Attached files
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
☑
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the
quarterly period ended March 31, 2018
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the
transition period from _____ to _____
Commission File Number: 001-32421
FUSION CONNECT, INC.
(Exact
name of registrant as specified in its charter)
Delaware
|
|
58-2342021
|
(State
or other jurisdiction of incorporation or
organization)
|
|
(IRS
Employer Identification No.)
|
420 Lexington Avenue, Suite 1718, New York, New
York 10170
(Address
of principal executive offices) (Zip
Code)
(212) 201-2400
(Registrants
telephone number, including area code)
Fusion Telecommunications International, Inc.
(Former
name, former address and former fiscal year, if changed since last
report)
Indicate
by check mark whether the issuer (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Exchange Act during the
preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes ☑ No ☐
Indicate
by check mark whether the registrant has submitted electronically
and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405
of Regulation S-T (§232.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant
was required to submit and post such files). Yes ☑ No ☐
Indicate
by check mark whether the registrant is a large accelerated filer,
an accelerated filer, a non-accelerated filer, a smaller reporting
company or an emerging growth company. See the definitions of
“large accelerated filer”, “accelerated
filer”, “non-accelerated filer”, “smaller
reporting company” and “emerging growth company”
in Rule 12b-2 of the Exchange Act.
Large
accelerated filer
|
☐
|
Accelerated
filer
|
☐
|
Non-accelerated
filer
|
☐
|
Smaller
reporting company
|
☑
|
(do not
check if a smaller reporting company)
|
Emerging
growth company
|
☐
|
If an emerging growth company that prepares its financial
statements in accordance with U.S. GAAP, indicate by check mark if
the registrant has elected not to use the extended transition
period for complying with any new or revised financial accounting
standards provided pursuant to Section 13(a) of the
Exchange Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined
in Rule 12b-2 of the Exchange
Act). Yes ☐ No ☑
Indicate
the number of shares outstanding of each of the issuer’s
classes of common stock, as of the latest practicable date: May 7,
2018.
Title of Each Class
|
Number of Shares Outstanding
|
Common
Stock, $0.01 par value
|
76,583,701
|
FUSION CONNECT, INC. AND SUBSIDIARIES
TABLE OF CONTENTS
Part 1 Financial
Information.
|
3
|
Item 1. Financial
Statements.
|
3
|
Item 2.
Management’s Discussion and Analysis of Financial Condition
and Results of Operations.
|
25
|
Item 3.
Quantitative and Qualitative Disclosures About Market
Risk.
|
32
|
Item 4. Controls
and Procedures.
|
32
|
Part II Other
Information.
|
33
|
Item 1. Legal
Proceedings.
|
33
|
Item 1A. Risk
Factors.
|
33
|
Item 2.
Unregistered Sales of Equity Securities and Use of
Proceeds.
|
33
|
Item 3. Defaults
Upon Senior Securities.
|
33
|
Item 4. Mine Safety
Disclosures.
|
33
|
Item 5. Other
Information.
|
33
|
Item 6.
Exhibits.
|
33
|
Signatures.
|
34
|
Index to
Exhibits
|
35
|
2
FUSION CONNECT, INC. AND SUBSIDIARIES
PART I –
FINANCIAL
INFORMATION
Condensed Consolidated Balance
Sheets
|
March
31,
2018
|
December
31,
2017
|
ASSETS
|
(unaudited)
|
|
Current assets:
|
|
|
Cash
and cash equivalents
|
$30,999,732
|
$2,472,836
|
Accounts
receivable, net of allowance for doubtful accounts of
|
|
|
approximately
$435,000 and $668,000, respectively
|
9,174,993
|
10,634,393
|
Prepaid
expenses and other current assets
|
1,871,183
|
1,609,518
|
Deferred
installation costs - current portion
|
798,166
|
-
|
Current
assets of discontinued operations
|
4,269,653
|
2,867,953
|
Total current assets
|
47,113,727
|
17,584,700
|
Property
and equipment, net
|
11,115,107
|
12,838,840
|
Security
deposits
|
612,299
|
612,299
|
Restricted
cash
|
27,153
|
27,153
|
Goodwill
|
35,181,698
|
34,773,629
|
Intangible
assets, net
|
55,687,545
|
56,156,023
|
Deferred
installation costs - net of current portion
|
1,102,648
|
-
|
Other
assets
|
35,632
|
43,937
|
Non-current
assets of discontinued operations
|
19,780
|
20,980
|
TOTAL ASSETS
|
$150,895,589
|
$122,057,561
|
|
|
|
LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
|
|
|
Current liabilities:
|
|
|
Term
loan - current portion
|
$6,500,000
|
$6,500,000
|
Obligations
under asset purchase agreements - current portion
|
723,297
|
227,760
|
Equipment
financing obligations - current portion
|
1,075,252
|
1,206,773
|
Deferred
installation revenue - current portion
|
797,332
|
-
|
Accounts
payable and accrued expenses
|
20,165,445
|
21,995,443
|
Current
liabilities from discontinued operations
|
4,660,278
|
3,093,602
|
Total current liabilities
|
33,921,604
|
33,023,578
|
Long-term liabilities:
|
|
|
Notes
payable - non-related parties, net of discount
|
32,083,554
|
31,953,163
|
Notes
payable - related parties
|
928,081
|
928,081
|
Term
loan
|
47,663,242
|
54,222,668
|
Indebtedness
under revolving credit facility
|
-
|
1,500,000
|
Obligations
under asset purchase agreements
|
477,162
|
222,240
|
Equipment
financing obligations - net of current obligations
|
407,345
|
590,602
|
Deferred
installation revenue - net of current portion
|
1,029,445
|
-
|
Derivative
liabilities
|
586,197
|
872,900
|
Total liabilities
|
117,096,630
|
123,313,232
|
Stockholders' equity (deficit):
|
|
|
Preferred
stock, $0.01 par value, 10,000,000 shares authorized,
|
|
|
13,466
and 14,216 shares issued and outstanding
|
134
|
142
|
Common
stock, $0.01 par value, 150,000,000 shares authorized,
|
|
|
23,847,140
and 14,980,756 shares issued and outstanding
|
238,471
|
149,807
|
Capital
in excess of par value
|
235,027,397
|
195,940,320
|
Accumulated
deficit
|
(201,318,706)
|
(197,264,083)
|
Total
Fusion Connect, Inc. stockholders' equity (deficit)
|
33,947,296
|
(1,173,804)
|
Noncontrolling
interest
|
(148,337)
|
(81,867)
|
Total stockholders' equity (deficit)
|
33,798,959
|
(1,255,671)
|
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY (DEFICIT)
|
$150,895,589
|
$122,057,561
|
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
3
FUSION CONNECT, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Operations
(unaudited)
|
For the Three Months Ended March 31,
|
|
|
2018
|
2017
|
Revenues
|
$29,038,043
|
$28,481,039
|
Cost
of revenues, exclusive of depreciation and
|
|
|
amortization,
shown separately below
|
12,918,895
|
12,140,707
|
Gross profit
|
16,119,148
|
16,340,332
|
Depreciation
and amortization
|
3,135,779
|
3,835,948
|
Selling,
general and administrative expenses
|
13,947,995
|
13,613,661
|
Impairment
charge
|
1,195,837
|
-
|
Total
operating expenses
|
18,279,611
|
17,449,609
|
Operating loss
|
(2,160,463)
|
(1,109,277)
|
Other (expenses) income:
|
|
|
Interest
expense
|
(2,147,775)
|
(2,092,312)
|
Change
in fair value of derivative liabilities
|
194,312
|
(40,445)
|
Loss
on disposal of property and equipment
|
(3,184)
|
(26,800)
|
Other
income, net
|
89,558
|
116,520
|
Total
other expenses
|
(1,867,089)
|
(2,043,037)
|
Loss
before income taxes
|
(4,027,552)
|
(3,152,314)
|
Provision
for income taxes
|
(14,050)
|
(7,811)
|
Net loss from continuing operations
|
(4,041,602)
|
(3,160,125)
|
Net loss from discontinued operations
|
(166,175)
|
(321,823)
|
Net loss
|
(4,207,777)
|
(3,481,948)
|
Less:
Net loss attributable to non-controlling interest
|
66,470
|
-
|
Net loss attributable to Fusion Connect, Inc.
|
(4,141,307)
|
(3,481,948)
|
Preferred
stock dividends
|
(243,582)
|
(1,254,109)
|
Net loss attributable to common stockholders
|
(4,384,889)
|
(4,736,057)
|
|
|
|
Basic and diluted loss per common share from continuing
operations:
|
$(0.20)
|
$(0.32)
|
Basic and diluted loss per common share from discontinued
operations:
|
$(0.01)
|
$(0.02)
|
Weighted average common shares outstanding:
|
|
|
Basic
and diluted
|
20,682,262
|
13,805,133
|
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
4
FUSION CONNECT, INC. AND SUBSIDIARIES
Condensed Consolidated Statement of Stockholders’ (Deficit)
Equity
(unaudited)
|
Preferred Stock
|
Common Stock
|
Capital in Excess of Par
|
Accumulated
|
Total Fusion Connect, Inc. (Deficit)
|
Non-controlling
|
Stockholders' (Deficit)
|
||
|
Shares
|
$
|
Shares
|
$
|
Value
|
Deficit
|
Equity
|
interest
|
Equity
|
Balance at
December 31, 2017
|
14,216
|
$142
|
14,980,756
|
149,807
|
$195,940,330
|
$(197,264,083)
|
$(1,173,804)
|
$(81,867)
|
$(1,255,671)
|
Cumulative
effect of change in accounting principle
|
-
|
-
|
-
|
-
|
-
|
86,684
|
86,684
|
|
86,684
|
Balance at
January 1, 2018
|
14,216
|
142
|
14,980,756
|
149,807
|
195,940,330
|
(197,177,399)
|
(1,087,120)
|
(81,867)
|
(1,168,987)
|
Conversion
of preferred stock into common stock
|
(750)
|
(8)
|
100,000
|
1,000
|
(992)
|
-
|
-
|
-
|
-
|
Dividends on
preferred stock
|
-
|
-
|
3,985
|
40
|
(40)
|
-
|
-
|
-
|
-
|
Exercise of
common stock purchase warrants
|
-
|
-
|
5,120
|
51
|
11,931
|
-
|
11,982
|
-
|
11,982
|
Cashless
exercise of warrants
|
-
|
-
|
22,155
|
222
|
(222)
|
-
|
-
|
-
|
-
|
Reclassification
of derivative liability
|
-
|
-
|
-
|
-
|
92,391
|
-
|
92,391
|
-
|
92,391
|
Common stock
issued in acquisition
|
-
|
-
|
110,124
|
1,101
|
498,899
|
-
|
500,000
|
-
|
500,000
|
Proceeds
from the sale of common stock, less expenses of
$2,843,000
|
-
|
-
|
8,625,000
|
86,250
|
38,119,846
|
-
|
38,206,096
|
-
|
38,206,096
|
Net
loss
|
-
|
-
|
-
|
-
|
-
|
(4,141,307)
|
(4,141,307)
|
(66,470)
|
(4,207,777)
|
Stock-based
compensation
|
-
|
-
|
-
|
-
|
365,254
|
-
|
365,254
|
-
|
365,254
|
Balance at
March 31, 2018
|
13,466
|
$134
|
23,847,140
|
$238,471
|
$235,027,397
|
$(201,318,706)
|
$33,947,296
|
$(148,337)
|
$33,798,959
|
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
5
FUSION CONNECT, INC. AND SUBSIDIARIES
Condensed Consolidated Statements of Cash Flows
(unaudited)
|
Three Months Ended March 31,
|
|
|
2018
|
2017
|
Cash flows from operating activities:
|
|
|
Net
loss from continuing operations
|
$(4,041,602)
|
$(3,160,125)
|
Net
loss from discontinued operations
|
(166,175)
|
(321,823)
|
Net
loss
|
(4,207,777)
|
(3,481,948)
|
|
|
|
Adjustments to reconcile net loss to net cash provided by (used in)
operating activities:
|
|
|
Depreciation
and amortization
|
3,135,779
|
3,835,948
|
Loss
on disposal of property and equipment
|
3,184
|
26,800
|
Stock-based
compensation
|
365,254
|
224,647
|
Impairment
charge
|
1,195,837
|
-
|
Stock
issued for services rendered or in settlement of
liabilities
|
-
|
164,450
|
Amortization
of debt discount and deferred financing fees
|
195,963
|
209,628
|
(Gain)
loss on the change in fair value of derivative
liability
|
(194,312)
|
40,445
|
Changes in operating assets and liabilities:
|
|
|
Accounts
receivable
|
1,459,401
|
179,518
|
Prepaid
expenses and other current assets
|
(304,442)
|
(873,401)
|
Other
assets and liabilities
|
20,952
|
8,295
|
Accounts
payable and accrued expenses
|
(1,949,917)
|
690,812
|
Cash
(used in) provided by operating activities - continuing
operations
|
(113,903)
|
1,385,070
|
Cash
provided by (used in) operating activities - discontinued
operations
|
107,612
|
(15,826)
|
Net cash (used in) provided by operating activities
|
(6,291)
|
1,369,244
|
|
|
|
Cash flows from investing activities:
|
|
|
Purchase
of property and equipment
|
(976,877)
|
(984,642)
|
Proceeds
from the sale of property and equipment
|
31,533
|
40,680
|
(Payment)
for acquisitions, net of cash acquired
|
-
|
(558,329)
|
Cash
used in investing activities - continuing operations
|
(945,344)
|
(1,502,291)
|
Cash
used in investing activities - discontinued operations
|
-
|
-
|
Net cash used in investing activities
|
(945,344)
|
(1,502,291)
|
|
|
|
Cash flows from financing activities:
|
|
|
Proceeds
from the exercise of common stock purchase warrants
|
11,982
|
780,951
|
Repayments
of term loan
|
(6,625,000)
|
(812,500)
|
Repayments
of revolving debt, net
|
(1,500,000)
|
-
|
Payments
for obligations under asset purchase agreements
|
(192,157)
|
(191,668)
|
Proceeds
from the sale of common stock, net of offering
expenses
|
38,206,096
|
-
|
Payments
on equipment financing obligations
|
(314,777)
|
(223,493)
|
Cash
provided by (used in) financing activities - continuing
operations
|
29,586,144
|
(446,710)
|
Cash
provided by (used in) financing activities - discontinued
operations
|
-
|
-
|
Net cash provided by (used in) financing activities
|
29,586,144
|
(446,710)
|
Net change in cash and cash equivalents
|
28,634,509
|
(579,757)
|
Cash and cash equivalents, including restricted cash, beginning of
period
|
2,557,541
|
7,249,063
|
Cash and cash equivalents, including restricted cash, end of
period
|
$31,192,050
|
$6,669,306
|
Less cash and cash equivalents of discontinued operations, end of
period
|
165,165
|
15,038
|
Cash and cash equivalents, including restricted cash of continuing
operations, end of period
|
31,026,885
|
6,654,268
|
The accompanying notes are an integral part of these Condensed
Consolidated Financial Statements.
6
FUSION CONNECT, INC. AND SUBSIDIARIES
Note 1. Organization and Business
Fusion
Connect, Inc. (f/k/a Fusion Telecommunications International, Inc.)
is a Delaware corporation incorporated in September 1997
(“Fusion” and together with its subsidiaries, the
“Company,” “we,” “us” and
“our”). Fusion changed its name to Fusion Connect, Inc.
on May 4, 2018. The Company is a provider of integrated cloud
solutions, including cloud voice, cloud connectivity, cloud
infrastructure, cloud computing, and managed cloud-based
applications to businesses of all sizes.
Note 2. Basis of Presentation and Summary of Significant Accounting
Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial
statements have been prepared in all material respects in
accordance with accounting principles generally accepted in the
United States of America (“U.S. GAAP”) for interim
financial information. Pursuant to the rules and regulations of the
U.S. Securities and Exchange Commission (the “SEC”),
certain information and footnote disclosures normally included in
annual consolidated financial statements prepared in accordance
with U.S. GAAP have been condensed or omitted.
Because certain information and footnote disclosures have been
condensed or omitted, these unaudited consolidated financial
statements should be read in conjunction with the audited
consolidated financial statements and related notes contained in
the Company’s Annual Report on Form 10-K for the fiscal year
ended December 31, 2017 (the “2017 Form 10-K”) as filed
with the SEC. In management’s opinion, all normal and
recurring adjustments considered necessary for a fair presentation
of the financial position, results of operations and cash flows for
the periods presented have been included. Management believes that
the disclosures made in these unaudited condensed consolidated
interim financial statements are adequate to make the information
not misleading. The results of operations for the interim periods
presented are not necessarily indicative of the results for the
entire year.
On May 4, 2018 (the “Closing Date”), Fusion completed
the various transactions contemplated by the Agreement and Plan of
Merger, dated August 26, 2017, as amended (the “Birch Merger
Agreement”), by and among Fusion, Fusion BCHI Acquisition
LLC, a wholly-owned subsidiary of Fusion (“BCHI Merger
Sub”), and Birch Communications Holdings, Inc.
(“Birch”). As contemplated by the Birch Merger
Agreement, on the Closing Date, Birch merged with and into BCHI
Merger Sub (the “Birch Merger”), with BCHI Merger Sub
surviving the Birch Merger as a wholly-owned subsidiary of
Fusion. See “Note 19 – Subsequent
Events”.
The Company determined that the acquisition of Birch qualified as a
reverse acquisition where Fusion was identified as a legal acquirer
and Birch was identified as an accounting acquirer. All periodic
reports for periods that end on or after the date the reverse
acquisition is completed will be filed within the time periods
specified by the SEC's rules and forms. The financial statements
included in periodic reports filed for periods that end on or after
the date the reverse acquisition is completed will be the
accounting acquirer's financial statements for all periods
presented (reflecting the combined company beginning with the date
of the reverse acquisition) since the accounting acquirer is
considered to be the successor to the legal issuer's reporting
obligation.
In the
quarter ended March 31, 2018, the Company determined that the
assets and liabilities of its Carrier Services reportable segment
met the discontinued operations criteria in ASC 205-20-45.
Accordingly, all assets, liabilities and results of operations have
been classified as discontinued operations for all periods
presented in the accompanying Consolidated Balance Sheet,
Consolidated Statements of Operations and Consolidated Statements
of Cash Flows. See “Note 3 - Discontinued
Operations”.
During the three months ended March 31, 2018 and 2017,
comprehensive loss was equal to the net loss amounts presented for
the respective periods in the accompanying condensed consolidated
interim statements of operations.
Reverse Stock Split
Fusion filed a Certificate of Amendment (the “Charter
Amendment”) to its Certificate of Incorporation with the
Secretary of State of the State of Delaware, to effect a reverse
split of the Fusion common stock at an exchange ratio of 1-for-1.5
(the “Reverse Split”), which became effective on May 4,
2018. The number of authorized shares of Fusion common stock was
not affected by the Reverse Split. Any fractional shares of Fusion
common stock resulting from the Reverse Split were rounded up to
the nearest whole share.
As a
result of the Reverse Stock Split, all share and per share amounts
as of December 31, 2017 as well as for the three months ended March
31, 2018 and March 31, 2017, have been restated at the Reverse
Split Ratio to give effect to the Reverse Stock Split.
7
FUSION CONNECT, INC. AND SUBSIDIARIES
Principles of Consolidation
The condensed consolidated interim financial statements include the
accounts of Fusion and each of its wholly-owned subsidiaries. All
intercompany accounts and transactions have been eliminated in
consolidation. Effective September 1, 2017, Fusion transferred 40%
of its membership interests in Fusion Global Services LLC
(“FGS”) to XcomIP, LLC (“XcomIP”), in
exchange for which XcomIP contributed assets of its carrier
business to FGS. In connection with this transaction, Fusion and
XcomIP also executed a shareholder agreement under which Fusion
agreed to provide up to $750,000 in working capital to FGS. The
Company has determined that, based on the terms of the shareholders
agreement, it has a controlling financial interest in FGS under the
guidance set forth in Accounting Standards Codification
(“ASC”) 810, Consolidation and, therefore, the accounts
of FGS are consolidated into Fusion’s consolidated financial
statements as of and for the year ended December 31, 2017. Prior to
the transfer of membership interests to XcomIP, Fusion transferred
its Carrier Services business to FGS. Effective March 31, 2018, the
Carrier Business is recorded as discontinued operations for all
periods presented. See “Note 19 – Subsequent
Events”.
Use of Estimates
The preparation of condensed consolidated interim financial
statements in conformity with U.S. GAAP requires management to make
estimates and assumptions that affect the reported amounts of
assets and liabilities and disclosure of contingent assets and
liabilities at the date of the condensed consolidated interim
financial statements and the reported amounts of revenues and
expenses during the reporting periods. On an on-going basis,
the Company evaluates its estimates, including, but not limited to,
those related to recognition of revenue; allowance for doubtful
accounts; fair value measurements of its financial instruments;
useful lives of its long-lived assets used in computing
depreciation and amortization; impairment assessment of goodwill
and intangible assets; accounting for stock options and other
equity awards, particularly related to fair value estimates; and
accounting for income taxes, contingencies and litigation. Changes
in the facts or circumstances underlying these estimates could
result in material changes and actual results could differ from
those estimates.
Cash Equivalents
Cash
and cash equivalents include cash on deposit and short-term,
highly-liquid investments with maturities of three months or less
on the date of purchase. As of March 31, 2018 and December 31,
2017, the carrying value of cash and cash equivalents approximates
fair value due to the short period to maturity.
Fair Value of Financial Instruments
At
March 31, 2018 and December 31, 2017, the carrying value of the
Company’s accounts receivable, accounts payable and accrued
expenses approximates their fair value due to the short-term nature
of these financial instruments.
Impairment of Long-Lived Assets
The
Company periodically reviews long-lived assets, including
intangible assets, for possible impairment when events or changes
in circumstances indicate that the carrying amount of an asset may
not be recoverable. If an impairment indicator is present, the
Company evaluates recoverability by a comparison of the carrying
amount of the assets to future undiscounted net cash flows expected
to be generated by the assets. If the carrying value of
the asset exceeds the projected undiscounted cash flows, the
Company is required to estimate the fair value of the asset and
recognize an impairment charge to the extent that the carrying
value of the asset exceeds its estimated fair value. During the
three-month period ended March 31, 2018, the Company recorded an
impairment charge of $1.2 million. The Company did not record any
impairment charges during the three months ended March 31,
2017.
Goodwill
Goodwill
is the excess of the acquisition cost of a business combination
over the fair value of the identifiable net assets acquired.
Goodwill at March 31, 2018 and December 31, 2017 was $35.2 million
and $34.8 million, respectively. All of the Company’s
goodwill is attributable to its Business Services
segment.
The
following table presents the changes in the carrying amounts of
goodwill during the three months ended March 31, 2018:
Balance
at December 31, 2017
|
$34,773,629
|
Increase
in goodwill associated with a business acquisition
|
408,069
|
Balance
at March 31, 2018
|
$35,181,698
|
8
FUSION CONNECT, INC. AND SUBSIDIARIES
Goodwill
is not amortized and is tested for impairment on an annual basis in
the fourth quarter of each fiscal year and whenever events or
circumstances indicate that it is more likely than not that fair
value of a reporting unit is below its carrying
amount.
The Company has the option to perform a qualitative assessment of
goodwill to determine whether it is more likely than not that the
fair value of its reporting unit is less than its carrying amount,
including goodwill and other intangible assets. The Company
also may elect not to perform the qualitative assessment and,
instead, proceed directly to the quantitative impairment test
by comparing the fair value of the
reporting unit to its carrying value. An impairment charge is
recorded to the extent the reporting unit’s carrying value
exceeds its fair value, however, the impairment loss recognized
would not exceed the total amount of goodwill allocated to that
reporting unit. The Company did not record any impairment
charges related to goodwill during the three months ended March 31,
2018 and 2017.
Advertising and Marketing Costs
Advertising and marketing expenses includes cost for promotional
materials and trade show expenses for the marketing of the
Company’s products and
services. Advertising and marketing expenses were
$0.1 million for each of the three months ended March 31, 2018 and
2017. Advertising and marketing expenses are reflected in selling,
general and administrative expenses in the Company’s
condensed consolidated statements of operations.
Income Taxes
The
accounting and reporting requirements with respect to accounting
for income taxes require an asset and liability approach. Deferred
income tax assets and liabilities are computed for differences
between the financial statement and tax bases of assets and
liabilities that will result in future taxable or deductible
amounts, based on enacted tax laws and rates applicable to the
periods in which the differences are expected to affect taxable
income. Valuation allowances are established, when necessary, to
reduce deferred income tax assets to the amount expected to be
realized.
In
accordance with U.S. GAAP, the Company is required to determine
whether a tax position of the Company is more likely than not to be
sustained upon examination by the applicable taxing authority,
including resolution of any related appeals or litigation
processes, based on the technical merits of the position. The tax
benefit to be recognized is measured as the largest amount of
benefit that is greater than fifty percent likely of being realized
upon ultimate settlement. Derecognition of a tax benefit previously
recognized could result in the Company recording a tax liability
that would reduce net assets. Based on its analysis, the Company
has determined that it has not incurred any liability for
unrecognized tax benefits as of March 31, 2018 and December 31,
2017. The Company is subject to income tax examinations by major
taxing authorities for all tax years since 2013 and its tax returns
may be subject to review and adjustment at a later date based on
factors including, but not limited to, on-going analyses of and
changes to tax laws, regulations and interpretations thereof. No
interest expense or penalties have been recognized as of March 31,
2018 and December 31, 2017. During the three months ended March 31,
2018 and 2017, the Company recognized no adjustments for uncertain
tax positions.
Stock-Based Compensation
The
Company recognizes expense for its employee stock-based
compensation based on the fair value of the awards on the date of
grant. The fair values of stock options are estimated on the date
of grant using the Black-Scholes option valuation model. The use of
the Black-Scholes option valuation model requires the input of
subjective assumptions. Compensation cost, net of estimated
forfeitures, is recognized ratably over the vesting period of the
related stock-based compensation award. For transactions in which
goods or services are received from non-employees in return for the
issuance of equity instruments, the expense is recognized in the
period when the goods and services are received at the fair value
of the consideration received or the fair value of the equity
instrument issued, whichever is more readily
determinable.
New and Recently Adopted Accounting Pronouncements
In July
2017, the Financial Accounting Standards Board (“FASB”)
issued Accounting Standard Update (“ASU”) No. 2017-11,
Earnings Per Share (Topic 260),
Distinguishing Liabilities from Equity (Topic 480), Derivatives and
Hedging (Topic 815). The amendments in Part I of this update
change the classification analysis of certain equity-linked
financial instruments (or embedded features) with down round
features. When determining whether certain financial instruments
should be classified as liabilities or equity instruments, a down
round feature no longer precludes equity classification when
assessing whether the instrument is indexed to an entity’s
own stock. The amendments also clarify existing disclosure
requirements for equity-classified instruments. As a result, a
freestanding equity-linked financial instrument (or embedded
conversion option) no longer would be accounted for as a derivative
liability at fair value as a result of the existence of a down
round feature. This standard is effective for fiscal years, and
interim periods within those fiscal years, beginning after December
15, 2018, with early adoption permitted. The Company is currently
evaluating the effect that the new guidance will have on its
financial statements and related disclosures.
9
FUSION CONNECT, INC. AND SUBSIDIARIES
In
February 2016, the FASB issued ASU No. 2016-02, Leases, which is effective for fiscal
years, and interim periods within those years, beginning after
December 15, 2018 with early adoption permitted. Under ASU 2016-02,
lessees will be required to recognize for all leases at the
commencement date a lease liability, which is a lessee’s
obligation to make lease payments arising from a lease measured on
a discounted basis, and a right to-use asset, which is an asset
that represents the lessee’s right to use or control the use
of a specified asset for the lease term. The Company is currently
evaluating the effect that the new guidance will have on its
financial statements and related disclosures.
Note 3: Discontinued Operations
On August 26, 2017, the Company and its wholly owned subsidiary,
Fusion BCHI Acquisition LLC, a Delaware limited liability company
(“Merger Sub”), entered into an Agreement and Plan of
Merger (the “Merger Agreement”) with Birch
Communications Holdings, Inc., a Georgia corporation
(“Birch”). As part of this Merger Agreement, the
Company is required to spin-off or otherwise exit its Carrier
Services business segment prior to the closing of the Merger. See
"Note 19 - Subsequent Events." Accordingly, the Company determined
that the assets and liabilities of its Carrier Services reportable
segment met the discontinued operations criteria in ASC 205-20-45
in the quarter ended March 31, 2018. As such, assets, liabilities
and results of operations have been classified as discontinued
operations for all periods presented in the accompanying
Consolidated Balance Sheet, Consolidated Statements of Operations
and Consolidated Statements of Cash Flows.
Summarized
operating results for discontinued operations, for the periods
ended March 31, 2018 and 2017, respectively, are as
follows:
|
For the Three Months Ended March 31,
|
|
|
2018
|
2017
|
Revenues
|
$9,955,558
|
$7,330,836
|
Cost
of revenues, exclusive of depreciation and
|
|
|
amortization,
shown separately below
|
9,659,011
|
7,130,207
|
Gross profit
|
296,547
|
200,629
|
Depreciation
and amortization
|
1,201
|
1,200
|
Selling,
general and administrative expenses
|
461,521
|
521,213
|
Total
operating expenses
|
462,722
|
522,413
|
Operating loss
|
(166,175)
|
(321,784)
|
Other (expenses) income:
|
|
|
Other
(expenses) income, net
|
-
|
(39)
|
Total
other expenses
|
-
|
(39)
|
Loss
before income taxes
|
(166,175)
|
(321,823)
|
Provision
for income taxes
|
-
|
-
|
Net loss
|
(166,175)
|
(321,823)
|
10
FUSION CONNECT, INC. AND SUBSIDIARIES
The
carrying amounts of assets and liabilities for discontinued
operations for the periods ended March 31, 2018 and December 31,
2017 are as follows:
|
March 31,
2018
|
December 31,
2017
|
|
|
|
Cash
and cash equivalents
|
$165,165
|
$57,552
|
Accounts
receivable, net of allowance for doubtful accounts of
|
|
|
approximately
$42,000 and $32,000, respectively
|
4,099,748
|
2,328,674
|
Prepaid
expenses and other current assets
|
4,740
|
481,727
|
Total current assets of discontinued operations
|
4,269,653
|
2,867,953
|
|
|
|
Property
and equipment, net
|
16,494
|
17,695
|
Security
deposits
|
3,286
|
3,285
|
Total non-current assets of discontinued operations
|
19,780
|
20,980
|
|
|
|
Accounts
payable and accrued expenses
|
3,991,463
|
2,303,122
|
Related
party payable
|
668,815
|
790,480
|
Total current liabilities of discontinued operations
|
4,660,278
|
3,093,602
|
|
|
|
Non-current
liabilities
|
-
|
-
|
Total non-current liabilities of discontinued
operations
|
-
|
-
|
Operating segments are defined under U.S. GAAP as components of an
enterprise for which discrete financial information is available
and evaluated regularly by a company's chief operating decision
maker in deciding how to allocate resources and assess
performance. Prior to the spin-off, the Company had two reportable segments –
Business Services and Carrier Services. These segments were
organized by the products and services that were sold and the
customers that were served. The Company measured and evaluated its
reportable segments based on revenues and gross profit margins.
Because of a spin-off, Carrier Services are reported as
Discontinued Operations and Business Services is the only remaining
segment. As a result, segment information is no longer presented in
a separate footnote.
Note 4. Acquisitions
In January 2018, the Company acquired substantially all of the
assets of IQMax, a Charlotte, N.C.-based provider of secure
messaging, enterprise data integration and advanced cloud
communications solutions. The total consideration for this
transaction was $1.0 million, $0.5 million of which was paid with
110,124 shares of Fusion common stock, with the remaining portion
of the purchase price, also payable in shares of common stock, due
six months from the closing date of the transaction. These shares
will remain in escrow until 12 months following the closing of the
transaction. The Company also agreed to pay a royalty fee to
the seller based on the net revenue in excess of $1.75 million from
the annual sales of acquired assets. The estimated present value of
the contingent royalty fee of $0.4 million was recognized as a
non-current liability in the condensed consolidated balance sheet
as of March 31, 2018.
11
FUSION CONNECT, INC. AND SUBSIDIARIES
The
allocation of the purchase price as of the acquisition date is as
follows:
|
|
Useful life
|
|
|
(in years)
|
Covenant
not to compete
|
$125,000
|
3
|
Trademark
|
16,125
|
10
|
Intellectual
property
|
1,017,805
|
17
|
Goodwill
|
408,069
|
|
Deferred
revenue
|
(119,921)
|
|
Total
purchase price
|
$1,447,078
|
|
Note 5. Loss per share
Basic
and diluted loss per share is computed by dividing the loss
attributable to common stockholders by the weighted-average number
of common shares outstanding during the period. The following table
sets forth the computation of basic and diluted net loss per share
for the three months ended March 31, 2018 and 2017:
|
Three Months Ended March 31,
|
|
|
2018
|
2017
|
Numerator
|
|
|
Net
loss from continuing operations
|
$(4,041,602)
|
$(3,160,125)
|
Net
loss from discontinued operations
|
(166,175)
|
(321,823)
|
Net
loss
|
(4,207,777)
|
(3,481,948)
|
Less
Net loss attributable to non-controlling interest
|
66,470
|
-
|
Net
loss attributable to Fusion Connect, Inc.
|
(4,141,307)
|
(3,481,948)
|
Undeclared
dividends on Series A-1, A-2 and A-4 Convertible Preferred
Stock
|
(99,518)
|
(99,518)
|
Conversion
price reduction on Series B-2 Preferred Stock (see note
14)
|
-
|
(623,574)
|
Series
B-2 warrant exchange (see note 14)
|
-
|
(347,190)
|
Dividends
declared on Series B-2 Convertible Preferred Stock
|
(144,064)
|
(183,827)
|
Net
loss attributable to common stockholders
|
$(4,384,889)
|
$(4,736,057)
|
|
|
|
Denominator
|
|
|
Basic
and diluted weighted average common shares outstanding
|
20,682,262
|
13,805,133
|
|
|
|
Loss per share basic and diluted
|
|
|
From
continuing operatins
|
$(0.20)
|
$(0.32)
|
From
discontinued operations
|
$(0.01)
|
$(0.02)
|
For the
three months ended March 31, 2018 and 2017, the following dilutive
securities were excluded from the calculation of diluted earnings
per common share because of their anti-dilutive
effects:
|
For the Three Months Ended March 31,
|
|
|
2018
|
2017
|
Warrants
|
1,274,126
|
1,798,453
|
Convertible
preferred stock
|
1,265,398
|
1,375,417
|
Stock
options
|
1,997,288
|
1,434,049
|
|
4,536,812
|
4,607,919
|
12
FUSION CONNECT, INC. AND SUBSIDIARIES
The net
loss per common share calculation includes a provision for
preferred stock dividends on Fusion’s outstanding Series A-1,
A-2 and A-4 preferred stock (collectively, the “Series A
Preferred Stock”) for the three months ended March 31, 2018
and 2017 of $0.1 million in each period. Through March 31, 2018,
the Board of Directors of Fusion has never declared a dividend on
any Series A Preferred Stock, resulting in approximately $5.2
million of accumulated preferred stock dividends. See
“Note 19 – Subsequent Events”.
The
Fusion Board declared dividends on Fusion Series B-2 Cumulative
Convertible Preferred Stock (the “Series B-2 Preferred
Stock”) of $0.1 million and $0.2 million for the three months
ended March 31, 2018 and 2017, respectively. As permitted by the
terms of the Series B-2 Preferred Stock, dividends were paid in the
form of 3,985 and 71,251 shares of Fusion’s common stock for
the three months ended March 31, 2018 and 2017, respectively. See
“Note 19 – Subsequent Events”.
Note 6. Intangible Assets
Intangible
assets as of March 31, 2018 and December 31, 2017 are as
follows:
|
March 31, 2018
|
December 31, 2017
|
||||
|
Gross Carrying Amount
|
Accumulated Amortization
|
Total
|
Gross Carrying Amount
|
Accumulated Amortization
|
Total
|
|
|
|
|
|
|
|
Trademarks
and tradename
|
$1,109,525
|
$(715,166)
|
$394,359
|
$1,093,400
|
$(672,314)
|
$421,086
|
Proprietary
technology
|
6,798,805
|
(5,209,277)
|
1,589,528
|
5,781,000
|
(5,005,400)
|
775,600
|
Non-compete
agreement
|
12,245,043
|
(11,758,563)
|
486,480
|
12,120,043
|
(11,701,307)
|
418,736
|
Customer
relationships
|
67,614,181
|
(14,397,003)
|
53,217,178
|
67,614,181
|
(13,073,580)
|
54,540,601
|
Favorable
lease intangible
|
-
|
-
|
-
|
218,000
|
(218,000)
|
-
|
Total
acquired intangibles
|
$87,767,554
|
$(32,080,009)
|
$55,687,545
|
$86,826,624
|
$(30,670,601)
|
$56,156,023
|
Amortization
expense was $1.6 million and $2.2 million for the three months
ended March 31, 2018 and 2017, respectively. Estimated future
aggregate amortization expense is expected to be as
follows:
Year
|
Amortization Expense
|
remainder
of 2018
|
$4,751,306
|
2019
|
5,469,042
|
2020
|
5,458,742
|
2021
|
5,284,375
|
2022
|
4,612,642
|
Note 7. Supplemental
Disclosure of Cash Flow Information
Supplemental
cash flow information for the three months ended March 31, 2018 and
2017 is as follows:
|
Three Months Ended March 31,
|
|
Supplemental Cash Flow Information
|
2018
|
2017
|
Cash
paid for interest
|
$1,961,727
|
$2,186,314
|
|
|
|
Supplemental Non-Cash Investing and Financing
Activities
|
|
|
Conversion
of preferred stock into common stock
|
$750,000
|
$2,958,000
|
Dividend
on Series B-2 preferred stock paid with the issuance of Fusion
common stock
|
$19,479
|
$183,827
|
Obligations
under acquisition
|
$500,000
|
$1,350,000
|
Common
stock issued in acquisition
|
$500,000
|
$-
|
Contingent royalty
fee
|
$447,079
|
-
|
Reconciliation of Cash, Cash Equivalents and Restricted
Cash
|
|
|
Cash
and cash equivalents of continuing operations
|
$30,999,732
|
$6,627,115
|
Restricted
cash of continuing operations
|
27,153
|
27,153
|
Total
cash, cash equivalents and restricted cash of continuing
operations
|
$31,026,885
|
$6,654,268
|
Cash
and cash equivalents of discontinued operations
|
165,165
|
15,038
|
Total
cash, cash equivalants and restricted cash
|
31,192,050
|
6,669,306
|
13
FUSION CONNECT, INC. AND SUBSIDIARIES
Note 8. Prepaid Expenses and Other Current Assets
Prepaid
expenses and other current assets at March 31, 2018 and December
31, 2017 are as follows:
|
March 31,
2018
|
December 31,
2017
|
Insurance
|
$69,355
|
$18,639
|
Rent
|
16,326
|
16,326
|
Marketing
|
157,162
|
55,801
|
Software
subscriptions
|
646,495
|
610,191
|
Comisssions
|
58,833
|
46,755
|
Line
costs
|
391,211
|
335,978
|
Other
|
531,801
|
525,828
|
Total
|
$1,871,183
|
$1,609,518
|
Note 9. Accounts Payable and Accrued Expenses
Accounts
payable and accrued expenses at March 31 2018 and December 31, 2017
are as follows:
|
March 31,
2018
|
December 31,
2017
|
Trade
accounts payable
|
$6,060,192
|
$7,434,257
|
Accrued
license fees
|
2,673,648
|
2,881,331
|
Accrued
sales and federal excise taxes
|
3,598,141
|
3,496,697
|
Deferred
revenue
|
1,517,100
|
1,283,969
|
Accrued
network costs
|
1,808,853
|
1,796,302
|
Accrued
sales commissions
|
956,150
|
911,192
|
Property
and other taxes
|
746,309
|
759,770
|
Accrued
payroll and vacation
|
487,711
|
422,097
|
Customer
deposits
|
393,868
|
383,032
|
Interest
payable
|
7,263
|
7,263
|
Credit
card payable
|
135,433
|
114,209
|
Accrued
USF fees
|
1,195,512
|
728,826
|
Accrued
bonus
|
131,593
|
333,337
|
Professional
and consulting fees
|
204,081
|
171,163
|
Rent
|
217,036
|
163,030
|
Other
|
32,555
|
1,108,968
|
Total
|
$20,165,445
|
$21,995,443
|
14
FUSION CONNECT, INC. AND SUBSIDIARIES
Note 10. Equipment Financing Obligations
From time to time, the Company enters into equipment financing or
capital lease arrangements to finance the purchase of network
hardware and software utilized in its operations. These
arrangements require monthly payments over a period of 24 to 48
months with interest rates ranging between 5.3% and 6.6% per annum.
The Company’s equipment financing obligations are as
follows:
|
March 31,
|
December 31,
|
|
2018
|
2017
|
Equipment
financing obligations
|
$1,482,597
|
$1,797,374
|
Less
current portion
|
(1,075,252)
|
(1,206,773)
|
Long-term
portion
|
$407,345
|
$590,601
|
The Company’s payment obligations under its capital leases
are as follows:
Year ending December 31:
|
Principal
|
remainder
of 2018
|
$891,996
|
2019
|
502,589
|
2020
|
88,012
|
|
$1,482,597
|
Note 11. Long-Term Debt
Secured Credit Facilities
As of
March 31, 2018 and December 31, 2017, secured credit facilities
consists of the following:
|
March 31,
|
December 31,
|
|
2018
|
2017
|
Term
loan
|
$55,125,000
|
$61,750,000
|
Less:
|
|
|
Deferred
financing fees
|
(961,758)
|
(1,027,332)
|
Current
portion
|
(6,500,000)
|
(6,500,000)
|
Term
loan - long-term portion
|
$47,663,242
|
$54,222,668
|
|
|
|
Indebtedness
under revolving credit facility
|
$-
|
$1,500,000
|
On
November 14, 2016, Fusion NBS Acquisition Corp.
(“FNAC”), a wholly-owned subsidiary of Fusion, entered
into a credit agreement (the “East West Credit
Agreement”) with East West Bank (“EWB”), as
administrative agent and the lenders identified therein
(collectively the “East West Lenders”). Under the East
West Credit Agreement, the East West Lenders extended FNAC (i) a
$65.0 million term loan and (ii) a $5.0 million revolving credit
facility (which includes up to $4 million in
“swingline” loans that may be accessed on a short-term
basis).
Borrowings
under the East West Credit Agreement are evidenced by notes bearing
interest at rates computed based upon either the then current
“prime” rate of interest or “LIBOR” rate of
interest, as selected by FNAC. Interest on borrowings that FNAC
designates as “base rate” loans bear interest at the
greater of the prime rate published by the Wall Street Journal or
3.25% per annum, in each case plus 2% per annum. Interest on
borrowings that FNAC designates as “LIBOR rate” loans
bear interest at the LIBOR rate of interest published by the Wall
Street Journal, plus 5% per annum. The current interest rate is
6.75% per annum.
Effective
January 1, 2018, the Company is required to make monthly principal
payments in the amount of $541,667 until the November 12, 2021
maturity date of the term loan, when the remaining $36.8 million of
principal is due. Borrowings under the revolving credit facility
are also payable on the November 12, 2021 maturity date of the
facility. At March 31, 2018 and December 31, 2017, $0 and $1.5
million, respectively, was outstanding under the revolving credit
facility.
15
FUSION CONNECT, INC. AND SUBSIDIARIES
Under
the East West Credit Agreement:
●
The Company is
subject to a number of affirmative and negative covenants,
including but not limited to, restrictions on paying indebtedness
subordinate to its obligations to the East West Lenders, incurring
additional indebtedness, making capital expenditures, dividend
payments and cash distributions by subsidiaries.
●
The Company is
required to comply with various financial covenants, including
leverage ratio, fixed charge coverage ratio and minimum levels of
earnings before interest, taxes, depreciation and amortization; and
its failure to comply with any of the restrictive or financial
covenants could result in an event of default and accelerated
demand for repayment of amounts outstanding.
●
The Company granted
the lenders security interests on all of its assets, as well as its
membership interest in FGS and the capital stock of FNAC and each
of its subsidiaries.
●
Fusion and its
subsidiaries (and future subsidiaries of both) other than FNAC and
FGS have guaranteed FNAC’s obligations, including
FNAC’s repayment obligations thereunder.
At
March 31, 2018 and December 31, 2017, the Company was in compliance
with all of the financial covenants contained in the East West
Credit Agreement. See “Note 19 – Subsequent
Events”.
Notes Payable – Non-Related Parties
At
March 31, 2018 and December 31, 2017, notes payable –
non-related parties consists of the following:
|
March 31,
|
December 31,
|
|
2018
|
2017
|
Subordinated
notes
|
$33,588,717
|
$33,588,717
|
Discount
on subordinated notes
|
(958,052)
|
(1,040,167)
|
Deferred
financing fees
|
(547,111)
|
(595,387)
|
Total
notes payable - non-related parties
|
32,083,554
|
31,953,163
|
Less:
current portion
|
-
|
-
|
Long-term
portion
|
$32,083,554
|
$31,953,163
|
On
November 14, 2016, FNAC, Fusion and Fusion’s other
subsidiaries entered into the Fifth Amended and Restated Securities
Purchase Agreement (the “Praesidian Facility”) with
Praesidian Capital Opportunity Fund III, L.P., Praesidian Capital
Opportunity Fund III-A, LP and United Insurance Company of America
(collectively, the “Praesidian Lenders”). The
Praesidian Facility amends and restates a prior facility, pursuant
to which FNAC previously sold its Series A, Series B, Series C,
Series D, Series E and Series F senior notes in an aggregate
principal amount of $33.6 million (the “SPA Notes”).
These notes require interest payments in the amount of $0.3 million
per month. The current interest rate is 10.8% per
annum.
Under
the terms of the Praesidian Facility, the maturity date of the SPA
Notes is May 12, 2022, no payments of principal are due until the
maturity date, and the financial covenants contained in the
Praesidian Facility are substantially similar to those contained in
the East West Credit Agreement. In connection with the execution of
the Praesidian Facility, the Praesidian Lenders entered into a
subordination agreement with the East West Lenders pursuant to
which the Praesidian Lenders have subordinated their right to
payment under the Praesidian Facility and the SPA Notes to
repayment of the Company’s obligations under the East West
Credit Agreement. At March 31, 2018 and December 31, 2017, the
Company was in compliance with all of the financial covenants
contained in the Praesidian Facility. See “Note 19 –
Subsequent Events”.
16
FUSION CONNECT, INC. AND SUBSIDIARIES
Notes Payable – Related Parties
At
March 31, 2018 and December 31, 2017, the Company had $0.9 million
of outstanding notes payable due to Marvin Rosen, the Chairman of
Fusion’s Board of Directors. These notes are subordinated to
borrowings under the East West Credit Agreement and the Praesidian
Facility. The notes are unsecured, pay interest monthly at an
annual rate of 7%, and mature 120 days after the Company’s
obligations under the East West Credit Agreement and the Praesidian
Facility are paid in full. See “Note 19 – Subsequent
Events”.
Note 12. Obligations Under Asset Purchase Agreements
In
connection with certain acquisitions and asset purchases completed
by the Company during 2016, 2017 and 2018, the Company has various
obligations to the sellers, mainly for payments of portions of the
purchase price that have been deferred under the terms of the
respective asset purchase agreements. Such obligations to sellers
or other parties associated with these transactions as of March 31,
2018 and December 31, 2017 are as follows:
|
March 31,
|
December 31,
|
|
2018
|
2017
|
Customer
base acquisitions
|
$253,380
|
$450,000
|
IQMax
|
947,079
|
-
|
|
1,200,459
|
450,000
|
Less
current portion
|
(723,297)
|
(227,760)
|
Long-term
portion
|
$477,162
|
$222,240
|
Note 13. Derivative Liability
Fusion has issued warrants to purchase shares of its common stock
in connection with certain debt and equity financing transactions.
These warrants are accounted for in accordance with the guidance
contained in ASC
Topic 815, Derivatives
and Hedging. For warrant
instruments that are not deemed to be indexed to Fusion’s
common stock, the Company classifies such instruments as a
liability at its fair value and adjusts the instrument to fair
value at each reporting period. This liability is subject to
re-measurement at each balance sheet date until the warrant is
exercised or expires, and any change in fair value
is recognized
in the Company’s statement of operations. At March 31, 2018,
Fusion had 203,647 warrants outstanding which provide for a
downward adjustment of the exercise price if Fusion were to issue
common stock at an issuance price, or issue convertible debt or
warrants with a conversion or exercise price, that is less than the
exercise price of these warrants. During the three months ended
March 31, 2018, 37,120 warrants were exercised, resulting in a
reclassification to equity in the amount of $0.1 million. During
the three months ended March 31, 2017, 12,800 of these warrants
were exercised, and $13,000 was reclassified from the
Company’s derivative liability into
equity.
The fair values of these warrants have been estimated using option
pricing and other valuation models, and the quoted market price of
Fusion common stock. The following weighted average
assumptions were used to determine the fair value of the warrants
for the three months ended March 31, 2018 and 2017:
|
Three months ended March 31,
|
|
|
2018
|
2017
|
Stock
price ($)
|
4.85
|
2.37
|
Adjusted
Exercise price ($)
|
2.34
|
2.34
|
Risk-free
interest rate (%)
|
2.09
|
2.23
|
Expected
volatility (%)
|
86.90
|
74.40
|
Time
to maturity (years)
|
1.00
|
1.75
|
At
March 31, 2018 and December 31, 2017, the fair value of the
derivative was $0.6 million and $0.9 million, respectively. For the
three months ended March 31, 2018, the Company recognized a gain on
the change in fair value of the derivative of $0.2 million, and for
the three months ended March 31, 2017, the Company recognized a
loss on the change in fair value of the derivative in the amount of
$40,000.
Note 14. Revenues from Contracts with Customers
In May
2014, the FASB issued ASU 2014-09, Revenues from Contracts with Customers (Topic
606) (“ASU 2014-09”), as subsequently amended,
that outlines a single comprehensive model for entities to use in
accounting for revenue arising from contracts with customers and
supersedes most recent revenue recognition guidance, including
industry-specific guidance. The core
principle of the revenue model is that an entity recognizes revenue
to depict the transfer of promised goods or services to customers
in an amount that reflects the consideration to which the entity
expects to be entitled in exchange for those goods or services.
This standard is effective for public companies for years ending
after December 15, 2017, with early adoption
permitted. In March 2016,
April 2016 and December 2016, the FASB issued ASU No. 2016-08,
Revenue From Contracts with
Customers (ASC 606): Principal Versus Agent Considerations,
ASU No. 2016-10, Revenue From
Contracts with Customers: Identifying Performance Obligations and
Licensing, and ASU No. 2016-20, Technical Corrections and Improvements to
Topic 606, Revenue From
Contracts with Customers, respectively, which further
clarify the implementation guidance on principal versus agent
considerations contained in ASU No. 2014-09. In May 2016, the FASB
issued ASU 2016-12, Revenue from
Contracts with Customers, narrow-scope improvements and practical
expedients which provides clarification on assessing the
collectability criterion, presentation of sales taxes, measurement
date for non-cash consideration and completed contracts at
transition. These standards became effective for the Company
beginning with the first quarter of 2018.
17
FUSION CONNECT, INC. AND SUBSIDIARIES
The
Company adopted ASC 606 using the modified retrospective method by
recognizing the cumulative effect of initially applying ASC 606 as
an adjustment to the opening balance of shareholders’ equity
at January 1, 2018. The historical periods have not been adjusted
and continue to be reported under ASC 605 “Revenue
Recognition”.
The
following table includes information for the transition adjustment
recorded as of January 1, 2018 to record the cumulative impact of
adoption of ASC 606:
|
Balance as of
|
ASC 606
|
Balance as of
|
|
December 31, 2017
|
Transition Adjustment
|
January 1, 2018
|
Assets
|
|
|
|
Deferred
installation costs, current
|
$-
|
$783,667
|
$783,667
|
Deferred
installation costs, non-current
|
-
|
1,125,414
|
1,125,414
|
|
-
|
1,909,081
|
1,909,081
|
Liabilities
|
|
|
|
Deferred
installation revenue, current
|
-
|
(785,740)
|
(785,740)
|
Deferred
installation revenue, non-current
|
-
|
(1,036,657)
|
(1,036,657)
|
|
-
|
(1,822,397)
|
(1,822,397)
|
Stockholders'
Equity
|
|
|
|
Accumulated
deficit
|
$-
|
$86,684
|
$86,684
|
Under
this new guidance, the Company recognizes revenue when its customer
obtains control of promised services, in an amount that reflects
the consideration which the Company expects to receive in exchange
for those services. To determine whether arrangements are within
the scope of this new guidance, the Company performs the following
five steps: (i) identifies the contract with a customer; (ii)
identifies the performance obligations in the contract; (iii)
determines the transaction price; (iv) allocates the transaction
price to the performance obligations in the contract; and (v)
recognizes revenue when (or as) the Company satisfies its
performance obligation. The details of changes under the new
guidance are as follow:
Contract Acquisition Costs
Under
ASC 606, certain costs to acquire customers must be deferred and
amortized over the related contract period of expected customer
life. For the Company, this includes certain commissions paid to
acquire new customers. Beginning January 1, 2018, commissions
attributable to new customer contracts are being deferred and
amortized into expense. Historically, these acquisition costs were
expensed as incurred. The Company determined that incremental
commissions paid as a result of acquiring customers are recoverable
and, therefore, as part of the transition adjustment above, current
deferred installation costs of $784,000 and non-current deferred
installation costs of $1,125,000 were capitalized. For the three
months ended March 31, 2018, the Company capitalized a total of
$209,000 and amortized $217,000 of commissions. As of March 31,
2018, the Company recorded a total of $798,000 of current deferred
installation costs and $1,103,000 of non-current deferred
installation costs in its consolidated balance sheet.
Installation Revenues
Under
ASC 606, certain installation fees charged to the customers did not
represent separate performance obligations and, as a result, these
fees must be deferred and recognized over the related contract
period of expected customer life. Beginning January 1, 2018,
installation revenues attributable to the customer contracts are
being deferred and amortized into revenue. Historically, these
revenues were recognized when completed. As part of the transition
adjustment above, the Company recorded a total of $786,000 of
current deferred installation revenue and $1,036,000 of non-current
deferred installation revenue at January 1, 2018. For the three
months ended March 31, 2018, the Company deferred a total of
$225,000 and recognized $221,000 of installation revenue. As of
March 31, 2018, the Company recorded a total of $797,000 of current
deferred installation revenue and $1,029,000 of non-current
deferred installation revenue on our consolidated balance
sheet.
The
following table summarize the impacts of adopting ASC 606 on
Company’s consolidated balance sheet and statement of
operations as of and for the three months ended March 31,
2018:
18
FUSION CONNECT, INC. AND SUBSIDIARIES
|
March 31, 2018
|
||
|
|
|
Impact of
|
|
As reported
|
Previous guidance
|
Adoption of ASC 606
|
Assets
|
|
|
|
Deferred
installation costs, current
|
$798,166
|
$-
|
$798,166
|
Deferred
installation costs, non-current
|
1,102,648
|
-
|
1,102,648
|
|
1,900,814
|
-
|
1,900,814
|
Liabilities
|
|
|
|
Deferred
installation revenue, current
|
(797,332)
|
-
|
$(797,332)
|
Deferred
installation revenue, non-current
|
(1,029,445)
|
-
|
(1,029,445)
|
|
(1,826,777)
|
-
|
(1,826,777)
|
Stockholders'
Equity
|
|
|
|
Accumulated
deficit
|
$(201,318,706)
|
$(201,244,669)
|
$(74,037)
|
|
For the three months ended March 31, 2018
|
||
|
|
|
Impact of
|
|
As reported
|
Previous guidance
|
Adoption of ASC 606
|
|
|
|
|
Revenues
|
$29,038,043
|
$29,042,422
|
$(4,379)
|
Selling,
general and administrative
|
(13,947,995)
|
(13,939,728)
|
(8,267)
|
Net
Impact
|
$15,090,048
|
$15,102,694
|
$(12,646)
|
The
impact of adoption of ASC 606 on net income, basic and diluted net
loss per share, consolidated statement of operations and the
consolidated statement of cash flows were not material for the
three months ended March 31, 2018.
The
following table includes estimated revenue expected to be
recognized in the future related to performance obligations that
are unsatisfied (or partially unsatisfied) at the end of the
reporting period:
|
Deferred installation
|
Deferred installation
|
Net
|
|
revenue
|
costs
|
|
|
|
|
|
2018
(remaining nine months)
|
$616,688
|
$(614,571)
|
$2,117
|
2019
|
634,105
|
(663,614)
|
(29,509)
|
2020
|
405,576
|
(459,859)
|
(54,283)
|
2021
and thereafter
|
170,408
|
(162,770)
|
7,638
|
|
$1,826,777
|
$(1,900,814)
|
$(74,037)
|
Summary of disaggregated revenue for the three months periods ended
March 31, 2018 and 2017 is as follows:
Revenue category
|
For the three months ended March 31, 2018
|
For ther three
|
||
|
|
|
Impact of
|
months ended
|
|
As
reported
|
Previous
guidance
|
Adoption of
ASC 606
|
March 31,
2017
|
Monthly
recurring
|
$24,313,686
|
$24,313,686
|
$-
|
24,721,490
|
Usage
and other
|
4,473,467
|
4,473,467
|
-
|
3,444,654
|
Installation
|
250,890
|
255,269
|
(4,379)
|
314,895
|
Total
revenue
|
$29,038,043
|
$29,042,422
|
$(4,379)
|
$28,481,039
|
Note 15. Equity Transactions
Common Stock
Fusion is authorized to issue 150,000,000 shares of common stock.
As of March 31, 2018 and December 31, 2017, 23,847,140 and
14,980,756 shares of its common stock, respectively, were issued
and outstanding. See “Note 19 – Subsequent
Events”.
In
February 2018, the Company completed an underwritten public
offering whereby Fusion issued 8,625,000 shares of its common stock
and received net proceeds of $38.2 million. The proceeds from this
offering are being used to pay down certain indebtedness and for
general corporate purposes.
19
FUSION CONNECT, INC. AND SUBSIDIARIES
During the three months ended March 31, 2018, Fusion issued 27,275
shares of common stock upon the exercise of outstanding warrants,
and declared dividends of
$144,000 on the Series B-2 Preferred Stock, which was paid in the
form of 3,985 shares of Fusion common stock.
In
March 2017, the Company entered into exchange agreements with
certain holders of its outstanding warrants whereby the outstanding
warrants were exchanged for new warrants (the “2017
Warrants”), which warrants permitted the holders to exercise
and purchase, for a limited period of 60 days, unregistered shares
of Fusion common stock at a discount of up to 10% below the closing
bid price of the common stock at the time of exercise but in no
event at a price of less than $1.95 per share. In connection with
these exchange agreements, the warrant holders exercised warrants
to purchase 374,556 shares of common stock on March 31, 2017 at an
exercise price of $2.09 per share. The Company received proceeds
from the exercise of the 2017 Warrants in the amount of $0.8
million, which will be used for general corporate purposes. All of
the 2017 Warrants were immediately exercised and none remained
outstanding as of March 31, 2017. As a result of the exchange, the
Company recorded a preferred stock dividend in the amount of $0.3
million for the difference in fair value of the warrants that were
exchanged (see note 5).
Preferred Stock
Fusion
is authorized to issue up to 10,000,000 shares of preferred stock.
As of March 31, 2018 and December 31, 2017, there were 5,045 shares
of Series A Preferred Stock issued and outstanding. In addition,
there were 8,421 and 9,171 shares of Series B-2 Preferred Stock
issued and outstanding as of March 31, 2018 and December 31, 2017,
respectively. See “Note 19 – Subsequent
Events”.
During
the three months ended March 31, 2018, 750 shares of Series B-2
Preferred stock were converted into 100,000 shares of Fusion common
stock.
On
March 31, 2017, the Company agreed with certain holders of its
Series B-2 Preferred Stock to convert their shares of Series B-2
Preferred Stock into shares of Fusion common stock at a conversion
price of $4.50 per
share (a three dollar reduction from the specified conversion
price). As a result, 2,958 shares of Series B-2 Preferred Stock
were converted into a total of 657,777 shares of Fusion common
stock, and the Company recorded a preferred stock dividend of $0.6
million for the value of the incremental number of common shares
issued in connection with the reduction in the conversion price of
the Series B-2 Preferred Stock (see note 5).
The
holders of the Series A Preferred Stock are entitled to receive
cumulative dividends of 8% per annum payable in arrears, when and
if declared by Fusion’s Board, on January 1 of each year. As
of March 31, 2018, no dividends have been declared with respect to
the Series A Preferred Stock (see note 5). The holders of the
Series B-2 Preferred Stock are entitled to receive cumulative
dividend of 6% per annum payable quarterly in arrears when and if
declared by Fusion’s Board, in cash or shares of Fusion
common stock, at the option of the Company (see note
5).
Stock Options
Fusion's 2016 equity incentive plan reserves a number of
shares of common stock equal to 10% of Fusion common stock
outstanding from time to time on a fully diluted basis, adjusted
upward for the number of shares available for grant under
Fusion’s 2009 stock option plan plus the number of shares
covered by options granted under the 2009 plan that expire without
being exercised. The 2016 equity incentive plan provides for the
grant of incentive stock options, stock appreciation rights,
restricted stock, restricted stock units, stock grants, stock
units, performance shares and performance share units to employees,
officers, non-employee directors of, and consultants to the
Company. Options issued under the various Fusion plans typically
vest in annual increments over a three or 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.
The following assumptions were used to determine the fair value of
the stock options granted under Fusion’s stock-based
compensation plans using the Black-Scholes option-pricing
model:
|
Three Months Ended March 31,
|
|
|
2018
|
2017
|
Dividend
yield
|
0.0%
|
0.0%
|
Expected
volatility
|
92.40%
|
92.40%
|
Average
Risk-free interest rate
|
2.56%
|
2.27%
|
Expected
life of stock option term (years)
|
8.00
|
8.00
|
20
FUSION CONNECT, INC. AND SUBSIDIARIES
The
Company recognized compensation expense of $0.4 million and $0.2
million for the three months ended March 31, 2018 and 2017,
respectively. These amounts are included in selling, general and
administrative expenses in the condensed consolidated interim
statements of operations.
The
following table summarizes stock option activity for the three
months ended March 31, 2018:
|
Number of Options
|
Weighted Average Exercise Price
|
Weighted Average Remaining Contract Term
|
Outstanding
at December 31, 2017
|
2,011,952
|
$3.57
|
|
Granted
|
4,800
|
5.48
|
|
Exercised
|
-
|
-
|
|
Forfeited
|
(1,500)
|
2.55
|
|
Expired
|
(17,964)
|
14.57
|
|
Outstanding
at March 31, 2018
|
1,997,288
|
3.48
|
8.09
|
Exercisable
at March 31, 2018
|
1,416,765
|
4.04
|
7.92
|
As of
March 31, 2018, the Company had approximately $0.9 million of
unrecognized compensation expense related to stock options granted
under the Company’s stock-based compensation plans, which is
expected to be recognized over a weighted-average period of 1.7
years.
Note 16. Commitments and Contingencies
From time to time, the Company may be involved in a variety of
claims, lawsuits, investigations and proceedings relating to
contractual disputes, employment matters, regulatory and compliance
matters, intellectual property rights and other litigation arising
in the ordinary course of business. Defending such proceedings can
be costly and can impose a significant burden on management and
employees. As of March 31, 2018, the Company does not expect that
the outcome of any such claims or actions will have a material
adverse effect on the Company’s liquidity, results of
operations or financial condition.
The
Company underwent a compliance audit for the use of certain
software licenses by one of the Company’s recently acquired
businesses. The Company is negotiating with the software vendor
with regard to a settlement and based upon correspondence and
conversations with the vendor, the Company has recorded an accrual
in accounts payable and accrued expenses in the accompanying
consolidated balance sheet. There can be no assurances that this
matter will be settled and, if settled, the amount that we would
pay in any such settlement.
Note 17. Related Party Transactions
Since March 6, 2014, the Company has engaged a tax advisor to
prepare its tax returns and to provide related tax advisory
services. The Company was billed $0 and $0.1 million for the
three months ended March 31, 2018 and 2017, respectively, by this
firm. Larry Blum, a member of Fusion’s Board of Directors, is
a Senior Advisor to, and a former partner of, this
firm.
The
Company has also issued notes payable to Marvin Rosen (see note
10). See “Note 19 – Subsequent
Events”.
Note 18. Fair Value Disclosures
Fair
value of financial and non-financial assets and liabilities is
defined as an exit price, representing the amount that would be
received to sell an asset or paid to transfer a liability in an
orderly transaction between market participants. The three-tier
hierarchy for inputs used in measuring fair value, which
prioritizes the inputs used in the methodologies of measuring fair
value for assets and liabilities, is as follows:
21
FUSION CONNECT, INC. AND SUBSIDIARIES
Level
1—Quoted prices in active markets for identical assets or
liabilities
Level
2—Observable inputs other than quoted prices in active
markets for identical assets and liabilities
Level
3—No observable pricing inputs in the market
The
following table represents the liabilities measured at fair value
on a recurring basis:
|
Level 1
|
Level 2
|
Level 3
|
Total
|
As of March 31, 2018
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
Contingent
purchase price liability
|
-
|
-
|
$223,297
|
$223,297
|
Non-current
liabilities:
|
|
|
|
|
Contingent
purchase price liability
|
-
|
-
|
$477,162
|
$477,162
|
Derivative
liability (see note 13)
|
-
|
-
|
$586,197
|
$586,197
|
As of December 31, 2017
|
|
|
|
|
Current
liabilities:
|
|
|
|
|
Contingent
purchase price liability
|
-
|
-
|
$227,760
|
$227,760
|
Non-current
liabilities:
|
|
|
|
|
Contingent
purchase price liability
|
-
|
-
|
$222,240
|
$222,240
|
Derivative
liability (see note 13)
|
-
|
-
|
$872,900
|
$872,900
|
Changes
in the derivative warrant liability for the three months ended
March 31, 2018 are as follows:
Balance
at December 31, 2017
|
$872,900
|
Change
for the period:
|
|
Change
in fair value included in net loss
|
(194,312)
|
Warrant
exercises (see note 13)
|
(92,391)
|
Balance
at March 31, 2018
|
$586,197
|
Note 19. Subsequent Events
Completion of the Acquisition of Birch Communications
On May 4, 2018 (the “Closing Date”), Fusion completed
the various transactions contemplated by the Merger Agreement. As
contemplated by the Merger Agreement, on the Closing Date, Birch
merged with and into Merger Sub, with Merger Sub surviving the
merger as a wholly-owned subsidiary of Fusion.
On the Closing Date, all of the outstanding shares of common stock,
par value $0.01 per share, of Birch (other than treasury shares or
shares owned of record by any Birch subsidiary) were cancelled and
converted into the right to receive, in the aggregate, 49,896,310
shares (the “Merger Shares”) of Fusion Common Stock.
Pursuant to subscription agreements executed by each of the
shareholders of Birch, the Merger Shares were issued in the name
of, and are now held by, BCHI Holdings, LLC, a Georgia limited
liability company owned by the former shareholders of
Birch.
Carrier Spin-Off
On the Closing Date, Fusion entered into a Membership Interest
Purchase and Sale Agreement (the “Membership Sale
Agreement”) with XComIP pursuant to which Fusion transferred
its sixty percent (60%) membership interest in FGS to XComIP in
exchange for a right to receive: (i) sixty percent (60%) of the Net
Profits (as defined in the Membership Sale Agreement) of FGS; (ii)
sixty percent (60%) of any distributions being made by FGS to its
members only to the extent such amounts are not distributed as part
of the distribution of Net Profits; and (iii) sixty percent (60%)
of the net proceeds received by the members from a sale of FGS to a
third party.
22
FUSION CONNECT, INC. AND SUBSIDIARIES
Senior Secured Credit Facilities
On the
Closing Date, Fusion entered into a First Lien Credit and Guaranty
Agreement (the “First Lien Credit Agreement”) with
Wilmington Trust, National Association, as Administrative Agent and
Collateral Agent (in such capacities, the “First Lien
Agent”), the lenders party thereto (the “First Lien
Lenders”), and all of the U.S.-based subsidiaries of Fusion,
as guarantors thereunder (the “Guarantors”), pursuant
to which the First Lien Lenders extended (a) term loans to Fusion
in an aggregate principal amount of $555,000,000, consisting of the
“Tranche A Term Loan” and “Tranche B Term
Loan,” in an aggregate principal amount of $45,000,000 and
$510,000,000, respectively (collectively, the “First Lien
Term Loan”), and (b) a revolving facility in an aggregate
principal amount of $40,000,000 (the “Revolving
Facility”, and together with the First Lien Term Loan, the
“First Lien Facility”). Borrowings under the First Lien
Credit Agreement are computed based upon either the then current
“base rate” of interest or “LIBOR” rate of
interest, as selected by Fusion at the time of its borrowings. The
Tranche A Term Loan has an original issue discount of 0.5%. The
Tranche B Term Loan has an original issue discount of 4%, except
for the $170 million portion of the Tranche B Term Loan made by one
lender and certain of its affiliates, which has an original issue
discount of 9%, for a blended original issue discount of
approximately 5.67%. The Tranche A Term Loan and the Revolving
Facility mature on the fourth anniversary of the Closing Date and
the Tranche B Term Loan matures on the fifth anniversary of the
Closing Date. The Guarantors guaranty the obligations of Fusion
under the First Lien Credit Agreement.
In
addition, Fusion simultaneously entered into a Second Lien Credit
and Guaranty Agreement (the “Second Lien Credit
Agreement”, and with the First Lien Credit Agreement, the
“Credit Agreements”), by and among Fusion, the
Guarantors, Wilmington Trust, National Association, as
Administrative Agent and Collateral Agent (in such capacities, the
“Second Lien Agent”, and together with the First Lien
Agent, collectively the “Agents”), and the lenders
party thereto (the “Second Lien Lenders”, and together
with the First Lien Lenders, the “Lenders”), pursuant
to which the Second Lien Lenders extended a term loan in the
aggregate principal amount of $85,000,000 (the “Second Lien
Term Loan”, and collectively with the First Lien Term Loan,
the “Term Loans”, and collectively with the First Lien
Facility, the “Credit Facilities”). Borrowings under
the Second Lien Credit Agreement are computed based upon either the
then current “base” rate of interest or
“LIBOR” rate of interest, as selected by Fusion at the
time of its borrowings. The Second Lien Term Loan has an original
issue discount of 4.00%, and it matures 5.5 years from the Closing
Date. The Guarantors guaranty the obligations of Fusion under the
Second Lien Credit Agreement. The Credit Facilities may be prepaid,
in whole or in part, subject to specified prepayment
premiums.
Under
the Credit Agreements, Fusion is subject to a number of affirmative
and negative covenants, including but not limited to, restrictions
on paying indebtedness subordinate to its obligations to the
Lenders, incurring additional indebtedness, making capital
expenditures, dividend payments and cash distributions by
subsidiaries. Furthermore, Fusion is required to comply with
various financial covenants, including net leverage ratio, fixed
charge coverage ratio and maximum levels of consolidated capital
expenditures; and its failure to comply with any of the restrictive
or financial covenants could result in an event of default and
accelerated demand for repayment of its indebtedness.
The
proceeds of the Term Loans have been used, in part, to refinance
all of the existing indebtedness of Fusion and its subsidiaries
(including Birch), under (i) the East West Bank Credit Agreement;
(ii) the Praesidian Facility; and (iii) the Credit Agreement, dated
as of July 18, 2014, among Birch Communications Holdings, Inc.,
Birch Communications, Inc., Cbeyond, Inc., the other guarantors
party thereto, the lenders party thereto and PNC Bank, National
Association, as Administrative Agent. In addition, the Term Loans
were used to repay, in full, approximately $929,000 of indebtedness
under that certain Second Amended and Restated Unsecured Promissory
Note, dated November 14, 2016, payable by Fusion to Marvin Rosen.
The proceeds were also be used to pay the fees and expenses
associated with the Birch Merger and related transactions,
including in connection with the Credit Facilities.
The
Term Loans were also used to make a prepayment of an aggregate of
approximately $3.0 million of indebtedness of Birch under the
subordinated notes each dated October 28, 2016, in favor of
Holcombe T. Green, Jr., R. Kirby Godsey and the Holcombe T. Green,
Jr. 2013 Five-Year Annuity Trust. The remaining indebtedness
thereunder is evidenced after the closing of the Birch Merger by
Amended and Restated Subordinated Notes, dated as of the Closing
Date, made by BCHI Merger Sub (as successor in interest to Birch
pursuant to the Birch Merger) with an aggregate principal amount of
$3.3 million (the “Bircan Notes”). The Bircan Notes
each have an interest rate of 12% per annum, and are amortized in
three equal installments, to be paid off completely in March 2019,
with interest due in quarterly installments. The indebtedness under
the Bircan Notes is unsecured, and obligations thereunder are
subordinated to the Credit Facilities.
In
addition, $62,000,000 of the Tranche B Term Loan under the First
Lien Credit Agreement has been deposited in a deposit account with
EWB, which account is subject to the terms of a deposit account
control agreement by and among Fusion, EWB, and the First Lien
Agent. The amounts deposited in this account will be used by Fusion
to pay the Purchase Price (as defined below) for MegaPath Holdings
Corporation (“MegaPath”). If the MegaPath Merger (as
defined below) is not completed by August 4, 2018, such funds must
be used to prepay the Tranche B Term Loan under the First Lien
Credit Agreement.
23
FUSION CONNECT, INC. AND SUBSIDIARIES
Green Subordinated Note
At
Closing, Holcombe T. Green, Jr. made an additional loan to Fusion
in the principal amount of $10,000,000, which is evidenced by a
Subordinated Promissory Note, dated the Closing Date (the
“Green Note”), that Fusion delivered to Mr. Green. The
Green Note has an interest rate of 13% per annum and an original
issue discount of 4%, and it matures on the date which is 91 days
after the maturity date of the Second Lien Term Loan. Until the
maturity date of the Green Note, only interest is due thereunder,
in quarterly payments. The indebtedness under the Green Note is
unsecured, and obligations thereunder are subordinated to the
Credit Facilities.
Vector Subordinated Note
In
connection with its participation in the Tranche B Term Loan under
the First Lien Credit Agreement, Vector Fusion Holdings (Cayman),
Ltd. (“Vector”) entered into a separate credit
agreement (the “Vector Credit Agreement”) with Goldman
Sachs & Co., as administrative agent and lender, and U.S. Bank
National Association, as collateral agent and collateral custodian,
pursuant to which Vector borrowed funds from Goldman Sachs, the
proceeds of which were used to purchase Tranche B Term Loans under
the First Lien Credit Agreement. In connection therewith, Vector
issued to Fusion, and Fusion bought from Vector using proceeds of
the various financing transactions consummated on the Closing Date,
a $25,000,000 unsecured subordinated note (the “Vector
Note”). The Vector Note bears interest at the rate earned by
the bank account in which the proceeds of the Vector Note will be
deposited and matures on May 3, 2024. The Vector Note is
subordinate in right of payment to Vector’s loan from Goldman
Sachs& Co. Other than payments permitted under certain limited
circumstances set forth in the Vector Credit Agreement, Fusion is
not entitled to any distribution on account of the principal,
premium or interest or any other amount in respect of the Vector
Note until all amounts owed by Vector under the Vector Credit
Agreement are paid in full. Similarly, while Fusion has the right
to declare obligations due under the Vector Note to be immediately
due and payable upon the occurrence of an event of default
(including, without limitation, in the event of any insolvency,
bankruptcy or liquidation or Vector), Fusion will not be entitled
to receive any payment on account of the Vector Note until
Vector’s obligations under the Senior Credit Agreement are
paid in full. Fusion pledged the Vector Note as security for its
obligations under the Credit Agreements.
Private Placements of Common Stock
On the Closing Date, Fusion entered into and consummated the sale
of shares of Fusion common stock under three separate common stock
purchase agreements. Specifically, Fusion issued and sold (i)
952,382 shares of Fusion common stock, for an aggregate purchase
price of approximately $5,000,000, to North Haven Credit Partners
II L.P., one of the First Lien Lenders under the Tranche B Term
Loan, which is managed by Morgan Stanley Credit Partners;
(ii) 380,953 shares of Fusion
common stock, for an aggregate purchase price of approximately
$2,000,000, to Aetna Life Insurance Company; and (iii) 190,477
shares of Fusion common stock, for an aggregate purchase price of
approximately $1,000,000, to Backcast Credit Opportunities Fund I,
L.P. These shares of common stock were sold in reliance upon the
exemption from the registration requirements under the Securities
Act of 1933, as amended (“Securities Act”) pursuant to
Section 4(a)(2) thereunder.
Private Placement of Series D Preferred Stock
On the Closing Date, Fusion entered into a preferred stock purchase
agreement with Holcombe T. Green, Jr. pursuant to which it issued
and sold to Mr. Green 15,000 shares of Series D Cumulative
Preferred Stock, par value $0.01 per share (the “Series D
Preferred Stock”) of Fusion, for an aggregate purchase price
of $14,700,000. The Series D Preferred Stock has a stated value of
$15,000,000. The Series D Preferred Shares were sold in reliance
upon the exemptions from the registration requirements under the
Securities Act pursuant to Section 4(a)(2) thereunder. The Series D
Preferred Stock accrues dividends when, as and if declared by the
Fusion Board at an annual rate of twelve percent (12%) per annum,
payable monthly in arrears on a cumulative basis.
MegaPath Merger Agreement
On May 4, 2018, Fusion, and its wholly owned subsidiary, Fusion
MPHC Acquisition Corp., a Delaware corporation (“MPHC Merger
Sub”), entered into an Agreement and Plan of Merger (the
“MegaPath Merger Agreement”), with MegaPath and
Shareholder Representative Services LLC, a Colorado limited
liability company, solely in its capacity as the representative of
the stockholders and optionholders of MegaPath. The MegaPath Merger
Agreement, provides, among other things, that upon the terms and
conditions set forth therein, MPHC Merger Sub will merge with and
into MPHC Merger Sub, with MegaPath surviving the MegaPath Merger
and continuing as a wholly-owned subsidiary of Fusion. The purchase
price for MegaPath is $71,500,000 (the “Purchase
Price”), up to $10,000,000 of which may be paid by Fusion, at
its option, in shares of Fusion’s common stock. The Purchase
Price is subject to a working capital adjustment as well as a
reduction for certain transaction expenses and any outstanding
indebtedness of MegaPath as of the closing of the MegaPath Merger,
in each case, as provided in the MegaPath Merger Agreement. At
closing, $2,500,000 of the Purchase Price will be deposited in an
escrow account held by Citibank, N.A., as escrow agent, for one (1)
year, to secure indemnification obligations in favor of Fusion
under the MegaPath Merger Agreement.
A full description of each of the foregoing events is contained in
our Current Report on Form 8-K which was filed with the Securities
and Exchange Commission on May 10, 2018.
24
FUSION CONNECT, INC. AND SUBSIDIARIES
Item 2. Management’s Discussion and Analysis of Financial
Condition and Results of Operations
The following discussion should be read in conjunction with the
information contained in our unaudited consolidated financial
statements and the notes thereto appearing elsewhere herein and in
conjunction with the Management’s Discussion and Analysis set
forth in the Company’s 2017 Form 10-K.
Certain statements and the discussion contained herein regarding
the Company’s business and operations may include
“forward-looking statements” within the meaning of the
Private Securities Litigation Reform Act of 1995. Such statements
consist of any statement other than a recitation of historical fact
and can be identified by the use of forward-looking terminology
such as “may,” “plans,”
“expect,” “anticipate,”
“intend,” “estimate” or
“continue” or the negative thereof or other variations
thereof or comparable terminology. The reader is cautioned that all
forward-looking statements are speculative, and there are certain
risks and uncertainties that could cause actual events or results
to differ from those referred to in such forward-looking
statements. The primary risk of the Company is its ability to
attract new capital to execute its comprehensive business strategy.
There may be additional risks associated with the integration of
businesses following an acquisition, the Company’s ability to
comply with the terms of its credit facilities, competitors with
broader product lines and greater resources, emergence into new
markets, natural disasters, acts of war, terrorism or other events
beyond the Company’s control and the other factors identified
by the Company from time to time in its filings with the SEC.
However, the risks included should not be assumed to be the only
risks that could affect future performance. All forward-looking
statements included are made as of the date hereof, based on
information available to the Company as of the date thereof, and
the Company assumes no obligation to update any forward-looking
statements.
OVERVIEW
Our Business
We
offer a comprehensive suite of cloud communications, cloud
connectivity, cloud computing and managed cloud-based applications
to small, medium and large businesses. Our advanced,
proprietary cloud services platforms, as well as our state-of-the
art switching systems, enable the integration of leading edge
solutions in the cloud, increasing customer collaboration and
productivity by seamlessly connecting employees, partners,
customers and vendors.
We are
focused on becoming our business customers’ single source for
leveraging the increasing power of the cloud, providing a robust
package of what we believe to be the essential services that form
the foundation for their successful migration to, and efficient use
of, the cloud. Our core Business Services products and
services include cloud voice and Unified Communications as a
Service, improving communication and collaboration on virtually any
device, virtually anywhere, cloud connectivity services, securely
and reliably connecting customers to the cloud with managed network
solutions that are designed to increase quality and optimize
network efficiency and contact center solutions. Our
cloud computing and Infrastructure as a Service solutions are
designed to provide our larger enterprise customers with a platform
on which additional cloud services can be
layered. Complemented by our Software as a Service
solutions, such as security and business continuity, our advanced
cloud offerings include private and hybrid cloud, storage, backup
and recovery and secure file sharing that allow our customers to
experience the increased efficiencies and agility delivered by the
cloud. The Company’s cloud-based services are flexible,
scalable and rapidly deployed, reducing our customers’ cost
of ownership while increasing their productivity.
We
continue to focus our sales and marketing efforts on developing
vertically oriented solutions for targeted markets that require the
kind of specialized solutions made possible by our state-of-the-art
network and advanced services platforms. Our vertically
oriented solutions, which are currently focused on healthcare,
legal, hospitality and real estate, offer a substantial opportunity
to gain additional market share. We intend to
accelerate the growth of our business with the goal of increasing
the portion of our total revenue derived from this higher
margin.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
Our
discussion and analysis of financial condition and results of
operations are based upon our consolidated financial statements,
which have been prepared in accordance with accounting principles
generally accepted in the United States of America (“U.S.
GAAP”). The preparation of these financial
statements requires us to make estimates and judgments that affect
the reported amounts of assets, liabilities, revenues and expenses,
and the related disclosure of contingent liabilities. We
base these estimates on our historical experience and on various
other assumptions that we believe to be reasonable under the
circumstances, and these estimates form the basis for our judgments
concerning the carrying values of assets and liabilities that are
not readily apparent from other sources. We periodically
evaluate these estimates and judgments based on available
information and experience. Actual results could differ from our
estimates under different assumptions and conditions. If
actual results significantly differ from our estimates, our
financial condition and results of operations could be materially
impacted.
25
FUSION CONNECT, INC. AND SUBSIDIARIES
We have
identified the policies and significant estimation processes
discussed below as critical to our operations and to an
understanding of our results of operations. For a
detailed discussion on the application of these and other
accounting policies, see Note 2 to the Consolidated Financial
Statements included in the 2017 Form 10-K.
Revenue Recognition
We
recognize revenue upon transfer of goods or services to a customer
at an amount that reflects the expected consideration to be
received in exchange for those goods or services. We use a
five-step approach for recognizing revenue: (i) identification of
the contract, (ii) identification of the performance obligations,
(iii) determination of the transaction price, (iv) allocation of
the transaction price to the performance obligations, and (v)
recognition of revenue as the entity satisfies the performance
obligations. These criteria for revenue recognition may require a
company to use more judgment and make more estimates. We record
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 and
current economic trends. The provisions for revenue
adjustments are recorded as a reduction of revenue at the time
revenue is recognized.
As a
result of the adoption of ASC 606 effective January 1, 2018, we now
defer certain installation revenues and installation costs and
recognize these revenues and costs ratable over 48-month period.
The implementation impact of ASC 606 is not material to the
Company’s financial statements.
Our
revenue includes monthly recurring charges (“MRC”) to
customers for whom services are contracted over a specified period
of time, and variable usage fees charged to customers that purchase
our business products and services. Revenue recognition
commences after the provisioning, testing and acceptance of the
service by the customer. MRC continues until the
expiration of the contract, or until cancellation of the service by
the customer. To the extent that payments received from
a customer are related to a future period, the payment is recorded
as deferred revenue until the service is provided or the usage
occurs.
Cost of Revenues
Our
cost of revenues include the MRC associated with certain platform
services purchased from other service providers, the MRC associated
with private line services and the cost of broadband Internet
access used to provide service to these business
customers.
Fair Value of Financial Instruments
The
carrying value of certain financial instruments such as accounts
receivable, accounts payable and accrued
expenses, approximates their fair values due to their short
term nature. Some of the warrants issued in conjunction
with the issuance of our debt and equity securities are accounted
for in accordance with the guidance contained in Accounting
Standards Codification (“ASC”) Topic 815, Derivatives
and Hedging. For these warrant instruments that are not
deemed to be indexed to Fusion’s stock, we classify the
warrant instrument as a liability at its fair value and adjust the
instrument to fair value at each reporting period. This liability
is subject to re-measurement at each balance sheet date until the
underlying warrants are exercised or as they expire, and any change
in fair value is recognized in our statement of
operations. The fair values of these warrants have been
estimated using option pricing and other valuation models, and the
quoted market price of Fusion common stock.
Accounts Receivable
Accounts
receivable is recorded net of an allowance for doubtful
accounts. On a periodic basis, we evaluate our accounts
receivable and adjust the 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, collection efforts have been exhausted and payment is
not expected to be received.
Impairment of Long-Lived Assets
We
periodically review long-lived assets, including intangible assets,
for impairment whenever events or changes in circumstances indicate
that the carrying amount of an asset may not be fully
recoverable. If an impairment indicator is present, we
evaluate recoverability by a comparison of the carrying amount of
the asset to future undiscounted net cash flows expected to be
generated by the asset. If the carrying value of the
asset exceeds the projected undiscounted cash flows, we are
required to estimate the fair value of the asset and recognize an
impairment charge to the extent that the carrying value of the
asset exceeds its estimated fair value.
26
FUSION CONNECT, INC. AND SUBSIDIARIES
Impairment
testing for goodwill is performed in the fourth fiscal quarter of
each year. The impairment test for goodwill uses a
two-step approach, which is performed at the reporting unit
level. We have determined that our reporting units are
our operating segments since that is the lowest level at which
discrete, reliable financial and cash flow information is
available. The authoritative guidance provides entities
with an option to perform a qualitative assessment to determine
whether a quantitative analysis is necessary. We recorded an
impairment charge of $1.2 million in the three months ended March
31, 2018. The Company did not record any impairment charges during
the three months ended March 31, 2017.
Income Taxes
We
account for income taxes in accordance with U.S. GAAP, which
requires the recognition of deferred tax liabilities and assets for
the expected future income tax consequences of events that have
been recognized in our financial statements. Deferred
income tax assets and liabilities are computed for temporary
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 to reduce
deferred income tax assets when we determine that it is more likely
than not that we will fail to generate sufficient taxable income to
be able to utilize the deferred tax assets.
Recently Issued Accounting Pronouncements
In July
2017, the Financial Accounting Standards Board (“FASB”)
issued Accounting Standards Update (“ASU”) No. 2017-11,
Earnings Per Share (Topic 260),
Distinguishing Liabilities from Equity (Topic 480), Derivatives and
Hedging (Topic 815). The amendments in Part I of this update
change the classification analysis of certain equity-linked
financial instruments (or embedded features) with down round
features. When determining whether certain financial instruments
should be classified as liabilities or equity instruments, a down
round feature no longer precludes equity classification when
assessing whether the instrument is indexed to an entity’s
own stock. The amendments also clarify existing disclosure
requirements for equity-classified instruments. As a result, a
freestanding equity-linked financial instrument (or embedded
conversion option) no longer would be accounted for as a derivative
liability at fair value as a result of the existence of a down
round feature. This standard is effective for fiscal years, and
interim periods within those fiscal years, beginning after December
15, 2018, with early adoption permitted. The Company is currently
evaluating the effect that the new guidance will have on its
financial statements and related disclosures.
In
February 2016, the FASB issued ASU No. 2016-02, Leases, which is effective for fiscal
years, and interim periods within those years, beginning after
December 15, 2018 with early adoption permitted. Under ASU 2016-02,
lessees will be required to recognize for all leases at the
commencement date a lease liability, which is a lessee’s
obligation to make lease payments arising from a lease measured on
a discounted basis, and a right to-use asset, which is an asset
that represents the lessee’s right to use or control the use
of a specified asset for the lease term. The Company is currently
evaluating the effect that the new guidance will have on its
financial statements and related disclosures.
In May
2014, the FASB issued new guidance related to revenue recognition,
ASU 2014-09, Revenue from
Contracts with Customers (“ASC 606”), which
outlines a comprehensive revenue recognition model and supersedes
most current revenue recognition guidance. The new guidance
requires a company to recognize revenue upon transfer of goods or
services to a customer at an amount that reflects the expected
consideration to be received in exchange for those goods or
services. ASC 606 defines a five-step approach for recognizing
revenue: (i) identification of the contract, (ii) identification of
the performance obligations, (iii) determination of the transaction
price, (iv) allocation of the transaction price to the performance
obligations, and (v) recognition of revenue as the entity satisfies
the performance obligations. The new criteria for revenue
recognition may require a company to use more judgment and make
more estimates than under the current guidance. The new guidance
became effective in calendar year 2018. Two methods of adoption are
permitted: (a) full retrospective adoption, meaning the standard is
applied to all periods presented; or (b) modified retrospective
adoption, meaning the cumulative effect of applying the new
guidance is recognized at the date of initial application as an
adjustment to the opening retained earnings balance.
In
March 2016, April 2016 and December 2016, the FASB issued ASU No.
2016-08, Revenue From Contracts
with Customers (ASC 606): Principal Versus Agent Considerations,
ASU No. 2016-10, Revenue From
Contracts with Customers (ASC 606): Identifying Performance Obligations and
Licensing, and ASU No. 2016-20, Technical Corrections and Improvements to
Topic 606, Revenue From
Contracts with Customers, respectively, which further
clarify the implementation guidance on principal versus agent
considerations contained in ASU No. 2014-09. In May 2016, the FASB
issued ASU 2016-12, Revenue from Contracts with Customers,
narrow-scope improvements and practical expedients which provides
clarification on assessing the collectability criterion,
presentation of sales taxes, measurement date for non-cash
consideration and completed contracts at transition. These
standards became effective for the Company beginning with the first
quarter of 2018.
27
FUSION CONNECT, INC. AND SUBSIDIARIES
We
adopted the new standard and related updates effective January 1,
2018, using the modified retrospective method of adoption. Adoption
of this standard resulted in an adjustment to our accumulated
deficit in the amount of $0.1 million.
RESULTS OF
OPERATIONS
Three Months Ended March 31, 2018 Compared with Three Months Ended
March 31, 2017
The
following table summarizes the results of our consolidated
operations for the three months ended March 31, 2018 and
2017:
|
2018
|
2017
|
||
|
$
|
%
|
$
|
%
|
Revenues
|
$29,038,043
|
100.0
|
$28,481,039
|
100.0
|
Cost
of revenues *
|
12,918,895
|
44.5
|
12,140,707
|
42.6
|
Gross profit
|
16,119,148
|
55.5
|
16,340,332
|
57.4
|
Depreciation
and amortization
|
3,135,779
|
10.8
|
3,835,948
|
13.5
|
Selling,
general and administrative expenses
|
13,947,995
|
48.0
|
13,613,661
|
47.8
|
Impariment
charge
|
1,195,837
|
4.1
|
-
|
-
|
Total
operating expenses
|
18,279,611
|
63.0
|
17,449,609
|
61.3
|
Operating loss
|
(2,160,463)
|
(7.4)
|
(1,109,277)
|
(3.9)
|
Other (expenses) income:
|
|
|
|
|
Interest
expense
|
(2,147,775)
|
(7.4)
|
(2,092,312)
|
(7.3)
|
Gain
(loss) on change in fair value of derivative liability
|
194,312
|
0.7
|
(40,445)
|
(0.1)
|
Loss
on disposal of property and equipment
|
(3,184)
|
(0.0)
|
(26,800)
|
(0.1)
|
Other
income, net
|
89,558
|
0.3
|
116,520
|
0.4
|
Total
other expenses
|
(1,867,089)
|
(6.4)
|
(2,043,037)
|
(7.2)
|
Loss before income taxes
|
(4,027,552)
|
(13.9)
|
(3,152,314)
|
(11.1)
|
Provision
for income taxes
|
(14,050)
|
(0.0)
|
(7,811)
|
(0.0)
|
Net loss from contining operations
|
$(4,041,602)
|
(13.9)
|
$(3,160,125)
|
(11.1)
|
Net loss from discontinued operations
|
(166,175)
|
(0.6)
|
(321,823)
|
(1.1)
|
Net loss
|
$(4,207,777)
|
(14.5)
|
$(3,481,948)
|
(12.2)
|
*Exclusive
of depreciation and amortization, shown separately.
Revenues
Consolidated
revenues were $29.0 million for the three months ended March 31,
2018, as compared to $28.5 million for the three months ended March
31, 2017, an increase of $0.5 million, or 2%. The increase is
primarily attributable to revenue derived from the customer base
acquired in March 2017. Only one month of revenue was included in
Q1 2017 as opposed to three months in Q1 2018.
Cost of Revenues and Gross Profit
Cost of
revenues was $12.9 million for the three months ended March 31,
2018, as compared to $12.1 million for the three months ended March
31, 2017.
Gross margin was 55.5% for the three months ended March 31, 2018,
as compared to 57.4% for the three months ended March 31,
2017.
The increase in cost of revenue and decrease in gross margin was
mainly due to higher circuit costs and lower margins from the
customer base acquired in March 2017.
Depreciation and Amortization
Depreciation
and amortization expense was $3.1 million for the three months
ended March 31, 2018, as compared to $3.8 million for the same
period of 2017. The decrease is primarily due to certain of our
intangible
assets becoming fully amortized and, to a lesser extent, some of
our property and equipment becoming fully
depreciated.
28
FUSION CONNECT, INC. AND SUBSIDIARIES
Selling, General and Administrative Expenses
Selling,
general and administrative expenses (“SG&A”) for
the three months ended March 31, 2018 was $14.0 million, as
compared to $13.6 million for the three months ended March 31,
2017. This
increase is driven primarily by higher sales commissions resulting
from the customer base acquisition and an increase of $0.2 million
in transaction costs associated with an announced acquisition of
Birch Communications Holdings, Inc., as these costs are expensed as
incurred.
Impairment Charge
During
the three months ended March 31, 2018, we recorded an impairment
charge on some of our property and equipment in the amount of $1.2
million, with no comparable charge in the first three months of
2017.
Operating Loss
Our
operating loss of $2.2 million for the three months ended March 31,
2018 represents an increase of approximately $1.1 million from the
operating loss for the three months ended March 31, 2017. The
increase is mainly due to the 2018 impairment charge.
Other Expenses
Other expenses, which includes interest expense, gains and losses
on the change in fair value of the Company’s derivative
liability, loss on the disposal of property and equipment and
miscellaneous income and expense, was $1.9 million for the three
months ended March 31, 2018, as compared to $2.0 million for the
three months ended March 31, 2017. The decrease is mainly due to a
gain on change in fair value of the derivative liability in 2018 of
$0.2 million, as compared to a loss of $40,000 during the first
quarter of 2017. Interest expense of $2.1 million for the three
months ended March 31, 2018 was largely unchanged from the same
period a year ago.
Net Loss from continuing operations
Our net loss from continuing operations for the three months ended
March 31, 2018 was $4.0 million, as compared to $3.1 million for
the three months ended March 31, 2017. The increase in net loss was
mainly due to the increase in operating loss, partially offset by a
decrease in other expenses.
LIQUIDITY AND CAPITAL RESOURCES
Since our inception, we have incurred significant net losses. At
March 31, 2018, we had working capital of $13.2 million and
stockholders’ equity of $33.8 million. At December 31, 2017,
we had a working capital deficit of $15.4 million and a
stockholders’ deficit of $1.3 million. Our consolidated cash
balance at March 31, 2018 was $31.0 million. While our management
projects that we have sufficient cash to fund our operations and
meet our operating and debt obligations for the next twelve months,
we may be required to either raise additional capital, limit our
discretionary capital expenditures or borrow amounts available
under our revolving credit facility to support our business plan.
There is currently no commitment for additional funding of
operations and there can be no assurances funds will be available
on terms that are acceptable to us, or at all. See
“Note 19 – Subsequent Events”.
In
February 2018, we completed an underwritten public offering whereby
Fusion issued 8,625,000 shares of its common stock and received net
proceeds of $38.2 million. The proceeds from this offering are
being used to pay down certain indebtedness and for general
corporate purposes.
We have never paid cash dividends on our common stock, and we do
not anticipate paying cash dividends on our common stock in the
foreseeable future. We intend to retain all of our earnings, if
any, for general corporate purposes, and, if appropriate, to
finance the further expansion of our business. Subject to the
rights of holders of our outstanding preferred stock, any future
determination to pay dividends is at the discretion of
Fusion’s Board, and will be dependent upon our financial
condition, operating results, capital requirements, general
business conditions, the terms of our then existing credit
facilities, limitations under Delaware law and other factors that
Fusion’s Board and senior management consider
appropriate.
The holders of our Series B-2 Preferred Stock are entitled to
receive quarterly dividends at an annual rate of 6%. These
dividends can be paid, at the Company’s option, either in
cash or, under certain circumstances, in shares of Fusion common
stock. For the three months ended March 31, 2018 we declared
dividends of $144,000 on the Series B-2 Preferred Stock, which, as
permitted by the terms of such Series, was paid in the form of
3,985 shares of Fusion common stock.
29
FUSION CONNECT, INC. AND SUBSIDIARIES
For the
past several years we have relied primarily on the sale of
Fusion’s equity securities and the cash generated from our
Business Services segment to fund our operations, and we issued
additional debt to fund our acquisitions and growth strategy. On
November 14, 2016, contemporaneously with an acquisition, we
entered into a credit agreement (the “East West Credit
Agreement”) with East West Bank, as administrative agent and
the lenders identified therein (collectively the “East West
Lenders”). Under the East West Credit Agreement, the East
West Lenders extended us a (i) $65.0 million term loan and (ii)
$5.0 million revolving credit facility (which includes up to $4
million in “swingline” loans that may be accessed on a
short-term basis). The proceeds of the term loan were used to
retire the $40 million that was outstanding under a previously
existing credit facility, and to fund the cash portion of the
purchase price of the Apptix acquisition in the amount of $23.1
million. See “Note 19 – Subsequent
Events”.
Borrowings
under the East West Credit Agreement are evidenced by notes bearing
interest at rates to be computed based upon either the then current
“prime” rate of interest or “LIBOR” rate of
interest, as selected by us at the time of borrowing. Interest on
borrowings that we designate as “base rate” loans bear
interest at the greater of the prime rate published by the Wall
Street Journal or 3.25% per annum, in each case plus 2% per annum.
Interest on borrowings that we designate as “LIBOR
rate” loans bear interest at the LIBOR rate published by the
Wall Street Journal, plus 5% per annum. The current interest rate
is 6.75% per annum.
We are
required to repay the term loan in equal monthly payments of
$541,667 until the maturity date of the term loan on November 12,
2021, when the remaining $36.8 million of principal is due.
Borrowings under the revolving credit facility are also payable on
the November 12, 2021 maturity date of the facility. During the
three months ended March 31, 2018, we paid down the $1.5 million
that was outstanding on the revolving credit facility as of
December 31, 2017, and at March 31, 2018, $55.1 million was
outstanding under the term loan and no amounts were outstanding
under the revolving credit facility.
Under
the East West Credit Agreement:
●
We are subject to a
number of affirmative and negative covenants, including but not
limited to, restrictions on paying indebtedness subordinate to our
obligations to the East West Lenders, incurring additional
indebtedness, making capital
●
We are required to
comply with various financial covenants, including leverage ratio,
fixed charge coverage ratio and minimum levels of earnings before
interest, taxes, depreciation and amortization; and our failure to
comply with any of the restrictive or financial covenants could
result in an event of default and accelerated demand for repayment
of this indebtedness.
●
We granted the East
West Lenders security interests in all of our assets, as well as
our 60% membership interest in FGS and the capital stock of our
Fusion NBS Acquisition Corp. subsidiary (“FNAC”) and
each of its subsidiaries.
●
Fusion and its
subsidiaries other than FNAC and FGS (and future subsidiaries of
both) guaranteed FNAC’s obligations, including FNAC’s
repayment obligations thereunder.
On
November 14, 2016, FNAC, Fusion and Fusion’s subsidiaries
other than FNAC entered into the Fifth Amended and Restated
Securities Purchase Agreement (the “Praesidian
Facility”) with Praesidian Capital Opportunity Fund III,
L.P., Praesidian Capital Opportunity Fund III-A, LP and United
Insurance Company of America (collectively, the “Praesidian
Lenders”). The Praesidian Facility amends and restates a
prior facility, pursuant to which FNAC previously sold its Series
A, Series B, Series C, Series D, Series E and Series F senior notes
in an aggregate principal amount of $33.6 million (the “SPA
Notes”). The proceeds from the SPA Notes were used to finance
previous acquisitions within our Business Services segment. These
notes require payments of monthly interest in the amount of $0.3
million and the entire principal amount of the notes are due May
12, 2022. The current interest rate is 10.8% per annum. See
“Note 19 – Subsequent Events”.
The
Praesidian Facility contains financial covenants that are
substantially similar to those contained in the East West Credit
Agreement. At March 31, 2018, we were in compliance with all of the
financial covenants under the East West Credit Agreement and the
Praesidian Facility. Under the terms of the Merger with Birch, all
amounts outstanding under the Praesidian Facility and the East West
Credit Agreement, as well as substantially all of Birch’s
outstanding indebtedness, were refinanced with a larger senior
credit facility at the time of closing.
The
Company underwent a compliance audit for the use of certain
software licenses by one of the Company’s recently acquired
businesses. The Company is negotiating with the software vendor
with regard to a settlement and based upon correspondence and
conversations with the vendor, the Company has recorded an accrual
in accounts payable and accrued expenses in the accompanying
consolidated balance sheet. There can be no assurances that this
matter will be settled and, if settled, the amount that we would
pay in any such settlement.
30
FUSION CONNECT, INC. AND SUBSIDIARIES
The following table sets forth a summary of our cash flows for the
periods indicated:
|
Three Months ended March 31,
|
|
|
2018
|
2017
|
Net
cash (used in) provided by operating activities
|
$(6,291)
|
$1,369,244
|
Net
cash used in investing activities
|
(945,344)
|
(1,502,291)
|
Net
cash provided by (used in) financing activities
|
29,586,144
|
(446,710)
|
Net
increase (decrease) in cash and cash equivalents
|
28,634,509
|
(579,757)
|
Cash
and cash equivalents, including restricted cash, beginning of
period
|
2,557,541
|
7,249,063
|
Cash
and cash equivalents, including restricted cash, end of
period
|
31,192,050
|
6,669,306
|
Less
cash and cash equivalents, discontinued operations, end of
period
|
165,165
|
15,038
|
Cash
and cash equivalents, including restricted cash of continued
operations, end of period
|
$31,026,885
|
$6,654,268
|
Cash used in operating activities was $6,000 for the three months
ended March 31, 2018, as compared to cash provided by operating
activities of $1.4 million during the three months ended March 31,
2017.
The following table illustrates the primary components of our cash
flows from operations:
|
Three Months ended March 31,
|
|
|
2018
|
2017
|
Net
loss from continuing operations
|
$(4,041,602)
|
$(3,160,125)
|
Net
loss from discontinued operations
|
(166,175)
|
(321,823)
|
Net
loss
|
(4,207,777)
|
(3,481,948)
|
Non-cash
expenses, gains and losses
|
4,701,705
|
4,501,918
|
Changes
in accounts receivable
|
1,459,401
|
179,518
|
Changes
in accounts payable and accrued expenses
|
(1,949,917)
|
690,812
|
Other
|
(283,490)
|
(865,106)
|
Cash
(used in) provided by operating activities - continuing
operations
|
(113,903)
|
1,347,017
|
Cash
provided by operating activities - discontinued
operations
|
107,612
|
22,227
|
Net
cash
(used in) provided by operating activities
|
$(6,291)
|
$1,369,244
|
Cash used in investing activities for the three months ended March
31, 2018 consists primarily of capital expenditures in the amount
of $1.0 million. Cash used in investing activities for the three
months ended March 31, 2017 consists primarily of capital
expenditures in the amount of $1.0 million and payments related to
acquisitions of approximately $0.6 million.
Cash provided by financing activities was $29.6 million for the
three months ended March 31, 2018. During the first three months of
2018, we received net proceeds from a public offering of Fusion
common stock in the amount $38.2 million, made principal payments
on the term loan and revolving credit facility under the East-West
Credit Agreement of $6.6 million and $1.5 million, respectively,
and made payments on capital lease obligations in the amount of
$0.3 million.
Cash used in financing activities for the three months ended March
31, 2017 was $0.4 million, as we received proceeds from the
exercise of common stock purchase warrants in the amount of $0.8
million, made principal payments on the East West Credit Agreement
term loan in the amount of $0.8 million, made payments under
capital lease obligations of $0.2 million and paid down obligations
under asset purchase agreements in the amount of $0.2
million.
31
FUSION CONNECT, INC. AND SUBSIDIARIES
Other Matters
Inflation
We do
not believe inflation has a significant effect on our operations at
this time.
Off Balance Sheet Arrangements
At March 31, 2018, we have no off-balance sheet arrangements that
have, or are reasonably likely to have, a current or future
material effect on our financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital
resources.
Item 3. Quantitative and Qualitative Disclosures About Market
Risk.
Disclosure
under this section is not required for a smaller reporting
company.
Item 4. Controls and Procedures.
We maintain disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) promulgated under the Securities Exchange
Act of 1934, as amended (the “Exchange Act”), that are
designed to ensure that information required to be disclosed in
Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the rules and forms
of the SEC and that such information is accumulated and
communicated to our management, including our Chief Executive
Officer and Chief Financial Officer, as appropriate, to allow
timely decisions regarding required disclosure. Any controls and
procedures, no matter how well designed and operated, can provide
only reasonable assurance of achieving the desired control
objectives.
Our management, with the participation of our Chief Executive
Officer and Chief Financial Officer, has evaluated the
effectiveness of the design and operation of our disclosure
controls and procedures as of March 31, 2018. Based upon that
evaluation and subject to the foregoing, our Chief Executive
Officer and Chief Financial Officer concluded that our disclosure
controls and procedures were effective to accomplish their
objectives.
Our Chief Executive Officer and Chief Financial Officer do not
expect that our disclosure controls or our internal controls will
prevent all error and all fraud. The design of a control system
must reflect the fact that there are resource constraints and the
benefit of controls must be
considered relative to their cost. Because of the inherent
limitations in all control systems, no evaluation of
controls can provide absolute
assurance that we have detected all of our control issues and all
instances of fraud, if any. The design of any system of controls also is based partly on certain
assumptions about the likelihood of future events and there can be
no assurance that any design will succeed in achieving our stated
goals under all potential future conditions.
Effective January 1, 2018, we adopted the new revenue guidance
under ASC Topic 606, Revenue from Contracts with
Customers. The adoption of this
guidance requires from the Company the implementation of new
accounting processes and policies, including changes to our
information systems, which changed the Company’s internal
controls over financial reporting for revenue recognition and
related disclosures. Other than the change noted above, there have
been no other changes in our internal control over financial
reporting that occurred during the three months ended March 31,
2018 that have materially affected, or are reasonably likely to
materially affect, our internal control over financial
reporting.
32
FUSION CONNECT, INC. AND SUBSIDIARIES
PART II – OTHER INFORMATION
Item 1. Legal Proceedings.
None.
Item 1A. Risk Factors.
Risk
factors describing the major risks to our business can be found
under Item 1A, “Risk Factors,” in our 2017 Form 10-K.
There have been no material changes to our risk factors from those
previously disclosed in the 2017 Form 10-K.
Item 2. Unregistered Sales of Equity Securities and Use of
Proceeds.
See the
disclosure set forth in “Note 19 – Subsequent
Events” under the captions “Completion of the
Acquisition of Birch Communications”, “Private
Placement of Common Stock” and “Private Placement of
Series D Preferred Stock”, which information is incorporated
herein by this reference.
Item 3. Defaults Upon Senior Securities.
None.
Item 4. Mine Safety Disclosures.
Not
applicable.
Item 5. Other Information.
None.
Item 6. Exhibits
|
|
EXHIBIT NO.
|
DESCRIPTION
|
Employment
Agreement, dated as of February 6, 2017, by and between Birch
Communications, LLC (formerly Birch Communications, Inc.) and Kevin
M. Dotts.
|
|
Certification
of the Chief Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
Certification
of the Chief Financial Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
Certification
of the Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
Certification
of the Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
|
|
101.INS
|
XBRL
Instance Document
|
101.SCH
|
XBRL
Taxonomy Extension Schema Document
|
101.CAL
|
XBRL
Taxonomy Extension Calculation Linkbase Document
|
101.DEF
|
XBRL
Taxonomy Extension Definition Linkbase Document
|
101.LAB
|
XBRL
Taxonomy Extension Label Linkbase Document
|
101.PRE
|
XBRL
Taxonomy Extension Presentation Linkbase Document
|
33
FUSION CONNECT, INC. AND SUBSIDIARIES
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 authorized.
|
FUSION CONNECT, INC.
|
|
|
|
|
|
|
May 15,
2018
|
By:
|
/s/
Kevin M. Dotts
|
|
|
|
Kevin
M. Dotts
|
|
|
|
Executive
Vice President, Chief Financial Officer and Principal Accounting
Officer
|
|
34
FUSION CONNECT, INC. AND SUBSIDIARIES
Index to Exhibits
|
|
EXHIBIT NO.
|
DESCRIPTION
|
Employment
Agreement, dated as of February 6, 2017, by and between Birch
Communications, LLC (formerly Birch Communications, Inc.) and Kevin
M. Dotts.
|
|
Certification
of the Chief Executive Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
Certification
of the Chief Financial Officer, pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
Certification
of the Chief Executive Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
Certification
of the Chief Financial Officer pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
|
|
|
|
101.INS
|
XBRL
Instance Document
|
101.SCH
|
XBRL
Taxonomy Extension Schema Document
|
101.CAL
|
XBRL
Taxonomy Extension Calculation Linkbase Document
|
101.DEF
|
XBRL
Taxonomy Extension Definition Linkbase Document
|
101.LAB
|
XBRL
Taxonomy Extension Label Linkbase Document
|
101.PRE
|
XBRL
Taxonomy Extension Presentation Linkbase Document
|
35