transport voice
traffic to and/or from that country. We believe that we have established our presence
in the voice markets due to (i) direct interconnections to postal telephone and
telegraph companies, and other licensed carriers, which facilitate higher quality
transmission than the services offered by gray market operators, and (ii) competitive
pricing. We believe that carriers seeking to access these gray markets will increasingly
want to work with companies that have established relationships with postal telephone
and telegraph companies and other licensed carriers, as opposed to quasi-legal gray
market operators who divert long distance traffic and revenue from those carriers.
We believe gray market operators generally provide poorer quality and reliability.
In several markets, we receive inbound traffic from the postal telephone and telegraph
company and other licensed carriers that tend to produce higher margin than our
outbound voice services. We believe this inbound traffic from postal telephone and
telegraph companies and other licensed carriers strengthens our ability to ensure
favorable contractual arrangements. We will use capacity on our international voice
networks to carry our own retail traffic in addition to selling capacity to other
carriers desiring termination to that specific destination. As we progress in the
execution of our business plan, we intend to use a greater percentage of our network
capacity to carry higher margin retail traffic.
• Support Partners
and Services with Advanced Packet Switched, Low Cost, Flexible Network.
We employ an Internet protocol network
that consists of Company-owned and partner-owned points of presence and usage based
or leased transmission facilities. Our network has several key attributes, including:
open standard compliance; distributed architecture; centralized management; a wide
array of signaling support; and policy based routing. With just one network point
of presence, our partners have acces to all of the products and services that we
offer, as well as to certain back office systems required to manage services being
delivered.
We believe that this strategy allows us
to control the network intelligence critical to providing transmission quality and
high quality customer support. At the same time, we are not burdened by large capital
requirements and high fixed network costs in a market that has seen dramatic price
reductions. The majority of our network operating costs are variable; that is, directly
proportional to usage and revenue.
• Target Enterprise,
including Government Market Segment.
We intend to build upon our market position
in the international VoIP business to market our managed private networks and other
Internet-based services to multinational businesses. By utilizing our own direct
sales force and local partner distribution channels, we are able to market our services
to customers in the United States and abroad. Our engineering team works closely
with both our sales team and customers to provide solutions to our clients. As part
of our corporate service offerings, we provide a single point of contact, ensure
active end-to-end management and guarantee service levels. As a result of our geographic
coverage, we have been approached by several large communication carriers and have
discussed the possibility of becoming their subcontractor for services in regions
they do not otherwise cover.
We believe that the U.S. Federal Government
provides an opportunity for us. By leveraging our relationships and experience in
navigating international markets, we have been able to penetrate this sector. In
2003, we were approved by the U.S. Government as a prime contractor to provide services
to the Department of Defense (“DoD”) and was awarded our first contract
in this sector. Under this contract, we are providing a private network connecting
two DoD facilities in the Persian Gulf. Although we are seeking to increase the
amount of our government contracts, only 3% of our revenue is currently derived
directly from them and arrangements whereby we act as a subcontractor on government
contracts. Under one such arrangement, we provide Internet connectivity to 17 U.S.
embassies and consulates in Asia and the Middle East. These contracts, however,
often give the government the right to terminate at any time. Although we try to
4
include liberal cancellation arrangements with our suppliers, we
may make contractual commitments with third party vendors to fulfill portions of
such contracts that do not contain similar termination provisions. In the event
that the government terminates a contract that we have made third arrangements for
we may have significant unrecouped costs.
• Exploit Communication
Patterns Among and Between Our Markets.
We look to provide connectivity to, from,
in and between our emerging markets. We are seeing demand from our business customers
for multi-country connectivity such as a U.S. corporation seeking connectivity to
India, China and the Philippines from one provider. We recently began marketing
this service. In addition, we are targeting connectivity between markets with significant
traffic flows such as the traffic flows between India and multiple countries in
the Middle East. In countries where we do not have facilities, we will work with
other international communications providers to utilize their networks to deliver
this service. In our VoIP business, we are seeing similar trends. We believe that
traffic among emerging markets is less susceptible to price and margin erosion than
traffic among developed countries. In countries where we install equipment, it is
common that our partners, customers or vendors will provide a facility to locate
the equipment.
Marketing
We deliver multi-product communications
solutions to targeted market segments requiring quality, reliability, flexibility
and scalability. VoIP services are offered on a private label or co-branded basis
to postal telephone and telegraph companies, other licensed carriers, Internet service
providers, cable companies and wireless operators. VoIP is also marketed to corporations,
government agencies and consumers through direct sale, in-country partners or third
party distri-bution. Private network solutions, including international point to
point private lines, IPVPN, IP-IPLs, ATM and Frame Relay are offered directly or
though in-country partners and third party distribution to postal telephone and
telegraph companies, other licensed carriers, ISPs, government agencies and corporations.
Internet Access is marketed through direct and alternate channels to postal telephone
and telegraph companies and other licensed carriers, Internet service providers,
cable companies, wireless operations, corporations and government agencies. Our
Internet protocol videoconferencing services, InterView, is marketed to small, medium
and large corporate customers through postal telephone and telegraph companies and
other licensed carriers, Internet service providers, in-countrty partners and other
distribution channels on a private label or re-sale basis. InterView is also offered
on a direct sale basis to corporations and government agencies.
We market our services via a variety of
distribution channels.
5
The terms of each non-joint venture partnership or distribution agreement
are different by partner but in general provide for a revenue or profit sharing
arrangement.
Joint Ventures
We enter into formal joint venture agreements
with certain partners and have established five joint ventures to market and provide
our services. The profits of each joint venture agreement are typically allocated
according to percentage of equity ownership.
Efonica
In January 2005, we entered into an agreement to acquire the 49.8% minority interest in one of our joint ventures, Efonica from Karamco, Inc. which was contingent upon the successful completion of our initial public offering by March 1, 2005. As our IPO was completed by this date, the Efonica transaction closed on February 18, 2005. The purchase price was a minimum of $5.5 million and a maximum of $14.3 million, as adjusted for the approximate $196,000 representing Karamco’s portion of Efonica’s debt owed to us as of the closing date and the $500,000 which was paid in cash in February 2005, based upon a multiple of earnings achieved by Efonica during the 12-month period ending February 28, 2006 (4.5 x Efonica’s net income as adjusted for certain intracompany and other expenses). Karamco received cash of $500,000, with the balance paid in shares of common stock. The number of shares issued to Karamco was determined by the $6.45 per share initial price of
the common stock at the date of the IPO.
Aproximately $4.4 million worth of such common stock (675,581 shares) issued to Karamco are being held in escrow until the final valuation of the joint venture is determined after the year ending February 28, 2006. In the event that the purchase price would be lower (based upon Efonica’s net income for that one year period) than $10 million, the excess of the common shares in escrow will be returned to us for cancellation out of the shares held in escrow. In the event that the purchase price would be higher than the $10 million (based upon Efonica’s net income), we will issue Karamco additional shares of our common stock (based on the IPO price of $6.45 per share), subject to the $14.3 million maximum purchase price.
Out of the shares to be issued to Karamco, we have agreed to register for resale 150,000 shares of common stock within sixty (60) days of the date of the registration statement for the IPO. If we do not register such shares, within the 60 day time period, we are obligated to purchase the shares from Karamco at the higher of $6.45 per share which was the IPO price or the average five (5) day bid price prior to the sixtieth day after the effective date of the registration statement. If the sale of the 150,000 shares that are to be registered results in less than $1 million of gross proceeds we will purchase additional shares owned by Karamco, at a price equal to the higher of the IPO price or the closing price 30 days after the last sale, so that they receive $1 million in gross proceeds. If we purchase additional shares from Karamco they will be returned for cancellation.
Karamco is owned by Roger Karam, who became the CEO of Efonica and our President of VoIP Services upon the effective date of the IPO.
India
6
Pakistan
In connection with the joint venture agreement, we entered into a non-exclusive service agreement with Pakistan Telecommunications Ltd. (“PTCL”), a public limited company incorporated under the laws of Pakistan, under which PTCL would provide for the termination of incoming VoIP traffic into Pakistan from the United States and Europe. The term is one year from September 1, 2004, renewable upon mutual consent. The agreement provides for us to place all necessary switching equipment in Pakistan, which we have done through our Pakistan joint venture, and the switching equipment is not returnable upon termination. In addition, PTCL may terminate the agreement if Fusion does not deliver a minimum of traffic over a three month period. The agreement also requires us to put up a $1,000,000 bank guarantee, which is pending the resolution of advances totaling $567,000 owed to us by PTCL as of December 31, 2004.
The joint venture entity is required to pay a management fee to Braddon equal to the number of minutes terminating in Pakistan on a monthly basis times a fixed rate per minute.
Jamaica
Turkey
Network Strategy
Our network strategy incorporates a packet
switched platform capable of interfacing with Internet protocols and other platforms
including Time Division Multiplexing (TDM). This is key to providing the flexibility
needed to accommodate the many protocols used to transport voice and data today.
We continually evaluate, and where appropriate, deploy additional communications
technologies such as Multi-Label Protocol Switching (MPLS) and Any Transport over
MPLS, which handle information transport in a more efficient fashion than other
earlier technologies such as frame relay and ATM.
The core of our network design is a packet-based
switching system that accommodates VoIP and traditional voice, Internet, data and
video services. Packet-based networking is considerably more efficient than circuit-switched
systems because it can disperse packets (information) in many directions and then
reassemble them at the destination. This makes much more efficient use of available
facilities when compared to circuit-based systems. We believe that this design offers
an extensible platform to support envisioned growth. The network design is intended
to embrace emerging technologies 7
as they become available. The network supports expansion outside
of the United States and, if necessary, can deliver packet technology to every part
of the network.
We are currently using a Veraz “Softswitch”,
Nuera Orca equipment, and carrier class Cisco and Juniper routers to transport voice,
data, video, and Internet traffic. Softswitch is a generic term that refers to a
new generation of telecommunications switching equipment that are entirely computerized
and are essentially software mounted on robust computer servers. This provides us
with routing capabilities to further enhance services and performance available
to our clients.
Key attributes of our soft switch include:
Historically, most large international communications
networks required investment and implementation of self-contained switching hardware
that, in turn, could then be connected with other comparable equipment nodes via
leased lines or other forms of networking. Examples of these would include equipment
such as large traditional carrier switching equipment. All of the intelligence and
functionality has to be replicated in each major location.
We, however, have implemented an environment
that we believe is far more flexible, adaptable, and less costly than the legacy
systems in use by some of our competition. Our Softswitch environment permits us
to centrally control our network and service offerings from one location yet deploy
gateways that interface with customers and vendors in remote locations. Each remote
gateway is able to deliver our service suite even though the intelligence is centrally
located in our New York facility. Instead of needing duplicative and expensive infrastructure
in every location, we economize by allowing multiple disparate network equipment
to be centrally managed. We believe that we can capitalize on market opportunities
that would previously have been unadvisable due to the expense of deployment and
associated marketplace risks.
Capacity
In traditional telecommunications systems,
capacity is a function of equipment and software. Because of its modular architecture,
Softswitch capacity is much less dependent on hardware. We believe that our Softswitch
environment will enable us to expand our capacity to handle traffic and our geographic
reach with greater ease in the future.
Ease of Modular Service Creation
Traditional telecommunications switching
systems are not easily modified to incorporate new features and functionality. Because
our Softswitch environment is entirely computer driven, our systems are flexible
and designed for the addition of features. We intend to expand our service offerings
by integrating additional hardware and software systems. 8
Our distributed architectures and flexible technology platform allows
us to roll out new services in a shorter period of time than many traditional telecommunication
companies.
Ease of Deployment
As we continue to penetrate emerging markets,
we will seek to establish regional points of presence that are then connected to
our New York facility. To facilitate this, we have created a standard concept for
the deployment of a point of presence in a remote region. These regional points
of presence will enable our VoIP services set to be offered and delivered from remote
locations while the intelligence and management of the services are in our New York
facility. This modular approach allows us to respond and deploy our services rapidly.
We currently maintain one point of presence in the Caribbean, Latin America and
the Middle East, two points of presence in the United States and five points of
presence in Asia. We are generally required to establish additional points of presence
where the partner or vendor does not have the necessary equipment, where it is a
requirement pursuant to a license agreement or the partner or vendor contractually
require us to provide the equipment.
Competition
The international communications industry
is highly competitive and significantly affected by regulatory changes, technology
evolution, marketing strategies, and pricing decisions of the larger industry participants.
In addition, companies offering Internet, data and communications services are,
in some circumstances, consolidating. We believe that service providers compete
on the basis of price, customer service, product quality, brand recognition and
breadth of services offered. Additionally, carriers may compete on the basis of
technology. Recently, we have seen carriers competing on their ability to carry
Voice over Internet Protocol (VoIP). As technology evolves and legacy systems become
an encumbrance, we expect carriers to compete on the basis of technological agility,
their ability to adapt to, and adopt, new technologies.
In the area of VoIP we compete with companies
such as Vonage, 8X8, Deltathree, Net2Phone, Dialpad and Mediaring. This business
segment is marketing-intensive and does not have high barriers to entry. While we
believe our distribution relationships and marketing skills provide us with a competitive
advantage, our competitors generally have more resources and more widely recognized
brand names.
We compete with several emerging international
carriers, many of whom are in or entering the VoIP market, among which are Primus
Telecommunications Group, Teleglobe International Holdings Ltd (which completed
its merger with IP-telephony pioneer ITXC in May 2004), and IDT Corporation. We
also compete with non-U.S. based emerging carriers. For example, in India, we compete
with Bharti Tele-Ventures, Reliance Telecom and Data Access, all of which are larger,
better capitalized and have broader name recognition than Fusion. Many of these
competitors are becoming increasingly focused on emerging markets as they seek to
find higher margin opportunities. Many of these carriers are also focused on voice
carriage but may become increasingly focused on providing private networks and other
Internet protocol services.
In each country where we operate, there
are numerous competitors, including VoIP service providers, wireline, wireless and
cable competitors. We believe that as international telecommunications markets continue
to deregulate, competition in these markets will increase, similar to the competitive
environment that has developed in the United States following the AT&T divestiture
in 1984 and the Telecommunications Act of 1996. Prices for long distance voice calls
in the markets in which we compete have been declining and are likely to continue
to decrease. In addition, many of our competitors are significantly larger, have
substantially greater financial, technical and marketing resources and larger networks.
In the area of Internet conferencing, we
compete with other Internet-based video or audio conferencing providers such as
WebEx Communications, PlaceWare, Talkway Communications, and InterCall. We can be
perceived as competitive with free services such as Yahoo video and Microsoft Netmeeting.
Each of these competitors has their own strengths and weaknesses. Some are unable
to do more than one-on-one conferencing or require use of free public servers and
are therefore subject to varying levels of quality and usefulness. Others are designed
solely for the corporate marketplace and require substantial up-front investment
in servers and on-going management. We also expect that companies such as Microsoft
and IBM will seek to integrate a video conferencing service directly into personal
computers. We compete with business-ori-
9
ented Internet access providers, including AT&T, MCI, Qwest,
and Cable & Wireless. These providers may offer both wholesale and retail Internet
connectivity and are considerably larger than us and have greater brand recognition.
We have been unable to identify any direct
and comprehensive competitors that deliver the same suite of services to the same
markets with the same marketing strategy as our Company. We compete with many different
providers in various aspects of our Business Plan, but have found none that directly
offer the same breadth of services focused on emerging markets. Some of our competitive
advantages include:
At this time, we are unable to provide quantified
disclosure regarding our market share in the markets in which we operate. As is
common with emerging markets, the aggregate market for our products and services
is usually not known until feasibility studies containing a wide range of demographic
variables are conducted. We are not aware of any studies that presently exist which
provide sufficient data for us to determine our market share.
Government Regulation
General. In the United States,
we are subject to varying degrees of federal, state and local regulation and licensing,
including that of the Federal Communications Commission. Internationally we also
encounter similar regulations from governments and their telecommunications/regulatory
agencies. At each of these levels, there are significant regulations, fees and taxes
imposed on the provision of telecommunications services in our business.
We cannot assure you that the applicable
U.S. and foreign regulatory agencies will grant required authority or refrain from
taking action against us if we are found to have provided services without obtaining
the necessary authorizations or pursuant to applicable regulations. If authority
is not obtained or if our pricing, and/or terms or conditions of service, are not
filed, or are not updated, or otherwise do not fully comply with the rules of these
agencies, third parties or regulators could challenge these actions and we could
be subject to forfeiture of our license, penalties, fines, fees and costs.
The U.S. Federal Government and state authorities
have the power to revoke our regulatory approval to operate internationally, interstate,
or intrastate, or to impose financial penalties, statutory interest and require
us to pay back taxes or fees if we fail to pay, or are delinquent in paying, telecommunications
taxes or regulatory fees or fail to file necessary tariffs or mandatory reports.
We are currently, and have been, delinquent in such financial, filing and reporting
obligations and required filings in the past including, but not limited to, Federal
Communications Commission and Universal Service Fund reports and payments.
During July 2004, the United States Senate
continued to consider how it might apply regulations to VoIP. The VoIP Regulatory
Freedom Act of 2004 exempts VoIP service from state taxes and regulations and defines
it as a lightly regulated information service for U.S. government regulators. This
does not, however, remove the uncertainty of regulatory impact within the United
States. For example, the bill reserves the ability for states to require VoIP to
provide 911 services, to require VoIP providers to contribute to state universal
service programs, and to pay intrastate access charges to other telecom providers.
On April 24, 2004, the FCC rendered a decision
on the AT&T Petition for Declaratory Ruling (WC Docket No. 02-361) pending before
them. The FCC determined that, where 1+ calls were made from regular telephones,
converted into an Internet protocol format, transported over AT&T Internet backbone,
and then converted back from IP format and delivered to the called party through
the local exchange carrier local business lines (not Feature Group D trunks), the
service was a “telecommunications service” for which terminating access
charges were due the local exchange carrier. In its decision, the Commission stated
that, under the current rules, the service provided by AT&T is a “telecommuni-
10
cations service” upon which interstate access charges may be
assessed against AT&T. The FCC limited its decision to the specific facts of
the AT&T case where the type of service involved ordinary Customer Premise Equipment
with no enhanced functionality, the calls originated and terminated on the public
switched telephone network, and the calls underwent no net protocol conversion and
provided no enhanced functionality to the end user due to the provider’s use
of Internet protocol technology. In fact, in the AT&T case the customer was
completely unaware of AT&T’s use of IP technology in transporting the call.
Although the FCC determined the services
provided by AT&T to be a telecommunications service subject to interstate access
charges rather than information services not subject to such charges, they did not
make a determination regarding the regulatory status of phone-to-phone VoIP or its
exposure to Universal Service Fund (USF), 911, Communications Assistance for Law
Enforcement Act (CALEA) or any other public policy issues. The FCC further qualified
the decision by stating that they “in no way intend to preclude the Commission
from adopting a different approach when it resolves the IP-Enabled Services rulemaking
proceeding or the Intercarrier Compensation rule making proceeding.” (Developing
a Unified Intercarrier Compensation Regime, CC Docket No. 01-92, Notice of Proposed
Rulemaking, 16 FCC Rcd 9610 (2001)(Intercarrier Compensation)).
As of August 2004, VoIP services provided
within the United States (Interstate) are not subject to USF charges or other public
policy regulation such as 911/E911, CALEA, etc.
Some states have tried to directly regulate
VoIP services on an intrastate basis, but these attempts, have, so far, not held
up to court challenges. Many states are holding forums to research the issues surrounding
VoIP, some are encouraging or even requesting that VoIP providers subject themselves
to public service commission jurisdiction and obtain certification as telephone
companies, most are hesitant to act until a final determination is made by the FCC,
but some have voluntarily done so.
It is uncertain when or how the effects
of such regulation would affect us, nor is it understood if other countries will
seek to follow suit. If additional regulation does occur, the FCC, any state or
any country may impose surcharges, taxes or additional regulations upon providers
of VoIP. The imposition of any such additional fees, charges, taxes and regulations
on Internet protocol service providers could materially increase our costs and may
limit or eliminate the competitive pricing we currently enjoy.
Trademarks
We have several trademarks and service
marks, all of which are of material importance to us.
The following trademarks and service marks
are registered with the United States Patent Trademark Office:
11
The following trademarks and service marks are filed with the United
States Patent Trademark Office and are currently in registration process:
The telecommunications markets have been characterized
by substantial litigation regarding patent and other intellectual property rights.
Litigation, which could result in substantial cost to and diversion of our efforts,
may be necessary to enforce trademarks issued to us or to determine the enforceability,
scope and validity of the proprietary rights of others. Adverse determinations in
any litigation or interference proceeding could subject us to costs related to changing
names and a loss of established brand recognition.
Employees
As of December 31, 2004, we had 58 employees
in Fusion Telecommunications International, Inc. and Efonica Available Information
We are subject to the informational requirements
of the Securities Exchange Actm and in accordance with those requirements file reports,
proxy statements and other information with the Securities and Exchange Commission.
You may read and copy the reports, proxy statements and other information that we
file with the Commission under the informational requirements of the Securities
Exchange Act at the Commission’s Public Reference Room at 450 fifth Street
N.W., Washington, D.C. 20549. Please call 1 -800-SEC-0339 for information about
the Commission’s Public Reference Room. The Commission also maintains a Web
site that contains reports, proxy and information statements and other information
regarding registrants that file elecronically with the Commission. The address of
the commission’s Web site is http://www.sec.gov. Our Web site is http://www.fusiontel.com.
We make available through our website, free of charge, our Annual Reports on Form
10-K, Quarterly Reports on Form 10-Q, Current reports on Form 8-K and amendments
to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities
Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically
file such material with, or furnish it to, the Commission. Information contained
on our web site is not a part of this report.
12
ITEM 2. PROPERTIES.
We are headquartered in New York, New York
and lease offices and space in a number of locations. Below is a list of our leased
offices and space as of December 31, 2004.
(2) This lease is subject to gradual increase to $130,712 from years 2005 to 2009.
We believe that our leased facilities are adequate
to meet our current needs and that additional facilities are available to meet our
development and expansion needs in existing and projected target markets.
ITEM 3. LEGAL PROCEEDINGS.
On May 8, 2002, Donna Marie Furlong, a
former employee, filed a complaint against us with the Executive Department, Division
of Human Rights, New York Office, State of New York (Donna Marie Furlong vs.
Fusion Telecommunications International, Inc., Case No. IB-E-DS-02-1254784-D)
seeking damages in an unspecified amount. This employee claims that she was discharged
from her job in violation of Title VII and the New York State Human Rights Law.
We are vigorously opposing these claims and have filed a position statement with
the Department. We believe the claim to be without merit.
On April 15, 2003, World Access, Inc.,
a former customer of ours, brought an action against us for recovery of preferential
transfers and other claims under the Bankruptcy Code in the United States Bankruptcy
Court, Northern District of Illinois Eastern Division (In Re: World Access, Inc.,
et al vs. Fusion Telecommunications International, Inc., Adv. Pro. No. 03 A
00851). The suit seeks damages in the amount of approximately $335,000 for our alleged
Avoidance of Preferential Transfers, Recovery of Transfers, Setoff, Recovery Setoff,
Payment of Improperly Setoff Debt, Turnover of Property, and Damages for Overdue
Debt & Turnover of Property. We filed a Proof of Claim with the Court in the
amount of approximately $85,000 for amounts that were due us at the time this customer
filed bankruptcy. In March 2005, we settled this matter for $5,500 and we agreed
to waive our proof of claim in the amount of approximately $85,000. We expect to
execute the formal settlement agreement on or before April 2, 2005.
On May 28, 2003, Jack Grynberg, et al.,
an investor in one of our private offerings; filed a complaint with the Denver District
Court, State of Colorado (Jack Grynberg, et al v. Fusion Telecommunications International,
Inc., et al, 03-CV-3912) seeking damages in the amount of $400,000 for the purchase
of an interest in Fusion’s 1999 private placement offering of subordinated
convertible notes through Joseph Stevens & Company, Inc., a registered broker
dealer. This complaint asserted the following claims for relief against us: Breach
of Fiduciary Duty, Civil Theft, Deceptive Trade Practices, Negligent Misrepresentation, Deceit Based on Fraud, Conversion,
Exemplary Damages and Prejudgment Interest. On June 25, 2004, we filed with the
Court our Motion to dismiss which was granted. The plaintiffs have filed an appeal
of the motion which is pending.
13
In 1999, we guaranteed a real property
lease on behalf of our joint venture, C&F Switching, LLC. The joint venture
subsequently defaulted on the lease and on July 17, 2003, the landlord, NWT Partners,
Ltd., brought an action in the Miami-Dade County Circuit Court, State of Florida.
(NWT Partners, Ltd. v. C&F Switching L.L.C. et al., Case No. 03-16654
CA 01 (6)). We were sued for back rent, interest, courts costs and attorney fees
in the amount in excess of $96,931.48. In addition, the landlord sought to accelerate
the balance of the lease, which would have resulted in us owing approximately $1,005,000
in additional rent. On January 17, 2005, we settled this matter for $132,500.
Due to the regulatory nature of the industry,
we are periodically involved in various correspondence and inquiries from state
and federal regulatory agencies. Management does not expect the outcome of these
inquiries to have a material impact on the operations or the financial condition
of the company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS
We held a Special Meeting of Stockholders
(the “Meeting”) on December 10, 2004. The following matters were submitted
to our stockholders for their vote, and the results of the votes taken at the Meeting
were as follows:
14
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND
RELATED STOCKHOLDER MATTERS
Market Information
Our common stock is currently listed on
the American Stock Exchange under the symbol “FSN”, and our redeemable
common stock purchase warrants are listed on the American Stock Exchange under the
symbol “FSN.WS”.
Prior to February 15, 2005, there was no
established trading market for our common stock and redeemable common stock warrants.
On March 24, 2004, the last reported sale
price for our common stock on the American Stock Exchange was 5.70 per share and
the last reported sale price for our redeemable common stock purchase warrant was
1.10 per warrant. The market price for our stock and warrants is highly volatile
and fluctuates in response to a wide variety of factors.
Holders
As of March 24, 2005, we had approximately
180 holders of record of our common stock and 181 holders of record of our redeemable
common stock purchase warrants. This does not reflect persons or entities who hold
their stock in nominee or “street” name through various brokerage firms.
Dividend Policy
We have never declared or paid any cash
dividends on our capital stock. We do not anticipate paying any cash dividends on
our capital stock in the foreseeable future. We currently intend to retain future
earnings, if any, to finance our operations and to expand our business. Any future
determination to pay cash dividends will be at the discretion of our board of directors
and will be dependent upon our financial condition, operating results, capital requirements
and other factors that our board of directors considers appropriate.
Equity Compensation Plans
The following table provides certain aggregate
information with respect to all of our equity compensation plans in effect as of
December 31, 2004:
Recent Sales of Unregistered Securities
In October 2004, we issued 19,048 shares
of common stock at $5.25 per share to the Saif Group in exchange for all outstanding
obligations owed to them as of July 1, 2004. In connection with the issuance of
such shares, we relied on Section 4(2) of the Securities Act. 15
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth selected
historical financial data as of and for each of the periods ended December 31, 2000,
2001, 2002, 2003, and 2004. The selected financial data as of December 31, 2001,
2002, 2003, and 2004 are derived from consolidated financial statements of Fusion
Telecommunications International, Inc., which have been audited by Rothstein, Kass
& Company, PC., independent auditors. The consolidated financial statements,
and the report thereon, as of December 31, 2003 and 2004, and for each of the three
years ended December 31, 2004, are included elsewhere in this prospectus. The following
financial information should be read in conjunction with “Management’s
Discussion and Analysis and Results of Operations” and our consolidated financial
statements and related notes appearing elsewhere in this prospectus.
16
17
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
The following discussion of our financial
condition and results of operations should be read together with our consolidated
financial statements and the related notes thereto included in another part of this
annual report. This discussion contains certain forward-looking statements that
involve substantial risks and uncertainties. When used in this report the words
“anticipate,” “believe,” “estimate,” “expect”
and similar expressions as they relate to our management or us are intended to identify
such forward-looking statements. Our actual results, performance or achievements
could differ materially from those expressed in, or implied by, these forward-looking
statements. Historical operating results are not necessarily indicative of the trends
in operating results for any future period.
Overview
We are an international communications
carrier delivering VoIP, private networks, Internet access, Internet protocol video
conferencing and other advanced services to, from, in and between emerging markets
in Asia, the Middle East, Africa, the Caribbean and Latin America. In 2000, after
early acquisitions, our focus on domestic retail and residential services and incurring
significant losses, our board of directors selected a new management team to develop
and initiate a new corporate strategy, improve our operational and financial performance
and identify growth opportunities.
The new corporate strategy focused our
resources on VolP and the emerging international markets, and we exited the more
highly competitive, infrastructure-dependent businesses that characterized us in
2000 and 2001. Since then, we sought to gain early entry in high growth emerging
markets, often in partnership with local organizations that have strong distribution
channels, regulatory experience, market intelligence, the ability to deliver local
loops and the capability of providing customer service support. This approach enabled
us to introduce our Internet protocol communications services in these markets,
thereby benefiting from the time-to-market advantages, expanded geographic reach
and reduced capital requirements that local partnerships afford. We embarked on
a network strategy that employs the most currently available Softswitch technology,
relieving us of the burden of costly, inefficient legacy systems and allowing more
rapid and cost-effective deployment and expansion of services worldwide. Additionally,
long-range efforts in cost controls and reductions were initiated, which included
significant reductions in staffing, fixed overhead expenses and debt. The combination
of these efforts has led to improved financial results. 18
The following table summarizes our results of operations for the
periods indicated:
The following table presents our historical operating
results as a percentage of revenues for the periods indicated:
19 Revenues
Since our restructuring in 2001, we have
generated the majority of our revenue from voice traffic sold to other carriers,
with a primary focus on VoIP terminations to the emerging markets. We have increased
our business in this area through an internal focus on the growth of our existing
customer base, which is primarily U.S. based, as well as the addition of new customers,
and the establishment of in-country partnerships that help us to more quickly deploy
direct VoIP terminating arrangements with postal telephone and telegraph companies
and other licensed carriers in emerging markets. Although we believe that this business
continues to be strong, ongoing competitive and pricing pressures have caused us
to increase our focus on higher margin, value-added services (VoIP to consumers
and businesses, Internet access, Internet protocol videoconferencing and private
networks) and market them to, or in conjunction with, international carriers, Internet
service providers, cable companies and wireless operators on a direct, co-branded
or private label basis.
In an effort to further increase margins,
expand our customer base, and develop more stable revenue streams, we have begun
to target enterprise customers (large corporations, government entities and other
businesses). Revenues generated from sales to these customers are primarily derived
from the sale of the value-added services mentioned above. With a primary focus
on marketing VoIP services to these Enterprise customers, we believe we will recognize
higher margin and stronger growth opportunities. While this does not yet represent
a significant portion of our revenue base, we expect to continue to increase our
emphasis in this area. We believe that this will complement our carrier business
with a higher margin and more stable customer base. In the third and fourth quarters
of 2004, we experienced a temporary decline in revenues during, and immediately
following, the migration to the new Softswitch technology which significantly contributed
to the net loss during those two quarters.
In 2002, we established Efonica F-Z, LLC
as a retail services company marketing VoIP products to consumer and corporate customers
in emerging markets. Beginning in the Middle East, Asia and Africa, then extending
into Latin America, Efonica’s services are primarily sold through distribution
channels on a pre-paid basis. Efonica’s customers can place calls from anywhere
in the world to any destination using a personal computer, Internet protocol telephone
or regular telephone when accompanied by a hardware device that may be purchased
through Efonica. We believe that the introduction of advanced features such as voicemail,
call waiting and call forwarding enhance this value-added offering. Since its inception
in 2002, Efonica’s revenue grew from $0 in 2002 to $0.3 million in 2003 and
to $3.0 million in 2004. In February 2005, we closed on the purchase of the 49.8%
minority interest in Efonica. See “Business—Joint Ventures—Efonica”.
Our increased focus on VoIP services resulted
in a growing upward trend in voice traffic carried over Internet protocol. During
2004, VoIP services accounted for 70.6% of our total voice revenue compared to 67.8%
in 2003. We also receive revenue from other services, including co-location and
the sale of customer premise equipment, however, these services currently represent
a small portion of the revenue base.
We manage our revenues by product and customer.
We manage our costs by provider (vendor). We track total revenue at the customer
level because our sales force has to manage the revenue generation at the customer
level, and invoices are billed to and collected at the customer level. We also have
to track the same revenues by product, because different products have different
billing and payment terms, and individual customers may have multiple billing and
payment terms if they purchase multiple products.
We manage our revenue segments based on
gross margin, which is net revenues less cost of revenues, rather than on net profitability,
due to the fact that our infrastructure is built to support all products, rather
than individual products. This applies both to the capital investments made (such
as switching and transmission equipment), and to Selling, General and Administrative
resources. The majority of our sales and operations personnel support all product
lines, and are not separately hired to support individual product segments. For
segment reporting purposes, all expenses below cost of revenues are allocated based
on percentage of revenues unless the items can be specifically identified to one
of the product segments.
We manage our cost of revenues by managing
the margins that we realize from individual providers. We also monitor the cost
of revenue terminated over our own networks (On-net) versus cost of revenue terminated
by third party providers (Off-net). Our On-net cost of revenues are managed through
our relationships with strategic partners and our 20
joint ventures, routing traffic to those networks where we can effectively
do so. Our Off-net cost of revenues are managed by routing to our third party providers
based on a least cost approach, and focusing on maximizing margins by providers.
Most providers offer multiple destinations for termination, and give better rates
for higher volumes.
Off-net revenue does not typically mirror
On-net revenue in regional geographic termination percentages, because Off-net revenues
are terminated by those other third party providers, and may terminate anywhere
in the world. On-net revenues only terminate to areas supported by our own network
of strategic partners that we have agreements with and also typically have made
investments with. If we have traffic to On-net destinations that exceeds our capacity,
we overflow such traffic to other providers (Off-net).
Total Consolidated Revenue includes VoIP
to carriers, Traditional Voice to carriers, VoIP to Consumers, and Internet, Private
Network & Other. Revenues are further broken down between On-net and Off-net
as mentioned above. All categories of revenue are recorded and tracked at the product
and customer level.
Fusion Telecommunications International Regional percentages are calculated based on Total
Consolidated Revenue.
OPERATING EXPENSES
Our operating expenses are categorized
as cost of revenues, depreciation and amortization, loss on impairment, and selling,
general and administrative expenses.
Cost of revenues includes costs incurred
with the operation of our leased network facilities, and the purchase of voice termination
and Internet protocol services from other telecommunications carriers and Internet
service providers. As we have increased the percentage of VoIP traffic carried on
the network, our fixed network cost of voice services to carriers as a percentage
of the voice revenues has declined. This is illustrated by the decrease of this
percentage to 2.0% during 2004 from 3.1% in 2003. We also continue to work to lower
the variable component of the cost of revenue through the use of least cost routing,
and continual negotiation of usage-based and fixed costs with domestic and international
service providers.
Depreciation and amortization includes
depreciation of our communications network equipment, amortization of leasehold
improvements of our switch locations and administrative facilities, and the depreciation
of our office equipment and fixtures.
Selling, general and administrative expenses
include salaries and benefits, commissions, occupancy costs, sales, marketing and
advertising, professional fees and other administrative expenses. 21
COMPANY HIGHLIGHTS
The following summary of significant events
during the three years ended December 31, 2004, highlights the accomplishments and
events that have influenced our performance during that time period.
2004
2003
2002
22
The information in our period-to-period comparisons
below represents only our results from continuing operations.
Year Ended December 31, 2004 Compared with Year
Ended December 31, 2003
Revenues
Consolidated revenues increased $17.6 million
or 54.8% to approximately $49.6 million in 2004 compared to $32.0 million in 2003.
$10.7 million of this revenue increase was from VoIP services sold to carriers,
evidencing our increased focus on VoIP services. This growth in revenue was impacted
during the third and fourth quarters of 2004 when we experienced a temporary decline
in revenues during, and immediately following, our migration to the new Softswitch
technology. Growth from our existing customer base contributed 69% of the increase
in the revenues for VoIP services to carriers, and 31% of the increase was attributable
to the addition of new carrier customers. Additionally, $3.1 million of the consolidated
revenue increase was from Traditional Voice services sold to carriers. Growth from
our existing customer base contributed 27% of the increase in the revenues for Traditional
Voice services to carriers, and 73% of the increase was attributable to the addition
of new carrier customers.
Revenues for VoIP services to consumers
and corporations represented $2.5 million of the consolidated revenue growth, increasing
from $0.3 million in 2003 to $2.8 million in 2004, mainly due to the growth of Efonica.
Additionally, revenues from our Internet, Private Network & Other Services represented
the remaining $1.2 million of the growth, increasing 87.3% from $1.3 million in
2003 to $2.5 million in 2004. Growth in this area was primarily due to the addition
of Government-related contracts that were awarded in the latter part of 2003.
Cost of Revenues
Consolidated cost of revenues increased
$15.1 million or 54.1% to $42.9 million in 2004 from $27.9 million in 2003. $12.2
million of this increase was attributable to an increase in voice services to carriers,
of which $9.4 million was an increase in VoIP services cost of revenues to carriers,
and $2.8 million was an increase in cost of Traditional Voice services to carriers.
These increases are consistent with the increases in revenues from the higher volumes
discussed above.
The cost of revenues for VoIP services
to consumers and corporations grew $2.0 million in 2004, from $0.2 million to $2.2
million, due primarily to the rapid growth in that revenue base. Cost of revenues
for Internet, Private Network & Other grew $0.9 million, from $0.8 million in
2003 to $1.7 million in 2004.
Gross Margin increased $2.5 million or
59% for 2004 over 2003, fueled by the continuing shift to higher margin VoIP and
Internet Private Network & Other. VoIP to Carriers margin increased $1.3 million
or 54.0%, while Traditional Voice to Carriers margin increased $0.3 million or 26.8%
from the previous year . Gross Margin for VoIP services to consumers and corporations
grew $0.6 million, or 570.8% year over year, and Internet, Private Network &
Other margin grew $0.3 million as well, which was a 47.9% increase.
Operating Expenses
Depreciation and Amortization. Depreciation
and amortization decreased $0.2 million or 9.0% during 2004 to $1.8 million from
$2.0 million during 2003 primarily due to certain assets becoming fully depreciated
during 2004, the impairment of our old switch at the end of 2003 which was later
replaced with our new Softswitch, and the disposal of assets during 2004.
23
Loss on impairment. No loss on impairment occurred during
2004. Our 2003 loss on impairment of $375,000 related to management’s decision
to sell (to a third-party) certain switching equipment which has since been replaced
by upgraded equipment.
Selling, General and Administrative.
Selling, general and administrative expenses increased $1.2 million or 14.3%
to $9.8 million in 2004 from $8.6 million in 2003. This increase is primarily attributed
to increased bad debt expense of approximately $0.7 million and an increase in salaries
and benefits in our Efonica joint venture of $0.3 million as more back office personnel
were required to support its growth, and a small increase in salaries in Fusion
of $0.2 million. Selling, general and administrative expenses have declined as a
percentage of revenue from 26.8% during 2003 to 19.8% during 2004. We believe that
as we execute our business strategies, selling, general and administrative expenses
as a percentage of revenue will continue to decline.
Operating Loss. Our operating loss
decreased $1.8 million or 26.5% to a loss of $5.0 million during 2004 from a loss
of $6.8 million during 2003. The decrease in operating loss was primarily attributable
to the increase in revenue and gross margin.
Other Income (Expense). Total other
income (expense) decreased $3.0 million to a $0.6 million expense in 2004 from a
$2.4 million income in 2003. Interest expense increased $1.4 million to $2.2 million
in 2004 from $0.8 million in 2003, primarily attributable to the adoption of SFAS
150 during 2003. SFAS 150 resulted in our recording $1.7 million in interest expense
during 2004 related to dividends and accretion on the Series C convertible preferred
stock subject to mandatory redemption. This interest accretion ceased in February
2005 when our Series C preferred stock was converted into common stock. We also
recorded $0.2 million in interest expense during 2004 related to a beneficial conversion
feature on convertible debt issued in November 2004. These increases are offset
with a decrease in interest expense of $0.5 million during 2004 resulting from the
reduction of average outstanding debt. Gain on debt forgiveness decreased in 2004
by $1.7 million to $2.2 million from $3.9 million during 2003. The 2004 gain on
debt forgiveness is attributed to $0.2 million of settlements of capital lease obligations,
$0.2 million of settlements of general obligations and $1.8 million of settlements
of network obligations. The loss from investment in Estel decreased by $0.2 million
due to a reduced loss from the previous period. Minority interest due from joint
venture partners changed $165,000 to an $8,000 loss in 2004 from $158,000 in income
during 2003.
Net Loss. The primary factors impacting
our 2004 net loss was an increase in gross margin net with an increase in interest
expense and a reduction in forgiveness of debt from 2003 (see discussions above).
Our 2004 net loss attributable to common stockholders was $5.4 million after giving
effect to $0.4 million in dividends applicable to common stockholders. This was
an improvement of $0.6 million from the prior year’s net loss applicable to
common stockholders of $4.8 million.
Year Ended December 31, 2003 Compared with Year Ended
December 31, 2002
Revenues
Consolidated revenues from continuing operations
increased $6.5 million or 25.4% to $32.0 million in 2003 compared to $25.5 million
in 2002. VoIP services to carriers grew $12.2 million, fueled by the growth in an
international network deployment in Asia. That growth was partially offset by a
decline in Traditional Voice services of $6.5 million, caused largely by the continued
impact of the loss of two large international voice networks in 2002 due to capital
constraints and disputes with vendors.
Internet, Private Network & Other revenues
increased $0.5 million in 2003 versus 2002, due primarily to the addition of Government-related
contracts awarded late in 2003. VoIP to consumers and corporations increased $0.3
million in 2003 over 2002, due primarily to the growth from Efonica.
24
Cost of Revenues
Total cost of revenues increased $4.2 million
or 17.8% to $27.8 million in 2003 from $23.6 million in 2002. While the cost of
VoIP services to carriers increased by $10.3 million due to a new international
network deployment in Asia, it was partially offset by a decrease in cost of revenues
for Traditional Voice services of $6.7 million. That cost decrease in Traditional
Voice services was primarily due to the loss of two large international voice networks
in 2002 due to capital constraints and disputes with vendors.
Cost of revenues for VoIP to consumers
and corporations increased by $0.2 million for 2003 versus 2002 due to the significant
growth in this product after its introduction in late 2002. Cost of revenues for
Internet, Private Network & Other increased by $0.4 million for 2003 versus
2002 due to the corresponding growth in the revenue segment. Gross margin improved
$2.3 million, or 119%, to $4.2 million in 2003 from $1.9 million in 2002. The majority
of the margin increase was in VoIP to carriers, which increased $1.8 million, from
$0.6 million to $2.4 million. This was due both to the significant growth in revenues
and increased efforts to decrease fixed costs and increase the utilization of least
cost routing. Gross margin for Traditional Voice to Carriers increased $0.2 million,
margin for VoIP to consumers and corporations increased $0.1 million, and margin
for Internet, Private Network & Other increased $0.2 million.
Operating Expenses
Depreciation and Amortization. Depreciation
and amortization from continuing operations decreased $0.4 million to $2.0 million
in 2003 from $2.4 million in 2002. This decrease was attributable to fixed assets
impaired during 2002 being depreciated during a portion of 2002 but not at all during
2003, the majority of which was associated with the abandonment of equipment located
in a country where a Caribbean voice network had been deactivated as it was no longer
producing revenue.
Loss on Impairment. Loss on Impairment
decreased $0.1 million in 2003. The $0.4 million recorded during 2003 relates to
an impairment on switching equipment which was replaced by upgraded equipment. The
impairment was determined based upon estimated future cash flows from these assets.
The $0.5 million impairment recorded during 2002 related to the termination and
abandonment of a voice network located in the Caribbean which was deactivated and
no longer generating revenue.
Selling General and Administrative.
Selling, general and administrative expenses decreased $1.1 million or 10.9%
to $8.6 million in 2003 from $9.6 million in 2002. This decrease is primarily attributed
to reduction of salary expense of $0.8 million due to staff reductions.
Operating Loss. The operating loss
decreased $3.8 million or 35.9% to $6.8 million in 2003 from $10.6 million in 2002,
due to the items mentioned above.
Other Income (Expense). Total other
income (expense) increased $1.2 million or 99% to $2.4 million in 2003 from $1.2
million in 2002, due to several factors. Interest expense decreased $0.2 million
to $0.8 million in 2003 from $1.0 million in 2002, mainly due to settlements of
$3.9 million and conversions of $3.2 million of outstanding debt. Gain on Debt Forgiveness
increased by $2.1 million to $3.9 million, from $1.8 million. The 2003 gain on debt
forgiveness of $3.9 million is attributed to $0.9 million of settlements of capital
lease obligations and $3.0 million of settlements of network obligations. The gain
(loss) on equity investment changed from $0.3 million in 2002 to a loss of $(0.7)
million in 2003 due to an increased loss in the Estel joint venture. Other represents
gains/losses on the disposal of fixed assets and changed from a loss of $0.1 million
in 2003 to a gain of $0.1 million in 2002. Minority interest due from joint venture
partners increased $138,000 to $158,000 in 2003 from $20,000 in 2002.
Discontinued Operations. Income
from discontinued operations in 2003 was $0.2 million due to the elimination of
a prior accrual for a vendor obligation, as it was determined it was no longer due.
There was no discontinued operations income in 2002. 25
Net Loss. The factors discussed above resulted in a decrease
in the 2003 net loss applicable to common stockholders by $5.2 million to $4.8 million
in 2003 from $10.0 million in 2002 after giving effect to $0.6 million in stock
dividends in both 2003 and 2002.
Liquidity and Capital Resources
Since our inception, we have incurred significant
operating and net losses. In addition, we have not generated positive cash flows
from operations. As of December 31, 2004, we had an accumulated stockholders’
deficit of approximately $13.3 million and a working capital deficit of approximately
$8.5 million. However, during the year ended December 31, 2004, we were able to
increase our revenues and renegotiate and pay down certain obligations, which has
resulted in reduced losses and reduced outstanding debt. Also, subsequent to December
31, 2004, the Company closed its initial public offering of securities of 3,600,000
shares of common stock at a price of $6.45 per share and 3,600,000 redeemable common
stock purchase warrants at $0.05 per warrant. Net proceeds from this offering were
approximately $20.4 million and will primarily be used for working capital and general
corporate purposes, repayment of certain indebtedness, international deployment,
and to fund the purchase of equipment for expanded capacity and service offerings.
Below is a summary of our cash flows for
the periods indicated. These cash flow results are consistent with prior years in
that we continued to use significant cash in connection with our operating and investing
activities and had significant cash provided by financing activities.
A summary of our cash flows for the periods
indicated is as follows:
Our cash flow results were impacted by
the costs associated with implementing the new corporate strategy focusing our resources
on VoIP and the emerging international markets, as we completed our exit from the
more highly competitive, infrastructure dependent business that previously characterized
us. We only started to migrate customers to our new Softswitch in August 2004 and
began to rely on it in October 2004. Therefore, we have only recently completed
the deployment of our packet-based network infrastructure including the latest Softswitch
technology. Because certain of our costs are fixed, we would expect that as our
revenues increase, total expenses will represent a smaller percentage of our revenues.
Source of Liquidity
As of December 31, 2004 we had cash and
cash equivalents of approximately $4.4 million. In addition, as of December 31,
2004, we had approximately $0.4 million of cash restricted from withdrawal and held
by banks as certificates of deposits securing letters of credit (equal to the amount
of the certificates of deposit).
From our inception through December 31,
2004, we financed our operations from cash provided from financing activities. These
activities were primarily through the private placement of approximately $52.2 million
of equity securities and $21.6 million of net proceeds resulting from the issuance
of notes. In addition, during this period we financed the acquisition of $6.8 million
of fixed assets through capital leases. 26
Although we believe the net proceeds from our February 2005 IPO,
together with our existing cash and cash equivalents and revenues from operations
will be sufficient to meet our working capital and capital expenditure needs for
the next 12 months, our long-term liquidity is dependent on our ability to attain
future profitable operations. We cannot predict if and when we will be able to attain
future profitability.
On November 10, 2004, we issued convertible
promissory notes to one individual in the aggregate amount of $2,508,333, representing
$1,400,000 in cash and $1,108,333 to refinance certain debt and accrued interest
owed to an existing related party. This transaction generated $1,330,000 in net
proceeds to us after deducting an advisory fee. The promissory notes had an interest
rate of 6.5% per annum and were due on November 2006. Upon the completion of our
IPO in February 2005, the notes automatically converted into 651,515 common shares
which was based upon a conversion price of $3.85 per share.
As previously discussed, subsequent to
December 31, 2004 (in February 2005) we raised approximately $20.4 million in net
proceeds from our Initial Public Offering.
Uses of Liquidity
Our short-term and long-term liquidity
needs arise primarily from interest and principal payments relating to our debt
and capital lease obligations, capital expenditures, working capital requirements
as may be needed to support the growth of our business, and any additional funds
that may be required for business expansion opportunities.
Our cash capital expenditures were approximately
$0.6 million during the years ended December 31, 2004 and 2003. We expect our cash
capital expenditures to be approximately $5.0 million for the year ending December
31, 2005. The 2005 estimated capital expenditures include network expansion, purchase
of additional software for expanded product offerings, new international deployments
and customer premise equipment.
Cash used in operations was approximately
$4.9 million during the years ended December 31, 2004 and 2003. The cash used in
our operations has historically been a function of our net losses, gains on forgiveness
of debt, and changes in working capital as a result of the timing of receipts and
disbursements. Our net cash used in operating activities included in our December
31, 2004 and 2003 cash flows statements include a significant amount of cash payments
and forgiveness of debt that relates to liabilities from prior periods. Consequently,
the resulting net cash used in operating activities during these two periods was
negatively impacted. Now that we have paid and settled a significant amount of these
old liabilities, as well as seeing an improvement in our operating results, we expect
our net cash used in operating activities to improve during future periods. Additionally,
the 2004 net cash used in operating activities includes approximately $1.7 million
in interest and dividends accreted on our series C preferred stock and a one time
charge of $0.2 million related to a beneficial conversion feature on the convertible
debt we issued in November 2004. The accretion on this stock will cease during February
2005 as we completed our IPO and all the Series C Preferred stock converted into
common stock.
In some situations, we may be required
to guarantee payment or performance under agreements, and in these circumstances
we would need to secure letters of credit or bonds to do so.
We intend to fund corporate overhead, including
management salaries from the working capital that we have raised from our IPO.
Debt Service Requirements
At December 31, 2004, we had approximately
$5.7 million of current and long-term notes payable and capital leases. All of this
debt, other than $0.2 million is due during the 12 months ending December 31, 2005.
Subsequent to our IPO, a significant portion of this debt was repaid or converted.
During February 2005, we repaid $1.5 million of this debt as well as $0.6 million
of interest and converted $2.5 million of this debt into common stock.
We expect our interest expense to decrease
significantly during 2005 due to the following factors:
27
Capital Instruments
The only outstanding preferred stock we
had as of December 31, 2004 was our Series C Preferred Stock. This stock provided
for the payment of dividends at a rate equal to 8.0% per annum. The dividends were
payable in cash annually, commencing on the first anniversary of the initial closing
of the Series C Preferred Stock offering, unless the Series C Preferred Stock was
converted into common stock upon the completion of an offering, in which case no
dividend would be due. So long as our common stock or other securities into which
Series C Preferred Stock was convertible into, was not publicly traded, at any time
after the second anniversary of the initial closing of this offering, the holders
of the Series C Preferred Stock may have required us to redeem their respective
shares of the Series C Preferred Stock for cash equal to 112% of the stated value
plus payment of accrued and unpaid dividends. Each share of the Series C Preferred
Stock was convertible, at the option of the holder at any time, at the conversion
price of $3.15 per share. As previously discussed, upon the closing of our IPO in
February 2005, the Series C Preferred Stock automatically converted into 3,141,838
shares of our common stock. The holders of the Series C Preferred Stock also received
a redeemable common stock purchase warrant.
Summary of Contractual Obligations Critical Accounting Policies and Estimates
We have identified the policies and significant
estimation processes below as critical to our business operations and the understanding
of our results of operations. The listing is not intended to be a comprehensive
list. In many cases, the accounting treatment of a particular transaction is specifically
dictated by accounting principles generally accepted in the United States, with
no need for management’s judgment in their application. In other cases, management
is required to exercise judgment in the application of accounting principles with
respect to particular transactions. The impact and any associated risks related
to these policies on our business operations is discussed throughout “Management’s
Discussion and Analysis of Financial Condition and Results of Operations” where
such policies affect reported and expected financial results. For a detailed discussion
on the application of these and other accounting policies, see Note 2 in the Notes
to Consolidated Financial Statements for the year ended December 31, 2004 included
in this Annual Report on Form 10-K. Our preparation of our consolidated financial
statements requires us to make estimates and assumptions that affect the reported
amount of assets and liabilities, disclosure of contingent assets and liabilities
at the date of our consolidated financial statements, and the reported amounts of
revenue and expenses during the reporting periods. Management bases its estimates
on historical experience and on various other assumptions that are believed to be
reasonable under the circumstances. There can be no assurance that actual results
will not differ from those estimates and such differences could be significant.
28
Revenue Recognition—Our revenue is primarily derived
from fees charged to terminate voice services over our network, and from monthly
recurring charges associated with Internet and Private Line services.
Variable revenue is earned based on the
number of minutes during a call and is recognized upon completion of a call, adjusted
for allowance for doubtful accounts receivable and billing adjustments. Revenue
for each customer is calculated from information received through our network switches.
Customized software has been designed to track the information from the switch and
analyze the call detail records against stored detailed information about revenue
rates. This software provides us the ability to do a timely and accurate analysis
of revenue earned in a period. Consequently, the recorded amounts are generally
accurate and the recorded amounts are unlikely to be revised in the future.
Fixed revenue is earned from monthly recurring
services provided to the customer that are fixed and recurring in nature, and are
contracted for over a specified period of time. The initial start of revenue recognition
is after the provisioning, testing and acceptance of the service by the customer.
The charges continue to bill until the expiration of the contract, or until cancellation
of the service by the customer. Additionally, the majority of our VoIP services
to consumersare prepaid. The revenue received from the prepayments that is related
to VoIP termination services in the current month is booked to the current month’s
revenue, and the remainder of the prepayments are booked to deferred revenue, until
usage occurs.
Accounts Receivable—Accounts
receivable are recorded net of an allowance for doubtful accounts. On a periodic
basis, we evaluate our accounts receivable and record an allowance for doubtful
accounts, based on our history of past write-offs and collections and current credit
conditions. Specific customer accounts are written off as uncollectible if the probability
of a future loss has been established and payments are not expected to be received.
Cost of revenues and cost of revenues
accrual—Cost of revenues is comprised primarily of costs incurred from
other domestic and international telecommunications carriers to originate, transport
and terminate calls. The majority of our cost of revenue is variable, based upon
the number of minutes of use, with transmission and termination costs being the
most significant expense. Call activity is tracked and analyzed with customized
software that analyzes the traffic flowing through our network switches. Each period
the activity is analyzed and an accrual is recorded for minutes not invoiced. This
cost accrual is calculated using minutes from the system and the variable cost of
revenue based upon predetermined contractual rates.
In addition to the variable cost of revenue,
there are also fixed expenses. One category of fixed expenses are those that are
associated with the network backbone connectivity to our switch facilities. These
would consist of hubbing charges at our New York switch facility that allow other
carriers to send traffic to our switch, satellite or cable charges to connect to
our international network, or Internet connectivity charges to connect customers
or vendors to Fusion’s switch via the public Internet, a portion of which are
variable costs. The other category of fixed expenses is associated with charges
that are dedicated point to point connections to specific customers (both private
line and Internet access).
Income Taxes—We account for
income taxes in accordance with the provisions of SFAS No. 109, “Accounting
for Income Taxes” (“SFAS 109”). SFAS 109 requires companies to recognize
deferred tax liabilities and assets for the expected future income tax consequences
of events that have been recognized in our consolidated financial statements. Deferred
tax liabilities and assets are determined based on the temporary differences between
the consolidated financial statements carrying amounts and the tax bases of assets
and liabilities, using enacted tax rates in the years in which the temporary differences
are expected to reverse. In assessing the likelihood of utilization of existing
deferred tax assets and recording a full valuation allowance, we have considered
historical results of operations and the current operating environment.
Recently Issued Accounting Pronouncements
In December 2004, the Financial Accounting
Standards Board “FASB”) issued SFAS No. 123 (revised 2004) (“123R”),
“Share-Based Payment”. Statement 123(R) will provide investors and other
users of financial statements with more complete and neutral financial information
by requiring that the compensation cost relating to share based payment transactions
be recognized in financial statements. That cost will be measured based on the fair
value of the equity or liability instruments issued. SFAS No. 123(R) covers a wide
range of share-based compensation arrangements including share options, restricted
share plans, performance-based awards, share appreciation rights and employee share
purchase plans. SFAS No. 123(R) replaces SFAS No. 123, “Accounting for Stock
Based Compensation”, and supersedes APB Opinion No. 25, “Accounting for
Stock Issued to Employees”. SFAS No. 123, as originally issued in 1995, established
as 29
preferable a fair-value-based method of accounting for share-based
payment transactions with employees. However, that Statement permitted entities
the option of continuing to apply the guidance in APB Opinion No. 25, as long as
the footnotes to financial statements disclosed what net income would have been
had the preferable fair-value based method been used. Public entities (other than
those filing as small business issuers) will be required to apply SFAS No. 123(R)
as of the first interim or annual reporting period that begins after June 15, 2005.
We are in the process of evaluating whether the adoption of SFAS No. 123(R) will
have a significant impact on our overall results of operations or financial position.
In December 2004, the FASB issued SFAS
No. 153, “Exchange of Nonmonetary Assets” an amendment of APB Opinion
No. 29, “Accounting for Nonmonetary Transactions”. The amendments made
by SFAS No. 153 are based on the principle that exchanges on nonmonetary assets
should be measured based on the fair value of the assets exchanged. Further, the
amendments eliminate the narrow exception for nonmonetary exchanges of similar productive
assets and replace it with a broader exception for exchanges of nonmonetary assets
that do not have commercial substance. SFAS No. 153 is effective for nonmonetary
asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier
application is permitted for nonmonetary asset exchanges occurring in fiscal periods
after the date of issuance. The provisions of SFAS No. 153 shall be applied prospectively.
We are in the process of evaluating whether the adoption of SFAS No. 153 will have
a significant impact on our overall results of operations or financial position.
Inflation
We do not believe inflation has a significant
effect on our operations at this time.
RISK FACTORS
In addition to the other information
included in this annual report, you should consider the following risk factors.
This annual report contains forward-looking statements covered by the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking
statements involve risks and uncertainties that may affect our business and prospects.
Our results may differ significantly from the results discussed in the forward-looking
statements as a result of certain factors that are listed below or discussed elsewhere
in this annual report and our other filings with the Securities and Exchange Commission.
Risks Related to Business
We have a history of operating losses, a working
capital deficit and a stockholders’ deficit and there can be no assurance that
we will ever achieve profitability.
There can be no assurance that any of our
business strategies will be successful or that we will ever achieve profitability.
At December 31, 2004, we had a working capital deficit of approximately $8.5 million
and a stockholders’ deficit of approximately $13.3 million. We have continued
to sustain losses from operations and for the years ended December 31, 2004, 2003
and 2002, we have incurred a net loss applicable to common stockholders of approximately
$5.4 million, $4.8 million, and $10.0 million, respectively. In addition, we have
not generated positive cash flow from operations for the years ended December 31,
2004, 2003 and 2002 . We may not be able to generate future profits and may not
be able to support our operations, or otherwise establish a return on invested capital.
If we are unable to manage our growth or implement our
expansion strategy, we may increase our costs without maximizing our revenues.
We may not be able to expand our product
offerings, our client base and markets, or implement the other features of our business
strategy at the rate or to the extent presently planned. Our projected growth will
place a significant strain on our administrative, operational and financial resources
and may increase our costs. If we are unable to successfully manage our future growth,
establish and continue to upgrade our operating and financial control systems, recruit
and hire necessary personnel or effectively manage unexpected expansion difficulties,
we may not be able to maximize revenues or profitability. 30
The success of our planned expansion is dependent upon market
developments and traffic patterns which will lead us to make expenditures that may
not result in increased revenues.
Our purchase of network equipment and software
will be based in part on our expectations concerning future revenue growth and market
developments. As we expand our network, we will be required to make significant
capital expenditures, including the purchase of additional network equipment and
software, and to add additional employees. To a lesser extent our fixed costs will
also increase from the ownership and maintenance of a greater amount of network
equipment including our Softswitch, gateways, routers, satellite equipment, and
other related systems. If our traffic volume were to decrease, or fail to increase
to the extent expected or necessary to make efficient use of our network, our costs
as a percentage of revenues would increase significantly.
We may be unable to adapt to rapid technology trends
and evolving industry standards which could lead to our products becoming obsolete.
The communications industry is subject
to rapid and significant changes due to technology innovation, evolving industry
standards, and frequent new service and product introductions. New services and
products based on new technologies or new industry standards expose us to risks
of technical or product obsolescence. We will need to use technologies effectively,
continue to develop our technical expertise and enhance our existing products and
services in a timely manner to compete successfully in this industry. We may not
be successful in using new technologies effectively, developing new products or
enhancing existing products and services in a timely manner or that any new technologies
or enhancements used by us or offered to our customers will achieve market acceptance.
Our growth is dependent upon our ability to build new
relationships with postal telephone and telegraph companies, bring on new customers
and to obtain the necessary licenses in new countries in which we have not previously
operated, of which there can be no assurance.
Our ability to grow through quick and cost
effective deployment of our Internet protocol services is due, in part, to our ability
to create new interconnection agreements with postal telephone and telegraph companies,
and other licensed carriers, to sign contracts with new customers, and, in many
cases, to enter into joint venture or strategic agreements with local partners,
as well as to obtain the necessary licenses to operate in emerging markets. While
we pursue several opportunities simultaneously, we might not be able to create the
necessary partnerships and interconnections, expand our customer base, deploy networks
and generate profitable traffic over these networks within the time frame envisioned.
We are pursuing new business lines, which require specialized
skill sets. Our ability to effectuate our business plan is due, in part, to the
roll out of new services, including PC-To-Phone, Internet protocol Phone-To-Phone
and Internet video conferencing.
Our ability to deploy new products and
services may be hampered by technical and operational issues which could delay our
ability to derive profitable revenue from these service offerings. These issues
include our ability to competitively price such products and services, in addition,
certain service offerings such as Internet protocol video are relatively new in
our industry and the market potential is relatively untested. Additionally, our
ability to market these products and service offerings may prove more difficult.
To date, we have not significantly focused on selling Internet video conferencing
and thus have derived extremely limited revenue from this service, and there can
be no assurance that we will increase our current focus and/or derive significant
revenue from this service.
The communications services industry is highly competitive
and we may be unable to compete effectively.
The communications industry, including
Internet and data services, is highly competitive, rapidly evolving, and subject
to constant technological change and intense marketing by providers with similar
products and services. We expect that new competitors, as well as gray market operators
(operators who arrange call termination in a manner that bypasses the postal telephone
and telegraph company, resulting in high margins for the gray market operator and
substantially lower revenues for the postal telephone and telegraph company), are
likely to join existing competitors in the communications industry, including the
market for VoIP, Internet and data services. Many of our current competitors are
31
significantly larger and have substantially greater market presence
as well as greater financial, technical, operational, marketing and other resources
and experience than we do. In the event that such a competitor expends significant
sales and marketing resources in one or several markets we may not be able to compete
successfully in such markets. We believe that competition will continue to increase,
placing downward pressure on prices. Such pressure could adversely affect our gross
margins if we are not able to reduce our costs commensurate with such price reductions.
In addition, the pace of technological change makes it impossible for us to predict
whether we will face new competitors using different technologies to provide the
same or similar services offered or proposed to be offered by us. If our competitors
were to provide better and more cost effective services than ours, we may not be
able to increase our revenues or capture any significant market share.
Industry consolidation could make it more difficult
for us to compete.
Companies offering Internet, data and communications
services are, in some circumstances, consolidating. We may not be able to compete
successfully with businesses that have combined, or will combine, to produce companies
with sub-stantially greater financial, sales and marketing resources, larger client
bases, extended networks and infrastructures and more established relationships
with vendors, distributors and partners than we have. With these heightened competitive
pressures, there is a risk that our revenues may not grow as expected and the value
of our common stock could decline.
Certain of our competitors are emerging from bankruptcy
and may have an advantage over us in pricing.
Several companies in the telecommunications
industry have gone through bankruptcy proceedings and have emerged, or are expected
to emerge, as viable competitors. These companies may emerge with cost structures
that are significantly lower than those companies that have not entered into and
emerged from bankruptcy proceedings, allowing them to market services at lower prices.
This in turn may result in us having to reduce our prices, which would have an adverse
impact on our future profitability.
Our ability to provide services is often dependent on
our suppliers and other service providers who may not prove to be effective.
A majority of the voice calls made by our
clients are connected through other communication carriers which provide us with
transmission capacity through a variety of arrangements. Our ability to terminate
voice traffic in our targeted markets is an essential component of our ongoing operations.
If we do not secure or maintain operating and termination arrangements, our ability
to increase services to our existing markets, and gain entry into new markets, will
be limited. Therefore, our ability to maintain and expand our business is dependent,
in part, upon our ability to maintain satisfactory relationships with incumbent
and other licensed carriers, Internet service providers, international exchange
carriers, satellite providers, fiber optic cable providers and other service providers,
many of which are our competitors, and upon our ability to obtain their services
on a cost effective basis, as well as the ability of such carriers to carry the
traffic we route to their networks or provide network capacity. If a carrier does
not carry traffic routed to it, or provide required capacity, we may be forced to
route our traffic to, or buy capacity from, a different carrier on less advantageous
terms, which could reduce our profit margins or degrade our network service quality.
In the event network service is degraded it may result in a loss of customers. To
the extent that any of these carriers raise their rates, change their pricing structure,
or reduce the amount of capacity they will make available to us, our revenues and
profitability may be adversely affected.
We rely on third party equipment suppliers who may not
be able to provide us the equipment necessary to deliver the services that we seek
to provide.
We are dependent on third party equipment
suppliers for equipment and hardware components, including Cisco, Nuera, Juniper
Networks, Santa Cruz Networks and Veraz. If these suppliers fail to continue product
development and research and development or fail to deliver quality products or
support services on a timely basis, or we are unable to develop alternative sources,
if and as required, it could result in our inability to deliver the services that
we currently and intend to provide. 32
We rely on the cooperation of postal telephone and telegraph companies
who may hinder our operations in certain markets.
In some cases we will require the cooperation
of the postal telephone and telegraph company or another carrier in order to provide
services under a license or partnership agreement. In the event the postal telephone
and telegraph company or another carrier does not cooperate, our service roll-out
may be delayed, or the services we offer could be nega-tively affected. If we acquire
a license for a market and the postal telephone and telegraph company or incumbent
carrier desires to negatively affect our business in the area, they may be in a
position to significantly delay our ability to provide services in that market and
ultimately make it not worth pursuing.
If we do not operate our new Softswitch technology effectively,
many of the potential benefits of the new technology may not be realized.
We have made a fundamental change in our
business operations by migrating to new Softswitch technology. There are inherent
risks associated with using such a relatively new technology. We may be required
to spend additional time or money on integration of this technology, which could
otherwise be spent on developing our services. We expect to experience a temporary
decline in revenues during and immediately following the migration to the new softswitch
technology. If we do not operate the technology effectively or if we and our technical
staff spend too much time on operational issues, it could result in increased costs
without the corresponding benefits.
If we are unable to develop and maintain successful
relationships with our joint venture partners, we could fail in an important market.
We are engaged in certain joint ventures
where we share control or management with a joint venture partner. If we are unable
to maintain a successful relationship with a joint venture partner, the joint venture’s
ability to move quickly and respond to changes in market conditions or respond to
financial issues, can erode and reduce the potential for value creation and return
on investment. For example, our joint venture partner in India has been unable to
pay us in a timely manner for services rendered. Further, the joint ventures may
also restrict or delay our ability to make important financial decisions, such as
repatriating cash to us from such joint ventures. This uncertainty with our joint
ventures could result in a failure in an important market.
Service interruptions could result in a loss of revenues
and harm our reputation.
Our networks have been and may be shut
down from time to time as a result of disputes with postal telephone and telegraph
companies, vendors, carriers or general service providers due to billing disputes,
late payments, or other issues. As an example, in June and July 2002, we experienced
a permanent service interruption on three networks which had 2002 year to date revenues
of approximately $8.2 million and gross profit of $395,000. These service interruptions
were related to the shut down of three networks, two of which were in Latin America
and one in the Caribbean. Any future network shut downs can have a significant negative
impact on revenue and cash flows, as well as hurting our reputation. In addition,
there is no assurance that we will be able to quickly resolve disputes, if ever,
which could result in a permanent loss of revenues.
If our information and processing systems for billing
and client service are not properly implemented, it could harm our ability to bill
and provide services effectively.
Sophisticated back office information and
processing systems are vital to our growth and our ability to monitor costs, bill
clients, provision client orders, and achieve operating efficiencies. Our plans
for the development and implementation of these systems rely, for the most part,
on having the capital to purchase and maintain required software, choosing products
and services offered by third party vendors, and integrating such products and services
with existing systems. We also may require customized systems in order to meet our
requirements which may delay implementation and increase expenses. These systems
must also integrate with our network infrastructure. In the event that these systems
do not integrate with our network infrastructure, our ability to manage our operational
or financial systems will be inhibited. We cannot ensure that they will be implemented
at all, or that, once implemented, they will perform as expected. Furthermore, our
right to use some of these systems is dependent upon license agreements with third
party vendors. 33
These third-party vendors may cancel or refuse to renew some of these
agreements, and the cancellation or non-renewal of these agreements may harm our
ability to bill and provide services efficiently.
Breaches in our network security systems may hurt our
ability to deliver services and reputation and result in liability.
We could lose clients and expose ourselves
to liability if there are any breaches to our network security systems, which could
jeopardize the security of confidential information stored in our computer systems.
In the last four years we experienced two known breaches of network security, which
resulted in a temporary failure of network operations. Any network failure could
harm our ability to deliver certain services, our reputation and subject us to liability.
Because we do business on an international level we
are subject to an increased risk of tariffs, sanctions and other uncertainties that
may hurt our revenues.
There are certain risks inherent in doing
business internationally, especially in emerging markets, such as unexpected changes
in regulatory requirements, the imposition of tariffs or sanctions, licenses, customs,
duties, other trade barriers, political risks, currency devaluations, high inflation,
corporate law requirements, and even civil unrest. Many of the economies of these
emerging markets are weak and volatile. We may not be able to mitigate the effect
of inflation on our operations in these countries by price increases, even over
the long-term. Further, expropriation of private businesses in such jurisdictions
remains a possibility, whether by outright seizure by a foreign government or by
confiscatory tax or other policies. Deregulation of the communications markets in
developing countries may not continue. Incumbent providers, trade unions and others
may resist legislation directed toward deregulation and may resist allowing us to
interconnect to their network switches. The legal systems in emerging markets frequently
have insufficient experience with commercial transactions between private parties.
Consequently, we may not be able to protect or enforce our rights in any emerging
market countries. Governments may change resulting in cancellations or suspensions
of operating licenses, confiscation of equipment and/or rate increases. The instability
of the laws and regulations applicable to our businesses and their interpretation
and enforcement in these markets could materially and adversely affect our business,
financial condition, or results of operations.
Regulatory treatment of VoIP outside the
United States varies from country to country. Some countries are considering subjecting
VoIP services to the regulations applied to traditional telephone companies and
they may assert that we are required to register as a telecommunications carrier
in that country. In such cases, our failure to register could subject us to fines,
penalties, or forfeiture. Regulatory developments such as these could have a material
adverse effect on our international operations.
The success of our business depends on the acceptance
of the Internet in emerging markets that may be slowed by limited bandwidth, high
bandwidth costs, and other technical obstacles.
The ratio of telephone lines per population,
or teledensity, in most emerging countries is low when compared to developed countries.
Bandwidth, the measurement of the volume of data capable of being transported in
a communications system in a given amount of time, remains very expensive in these
regions, especially when compared to bandwidth costs in the United States. Prices
for bandwidth capacity are generally set by the government or incumbent telephone
company and remain high due to capacity constraints among other things. While this
trend tends to diminish as competitors roll out new bypass services, these rollouts
may be slow to occur. Further, constraints in network architecture limit Internet
connection speeds on conventional dial-up telephone lines, and are significantly
less than the up to 1.5 megabits per second connection speed on direct satellite
link or digital subscriber lines and cable modems in the United States. These speed
and cost constraints may severely limit the quality and desirability of using the
Internet in emerging countries and can be an obstacle to us entering emerging markets.
Additional taxation and the regulation of the communications
industry may slow our growth, resulting in decreased demand for our products and
services and increased costs of doing business.
We could have to pay additional taxes because
our operations are subject to various taxes. We structure our operations based on
assumptions about various tax laws, U.S. and international tax treaty developments,
international cur-
34
rency exchange, capital repatriation laws, and other relevant laws
by a variety of non-U.S. jurisdictions. Taxation or other authorities might not
reach the same conclusions we reach. We could suffer adverse tax and other financial
consequences if our assumptions about these matters are incorrect or the relevant
laws are changed or modified.
We are subject to varying degrees of international,
federal, state, and local regulation. Significant regulations imposed at each of
these levels govern the provision of some or all of our services and affect our
business. We cannot assure you that we or our joint venture partners, have, or,
will receive the international, United States Federal Communications Commission
(“FCC”), or state regulatory approvals we or they require. Nor can we
provide you with any assurance that international, FCC or state regulatory authorities
will not raise material issues with respect to our compliance with applicable regulations
or that the cost of our compliance will not have a materially adverse effect on
our revenues and profitability.
The U.S. Federal Government and state authorities
have the power to revoke our regulatory approval to operate internationally, interstate,
or intrastate, or to impose financial penalties if we fail to pay, or are delinquent
in paying, telecommunications taxes or regulatory fees or fail to file necessary
tariffs or mandatory reports. We are currently, and have been, delinquent in such
financial obligations and required filings in the past. Furthermore, delays in receiving
required regulatory approvals or the enactment of new and adverse legislation, regulations
or regulatory requirements could also have a materially adverse affect on our condition.
In addition, future legislative, judicial and regulatory agency actions could alter
competitive conditions in the markets in which we intend to operate, to our detriment.
In addition to new regulations being adopted,
existing laws may be applied to the Internet, which could hamper our growth.
New and existing laws may cover issues
that include: sales and other taxes; user privacy; pricing controls; characteristics
and quality of products and services; consumer protection; cross-border commerce;
copyright, trademark and patent infringement; and other claims based on the nature
and content of Internet materials. This could delay growth in demand for our products
and services and limit the growth of our revenue.
Risks Related to our Common Stock
Voting Control by Principal Stockholders.
Our executive officers and directors collectively
will control approximately 26.1% of our outstanding common stock after our February
2005 IPO and, therefore they will be able to significantly influence the vote on
matters requiring stockholder approval, including the election of directors.
We Do Not Intend to Pay Dividends.
We have never declared or paid any cash
dividends on our common stock. We intend to retain any future earnings to finance
our operations and to expand our business and, therefore, do not expect to pay any
cash dividends in the foreseeable future.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISKS
Quantitative and Qualitative Disclosures About Market
Risk
We are exposed to certain market risks
that are inherent in our financial instruments. These instruments arise from transactions
in the normal course of business.
At December 31, 2004, the majority of our
cash balances were held primarily in the form of a short-term highly liquid investment
grade money market fund in a major financial institution. Due to the short-term
nature of our investments, we believe that we are not subject to any material interest
or market rate risks. 35
At December 31, 2004, we were subject to interest rate risk on one
$25,000 convertible note payable (this note was repaid during February 2005). Therefore,
our exposure to interest rate risk is limited as all of our other debt at December
31, 2004 is at fixed interest rates. As such, we currently believe that our interest
rate risk is fairly low.
We currently do not conduct our business
in currencies other than the United States dollar. The reporting currency for our
financial statements is the United States dollar and the functional currency for
both of our respective subsidiaries is the U.S. dollar. However, in the future,
we may conduct a larger percentage of our business in other foreign currencies that
could have an adverse impact on our future results of operations.
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY
DATA
The Company’s Consolidated Financial
Statements required by this Item are included in Item 14 of this report on pages
F-1 through F-34.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
(a) Evaluation of Disclosure Controls and
Procedures. Our principal executive officer and principal financial officer, after
evaluating the effectiveness of our disclosure controls and procedures (as defined
in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered
by this Annual Report on Form 10-K, have concluded that, based on such evaluation,
our disclosure controls and procedures were adequate and effective to ensure that
material information relating to us, including our consolidated subsidiaries, was
made known to them by others within those entities, particularly during the period
in which this Annual Report on Form 10-K was being prepared.
(b) Changes in Internal Controls. There
were no changes in our internal control over financial reporting, identified in
connection with the evaluation of such internal control that occurred during our
last fiscal year, that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
36
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this Item is
incorporated herein by reference to the sections entitled “Management”
and “Principal Stockholders” in the proxy statement for our 2005 Annual
Meeting of Stockholders.
On November 1, 2004, we adopted a Corporate
Code of Conduct and Ethics applicable to all employees and directors of Fusion,
including our principal executive officer and principal financial and accounting
officer. A copy of the Code of Conduct is posted on our website. We intend to post
on our website any amendments to, or waivers from, our Code of Conduct and Ethics
that apply to our principal executive officer and principal financial and accounting
officer.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is
incorporated herein by reference to the section entitled “Executive Compensation”
in the proxy statement for our 2005 Annual Meeting of Stockholders.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this Item is
incorporated herein by reference to the section entitled “Principal Stockholders”
in the proxy statement for our 2005 Annual Meeting of Stockholders.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this Item is
incorporated herein by reference to the section entitled “Related Party Transactions”
in the proxy statement for our 2005 Annual Meeting of Stockholders.
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this Item is
incorporated herein by reference to the section entitled “Principal Accounting
Fees and Services” in the proxy statement for our 2005 Annual Meeting of Stockholders.
37
PART IV
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)(1) Financial Statements.
The Consolidated Financial Statements filed
as part of this Annual Report on Form 10-K are identified in the Index to Consolidated
Financial Statements on page F-1 hereto.
(a)(2) Financial Statement Schedules.
Financial Statement Schedules have been
omitted because the information required to be set forth therein is not applicable
or is shown on the financial statements or notes thereto.
(a)(3) Exhibits.
The following exhibits are filed herewith or are incorporated by reference to exhibits previously filed with the Securities and Exchange Commission
38
We furnished a report on Form 8-K dated March 14, 2005 reporting under Item 1.01 the entry into a Stock Purchase Agreement between FUSION TURKEY, L.L.C., LDTS UZAK MESAFE TELEKOMÜNIKASYON VE .ILETIS,IM HIZMETLERI SAN.TIC.A.S. and Bayram Ali BAYRAMOùGLU; Mecit BAYRAMOùGLU Mehmet; Musa BAYSAN; Yahya BAYRAMOùGLU and Özlem BAYSAN.
39
SIGNATURES
Pursuant to the requirements of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly autgorized.
Fusion Telecommunications International,
Inc.
Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed by the following persons on behalf
of the registrant and in the capacities and on the dates indicated.
40 FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
F-1
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
Board of Directors and Stockholders of We have audited the accompanying consolidated
balance sheets of Fusion Telecommunications International, Inc. and Subsidiaries
(the “Company”) as of December 31, 2004 and 2003, and the related consolidated
statements of operations, changes in stockholders’ deficit and cash flows for
each of the three years in the period ended December 31, 2004. These consolidated
financial statements are the responsibility of the Company’s management. Our
responsibility is to express an opinion on these consolidated financial statements
based on our audits.
We conducted our audits in accordance with
the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audits to obtain reasonable
assurance about whether the financial statements are free of material misstatement.
The Company is not required to have, nor were we engaged to perform, an audit of
its internal control over financial reporting. Our audit included consideration
of internal control over financial reporting as a basis for designing audit procedures
that are appropriate in the circumstances, but not for the purpose of expressing
an opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates made
by management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial
statements referred to above present fairly, in all material respects, the financial
position of the Company as of December 31, 2004 and 2003, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2004, in conformity with accounting principles generally accepted in
the United States of America.
In connection with our audits of the financial
statements referred to above, we audited the financial statement schedule on page F-34. In our opinion, the financial statement schedule,
when considered in relation to the consolidated financial statements taken as a
whole, presents fairly, in all material respects, the information stated therein.
/s/ Rothstein, Kass & Company, P.C. F-2
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
See accompanying notes to consolidated financial statements.
F-3
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
See accompanying notes to consolidated financial statements.
F-4
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
See accompanying notes to consolidated financial statements.
F-5
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. See accompanying notes to consolidated financial
statements. F-6
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
See accompanying notes to consolidated financial statements.
F-7
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Fusion Telecommunications International,
Inc. and Subsidiaries (collectively the “Company”) is a Delaware corporation,
incorporated in September 1997. The Company is an international communications carrier
delivering Voice over Internet Protocol (“VoIP”), Private Networks, Internet
Access, IP Video Conferencing and other advanced services to, from and within emerging
markets in Asia, the Middle East, Africa, the Caribbean, and Latin America. With
its lead product, VoIP, the Company provides a full suite of communications solutions
to corporations, Postal Telephones and Telegraphs, Internet Service Providers, government
entities, consumers and cable operators.
2. Summary of significant accounting
policies
Principles of Consolidation
The consolidated financial statements include
the accounts of Fusion Telecommunications International, Inc. and its wholly owned
and majority owned subsidiaries. All material intercompany accounts and transactions
have been eliminated in consolidation.
Stock Split
On November 1, 2004, the Board of Directors,
as approved by the shareholders on December 10, 2004, authorized a 3.5 to 1 reverse
stock-split applicable to all outstanding shares of the Company’s common stock.
All transactions and disclosures in the consolidated financial statements, related
to the Company’s common stock have been restated to reflect the effect of the
reverse stock-split.
Revenue Recognition
The Company recognizes revenue when persuasive
evidence of a sales arrangement exists, delivery has occurred or services have been
rendered, the sales price is fixed and determinable and collectibility is reasonably
assured. When significant, the Company records provisions against revenue for billing
adjustments, which are based upon estimates derived from factors that include, but
are not limited to, historical results, analysis of credits issued, current economic
trends and changes in demand. The provisions for revenue adjustments are recorded
as a reduction of revenue when incurred or ratably over a contract period, as applicable.
The Company derives revenue principally
from international voice, including VoIP, private networks and Internet services.
Variable revenue derived from international voice services is recognized upon completion
of a call and is based upon the number of minutes of traffic carried. Revenue from
monthly recurring service from long distance, private networks and Internet services
are fixed and recurring in nature and are contracted over a specific period of time.
Advanced billings for monthly fees are reflected as deferred revenues and are recognized
as revenue at the time the service is provided. VoIP services enables customers,
typically international corporations or cable operators, to place voice calls anywhere
in the world using their personal computer. The majority of the Company’s VoIP
services to consumers are prepaid which is initially recorded as deferred revenue.
Revenues from VoIP services are recognized based upon the usage of minutes by the
consumer.
Cash and Cash Equivalents
The Company considers all highly-liquid
debt instruments purchased with maturities of three months or less to be cash equivalents.
F-8
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Accounts Receivable
The Company values its accounts receivable
net of an allowance for doubtful accounts. On a periodic basis, the Company evaluates
its accounts receivable and establishes an allowance for doubtful accounts, based
on a history of past write-offs and collections and current credit conditions. Specific
customer accounts are written off as uncollectible if the probability of a future
loss has been established and payments are not expected to be received.
Fair Value of Financial Instruments
The fair value of the Company’s assets
and liabilities which qualify as financial instruments under Statement of Financial
Accounting Standards (“SFAS”) No. 107, “Disclosures About Fair Value
of Financial Instruments,” approximate the carrying amounts presented in the
accompanying consolidated balance sheets.
Impairment of Long-Lived Assets and Impairment Charges
The Company complies with SFAS No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets,” which
requires impairment losses to be recorded on long-lived assets used in operations
when indicators of impairment are present and undiscounted cash flows estimated
to be generated by those assets are less than the assets’ carrying amount.
The Company continually evaluates whether events and circumstances have occurred
that indicates the remaining estimated useful life of long-lived assets, such as
property and equipment may warrant revision, or the remaining balance may not be
recoverable.
During 2003, the Company recorded an impairment
of $375,000 related to management’s decision to lease (to a third-party) certain
switching equipment, which will be replaced by upgraded equipment. In accordance
with the provisions of SFAS No. 144, the Company evaluated the present value of
the future cash flows to be generated from this lease and determined that the present
value of the future cash flows were less than the carrying value of the equipment,
thus there was an impairment on the switching equipment. The Company continued to
utilize the switching equipment in 2003 and in 2004.
During 2002, the Company recorded an impairment
on equipment for approximately $468,000. This impairment was due to the termination
and abandonment of a voice network to a route in the Caribbean, which during 2002,
was deactivated and no longer generating revenues for the Company. The impairment
was equal to the net book value of the equipment at the date this Caribbean voice
network was deactivated.
Property and Equipment
Property and equipment are stated at cost
and are depreciated or amortized on the straight-line method over the estimated
useful lives of the assets as follows:
Maintenance and repairs are charged to operations,
while betterments and improvements are capitalized. F-9
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Advertising
Advertising costs are charged to operations
as incurred and were approximately $82,000, $59,000 and $19,000 for 2004, 2003 and
2002, respectively.
Income Taxes
The Company complies with SFAS No. 109,
“Accounting for Income Taxes,” which requires an asset and liability approach
to financial 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.
Comprehensive Income
The Company complies with SFAS No. 130,
“Reporting Comprehensive Income.” SFAS No. 130 establishes rules for the
reporting and display of comprehensive income and its components. SFAS No. 130 requires
the Company’s change in the foreign currency translation adjustment to be included
in other comprehensive income. During the years ended December 31, 2004, 2003 and
2002, the Company did not have any changes in its equity resulting from non-owner
sources and accordingly, comprehensive loss was equal to the net loss amounts presented
for the respective periods in the accompanying Consolidated Statements of Operations.
Earnings Per Share
SFAS No. 128, “Earnings Per Share,”
requires dual presentation of basic and diluted income per share for all periods
presented. Basic income per share excludes dilution and is computed by dividing
income available to common stockholders by the weighted-average number of common
shares outstanding during the period. Diluted income 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.
Unexercised stock options to purchase 1,848,578,
656,207 and 1,009,771 shares of the Company’s common stock as of December 31,
2004, 2003 and 2002, respectively, were not included in the computation of diluted
earnings per share because the exercise of the stock options would be anti-dilutive
to earnings per share.
Unexercised warrants to purchase 286,578,
252,758 and 159,217, shares of the Company’s common stock as of December 31,
2004, 2003 and 2002, respectively, were not included in the computation of diluted
earnings per share because the exercise of the warrants would be anti-dilutive to
earnings per share.
Non-converted debt to purchase 97,998,
47,215 and 39,286 shares of the Company’s common stock as of December 31, 2004,
2003 and 2002, respectively were not included in the computation of diluted earnings
per share because the conversion of the debt would be anti-dilutive to earnings
per share. Had the debt been converted interest expense would have been reduced
by approximately $49,000 in the year ended December 31, 2004 and $30,000 in the
years ended December 31, 2003 and 2002. F-10
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Stock-Based Compensation
The Company follows SFAS No. 123, “Accounting
for Stock-Based Compensation”. The provisions of SFAS No. 123 allow companies
to either expense the estimated fair value of stock options or to continue to follow
the intrinsic value method set forth in Accounting Principles Board Opinion 25,
“Accounting for Stock Issued to Employees” (“APB 25”) but disclose
the pro forma effect on net income (loss) had the fair value of the options been
expensed. The Company has elected to continue to apply APB 25 in accounting for
its stock option incentive plans.
The Company provides the disclosure only
requirements of SFAS No. 148, “Accounting for Stock-Based Compensation-Transition
and Disclosure, an amendment of FASB Statement No. 123”. If compensation expense
for the Company’s stock option incentive plan had been determined based on
the fair value at the grant dates as calculated in accordance with SFAS No. 123,
the Company’s net loss attributable to common stockholders and net loss per
common share would approximate the pro forma amounts below:
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: dividend yield of 0%; weighted average
option term of four years; average risk free interest rate of 4.50%, 4.43% and 5.61%,
in 2004, 2003, and 2002, respectively. The weighted-average fair value of common
stock options granted was $0.35 during 2004 and $0.00 during 2003 and 2002.
Recently Issued Accounting Pronouncements
In December 2004, the Financial Accounting Standards Board
(“FASB”) issued SFAS No. 123 (revised 2004)(“123R”), “Share-Based
Payment”. Statement 123(R) will provide investors and other users of financial
statements with more complete and neutral financial information by requiring that
the compensation cost relating to share based payment transactions be recognized
in financial statements. That cost will be measured based on the fair value of the
equity or liability instruments issued. SFAS No. 123(R) covers a wide range of share-based
compensation arrangements including share options, restricted share plans, performance-based
awards, share appreciation rights and employee share purchase plans. SFAS No. 123(R)
replaces SFAS No. 123, “Accounting for Stock Based Compensation”, and
supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees”.
SFAS No. 123, as originally issued in 1995, established as preferable a fair-value-based
method of accounting for share-based payment transactions with employees. However,
that Statement permitted entities the option of continuing to apply the guidance
in APB Opinion No. 25, as long as the footnotes to financial statements disclosed
what net income would have been had the preferable fair-value based method been
used. Public entities (other than those filing as small business issuers) will be
required to apply SFAS No. 123(R) as of F-11
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Recently Issued Accounting Pronouncements (continued)
the first interim or annual reporting period
that begins after June 1, 2005. The Company is in the process of evaluating whether
the adoption of SFAS No. 123(R) will have a significant impact on the Company’s
overall results of operations or financial position.
In December 2004, the FASB issued SFAS
No. 153. “Exchange of Nonmonetary Assets” an amendment of APB Opinion
No. 29. “Accounting for Nonmonetary Transactions”. The amendments made
by SFAS No. 153 are based on the principle that exchanges of nonmonetary assets
should be measured based on the fair value of the assets exchanged. Further, the
amendments eliminate the narrow exception for nonmonetary exchanges of similar productive
assets and replace it with a broader exception for exchanges of nonomnetary assets
that do not have commercial substance. SFAS No. 153 is effective for nonmonetary
asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier
application is permitted for nonomnetary asset exchanges occurring in fiscal periods
after the date of issuance. The provisions of SFAS No. 153 shall be applied prospectively.
The Company is in the process of evaluating whether the adoption of SFAS No. 153
will have a significant impact on the Company’s overall results of operations
or financial position.
Use of Estimates
The preparation of the consolidated financial statements
in conformity with accounting principles generally accepted in the United States
of America 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 consolidated financial statements and the reported
amounts of revenues and expenses during the year. Actual results could differ from
those estimates.
Reclassifications
Certain reclassifications have been made
to the 2003 and 2002 consolidated financial statements to conform to the 2004 presentation.
3. Liquidity
At December 31, 2004, the Company has a
working capital deficit of approximately $8,514,000 and a stockholders’ deficit
of approximately $13,290,000. The Company has continued to sustain losses from operations
and for the years ended December 31, 2004, 2003 and 2002 has incurred a net loss
of approximately $5,030,000, $4,177,000 and $9,359,000, respectively. In addition,
the Company has not generated positive cash flow from operations for the years ended
December 31, 2004, 2003 and 2002. Subsequent to December 31, 2004, the Company raised
net proceeds of approximately $20,400,000 in connection with an Initial Public Offering
(see Note 22). Consequently, management believes that its current cash resources
will be adequate to fund its operations for the forseeable future. However, the
Company’s long-term liquidity is dependent on its ability to attain future
profitable operations. The Company cannot make any guarantees if and when it will
be able to attain future profitability.
4. Joint ventures, acquisitions and
divestitures
In March 2000, the Company entered into
a joint venture agreement with Communications Ventures India Pvt. Ltd. to form an
entity named Estel Communication Pvt. Ltd. (“Estel”). Estel is organized
and exists under the laws of India and has its office in New Delhi, India. The Company
directly owns 49% of the joint venture and has voting rights in another 1.01%, which
in turn gives the Company a 50.01% voting control in the joint venture. Estel was
established to engage in the business of selling and supporting internet service
protocol operations. Basically, Estel is in business as an Internet
F-12
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. service provider in India. The joint venture
has been funded primarily by the Company, which has also provided certain equipment
for the establishment of the required technology platforms.
In July 2002, the Company acquired a 75% equity interest
in a joint venture with Turner Hill Investments, L.P. (“Turner Hill”)
to provide VoIP services for calls terminating in Pakistan. During 2003 and 2002,
the Company contributed certain telecommunications equipment and advances to the
joint venture in exchange for its equity interest in the new joint venture. This
joint venture operates out of facilities provided by Turner Hill and began providing
VoIP service in November 2002. In connection with this joint venture agreement,
the Company entered into a service agreement with a Pakistan telecommunications
company to provide termination services for calls terminating in Pakistan (see Note
12 for additional details).
In December 2002, the Company acquired
a 50.2% equity interest in a joint venture with Karamco, Inc. (referred to as “Karamco”
and “Efonica”) to provide various VoIP services throughout the emerging
markets. As of December 31, 2003 no capital has been contributed to the joint venture
by either partner, but rather working capital loans have been provided for operating
purposes. Operations of the joint venture began during 2003. See subsequent events
Note 22 for discussion regarding the Company’s acquisition of the 49.8% minority
interest from Karamco.
In considering, EITF No. 96-16, “Investor’s
Accounting for an Investee When the Investor Has a Majority of the Voting Interest
but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights”,
management has evaluated the facts and circumstances underlying each joint venture
relationship such as the financial dependence of the minority shareholders on the
Company and corporate governance of each joint venture. Based upon these facts and
circumstances, the Company has determined that the minority shareholder of Estel
has substantive rights that prohibit the consolidation of this joint venture. As
a result, the Company has accounted for this joint venture under the equity method
of accounting (see Note 5).
All joint ventures identified above, excluding
Estel, have been accounted for under the consolidation method of accounting as the
Company maintained a majority equity ownership in the aforementioned joint ventures.
In December 2004, the Company entered into
an agreement to acquire 51% of the common stock of a Jamaican telecommunications
company in exchange for $150,000. The approximate amounts of net assets acquired
are as follows:
The intangible assets represent contractual assets
consisting of international and domestic carrier license agreements with the Jamaican
government which expire in 2013 and 2018, respectively. The intangible assets will
be amortized based upon the life of each license. The closing of this acquisition
took place on January 11, 2005 (see Note 22). Consequently, this acquisition had
no impact on the accompanying consolidated financial statements other than a $75,000
payment made in December 2004 which is reflected in the December 31, 2004 prepaid
expenses and other current assets.
Since the Company maintains operations
in foreign countries through its joint ventures, the Company may be subject to exchange
control regulations or other impediments to convert foreign currencies into US dollars.
In addition, the Company may generate earnings which may be unable to be repatriated
outside the country in which they are earned. As of December 31, 2004, the Company’s
joint ventures have not generated profits that would be subject to such restrictions.
F-13
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. As of December 31, 2004 and 2003, the loss
in excess of investment in Estel of approximately $141,000 and the investment in
Estel of approximately $761,000, respectively, represents the Company’s 49%
investment in Estel (Note 4). Income (loss) from investment in Estel was approximately
($520,000), ($747,000) and $326,000 for the years ended December 31, 2004, 2003
and 2002, respectively. Summarized financial data of Estel is below.
The investment by the other shareholder of Estel
was fully absorbed by its pro rata share of losses during 2001. The Company has
continued to fund 100% of Estel’s operations and as a result, the Company has
recorded 100% of Estel’s losses for the years ended December 31, 2004, 2003
and 2002 as income (loss) from investment in Estel.
For the years ended December 31, 2004,
2003, and 2002, revenues included approximately $321,000, $412,000, and $405,000,
respectively, for VoIP and IP services provided to Estel. At December 31, 2004 and
2003, the amounts due from this joint venture were approximately $118,000 which
is net of a $644,000 allowance and $499,000, respectively, are non-interest bearing,
due on demand, and are included in Investment in Estel on the accompanying balance
sheets.
6. Discontinued operations
During 2001, management of the Company
decided to cease the operations of its domestic retail telecommunication services
business lines. In connection with this decision, the Company abandoned an office
located in Miami, which was being used to house the switching equipment. The office
was being leased under a non-cancelable operating lease agreement. In January 2005,
the Company and the landlord reached a settlement agreement whereby the remaining
liability under the operating lease was reduced to $132,500. At December 31, 2004,
included in gain from discontinued operations is approximately $538,000 related
to this settlement. The remaining liability at December 31, 2004 of approximately
$984,000 relates to trade payables and accrued expenses associated with the discontinued
retail telecommunications services.
During the year ended December 31, 2003,
certain trade payables, associated with the discontinuation of the Company’s
retail services, were determined to be not payable to a vendor, which resulted in
a gain on trade payable reductions of approximately $209,000.
F-14
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. At December 31, 2004 and 2003, property
and equipment is comprised of the following:
8. Restricted cash
As of December 31, 2004 and 2003, the Company
had approximately $380,000 and $737,000, respectively, of cash restricted from withdrawal
and held by banks as certificates of deposit securing letters of credit (equal to
the amount of the certificates of deposit). A significant portion of this restricted
cash is required as security deposits for certain of the Company’s non-cancelable
operating leases for office facilities.
9. Accounts payable and accrued expenses
Accounts payable and accrued expenses consist
of the following at December 31, 2004 and 2003:
The deferred revenue balance at December 31, 2004
includes approximately $470,000 related to a debt settlement agreement with a domestic
carrier. The provisions of the agreement provided that $555,000 due to the carrier
would be resolved with a service agreement whereby the carrier will receive a reduced
rate for every minute of traffic that is passed through the Company’s network
for a period of 24 months beginning in December 2003. During the year ended December
31, 2004, approximately $85,000 of revenue was recognized in connection with this
service agreement.
F-15
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. At December 31, 2004 and 2003 components
of long-term debt and capital lease obligations of the Company are comprised of
the following:
(a) Three stockholders of the Company each entered
into convertible subordinated note agreements aggregating $300,000, which mature
in five years (or April 9, 2004), at an interest rate of 7.25% per annum (modified
to 9.25% in April 2004). Interest shall be paid semi-annually on January 31 and
July 31. At the sole discretion of the Company, the principal of the note shall
be automatically converted into shares of common stock of the Company, at the closing
of a qualified initial public offering (“IPO”) if the IPO price equals
or exceeds 125% of the conversion price, which is $18.66 per share. There is also
an optional conversion clause that the note holders shall have the right, at their
option, at any time up to and including the maturity date, to convert the outstanding
principal. In February 2004, one stockholder converted $33,750 of its notes into
375 shares of Preferred C Stock at $90 per share. The remaining $16,250 note balance
was paid in April 2004. Consequently, the December 31, 2004 balance includes two
convertible subordinated note agreements aggregating $250,000, both of which are
covered under forbearance agreements (see below for further details). Subsequent
to December 31, 2004, these notes were paid in full upon completion of the Company’s
IPO (see Note 22 for further discussion).
(b) Two officers of the Company each entered
into various loan agreements with the Company in exchange for demand notes payable.
The notes bear interest at rates ranging from 4%–4.75% per annum and are due
on demand. The outstanding balance of these notes were $898,931 as of December 31,
2004 and 2003. Subsequent to December 31, 2004, these notes were paid in full upon
completion of the Company’s IPO (see Note 22 for further discussion).
(c) In connection with the development
of an Asian venture opportunity to provide VoIP services, the Company raised funds
from certain existing shareholders, officers, and directors during 2002. During
November 2003, the Company issued two convertible notes payable, aggregating $140,000,
related to a portion of these funds. The notes accrued interest at the prime rate
and were payable monthly on the first of every month. In the event this Asian venture
materialized, the principal of the notes, at the option of the stockholders, was
convertible into shares of common stock of the Company. During 2004, $99,990 of
the notes were converted to 1,111 shares of Preferred C Stock and $40,010 was repaid
in cash.
In December 2000, the Company issued a promissory note
in the principal amount of $200,000, to a stockholder, calling for monthly payments
of approximately $4,500, including interest at 12% per annum, through January 2006.
On F-16
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. September 1, 2002, the Company added an
additional agreement providing for the option to convert a portion of the promissory
note into 28,571 shares of the Company’s common stock at $2.28 per share. In
September 2003, the Company revised the promissory note agreement for an additional
principal amount of $100,000 with monthly payments of approximately $2,500, including
interest at 12% per annum. At December 31, 2003 the outstanding promissory note
payable balance aggregated $159,079. During 2004, these notes were repaid in full.
(d) During February 2004, the Company entered
into a settlement agreement for $600,000. In the same month, the Company paid $450,000
and agreed to make 12 monthly payments for the remaining $150,000. The debt has
not been repaid as of December 31, 2004 as the debtor has not complied with the
terms of the settlement agreement.
(e) Between April 2001 and September 2002,
the Company issued promissory notes to three stockholders, that have an outstanding
balance of $81,790 and $110,688 at December 31, 2004 and 2003, respectively. The
notes bear interest at rates ranging from 4.75% to 12% per annum and are due on
demand. Subsequent to December 31, 2004, these notes were paid in full upon completion
of the Company’s IPO (see Note 22 for further discussion).
(f) In January 2001, the Company issued
a promissory note in the amount of $1,000,000, with monthly payments of interest
only at 13% per annum, with principal to be paid in full December 2001. This promissory
note was secured by certain of the Company’s accounts receivables. In November
2004, this note was repaid by the Company with proceeds from another investor who
assumed the note with certain provisions (see Note 10(j) for further discussion).
Between September 2002 and April 2003,
the Company issued various promissory notes aggregating $150,000. Interest at 4.75%
per annum is to be paid in full through May 2003. At December 31, 2004 and 2003,
these notes were in default and, accordingly, have been classified as currently
due. Subsequent to December 31, 2004, this note was paid in full upon completion
of the Company’s IPO (see Note 22 for further discussion).
(g) Between December 2002 and February
2003, the Company entered into loan agreements with various stockholders, for the
purpose of generating funds to initiate the Karamco joint venture project in the
United Arab Emirates (see Note 4). As of December 31, 2003, these loans had an outstanding
balance of $150,000. During January and February 2004, all but one stockholder converted
the outstanding notes to 277 shares of Preferred C stock at $90 per share. During
September 2004, the remaining stockholder converted his $25,000 note into a new
promissory note, which beared interest at 4.5% per annum. Principal and interest
were payable in one lump sum on the earlier of 15 days from the completion of an
IPO or September 1, 2005. Subsequent to December 31, 2004, this note was repaid
in full upon completion of the Company’s IPO (see Note 22 for further discussion).
(h) In July 2002, the Company entered into
loan agreements with various stockholders, aggregating $500,000 for the purpose
of generating funds to initiate the Pakistan service project with Pakistan Telecommunications
Company Limited (“PTCL”) (see Note 12). The loans were to be repaid by
the Company with funds it receives from PTCL in equal monthly installments, immediately
upon available funds or February 2003, and continuing through August 2003, bearing
interest at 15% per annum. In 2003, a portion of these loan agreements, aggregating
$250,000, was converted into shares of the Company’s Series C Preferred Stock
and common stock. In January 2004, $148,000 was converted to 1,644 shares of the
Company’s Series C Preferred Stock. As of December 31, 2004 and 2003, these
loan agreements have outstanding balances of $102,000 and $250,000, respectively.
Subsequent to December 31, 2004, the remaining $102,000 note was repaid in full
upon completion of the Company’s IPO (see Note 22 for further discussion).
F-17
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. (i) In September 2003, the Company issued
promissory notes aggregating $300,000 to various stockholders for the purpose of
resolving the Company’s capital lease debt service contract with the lessor
of the equipment under lease. The notes were to accrue interest at 8% per annum
and be paid in equal monthly installments of approximately $500 to $2,000 per month
with the outstanding principal due on June 30, 2005. The Company also issued warrants
to these investors to purchase the aggregate of 85,714 shares of the Company’s
common stock at a purchase price of $2.98 per share. The warrants are to expire
July 1, 2005. At the date of grant, these warrants had a nominal value assigned
to them that was immaterial to the consolidated financial statements. As of December
31, 2004 and 2003 the outstanding balance of the various notes payable aggregated
$233,252 and $283,504, respectively.
(j) In November 2004, the Company received
net cash proceeds of $1,330,000 ($1,400,000 for a convertible note net with a $70,000
advisory fee) and refinanced $1,108,333 of existing notes payable and accrued interest
in exchange for a convertible promissory note. These two notes aggregate $2,508,333,
bear interest at 6.5% per annum and are due in November 2006. The notes would automatically
convert into common shares at a conversion price of $3.85 per share upon successful
registration from an initial public offering (See subsequent events note 22 regarding
conversion). The common stock is subject to a one year lock up provision. The beneficial
conversion feature resulted in a charge to interest expense of approximately $228,000
in the fourth quarter of 2004.
(k) As of December 31, 2004 and 2003, approximately
$193,000 and $1,247,000, respectively of capital lease obligations had been forgiven
and recorded to forgiveness of debt (see Note 16).
At December 31, 2004 and 2003, approximately
$720,000 and $900,000 of the capital lease obligations were in default and accordingly
have been classified as currently due.
During the year ended December 31, 2004,
the Company entered into an equipment financing agreement in connection with the
purchase of the Company’s new soft switch. The balance at December 31, 2004
was approximately $379,000 and is payable every 90 days over an 18 month period.
The Company has imputed an interest rate of 10% related to this agreement.
Future aggregate principal payments on
long-term debt and capital leases in the years subsequent to December 31, 2004 are
as follows:
In December 2003, two officers of the Company
signed forbearance agreements, providing the officers would not call due approximately
$1,829,000 of long-term debt and accrued interest until such time the Company completed
a successful IPO, or December 19, 2004, whichever occurred first. Subsequent to
December 31, 2004, these notes were repaid in full upon completion of the Company’s
IPO (see Note 22 for further discussion).
F-18
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Due to the operating losses incurred, the
Company has no current income tax provision for the years ended December 31, 2004,
2003 and 2002. The provision for income taxes consists of the following:
The following reconciles the Federal statutory
tax rate to the effective income tax rate:
The components of the Company’s deferred
tax assets and liability consist of approximately the following at December 31,
2004 and 2003, respectively:
The Company has available at December 31, 2004
and 2003, approximately $73,269,000 and $69,320,000, respectively, of unused net
operating loss carryforwards that may be applied against future taxable income,
which expire in various years from 2012 to 2024. Under the Tax Reform Act of 1986,
the amounts of and benefits from net operating loss carryforwards and credits may
be impaired or limited in certain circumstances. Events which cause limitations
in the amount of net operating losses that the Company may utilize in any one year
include, but are not limited to, a cumulative ownership change of more than 50%,
as defined, over a three year period. The amount of such limitation, if any, has
not been determined. F-19
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Management of the Company had decided to
fully reserve for its net deferred tax assets, as it is more likely than not that
the Company will not be able to utilize these deferred tax assets against future
taxable income, coupled with certain limitations on the utilization of the net operating
losses due to various changes in ownership over the past several years.
12. Commitments and contingencies
The Company has various non-cancelable
operating lease agreements for office facilities. A summary of the lease commitments
under non-cancelable leases at December 31, 2004 is approximately as follows:
Rent expense for all operating leases was approximately
$1,145,000 $1,238,000 and $1,033,000 for the years ended December 31, 2004, 2003
and 2002, respectively.
In May 2002, the Company entered into a
Service Agreement (the “Agreement”) with Pakistan Telecommunications Company,
Ltd (“PTCL”), under which PTCL would provide for the termination of incoming
international traffic into Pakistan focusing on VoIP services from the United States
and Europe. The Agreement provided for an initial term of one year, with additional
one year extensions terms. The Company had exercised its option to extend the agreement,
which was in effect through August 31, 2004 (see discussion below regarding new
agreement). The Agreement provided for the Company to place all necessary switching
equipment in Pakistan, the United States and Europe (which it had done through the
Pakistan joint venture formed with Turner Hill–see Note 4). Under the terms
of the Agreement PTCL provided the Company with voice termination services within
Pakistan, for which the Company paid PTCL a maximum service charge of $0.19 per
minute for all calls terminating in Pakistan using the Company’s VolP platform.
The Agreement also required the Company to guarantee a minimum of three million
minutes a month to terminate to Pakistan. The Company was also required to keep
on deposit with PTCL, a one month rolling advance equal to the number of minutes
terminated during the preceding month, times the prevailing termination rate charged
by PTCL to the Company. For the years ended December 31, 2004, 2003 and 2002 the
Company has incurred approximately $8,545,000, $9,327,000 and $783,000, respectively,
of termination charges under this and the September 2004 agreement.
On September 1, 2004, the Company entered
into a non-exclusive service agreement with PTCL covering the termination of incoming
VoIP traffic into Pakistan from the United States and Europe. The term is one year
from September 1, 2004, renewable upon mutual consent. The agreement stipulates
that the switching equipment installed in Pakistan by the Company through its Pakistan
joint venture shall be owned and operated by PTCL. In addition, PTCL may terminate
the agreement if the Company does not deliver a minimum of traffic over a three
month period. The agreement also requires the Company to put up a $1,000,000 bank
guarantee, which is pending the resolution of advances totaling $567,000 owed to
the Company by PTCL as of December 31, 2004 ($467,000 is owed as of March 2005).
In connection with the joint venture agreement
with Turner Hill (See Note 4), the joint venture entity is required to pay a management
fee to Turner Hill equal to the number of minutes terminating in Pakistan on a monthly
basis times a fixed rate per minute. For the years ended December 31, 2004, 2003,
and 2002 the joint venture incurred management fees to Turner Hill for approximately
$314,000, $361,000 and $36,000, respectively. F-20
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Legal Matters
The Company is a defendant in an employment
claim that management believes has no merit. The claim is filed in the State of
New York before an administrative agency. The administrative department is currently
reviewing the case and management believes it will be dismissed. Regardless, management
believes that this claim will not have a material effect on the Company’s business
or results of operations.
In April 2003, a former customer of the
Company brought an action against the Company for recovery of preferential transfers
and other claims under the Bankruptcy Code. The suit, brought in the United States
Bankruptcy Court for the Northern District of Illinois Eastern Division, seeks damages
in the amount of approximately $335,000. The Company filed a Proof of Claim with
the Court in the amount of approximately $85,000 for amounts that were due the Company
at the time this customer filed for bankruptcy. In March 2005, the Company settled
this matter for $5,500 and the Company agreed to waive its Proof of Claim in the
amount of approximately $85,000. The Company expects to execute the formal settlement
agreement on or before April 2, 2005.
In May 2003, a shareholder of the Company
brought an action in the District Court in and for the City and County of Denver
and the State of Colorado. The action is seeking damages in the amount of $400,000.
The Company and management plan to defend this suit vigorously and do not expect
the outcome to have an adverse effect on the Company’s financial condition.
This action was dismissed in August 2004. The plaintiff has filed an appeal for
the motion, which is pending.
In 1999, the Company guaranteed a real
property lease on behalf of a joint venture. The joint venture subsequently defaulted
on the lease and in July 2003 the landlord brought an action in the Circuit Court,
Miami, Florida. The Company was also sued for back rent and costs of approximately
$1.1 million. On January 17, 2005, the Company settled this action for $132,500
(see Note 6).
The Company is involved in other claims
and legal actions arising in the normal course of business. Management does not
expect that the outcome of these cases will have a material effect on the Company’s
financial position or results of operations. Due to the regulatory nature of the
industry, the Company is periodically involved in various correspondence and inquiries
from state and federal regulatory agencies. Management does not expect the outcome
of these inquiries to have a material impact on the operations or the financial
condition of the Company.
13. Preferred stock
The Company has authorized 10,000,000 shares
of its stock for the issuance of Preferred Stock. The Company has designated 1,100,000,
1,500,000 and 110,000 shares of $10 Series A Convertible Redeemable Preferred Stock
(“Series A Preferred Stock”), $10 Series B Convertible Redeemable Preferred
Stock (“Series B Preferred Stock”) and $90 Series C Convertible Redeemable
Preferred Stock (“Series C Preferred Stock”), respectively (collectively
“Preferred Stock”).
During May 2004, each outstanding share
of Series A and Series B Preferred Stock was converted to common stock at a conversion
rate of $3.50 per share, consequently as of December 31, 2004, there were no shares
outstanding of series A and B preferred stock. At December 31, 2004, there were
109,962 shares of the Series C Preferred Stock outstanding (see Note 22 regarding
February 2005 conversion).
Dividends
The holders of Series A Preferred Stock were entitled to
receive cumulative dividends of 12% per share per annum, which were payable annually
in arrears beginning on August 31, 2002 and were payable (at the Company’s
option) in cash or shares of the Company’s common stock at a rate equal to
the conversion rate in effect at the date of declaration of the dividend. The holders
of Series B Preferred Stock were entitled to a cumulative dividend of 11.5% per
share per annum, which were payable annually in arrears beginning on March 31, 2003
and were payable (at the Company’s option) in cash or shares of the Company’s
common stock at a rate equal to the conversion rate in effect at the date of
F-21
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. declaration of the dividend. The holders
of Series C Preferred Stock were entitled to receive cumulative dividends of 8%
per share per annum which were payable annually beginning on December 18, 2004 and
were payable in cash, unless the Company completed its IPO before December 18, 2004.
Since the IPO was not completed until February 2005, the dividends on the Series
C Preferred Stock of approximately $673,000 were paid on January 18, 2005.
Historically, no dividends were to be paid
on any outstanding shares of common stock, or Series A and B Preferred Stock, unless
all then accrued, but unpaid dividends had been paid with respect to all outstanding
shares of Series C Preferred Stock. See subsequent events Note 22 regarding conversion
of the Series C Preferred Stock during 2005.
Dividends in arrears at December 31, 2002
on the Company’s Series A Preferred Stock were approximately $665,000.
In January 2003, the Company’s Board
of Directors (the “Board”) declared a stock dividend payable on the outstanding
shares of Series A and B Preferred Stock (due on August 31, 2002 and March 31, 2003,
respectively). The Board elected to issue shares of the Company’s common stock
in lieu of cash at a conversion rate equal to $2.28 per share times the aggregate
dividends due to the holders of both Series A and B preferred Stock at the date
of record (August 15, 2002 and March 15, 2003, respectively). During the year ended
December 31, 2003, 318,491 shares of the Company’s common stock valued at approximately
$725,000 were recorded and issued as a dividend to the Series A and Series B Preferred
shareholders.
In December 2003, the Board declared a
stock dividend payable on the outstanding shares of Series A and B Preferred Stock
(due on August 31, 2003 and March 31, 2004, respectively). The Board elected to
issue shares of the Company’s common stock in lieu of cash at a conversion
rate equal to $2.98 per share times the aggregate dividends due to the holders of
both Series A and B Preferred Stock at date of record (August 15, 2003 and March
15, 2004, respectively). At December 31, 2003, the Company recorded a stock dividend
distributable of approximately $553,000 for the issuance of 185,962 shares of common
stock to the holders of the Company’s Series A and Series B Preferred Stock.
These shares were issued during the year ended December 31, 2004, along with an
additional 6,708 shares of common stock for dividends on Series B Preferred Stock
totaling approximately $20,000.
Liquidation
In connection with the conversion of the
Series A and Series B Preferred Stock into common stock, accrued dividends from
September 1, 2003 and April 1, 2004 to the date of the respective conversions were
issued in the form of common stock. These common stock dividends aggregated 123,012
additional shares of common stock and were issued during September 2004.
In the event of any liquidation, dissolution,
or winding up of the Company either voluntary or involuntary or a merger or consolidation
with any other corporation, or a sale or other transfer of substantially all the
assets of the Company, the holders of Series C Preferred Stock were entitled to
receive, in preference to holders of Series A and B Preferred Stock and common stock,
an amount equal to $90 per each outstanding share plus an amount equal to all accrued
but unpaid dividends.
Following the Series C Preferred Stock
liquidation payment, the remaining assets and funds of the Company legally available
for distribution, if any, were to be distributed ratably among the holders of common
stock, Series A, B and C Preferred Stock in proportion to the number of shares of
common stock held on an as-if converted basis. F-22
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Redemption
The Company had the right to redeem the
outstanding shares of Series A and B Preferred Stock at any time (with 30 days prior
notice) for a redemption price of $10 per share plus accrued, but unpaid dividends.
The Company had the right to redeem the outstanding shares of Series C Preferred
Stock, commencing on the first anniversary of the first issuance of Series C Preferred
Stock, at a price per share equal to 115% of the stated value of $90, plus pro rata
accrued and unpaid dividends due through the date of redemption.
As discussed in Note 22, the Series C Preferred
Stock was converted to common stock in February 2005. Had the conversion not occurred
after the second anniversary of the first issuance of the Company’s Series
C Preferred Stock (December 18, 2005) and so long as all classes of the Company’s
stock were not publicly traded and a liquidation had not occurred, each holder of
Series C Preferred Stock may have, at its option, required the Company to redeem
its shares at a price equal to 112% of the stated value of the stock, plus pro rata
accrued and unpaid dividends due through the date of redemption. At December 31,
2004, the redemption value of the Series C Preferred Stock was approximately $10,932,000.
Conversion
When outstanding, each share of Series
A and B Preferred Stock was convertible, at the option of the stockholder, at any
time after the issuance date of such share into a number of shares of common stock
as determined by the conversion rate in effect at the time of conversion, plus all
accrued and unpaid dividends payable in either cash or common stock (at the Company’s
option) (See conversion table below).
Each share of Series C Preferred Stock was convertible,
at the option of the stockholder, at any time after the issuance date of such shares
into a number of shares of common stock, based upon a conversion price of $3.15
per common share.
Upon the closing of an initial public offering
of common stock by the Company (see Note 22 for discussion regarding the Company’s
February 2005 IPO), the Series C preferred stock shall automatically convert into
shares of the Company’s common stock at the lesser of the voluntary conversion
price then in effect or 75% of the offering price of the common stock. There was
no beneficial conversion feature associated with this conversion.
At various times during 2004, all the holders
of the Company’s Series A & B Preferred Stock, elected to convert their
shares into common stock.
Voting
No holders of Preferred Stock have voting
rights, except as provided by law. F-23
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. Under the Company’s 1998 stock option
plan (as amended), the Company has reserved 2,680,857 shares of common stock for
issuance to employees at exercise prices determined by the Board of Directors. Options
under the plan vest in annual increments over a four year period, expire ten years
from the date of grant and are issued at exercise prices no less than 100%
of the fair market value at the time of grant. As reported in Note 2, the Company
has elected to adopt the disclosure-only provisions of SFAS No. 123 and will account
for stock-based employee compensation plans in accordance with APB 25. As a result,
no compensation cost for its stock option plan has been recognized in the periods
presented.
On July 14, 2004, the Company’s Stock
Option Committee approved a recommendation to issue 446,057 options to its employees
who had been previously granted stock options. Each employee received new options
equal to 50% of their existing options priced at $3.15 per share and 50% at $4.38
per share, both with a four year vesting period and furthermore received credit
for the vesting time on previously issued options, and the original options would
be cancelled if not exercised within six months and one day of the issuance of the
new options (approximately 480,000 options were cancelled on January 14, 2005).
A summary of the Company’s stock option
plan as of December 31, 2004, 2003 and 2002 and changes during the years ended on
those dates is as follows:
F-24
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. The following table summarizes information
about stock options outstanding at December 31, 2004:
The Company, as part of various debt and other
agreements, have issued warrants to purchase the Company’s common stock. The
following summarizes the information relating to warrants issued and the activity
during 2004, 2003 and 2002:
All warrants are fully exercisable upon issuance.
15. Equity transactions
On November 1, 2004, the Board of Directors,
upon approval of the stockholders, increased the authorized number of common shares
to 126,000,000 which includes 105,000,000 shares of common stock and 21,000,000
shares of Class A common stock. This increase was approved by the stockholders on
December 10, 2004. On December 10, 2004, the stockholders approved the amendment
to the Company’s Certificate of Incorporation to automatically convert each
share of the Company’s outstanding common stock (except for shares of common
stock issuable upon conversion of Series C preferred stock) into one share of Class
A common stock. The Class A common stock may not be converted into common stock
until February 17, 2006, which is one year after the successful completion of the
Company’s initial public offering, unless the holder agrees to exercise a one
year lock up agreement. The rights of a Class A shareholder are identical in all
respects to the common stock other than the shares of Class A common stock are not
transferable for a period of one year following the closing of the IPO which occurred
in February 2005.
In October 2004, the Company issued 19,048
shares of common stock at $5.25 per share in lieu of cash to the Saif. Telecom (Pvt)
Ltd for management fees related to the Pakistan joint venture.
F-25
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. At various times through the first six
months of 2004, all the shareholders of the Company’s Series A Preferred Stock,
elected to convert their shares into common stock at a conversion rate of $3.50
per share. This conversion resulted in the issuance of 1,163,500 shares of common
stock. In connection with this conversion accrued dividends from September 1, 2003
to the date of the respective conversions were issued in the form of common stock.
These common stock dividends resulted in the issuance of 119,479 additional shares
of common stock.
At various times through the first six
months of 2004, all the shareholders of the Company’s Series B Preferred Stock,
elected to convert their shares into common stock at a conversion rate of $3.50
per share. This conversion resulted in the issuance of 210,000 shares of common
stock. In connection with this conversion accrued dividends from April 1, 2004 to
the date of the respective conversions were issued in the form of common stock.
These common stock dividends resulted in the issuance of 3,533 additional shares
of common stock.
During March 2004, certain investors elected
to convert approximately $407,000 of their notes and $177,000 of escrow advances
into shares of the Company’s Series C Preferred Stock at a conversion rate
of $90 a share. The conversion resulted in the issuance of 6,504 additional shares
of Series C Preferred Stock.
In December 2003, certain note holders
elected to convert their notes and related accrued interest, totaling approximately
$930,000, into shares of the Company’s Series C Preferred Stock at a conversion
rate of $90 per share, resulting in the issuance of 10,336 shares of Series C Preferred
Stock. Also during December 2003, a $10,000 advance from a potential investor in
a proposed Asian joint venture (which did not materialize) was converted into 111
shares of Series C Preferred Stock at a conversion rate of $90 per share.
In November 2003, the Company commenced
a private placement for the purpose of raising working capital for the Company’s
operations. The private placement provided for the issuance of a maximum of 110,000
shares of the Company’s Series C Preferred Stock at $90 per share. The private
placement was valid through December 15, 2003, but was extended for an additional
107 days. The total number of shares of Series C Preferred Stock issued in this
private placement during 2003 was 33,542 shares for which proceeds of approximately
$2,526,000 were received, net of expenses of approximately $492,000. During 2004,
an additional 59,470 shares of Series C Preferred Stock were issued in a final closing
of this private placement. The proceeds were approximately $4,631,000 which is net
of expenses of approximately $724,000.
In June 2003, the Company commenced a private
placement for the purpose of raising working capital for the Company’s operations.
The private placement provided for the issuance of a maximum of 5,714,286 shares
of the Company’s $0.01 par value common stock at $2.98 per share. The private
placement was valid through September 15, 2003, but was extended for an additional
90 days. The total number of shares of common stock issued in this private placement
was 1,342,844 shares for which proceeds of approximately $3,774,000 were received,
net of expenses of approximately $247,000. During the year ended December 31, 2004,
an additional 430,252 shares were issued in this private placement for which proceeds
of approximately $1,277,000 were received, which is net of expenses of approximately
$3,000.
At various times during the year ended
December 31, 2003, certain note holders elected to convert approximately $2,280,000
(in the aggregate) of their notes and accrued interest into common stock at conversion
rates ranging between $2.28 and $5.25 per share. The conversions resulted in the
issuance of an additional 623,234 shares of common stock. Also during 2003, the
Company issued 16,807 shares of its common stock, at $2.98 per share for the assumption
of a $50,000 letter of credit in the name of and secured by a shareholder of the
Company.
F-26
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. In July 2002, the Company commenced a private
placement for the purpose of raising working capital for the Company’s operations.
The private placement provided for the issuance of a maximum of 8,000,000 shares
of common stock at $2.28 per share. The private placement was valid through September
21, 2002 but was extended for an additional 135 days. The total number of shares
of common stock issued in this private placement during 2002 was 719,106 shares
for which proceeds of approximately $1,636,000 were received. The total number of
shares of common stock issued in this private placement during 2003 was 1,353,508
shares for which proceeds of approximately $3,084,000 were received.
In March 2002, the Company commenced a
private placement for the purpose of raising working capital for the Company’s
operations. The private placement provided for the issuance of a maximum of 1,500,000
shares of Series B Preferred Stock at $10 per share. The private placement was valid
through June 30, 2002, but was extended for an additional 90 days. The total number
of shares of Series B Preferred Stock issued in this private placement was 83,500
shares for which proceeds of approximately $705,000 were received, net of expenses
of approximately $130,000.
At various times during the year ended
December 31, 2002, certain note holders elected to convert approximately $3,731,000
(in the aggregate) of their notes into common stock at a conversion rate of $2.28.
The conversion resulted in the issuance of an additional 1,639,850 shares of common
stock.
During 2002, holders of Series A and B
Preferred Stock elected to convert 112,250 and 10,000 shares, respectively, of their
stock into common stock at conversion rates of $8.75 and $8.23, respectively. The
conversion resulted in the issuance of 140,444 shares of common stock.
16. Forgiveness of debt
During 2004, the Company recorded approximately
$2,175,000 related to forgiveness of debt. As of December 31, 2003, the Company
had an outstanding capital lease obligation aggregating approximately $238,000.
In January 2004, the Company entered into an agreement whereas the Company agreed
to pay the sum of $45,000 resulting in a $193,000 forgiveness of debt. In addition,
during 2004, the Company recorded approximately $1,982,000 of additional forgiveness
of debt primarily related to settlements of network and general obligations.
During 2003, the Company had three outstanding
capital lease obligations with lessors, aggregating approximately $1,974,000. During
2003, the Company entered into settlement agreements whereas the Company agreed
to pay the sum of $695,000 and agreed to issue 14,286 shares of common stock at
$2.28 per share, resulting in approximately $1,247,000 forgiveness of debt. For
the year ended December 31, 2003, the Company recorded approximately $3,918,000
of forgiveness of debt, including approximately $2,671,000 of settled accounts payable
disputes.
During 2002, the Company had an outstanding
capital lease obligation with a lessor, aggregating approximately $1,814,000. In
June 2002, the Company entered into a settlement agreement with the lessor whereas
the Company agreed to pay the sum of $175,000, and the lessor would receive 166,571
shares of the Company’s common stock at $2.28 per share, resulting in a $1,260,000
forgiveness of debt. The settlement agreement also granted the lessor warrants to
purchase 14,286 shares of the Company’s common stock at a purchase price of
$.04 per share (See Note 9). For the year ended December 31, 2002, the Company recorded
approximately $1,812,000 forgiveness of debt, including approximately $552,000 of
settled accounts payable disputes. F-27
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. The Company has a defined contribution
profit sharing plan, which covers all employees who meet certain eligibility requirements.
Contributions to the plan are made at the discretion of the Board. No contributions
to the profit sharing plan were made for the years ended December 31, 2004, 2003
and 2002.
18. Related party transactions
At December 31, 2004 and 2003, the Company
had an aggregate of approximately $1,700,000 and $3,400,000 of long-term debt due
to stockholders of the Company. The repayment, conversion terms and interest
rates are outlined in Note 10. In addition, the Company had approximately $539,000
and $564,000 of accrued interest outstanding on this related debt as of December
31, 2004 and 2003, respectively. Interest expense related to this debt was approximately
$230,000, $416,000 and $680,000 for the years ended December 31, 2004, 2003, and
2002, respectively.
During 2003 and 2002, the Company generated
funds from certain investors for the purposes of potential joint ventures and projects.
These funds were put into escrow accounts, whereby if the projects are successful,
the investors receive additional issuances of stock at the prevailing fair value
of the stock or if unsuccessful are to be refunded to these investors. For the years
ended December 31, 2004 and 2003, accounts payable and accrued expenses included
$0 and $250,000, respectively, of amounts due to investors (see Note 9).
19. Concentrations
Major Customers
During 2004, two customers of the Company
accounted for revenues exceeding 21% in total and at least 5% individually of the
Company’s total revenues for 2004. During 2003, eight customers of the Company
accounted for revenues exceeding 59% in total and at least 5% individually of the
Company’s total revenues for 2003. During 2002, five customers of the Company
accounted for revenues exceeding 48% in total and at least 5% individually of the
Company’s total revenues for 2002. These customer revenues were all in the
traditional voice and VoIP to carrier segments. Revenues earned from these customers
were approximately $10,479,000 in 2004, $18,816,000 in 2003 and $12,169,000 in 2002.
At December 31, 2004, 2003 and 2002, the amounts owed to the Company by these customers
were approximately $1,429,000, $1,004,000 and $474,000, respectively.
Geographic Concentrations
The Company’s operations are significantly
influenced by economic factors and risks inherent in conducting business in foreign
countries, including government regulations, currency restrictions and other factors
that may significantly affect management’s estimates and the Company’s
performance.
During 2004, 2003 and 2002, the Company
generated approximate revenue from continuing operations from customers in the following
countries:
F-28
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. At December 31, 2004 and 2003, the Company had
foreign long-lived assets in Pakistan of $115,169 and $229,522, respectively.
Revenues by geographic area are based upon
the location of the customers. The foreign long lived assets by geographic area
represent those assets physically used in the operations in each geographic area.
20. Selected quarterly results (unaudited)
F-29
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. The Company adopted Statement of Financial
Accounting Standards No. 131 (SFAS No. 131), “Disclosures about Segments of
an Enterprise and Related Information”. SFAS No. 131 requires disclosures of
segment information on the basis that is used internally for evaluating segment
performance and deciding how to allocate resources to segments.
The Company has four reportable segments,
that it operates and manages which are organized by products and services. The Company
measures and evaluates its reportable segments based on revenues and cost of revenues.
This segment income excludes unallocated corporate expenses and other adjustments
arising during each period. The other adjustments include transactions that the
chief operating decision makers exclude in assessing business unit performance due
primarily to their non-operational and/or non-recurring nature. Although such transactions
are excluded from the business segment results, they are included in reported consolidated
earnings. Each segment is managed according to the products, which are provided
to the respective customers, and information is reported on the basis of reporting
to the Company’s Chief Operating Decision Maker.
The Company’s segments and their principal
activities consist of the following:
Traditional Voice — This segment includes
the termination of voice telephony minutes from or to the countries served by the
Company, utilizing traditional Time Division Multiplexing (TDM) and “circuit-switched”
technology. Typically, this will include interconnection with traditional telecommunications
carriers either located internationally or those carriers that interconnect with
the Company at its US Points of Presence (POP) and provide service to other destinations.
VoIP (Voice over Internet Protocol) to
Carriers — VoIP includes the termination of voice telephony minutes by the
internet rather than older circuit-switched technology. This permits far less costly
and more rapid interconnection between the Company and international telecommunications
carriers.
VoIP (Voice over Internet Protocol) to
Consumers and Corporations — Primarily through the Company’s Efonica and
Estel joint ventures, the Company provides VoIP services targeted to end-users and
corporations. The Company offers services that permit consumers or corporations
to originate calls via IP telephones or telephone systems that use the Internet
for completion to standard telephone lines anywhere in the world. The Company also
provides PC-to-phone service that utilizes the Internet to allow consumers to use
their personal computers to place calls to the telephone of their destination party.
Internet, Private Networks & Other
— The Company provides Internet connectivity to telecommunications carriers,
Internet Service Providers, government entities, and multinational customers via
its POPs in the US, India, and through its partners elsewhere. The Company also
offers point-to-point private lines, virtual private networking, and call center
communications services to customers in its target markets. Lastly, the Company
offers the Interview desktop-to-desktop video conferencing service to customers
anywhere in the world.
F-30
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. 21. Segment
Information (continued)
Operating segment information for 2004
and 2003 is summarized as follows:
F-31
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. The Company employs engineering and operations
resources that service across multiple product lines. Depreciation and indirect
operating expenses were allocated to each product line based upon their respective
revenues. The amounts reflected as Corporate and unallocated represent those expenses
that were not appropriate to allocate to each product line.
22. Subsequent events
As discussed in Note 4, on December 16,
2004, the Company entered into an agreement to acquire 51% of the common stock of
a Jamaican company. The closing of this acquisition took place on January 11, 2005.
In January 2005, the Company entered into
an agreement to acquire the 49.8% minority interest in one of its joint ventures,
Efonica from Karamco, Inc., which was contingent upon the successful completion
of the Company’s initial public offering by March 1, 2005. As the Company’s
IPO was completed by this date, the Efonica transaction closed on February 18, 2005.
The purchase price will be a minimum of $5,500,000 and a maximum of $14,300,000,
as adjusted for the approximate $196,000 representing Karamco’s portion of
Efonica’s debt owed to the Company as of the closing date and the $500,000
which was paid in cash during February 2005, based upon a multiple of earnings achieved
by Efonica during the 12-month period ending February 28, 2006 (4.5 x Efonica’s
net income as adjusted for certain intracompany and other expenses). Karamco received
cash of $500,000, with the balance paid in shares of common stock. The number of
shares issued to Karamco was determined by the $6.45 per share initial price of
the common stock at the date of the IPO. On the date of the transaction, approximately
$4,400,000 worth of such shares of common stock (675,581 shares) were issued to
Karamco and are being held in escrow until the final valuation of the joint venture
is determined after the year ending February 28, 2006. In the event that the purchase
price would be lower (based upon Efonica’s net income for that one year period)
than $10,000,000, the excess of the common shares in escrow will be returned to
the Company for cancellation. In the event that the purchase price would be higher
than the $10,000,000 (based upon Efonica’s net income), the Company will issue
Karamco additional shares of our common stock (based on the IPO price of $6.45 per
share), subject to the $14,300,000 maximum. The excess of the purchase price over
the book value of the minority interest acquired, based upon the minimum purchase
price of approximately $5,500,000, will primarily be allocated to amortizable intangible
assets and goodwill in the aggregate of approximately $5,500,000. The Company is
currently in process of employing an independent valuation expert to determine the
final purchase price allocation.
Out of the shares to be issued to Karamco,
the Company has committed to register for resale 150,000 shares of common stock
within 60 days of the effective date of the registration statement for the IPO.
If the Company does not register such shares, within the 60 day time period, the
Company is obligated to purchase the shares from Karamco at the higher of $6.45
which was the IPO price or the average five (5) day bid price prior to the sixtieth
day after the effective date of the registration statement. If the sale of the 150,000
shares that are to be registered results in less than $1 million of gross proceeds
the Company will purchase additional shares owned by Karamco, at a price equal to
the higher of the IPO price or the closing price 30 days after the last sale, so
that Karamco receives $1 million in gross proceeds. If the Company purchases additional
shares from Karamco they will be returned for cancellation. Karamco is owned by
Roger Karam, who became the CEO of Efonica and the Company’s President of VoIP
Services upon the effective date.
On February 17, 2005, the Company closed
its initial public offering of securities of 3,600,000 shares of common stock at
a price of $6.45 per share and 3,600,000 redeemable common stock purchase warrants
at $0.05 per warrant. Gross proceeds of the offering were $23,400,000. Total estimated
offering costs are approximately $3,000,000 which will result in net proceeds to
the Company of $20,400,000.
Upon completion of the IPO, all of our
outstanding Series C preferred stock converted into an aggregate of 3,141,838 shares
of common stock (there was no beneficial conversion feature associated with this
conversion). In addition, the $2.5 million of convertible debt the Company entered
into during November 2004, was converted into 651,515 shares of common stock and
the Company repaid approximately $1,508,000 in debt and $559,000 in interest payable
to certain officers, directors, and investors. Also, as previously discussed, $500,000
was paid in cash and 1,439,643 shares of common stock were issued, of which 675,581 shares are held in escrow.
F-32
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. On March 8, 2005, a new wholly owned subsidiary
of the Company, Fusion Turkey, LLC entered into a Stock Purchase Agreement to acquire
75% of the shares of LDTS Uzak Mesafe Telekomikasyon ve Iletism Hizmetleri San.
Tic. A.S. (“LDTS”) from the existing shareholders. LDTS possesses a Type
2 telecommunications license approved by the Turkish Telecom Authority. This license
will permit the Company to offer VoIP services under its Efonica brand and
other Internet services to corporations and consumers in Turkey. The Company is
acquiring the shares for approximately $131,000 cash and the posting of a bank guarantee
of $251,000. The transaction is subject to receipt of approval from the Turkish
Telecom Authority. The primary net asset acquired is the license which was issued
on March 17, 2004 and is valid for 15 years. Consequently, this license will be
amortized over the remaining 14 year term.
On March 24, 2005, Kirlin, the Company’s
investment banker, has expressed its intent on exercising the over allotment consisting
of 480,000 shares of common stock at $6.45 per share and 540,000 redeemable common
stock purchase warrants at $0.05 per share. The closing of the transaction is scheduled
for March 30, 2005. F-33
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. F-34
2004 ANNUAL REPORT ON FORM 10-K
Page
ITEM
1.
Business
1
ITEM 2.
Properties
13
ITEM 3.
Legal Proceedings
13
ITEM 4.
Submission of Matters to a Vote of
Security Holders
14
ITEM
5.
Market for Registrant’s Common
Equity and Related Stockholder Matters.
15
ITEM 6.
Selected Financial Data
16
ITEM 7.
Management’s Discussion and
Analysis of Financial Condition and Results of Operations
18
ITEM 7A.
Quantitative and Qualitative Disclosures
About Market Risk
36
ITEM 8.
Financial Statements and Supplementary
Data
36
ITEM 9.
Changes in and Disagreements with
Accountants on Accounting and Financial Disclosure
36
ITEM 9A.
Controls and Procedures
36
ITEM
10.
Directors and Executive Officers
of the Registrant
37
ITEM 11.
Executive Compensation
37
ITEM 12.
Security Ownership of Certain Beneficial
Owners and Management and Related Stockholder Matters
37
ITEM 13.
Certain Relationships and Related
Transactions
37
ITEM 14.
Principal Accounting Fees and Service.
37
ITEM
15.
Exhibits, Financial Statement Schedules
38
Index to Consolidated
Financial Statements
•
•
•
•
•
•
•
•
•
The details
of our strategy include: •
•
•
•
Efonica was incorporated in the Technology, Electronic Commerce and Media Free Zone in Dubai, United Arab Emirates.
•
•
•
•
•
•
•
•
•
1.
Fusion Telecommunications International
2.
FTI
3.
Diamond / Block Logo
4.
Diamond Logo
5.
Fusion 1.
O Efonica (logo)
2.
Efonica
3.
Fusion Tel
4.
Fusion Telecom
5.
Fusion (logo)
F-Z LLC had 14
employees. None of our employees is represented by a labor union. We consider our
employee relations to be good.
Location
Lease expiration
Annual Rent
Purpose
Approx. sq. ft
420
Lexington Avenue, Suite 518
January 2010
$330,624
Lease of principal
8,100
New York, New
York 10170
executive offices
75 Broad Street
March 2010
$522,878 (1)
Lease of network
15,000
New York, New
York 10007
facilities
1475 W. Cypress Creek Road,
July 2009
$116,203 (2)
Lease of network
9,700
Suite 204
facilities and office
Fort Lauderdale, Florida 33309
space
Premises GO2-
GO3
December 2005
$36,614
Lease of office space
1,300
Building No. 9
Dubai Internet
City
Dubai, United Arab Emirates
(1) This lease
is subject to gradual increase to $672,702 from years 2005 to 2010.
•
•
•
•
•
Number of
Weighted average
securities to be
exercise price of
Number of
issued upon exercise of
outstanding
securities remaining
outstanding options,
options,warrants
available for future
Plan category
warrants and rights
and rights
issuance
Equity compensation plans approved
by
security holders
Equity
compensation plans not approved by
security
holders
Total
2000
2001
2002
2003
2004
Revenues
$ 24,461,374
$28,142,302
$25,537,163
$ 32,018,471
$49,557,973
Operating expenses:
Cost
of revenues
16,676,984
23,139,984
23,638,447
27,855,508
42,927,994
Depreciation and
amortization734,750
1,948,823
2,361,495
1,981,805
1,804,184
Loss on impairment
6,861,412
2,825,149
467,765
375,000
—
Selling, general and
administrative
expenses8,940,479
10,085,468
9,626,160
8,575,807
9,804,405
Operating
loss
(8,752,251)
(9,857,122)
(10,556,704)
(6,769,649)
(4,978,610)
Other
income (expense)
Interest
expense, net
(108,353)
(543,754)
(1,058,345)
(846,896)
(2,228,060)
Forgiveness of debt
—
—
1,812,092
3,918,295
2,174,530
Gain (loss)
on equity
investments(276,765)
(1,711,352)
326,367
(746,792)
(519,728)
Other
—
—
98,626
(97,766)
(15,965)
Minority interests
1,740,625
—
19,440
157,617
(7,654)
1,355,507
(2,255,106)
1,198,180
2,384,458
(596,877)
Loss
from continuing
operations(7,396,744)
(12,112,228)
(9,358,524)
(4,385,191)
(5,575,487)
Discontinued operations:
Income
(loss) from
discontinued operations (1)7,588,938
(7,029,511)
—
208,620
545,215
Net
income (loss)
$ 192,194
$ (19,141,739)
$(9,358,524)
$ (4,176,571)
$ (5,030,272)
Losses
applicable to
common stockholders:Loss
from continuing
operations$ (7,396,744)
$(12,112,228)
$(9,358,524)
$ (4,385,191)
$ (5,575,487)
Preferred stock
dividends
—
—
(642,552)
(635,254)
(385,918)
Net
loss applicable to
common stockholders
from
continuing
operations(7,396,744)
(12,112,228)
(10,001,076)
(5,020,445)
(5,961,405)
Income (loss)
from
discontinued operations 7,588,938
(7,029,511)
—
208,620
545,215
Net
income (loss)
applicable to common
stockholders$ 192,194
$ (19,141,739)
$ (10,001,076)
$ (4,811,825)
$ (5,416,190)
2000
2001
2002
2003
2004
Basic
and diluted net loss
per common share:
Loss
from continuing
operations$ (0.81)
$ (1.30)
$ (1.01)
$ (0.37)
$ (0.35)
Income
(loss) from
discontinued
operations0.83
(0.76)
—
0.02
0.03
Net
income (loss)
applicable to
common
stockholders$ 0.02
$ (2.06)
$ (1.01)
$ (0.35)
$ (0.32)
Weighted
average shares
outstandingBasic
and diluted
9,082,483
9,305,857
9,885,901
13,616,803
16,707,114
Operating
Data:
Capital
expenditures
(1,104,516)
(346,452)
(427,057)
(582,149)
(627,219)
Summary
Cash Flow Data:
Net
cash used in operating activities
$ (5,269,324)
$ (9,424,534)
$ (4,265,500)
$ (4,884,543)
$ (4,874,834)
Net cash used
in investing activities
(820,010)
(830,843)
(983,453)
(744,071)
(250,460)
Net cash provided by financing
activities
2,937,961
10,084,405
5,985,380
8,097,832
6,288,375
Balance
Sheet Data
(at period end):Cash
$ 170,972
$ —
$ 736,427
$ 3,205,645
$ 4,368,726
Restricted
cash
—
784,000
1,051,182
736,626
380,276
Property and equipment
13,294,563
11,715,389
10,623,109
10,078,806
11,022,330
Property and
equipment, net
10,629,321
8,281,089
5,649,787
3,743,293
3,271,474
Total assets
17,913,616
12,624,810
10,992,016
11,681,625
13,662,117
Total debt
7,556,157
11,729,653
9,151,925
4,644,904
5,687,631
Redeemable preferred stock
—
—
—
3,466,538
9,716,026
Total stockholders’
deficit
(665,330)
(11,581,006)
(14,867,407)
(9,866,927)
(13,290,029)
(1)
The December 31, 2000 income from discontinued operations includes a $16.4 million gain on the sale of one of our subsidiaries which is net with a loss of $8.8 million from the discontinued operations of three subsidiaries.
Years Ended December 31,
2002
2003
2004
Revenues
$25,537,163
$32,018,471
49,557,973
Operating expenses:
Cost
of revenues
23,638,447
27,855,508
42,927,994
Depreciation
and amortization
2,361,495
1,981,805
1,804,184
Loss
on impairment
467,765
375,000
Selling,
general and administrative
9,626,160
8,575,807
9,804,405
Operating
loss
(10,556,704)
(6,769,649)
(4,978,610)
Other income
(expense)
Interest
expense, net
(1,058,345)
(846,896)
(2,228,060)
Forgiveness
of debt
1,812,092
3,918,295
2,174,530
Gain
(loss) on equity investment
326,367
(746,792)
(519,728)
Other
98,626
(97,766)
(15,965)
Minority
interests
19,440
157,617
(7,654)
1,198,180
2,384,458
(596,877)
Loss from continuing operations
(9,358,524)
(4,385,191)
(5,575,487)
Loss from discontinued
operations
—
208,620
545,215
Net
Loss
$ (9,358,524)
$(4,176,571)
$(5,030,272)
2002
2003
2004
Revenues
100.0%
100.0%
100%
Operating expenses:
Cost
of revenues
92.6%
87.0%
86.6%
Depreciation
and amortization
9.2%
6.2%
3.6%
Loss
on impairment
1.8%
1.2%
0.0%
Selling,
general and administrative
37.7%
26.8%
19.8%
Operating
loss
(41.3)%
(21.1)%
(10.0)%
Other income
(expense)
Interest
expense, net
(4.1)%
(2.6)%
(4.5)%
Forgiveness
of debt
7.1%
12.2%
4.4%
Gain
(loss) on equity investment
1.3%
(2.3)%
(1.0)%
Other
0.4%
0.3%
0.0%
Minority
interests
0.1%
0.5%
0.0%
4.7%
7.4%
(1.2)%
Loss from continuing operations
(36.6)%
(13.7)%
(11.3)%
Loss from discontinued
operations
0.0%
0.7%
1.1%
Net
Loss
(36.6)%
(13.0)%
(10.2)%
Terminating
Revenue by Geographic Region
On-Net Versus Off-Net
Consolidated
Terminating
Consolidated
Total
Latin
Middle
On-Net
Off-Net
Consolidated
Year
Caribbean
America
Asia
East
Africa
Revenue
Revenue
Revenue
$7,229,459
$5,303,856
$ 940,244
$ 110,068
$ —
$13,583,627
$11,953,536
$25,537,163
28.3%
20.8%
3.7%
0.4%
0.0%
53.2%
46.8%
$1,070,571
$ 714,529
$10,490,215
$2,869,919
$ 19,113
$15,164,347
$16,854,124
$32,018,471
3.3%
2.2%
32.8%
9.0%
0.1%
47.4%
52.6%
$1,522,667
$ 180,681
$ 9,899,638
$4,454,235
$462,645
$16,519,866
$33,058,107
$49,577,973
3.1%
0.4%
20.0%
9.0%
0.9%
33.3%
66.7%
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Year Ended
Year Ended
Year ended
December 31,
December 31,
December 31,
2002
2003
2004 (1)
Cash
used in operating activities
$(4,265,500)
$(4,884,543)
$(4,874,834)
Cash used in investing activities
(983,453)
(744,071)
(250,460)
Cash provided
by financing activities
5,985,380
8,097,832
6,288,375
Increase
in cash and cash equivalents
736,427
2,469,218
1,163,081
Cash and cash
equivalents, beginning of period
736,427
3,205,645
Cash
and cash equivalents, end of period
$ 736,427
$ 3,205,645
$ 4,368,726
(1) These figures include an aggregate of approximately
$2.2 million that was paid during the period to satisfy past obligations.
1.
2.
As of December 31, 2004
Less than
More than
1 year
1-3 years
3-5 years
5 years
Total
Contractual
obligations:
Debt maturing
within one year
$ 4,399,306
$ 0
$ 0
$ 0
$ 4,399,306
Preferred shares subject to mandatory
redemption (1)
664,635
9,716,026
0
0
10,380,661
Capital leases
1,131,830
156,495
0
0
1,288,325
Operating leases
1,086,000
2,167,000
1,999,000
350,000
5,602,000
Minimum purchase
commitments
48,124
0
0
0
48,124
Total
contractual cash obligations
$ 7,329,895
$12,039,521
$1,999,000
$350,000
$21,718,416
(1)
This represents the obligation for the redemption of our Series C Preferred Stock plus accrued and unpaid dividends if we did not convert the shares to common stock in an initial public offering prior to the second anniversary of the initial closing. The $664,635 represents the liability for cash dividends that were paid in January 2005. The remaining obligation was eliminated in February 2005 upon the completion of our initial public offering because this Series C Preferred Stock automatically converted into shares of our common stock in connection with the IPO.
Exhibit No.
Description
3.1
Certificate of Incorporation, as
amended (*)
3.1
(a) Certificate of Designation of
Series C Convertible Redeemable Preferred Stock (*)
3.3
Bylaws (*)
10.1
1998 Stock Option Plan (*)
10.2
Employment Agreement between registrant
and Matthew Rosen (*)
10.3
Master Service Agreement between
registrant and Terremark Worldwide, Inc., dated May 29, 2003 (*)
10.4
Agreement between registrant and
Pakistan Telecommunications Company, Ltd, dated May 20, 2002 (*)
10.4.1
Agreement between Registrant and
Pakistan Telecommunications Company, Ltd, dated September 1, 2004 (2)
10.5
Joint Venture Agreement between registrant
and Karamco, Inc., dated December 12, 2002 (*)
10.6
Agreement between Fusion registrant
and Communications Ventures PVT. LTD, dated May 13, 2004 (*)
10.7
Form of Warrant to Purchase Common
Stock (*)
10.8
Lease Agreement between registrant
and SLG Graybar Sublease, LLC for the 420 Lexington Avenue,
New York, NY office
(*)
10.9
Lease Agreement between registrant
and 67 Broad Street LLC for the 75 Broad Street, New York, NY office (*)
10.10
Lease Agreement between registrant
and Fort Lauderdale Crown Center, Inc. for the Fort Lauderdale, Florida office,
as amended (*)
10.11
Lease Agreement between Efonica FZ-
LLC and Dubai Internet City for Dubai offices (2)
10.12
Agreement between registrant and
Dennis Mehiel, dated November 10, 2004 and attached Promissory note of even date
therewith (*)
10.13
Shareholders Joint Venture Agreement
between registrant and Communications Ventures Index Pvt. Ltd., dated March 11,
2000 (*)
10.14
Convertible Subordinated Note issued
by registrant to Marvin Rosen, dated April 9, 1999 (*)
10.15
Demand note issued by registrant
to Marvin Rosen, dated March 28, 2001 (*) Exhibit No.
Description
10.16
Demand note issued by registrant
to Marvin Rosen, dated April 13, 2001 (*)
10.17
Demand note issued by registrant
to Marvin Rosen, dated December 4, 2000 (*)
10.18
Demand note issued by registrant
to Marvin Rosen, dated May 24, 2001 (*)
10.19
Warrant to Purchase Common Stock
issued by registrant to Marvin Rosen, dated July 31, 2002 (*)
10.20
Convertible Subordinated Note issued
by registrant to Philip Turits, dated April 9, 1999 (*)
10.21
Demand note issued by registrant
to Philip Turits, dated January 31, 2003 (*)
10.22
Demand note issued by registrant
to Philip Turits, dated October 14, 2002 (*)
10.23
Demand note issued by registrant
to Philip Turits, dated December 31, 2002 (*)
10.24
Demand note issued by registrant
to Philip Turits, dated July 31, 2002 (*)
10.25
Demand note issued by registrant
to Philip Turits, dated September 24, 2002 (*)
10.27
Demand note issued by registrant
to Evelyn Langlieb Greer, dated July 10, 2002 (*)
10.28
Non-Competition Agreement between
registrant and Marvin Rosen (*)
10.29
Stock Purchase Agreement between
registrant, Convergent Technologies, Ltd. and the stockholders listed on Schedule
1 Attached thereto, dated December 16, 2004, as amended and restated, dated January
11, 2005 (*)
10.30
Employment Agreement between registrant
and Roger Karam (*)
10.31
Stock Purchase Agreement between
registrant, Efonica FZ-LLC and Karamco, Inc., dated January 11, 2005 and the amendment
thereto (*)
10.32
Carrier Service Agreement for International
Terminating Traffic between the registrant and Qwest Communications Corporation,
dated May 17, 2000 (*)
10.33
Carrier Service Agreement between
registrant and Telco Group, Inc. dated April 3, 2001, as amended (*)
10.34
Colocation License Agreement between
the registrant and Telco Group, dated January 28, 2002.(*)
10.35
International VoIP Agreement, dated
April 25, 2002, as amended (*)
10.36
Stock Purchase Agreement dated March
8, 2005 between FUSION TURKEY, L.L.C., LDTS UZAK MESAFE TELEKOMÜNIKASYON VE
..ILETIS,IM HIZMETLERI SAN.TIC.A.S. and Bayram Ali BAYRAMOGLU; Mecit BAYRAMOGLU
Mehmet; Musa BAYSAN; Yahya BAYRAMOGLU and Özlem BAYSAN.(1)
21.1
List of Subsidiaries (2)
31.1
Certification of Chief
Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (2)
31.2
Certification of Principal Accounting
Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (2)
32
Certification Pursuant to Section
906 of the Sarbanes-Oxley Act of 2002 (2)
*originally filed with our Registration Statement
no. 33-120412 and incorporated herein by reference.
(1)
Filed as Exhibit to our Current Report
on Form 8-K filed on March 14, 2005 and incorporated herein by reference.
(2)
Filed herewith.
(b) Reports on Form 8-K.
By:
/s/ Mathew D. Rosen
Mathew D. Rosen
President and Chief Operating Officer
March 31, 2005
(Date)
Name
Title
/s/
Marvin S. Rosen
Chairman of the Board and Chief Executive
Officer
Marvin
S. Rosen
/s/ Barbara Hughes
Vice President of Finance and Principal
Accounting
and Financial Officer
Barbara
Hughes
/s/ Philip
Turits
Secretary, Treasurer, and Director
Philip
Turits
/s/ E. Alan Brumberger
Director
E.
Alan Brumberger
/s/ Evelyn
Langlieb Greer
Director
Evelyn
Langlieb Greer
/s/ Raymond E. Mabus
Director
Raymond
E. Mabus
/s/ Manuel
D. Medina
Director
Manuel
D. Medina
/s/ Paul C. O’Brien
Director
Paul
C. O’Brien
/s/ Michael
Del Giudice
Director
Michael
Del Giudice
/s/ Fred P. Hochberg
Director
Fred
P. Hochberg
Director
Cesar
Baez
/s/ Julius Erving
Director
Julius Erving
CONSOLIDATED
FINANCIAL STATEMENTS
Table of Contents
Page
Report
of Independent Registered Public Accounting Firm
F-2
Consolidated
Balance Sheets as of December 31, 2004 and 2003
F-3
Consolidated
Statements of Operations for the years ended December 31, 2004, 2003 and 2002
F-4
Consolidated
Statements of Changes in Stockholders’ Deficit for the years ended
December
31, 2004, 2003 and 2002
F-5
Consolidated
Statements of Cash Flows for the years ended December 31, 2004, 2003 and 2002
F-6
Notes
to Consolidated Financial Statements
F-8
Fusion Telecommunications
International, Inc.
Roseland, New Jersey
March 9, 2005, except for paragraph
7 of Note 22, which is as of March 24, 2005
AND SUBSIDIARIES
Consolidated
Balance Sheets
December
31,
2004
2003
ASSETS
Current
assets
Cash
and cash equivalents
$ 4,368,726
$ 3,205,645
Accounts
receivable, net of allowance for doubtful accounts of
approximately
$414,000 and $688,000, in 2004 and 2003, respectively
3,145,535
1,654,913
Restricted
cash
145,000
386,351
Prepaid
expenses and other current assets
889,761
226,631
Total
current assets
8,549,022
5,473,540
Property
and equipment, net
3,271,474
3,743,293
Other
assets
Security
deposits
902,028
1,230,909
Restricted
cash
235,276
350,275
Investment
in Estel
—
760,563
Other
704,317
123,045
Total
other assets
1,841,621
2,464,792
$ 13,662,117
$ 11,681,625
LIABILITIES
AND STOCKHOLDERS’ DEFICIT
Current
liabilities
Long-term
debt, related parties, current portion
$ 1,739,025
$ 3,423,452
Long-term
debt, current portion
2,660,281
—
Capital
lease obligations, current portion
1,131,830
1,011,280
Accounts
payable and accrued expenses
10,274,688
11,701,086
Investment
in Estel
140,821
—
Liabilities
of discontinued operations
1,116,090
1,686,617
Total
current liabilities
17,062,735
17,822,435
Long-term
liabilities
Long-term
debt, related parties, net of current portion
—
18,750
Capital
lease obligations, net of current portion
156,495
191,422
Preferred
stock, Series C, subject to mandatory redemption
(liquidation
preference in the aggregate of approximately $10,932,000
and
$3,959,000 in 2004 and 2003, respectively)
9,716,026
3,466,538
Total
long-term liabilities
9,872,521
3,676,710
Minority
interests
16,890
49,407
Commitments
and contingencies
Stockholders’
deficit
Preferred
stock, Series A, $.01 par value, authorized 1,100,000 shares,
0
and 407,225 shares issued and outstanding in 2004 and 2003, respectively
—
4,072
Preferred
stock, Series B, $.01 par value, authorized 1,500,000 shares,
0
and 73,500 shares issued and outstanding (liquidation preference, in the
aggregate,
of approximately $0 and $1,167,000 in 2004 and
2003,
respectively)
—
735
Common
stock, $.01 par value, authorized 105,000,000 shares, 0 and 15,341,193
shares
issued and outstanding in 2004 and 2003, respectively
—
153,412
Common
stock, Class A $.01 par value, authorized 21,000,000 shares,
17,479,933
and 0 shares issued and outstanding in 2004 and 2003, respectively
174,800
—
Capital
in excess of par value
65,127,291
62,597,546
Stock
dividend distributable
—
553,238
Accumulated
deficit
(78,592,120)
(73,175,930)
Total
stockholders’ deficit
(13,290,029)
(9,866,927)
$ 13,662,117
$ 11,681,625
AND SUBSIDIARIES
Consolidated
Statements of Operations
2004
2003
Revenues
$49,557,973
$32,018,471
$ 25,537,163
Operating
expenses:
Cost
of revenues, exclusive of depreciation
and
amortization shown separately below
42,927,994
27,855,508
23,638,447
Depreciation
and amortization
1,804,184
1,981,805
2,361,495
Loss
on impairment
—
375,000
467,765
Selling,
general and administrative expenses
9,804,405
8,575,807
9,626,160
Operating
loss
(4,978,610)
(6,769,649)
(10,556,704)
Other
income (expense)
Interest
expense, net
(2,228,060)
(846,896)
(1,058,345)
Forgiveness
of debt
2,174,530
3,918,295
1,812,092
Income
(loss) from investment in Estel
(519,728)
(746,792)
326,367
Other
(15,965)
(97,766)
98,626
Minority
interests
(7,654)
157,617
19,440
(596,877)
2,384,458
1,198,180
Loss
from continuing operations
(5,575,487)
(4,385,191)
(9,358,524)
Discontinued
operations:
Income
from discontinued operations
545,215
208,620
—
Net
loss
$(5,030,272)
$ (4,176,571)
$ (9,358,524)
Losses
applicable to common stockholders:
Loss
from continuing operations
$(5,575,487)
$ (4,385,191)
$ (9,358,524)
Preferred
stock dividends
(385,918)
(635,254)
(642,552)
Net
loss applicable to common stockholders from
continuing
operations
(5,961,405)
(5,020,445)
(10,001,076)
Income
from discontinued operations
545,215
208,620
—
Net
loss applicable to common stockholders
$(5,416,190)
$ (4,811,825)
$(10,001,076)
Basic
and diluted net loss per common share:
Loss
from continuing operations
$ (0.35)
$ (0.37)
$ (1.01)
Income
from discontinued operations
0.03
0.02
—
Net
loss applicable to common stockholders
$ (0.32)
$ (0.35)
$ (1.01)
Weighted
average shares outstanding
Basic
and diluted
16,707,114
13,616,803
9,885,901
AND SUBSIDIARIES
Consolidated
Statements of Changes in Stockholders’ Deficit
Years
Ended December 31, 2004, 2003, and 2002
Redeemable
Preferred
Preferred
Preferred
Common
Capital in
Stock
Stock
Stock
Stock
Common
Stock
Excess of
Dividend
Accumulated
Series C
Series A
Series B
Stock
Class A
Par Value
Distributable
Deficit
Total
Balances, January 1, 2002
$ —
$5,195
$ —
$ 92,968
$ —
$46,683,861
$ —
$(58,363,029)
$(11,581,005)
Proceeds from
sale of
common stock
7,188
1,628,779
1,635,967
Proceeds from sale of
Series
B preferred
stock, net of investment
expenses
835
704,662
705,497
Conversion
of Series A & B
preferred stock to
common
stock
(1,123)
(100)
1,405
(182)
Conversion of long-term
debt
to common stock
15,302
3,715,356
3,730,658
Net loss
(9,358,524)
(9,358,524)
Balances,
December 31, 2002
4,072
735
116,863
52,732,476
(67,721,553)
(14,867,407)
Proceeds from
sale of
common stock, net of
investment
expenses
26,964
6,819,923
6,846,887
Proceeds from sale of
Series
C preferred
stock, net of investment
expenses
2,526,299
Conversion
of long-term
debt to common stock
6,232
2,273,932
2,280,164
Conversion of long-term
debt
to Series C
preferred stock
930,239
Common stock
issued for
the assumption of letter
of
credit
168
49,832
50,000
Conversion of advances to
Series
C preferred stock
10,000
Stock dividends
declared
1,277,806
(1,277,806)
Stock dividends issued
3,185
721,383
(724,568)
Net loss
(4,176,571)
(4,176,571)
Balances,
December 31, 2003
3,466,538
4,072
735
153,412
62,597,546
553,238
(73,175,930)
(9,866,927)
Proceeds from
sales of
common stock, net
of
investment
expenses
4,299
1,272,771
1,277,070
Proceeds from sales of
Series
C preferred
stock, net of investment
expenses
4,630,626
—
Conversion
of long-term
debt to Series C
preferred
stock
Conversion of advances to
Series
C preferred stock
176,620
—
Common stock
issued in
settlement of
accounts
payable
197
101,873
102,070
Conversion of Series A&B
preferred
stock to
common stock
(4,072)
(735)
13,735
(8,928)
—
Conversion
of common
stock to Class A
common
stock
(174,800)
174,800
—
Issuance of convertible
debt
with beneficial
conversion feature
228,030
228,030
Stock dividend
declared
385,918
(385,918)
—
Stock dividend issued
3,157
935,999
(939,156)
—
Accretion of
Series C
preferred stock
1,035,502
Net loss
(5,030,272)
(5,030,272)
Balances, December 31, 2004
$9,716,026
$ —
$ —
$ —
$174,800
$65,127,291
$ —
$(78,592,120)
$(13,290,029)
AND SUBSIDIARIES
Consolidated
Statements of Cash Flows
Cash
flows from operating activities
Net
loss
$(5,030,272)
$(4,176,571)
$(9,358,524)
Adjustments
to reconcile net loss to net cash
used
in operating activities:
Loss
on impairment
—
375,000
467,765
Loss
(gain) from sale of assets
18,421
101,838
(98,627)
Depreciation
and amortization
1,804,184
1,981,805
2,361,495
Bad
debt expense
780,479
183,735
231,088
Beneficial
conversion feature on convertible debt
228,030
—
—
Gain
on forgiveness of debt
(2,174,530)
(3,918,295)
(1,812,092)
Gain
on discontinued operations
(556,904)
—
—
Accretion
of Series C Preferred Stock
1,035,502
—
—
(Income)
loss from investment in Estel
519,728
746,792
(326,367)
Minority
interest
7,654
(157,617)
(19,440)
Increase
(decrease) in cash attributable to
changes
in operating assets and liabilities:
Accounts
receivable
(1,627,047)
(752,779)
184,537
Prepaid
expenses and other current assets
(1,207,139)
(105,666)
6,188
Other
assets
32,737
(22,045)
414,439
Accounts
payable and accrued expenses
1,307,946
1,261,261
4,031,290
Liabilities
of discontinued operations
(13,623)
(402,001)
(347,252)
Net
cash used in operating activities
(4,874,834)
(4,884,543)
(4,265,500)
Cash
flows from investing activities
Purchase
of property and equipment
(627,219)
(582,149)
(427,057)
Proceeds
from sale of property and equipment
36,850
15,000
215,570
Advances
to Estel
(262,398)
(219,926)
(104,778)
Returns
of (payments for) security deposits
245,957
(271,552)
(197,731)
Repayments
of (payments for) restricted cash
356,350
314,556
(469,457)
Net
cash used in investing activities
(250,460)
(744,071)
(983,453)
Cash
flows from financing activities
Proceeds
from sale of common stock, net
1,277,070
6,846,887
1,635,967
Proceeds
from sale of Series B preferred stock, net
—
705,497
Proceeds
from sale of Series C preferred stock, net
4,630,626
2,526,299
Proceeds
from (repayments of) escrow advances
(73,060)
(1,130,500)
1,380,500
Proceeds
from long-term debt
1,330,000
2,091,696
3,854,749
Payments
of long-term debt and capital lease obligations
(836,090)
(2,340,706)
(1,713,641)
Contributions
from (to) minority stockholders of
joint
ventures
(40,171)
104,156
122,308
Net
cash provided by financing activities
6,288,375
8,097,832
5,985,380
Net
increase in cash and cash equivalents
1,163,081
2,469,218
736,427
Cash and
cash equivalents, beginning of year
3,205,645
736,427
Cash
and cash equivalents, end of year
$ 4,368,726
$ 3,205,645
$ 736,427
AND SUBSIDIARIES
Consolidated
Statements of Cash Flows (continued)
2004
2003
2002
Supplemental
disclosure of cash flow information:
Cash
paid during the years for interest
302,860
187,600
250,932
Supplemental
disclosure of noncash investing and
financing
activities:
Acquisition
of capital leases
760,417
373,200
193,963
Conversion
of accounts payable to common stock
102,070
—
—
Note
issued in settlement agreement
150,000
—
—
Conversion
of Series A and B preferred stock
to
common stock
13,735
—
1,405
Credits
received from sale of property and equipment
—
15,000
—
Conversion
of long-term debt to common stock
—
2,280,164
3,730,658
Common
stock issued for the assumption of a
letter
of credit
—
50,000
—
Conversion
of long-term debt to Series C preferred stock
406,740
930,239
—
Conversion
of escrow advances to Series C preferred stock
176,620
10,000
—
Conversion
of interest payable to debt
108,333
—
—
Stock
dividends issued
939,156
724,568
—
Stock
dividends declared
385,918
1,277,806
—
Conversion
of long-term debt to deferred revenue
—
555,000
—
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
1. Nature
of operations
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
2. Summary
of significant accounting policies (continued)
Estimated
Asset
Useful Lives
Network
equipment
5-7 Years
Furniture and
fixtures
3-7 Years
Computer equipment and software
3-5 Years
Leasehold improvements
Lease terms
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
2. Summary
of significant accounting policies (continued)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
2. Summary
of significant accounting policies (continued)
2004
2003
2002
Net
loss applicable to common stockholders,
as
reported
$(5,416,190)
$(4,811,825)
$(10,001,076)
Deduct: total stock-based compensation
expense
under fair value method for awards,
net of related
tax effect
(771,852)
(99,911)
(345,221)
Net
loss applicable to common stockholders,
pro
forma
$(6,188,042)
$(4,911,736)
$(10,346,297)
Earnings
per share:
Basic
and diluted net loss applicable to common
stockholders,
as reported
$ (0.32)
$ (0.35)
$ (1.01)
Basic
and diluted net loss applicable to common
stockholders,
pro forma
$ (0.37)
$ (0.36)
$ (1.05)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
2. Summary
of significant accounting policies (continued)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
4. Joint
ventures, acquisitions and divestitures (continued)
Current assets
$ 49,000
Restricted
assets
85,000
Fixed assets
156,000
Intangible
assets
89,000
Current liabilities
(85,000)
Minority interest
(144,000)
Net
assets
$ 150,000
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
5. Investment
in Estel
December 31
2003
Current
assets
$ 599,000
$ 725,000
Non-current
assets
1,147,000
1,407,000
Current liabilities
1,893,000
1,759,000
Total stockholders’
equity (deficit)
(147,000)
373,000
Years Ended December 31,
2004
2003
2002
Net
revenues
$2,280,000
$2,119,000
$3,290,000
Net income
(loss)
(520,000)
(747,000)
326,000
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
7. Property
and equipment
2004
2003
Network
equipment, including $1,743,269 and $982,852
under
capital leases in 2004 and 2003, respectively
$ 7,478,487
$ 6,759,800
Furniture and fixtures
92,298
101,991
Computer equipment
and software
741,326
579,815
Leasehold improvements
2,710,219
2,637,200
11,022,330
10,078,806
Less accumulated
depreciation and amortization, including $951,966
and
$721,158 under capital leases in 2004 and 2003, respectively
7,750,856
6,335,513
$ 3,271,474
$ 3,743,293
2004
2003
Trade
accounts payable
$5,662,058
$ 6,400,804
Accrued expenses
2,050,175
3,165,702
Interest payable
814,262
795,662
Dividends payable on Series C
Preferred Stock
664,635
—
Deferred revenue
971,456
832,599
Amounts due to investors
—
250,000
Other
112,102
256,319
$10,274,688
$11,701,086
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
10. Long-term
debt and capital lease obligations
2004
2003
Convertible
notes payable
(a)
$ 250,000
$ 300,000
Demand notes payable
(b)
898,931
898,931
Convertible
notes payable
(c)
—
299,079
Promissory notes payable
(d)
150,000
—
Demand notes
payable
(e)
81,790
110,688
Promissory notes payable
(f)
150,000
1,150,000
Promissory
notes payable
(g)
25,000
150,000
Promissory notes payable
(h)
102,000
250,000
Promissory
notes payable
(i)
233,252
283,504
Convertible notes payable
(j)
2,508,333
—
Capital lease
obligations
(k)
1,288,325
1,202,702
Total
long-term debt and capital lease obligations
5,687,631
4,644,904
Less current
portion
5,531,136
4,434,732
$ 156,495
$ 210,172
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
10. Long-term
debt and capital lease obligations (continued)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
10. Long-term
debt and capital lease obligations (continued)
Year ending December
31,
2005
$5,802,108
2006
157,358
Total
minimum payments
5,959,466
Less amount representing interest
(271,835)
Present
value of minimum payments
5,687,631
Less current portion
(5,531,136)
$ 156,495
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
11. Income
taxes
2004
2003
2002
Deferred
Federal
$(1,662,000)
$(1,728,000)
$(3,174,000)
State
(56,000)
(19,000)
20,000
(1,718,000)
(1,747,000)
(3,154,000)
Change in valuation
allowance
1,718,000
1,747,000
3,154,000
$ —
$ —
$ —
2004
2003
2002
%
Federal
statutory rate
34.0
34.0
34.0
State, net
of federal tax
1.1
0.3
(0.2)
Other
(0.1)
7.5
(0.1)
Change in valuation
allowance
(35.0)
(41.8)
(33.7)
Effective
income tax rate
—
—
—
2004
2003
Deferred
tax assets
Net
operating losses
$24,912,000
$ 23,569,000
Allowance
for doubtful accounts
423,000
257,000
Accrued
liabilities and other
446,000
677,000
25,781,000
24,503,000
Deferred tax liability
Property
and equipment
(99,000)
(539,000)
Deferred
tax asset, net
25,682,000
23,964,000
Less
valuation allowance
(25,682,000)
(23,964,000)
$ —
$ —
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
11. Income
taxes (continued)
Year
ending December 31,
2005
$1,086,000
2006
1,072,000
2007
1,095,000
2008
1,119,000
2009
880,000
Thereafter
350,000
$5,602,000
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
12. Commitments
and contingencies (continued)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
13. Preferred
stock (continued)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
13. Preferred
stock (continued)
Series A
Series B
Conversion
Conversion
Conversion
Conversion
Price
Date
Price
Date
$2.50
up to 8/30/02
$2.50
up to 3/30/03
$3.50
up to 8/30/03
$3.50
up to 3/30/04
$5.00
up to 8/30/04
$5.00
up to 3/30/05
$6.00
up to 8/30/05
$6.00
up to 3/30/06
$7.00
after 8/31/05
$7.00
after 8/31/07
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
14. Stock
options and warrants
Shares
under options at January 1, 2002
937,314
$2.35 –$14.00
$10.15
Granted
in 2002
184,757
8.23 –17.50
8.96
Expired
in 2002
(112,300)
2.35 –17.50
10.50
Shares
under options at December 31, 2002
1,009,771
2.35 –14.00
7.39
Granted
in 2003
9,771
8.75 –8.75
8.75
Expired
in 2003
(363,335)
2.35 –14.00
5.11
Shares
under options at December 31, 2003
656,207
2.35 –11.66
8.72
Granted
in 2004
1,337,764
3.15 –8.75
4.21
Expired
in 2004
(145,393)
2.35 –11.66
9.26
Shares
under options at December 31, 2004
1,848,578
$2.35 –$ 8.75
$ 5.42
Options
exercisable at December 31, 2002
573,743
$3.35 –$14.00
$ 6.44
Options
exercisable at December 31, 2003
452,315
$2.35 –$11.66
$ 8.58
Options
exercisable at December 31, 2004
440,049
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
14. Stock
options and warrants (continued)
Number
Weighted-Average
Number
Outstanding
Remaining
Weighted-Average
Exercisable
Weighted-Average
at 12/31/04
Contractual Life
Exercise Price
at 12/31/04
Exercise Price
$ 2.35
21,429
3.7 years
$ 2.35
21,429
$ 2.35
3.15
238,624
9.5 years
3.15
4.38
1,070,060
9.5 years
4.38
8.75
518,465
7.2 years
8.75
418,620
8.75
1,848,578
440,049
Shares
under warrants at January 1, 2002
59,217
$2.98 –$8.75
$4.52
Issued
in 2002
100,000
0.04 –3.50
3.01
Shares
under warrants at December 31, 2002
159,217
0.04 –8.75
3.57
Issued
in 2003
93,541
2.98 –3.57
3.01
Shares
under warrants at December 31, 2003
252,758
0.04 –8.75
3.33
Issued
in 2004
33,820
2.28 –8.75
5.53
Shares
under warrants at December 31, 2004
286,578
$0.04 –$8.75
$3.61
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
15. Equity
transactions (continued)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
15. Equity
transactions (continued)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
17. Profit
sharing plan
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
19. Concentrations
(continued)
2004
2003
2002
United
States
$46,248,000
$31,350,000
$25,132,000
Other
3,310,000
668,000
405,000
$49,558,000
$32,018,000
$25,537,000
Revenues
10,187,664
16,117,765
13,023,371
10,229,173
Operating loss
(1,101,341)
(639,021)
(911,750)
(2,326,498)
Interest expense, net
285,131
538,389
552,739
851,801
Forgiveness of debt
1,819,412
157,184
197,934
—
Net income (loss)
265,427
(1,122,493)
(1,369,749)
(2,803,457)
Preferred stock dividends
(19,957)
(365,961)
—
—
Net income (loss) applicable to common
stockholders
245,470
(1,488,454)
(1,369,749)
(2,803,457)
Basic and diluted net income (loss) per
common share applicable to
common stockholders
0.02
(0.09)
(0.08)
(0.16)
Revenues
8,919,861
7,118,713
7,501,774
8,478,123
Operating loss
(1,462,628)
(1,697,530)
(1,610,632)
(1,998,859)
Interest expense, net
190,856
231,783
194,201
230,056
Forgiveness of debt
12,206
1,184,088
582,739
2,139,262
Net loss
(1,825,083)
(904,620)
(1,375,532)
(71,336)
Preferred stock dividends
(82,015)
—
(488,670)
(64,569)
Net loss applicable to common
stockholders
(1,907,098)
(904,620)
(1,864,202)
(135,905)
Basic and diluted net loss per
common share applicable to
common stockholders
(0.14)
(0.07)
(0.14)
(0.01)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
21. Segment
Information
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
Traditional
VoIP to
and
Private Networks
&
Revenues
12,063,581
32,160,011
2,848,829
2,485,552
49,557,973
Cost of revenues (exclusive of
depreciation and
amortization) (10,674,407)
(28,421,832)
(2,136,922)
(1,694,833)
(42,927,994)
Depreciation and amortization
(491,185)
(1,028,281)
(26,363)
(91,965)
(166,390)
(1,804,184)
Selling, general and
administrative (1,937,418)
(3,909,634)
(595,140)
(413,702)
(2,948,511)
(9,804,405)
Other income (expense)
1,561,870
348,621
600
(1,758)
(2,506,210)
(596,877)
Income (loss) from
continuing operations 522,441
(851,115)
91,004
283,294
(5,621,111)
(5,575,487)
Income from discontinued
operations 545,215
545,215
Net Income (loss)
1,067,656
(851,115)
91,004
283,294
(5,621,111)
(5,030,272)
Assets
2,074,699
4,563,839
547,588
433,707
6,042,284
13,662,117
Capital Expenditures
137,412
366,323
32,450
28,312
62,722
627,219
Traditional
VoIP to
and
Private Networks
&
Revenues
8,968,278
21,433,417
289,652
1,327,124
32,018,471
Cost of revenues (exclusive of
depreciation and
amortization) (7,872,773)
(19,006,635)
(183,523)
(792,577)
(27,855,508)
Depreciation and amortization
(499,588)
(1,193,972)
(16,135)
(73,929)
(198,181)
(1,981,805)
Loss on impairment
(105,036)
(251,029)
(3,392)
(15,543)
(375,000)
Selling, general and
administrative (1,270,598)
(3,036,621)
(41,037)
(188,023)
(4,039,528)
(8,575,807)
Other income (expense)
3,393,272
526,009
91,191
(693,559)
(932,455)
2,384,458
Income (loss) from
continuing operations 2,613,555
(1,528,831)
136,755
(436,507)
(5,170,163)
(4,385,191)
Income from discontinued
operations 208,620
208,620
Net Income (loss)
2,822,175
(1,528,831)
136,755
(436,507)
(5,170,163)
(4,176,571)
Assets
1,518,611
4,088,569
350,449
1,752,244
3,971,752
11,681,625
Capital Expenditures
146,752
350,726
4,740
21,716
58,215
582,149
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
21. Segment
Information (continued)
AND SUBSIDIARIES
Notes
to Consolidated Financial Statements
22. Subsequent
events (continued)
AND SUBSIDIARIES
SCHEDULE II
VALUATION
AND QUALIFYING ACCOUNTS
Balance at
Additions
beginning of
charged to
Deductions
Balance at end
period
expense
from Reserves
of period
Allowance
for Doubtful Accounts for the Years Ended:
December 31, 2004(1)
$ 687,490
$ 780,479
$ 409,555
$ 1,058,414
December 31,
2003
517,409
183,735
13,654
687,490
December 31, 2002
972,073
231,088
685,752
517,409
Tax Valuation
Account for the Years Ended:
December 31, 2004
$ 23,964,000
$1,718,000
$ —
$25,682,000
December 31,
2003
22,217,000
1,747,000
—
23,964,000
December 31, 2002
19,063,000
3,154,000
—
(1)
Additions charged to expense and balance at end of period include amounts associated with the Company’s equity investment in Estel. This allowance is net against the receivable balance which is included in Investment in Estel on the Company’s consolidated balance sheet.