FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
We are seeking to capitalize on the rapid growth of the worldwide cloud services market, which Gartner, in its January, 2014 forecast analysis estimated to be a $155 billion market, with a five year CAGR of 16.9%, reaching $244 billion in 2017. The Company is leveraging strategic partnerships with integrated solution providers such as Unisys to complement its existing cloud technology and network services platform in order to rapidly expand and scale its cloud services portfolio, moving beyond an initial focus on cloud communications to embrace opportunities to grow in the cloud computing and managed cloud solutions market. We believe that our strategic partnerships will allow us to scale more rapidly and offer a broader range of cloud services targeted to large enterprises in our vertical markets, which demand specialized solutions and applications. We anticipate that our strategic partnerships will relieve us of costly development efforts while increasing distribution and extending sales and technical support capabilities for a real time-to-market advantage.
Fusion’s management team, Board of Directors and Advisory Board have long term experience in the technology, services and communications industry, with demonstrated leadership in middle market, entrepreneurial, small company, distressed and M&A environments. We believe that our executive team has the experience and expertise to drive high value opportunities to the Company and execute on our organic and acquisition growth strategy.
We were incorporated in Delaware and commenced operations in 1997 and completed our initial public offering in February 2005. Since 2009, when we sold our consumer services business segment, the Company has focused its efforts on growing its Business Services and Carrier Services segments. We have offices in New York, N.Y., Wayne, N.J., Fort Lauderdale, FL., Atlanta, GA., Cleveland, OH, and Seattle, WA.
Acquisitions
Fusion believes that the cloud services marketplace offers strong opportunities for acquisitions. Large and fast-growing, the landscape is highly fragmented, with most providers challenged by a limited product set and only regional geographic coverage. Many of the smaller organizations lack the financial and operational resources to scale and expand. We believe that the cross marketing synergies and economies of scale made possible by strategic acquisitions make such acquisitions an attractive vehicle to enhance our growth profile. We acquired our first cloud services company in October 2012, and fully integrated the business into our existing Business Services business segment within 120 days of acquisition. The experience and technical infrastructure acquired in that transaction facilitated our second acquisition, which was completed on December 31, 2013. As we acquire a business, we look to swiftly and deeply integrate that business, immediately organizing the employees under one management team with one integrated set of products and services and processes and procedures, with cross-trained support staff and partners, ready to cross and up-sell solutions to the existing base. We believe that our integration strategy, in combination with our increasing expertise and efficient support systems, will enable us to efficiently assimilate additional acquisitions.
NBS Acquisition
In October 2012, we completed our acquisition of Network Billing Systems, LLC (“NBS”), a cloud services provider delivering cloud voice and unified communications, cloud connectivity and managed network services to small, medium and large businesses nationwide. Headquartered in Wayne, New Jersey, NBS generated $26.5 million in revenue in the fiscal year ended December 31, 2011, approximately 95% of which is monthly recurring. This acquisition added approximately 4,000 small, medium and large business customer locations to our Business Services business segment. NBS sells primarily through its network of approximately 185 active authorized channel partners (distributors) that include value added resellers, system integrators, IT consultants, and telecommunications sales agents. The combined and complementary portfolio of Fusion and NBS business services are now sold under the NBS brand, creating increased revenue opportunities through the cross-sale and up-sale of an expanded and fully integrated solution set. All Business Services sales, operations and support staff have been consolidated into a single Business Services segment, with Jonathan Kaufman, founder and former CEO of NBS, as President of that division, and Russell Markman, former President of NBS, as Executive Vice President of the division.
Broadvox Cloud Services Asset Acquisition
In December, 2013, Fusion completed its acquisition of the assets of Broadvox LLC’s cloud services business, which delivers cloud-based voice, unified communications and cloud connectivity to small, medium and large businesses. The acquisition added approximately 6,900 business customer locations and approximately 285 active distribution partners to our NBS Business Services Division, increasing our combined customer base to over 10,000, and expanding our distribution network to include approximately 470 active partners. For the year ended December 31, 2013, the acquired business generated unaudited revenue of approximately $32.7 million, more than 90% of which is recurring. Broadvox’s cloud services marketing and sales efforts, with a strong focus on legal services, hospitality and real estate management, complement our strategy of providing specialized, market-based solutions to key vertical markets.
The integration of the Broadvox cloud services business with our NBS Business Services division creates a strong and robust platform that will allow us to more rapidly scale, accelerating our organic growth plans with advanced service and delivery systems, infrastructure, network facilities and staff, while facilitating additional acquisitions.
Services
Our cloud-based services are designed to meet the communications, network and computing requirements of growing businesses, while maximizing the price-performance ratio. We believe that giving our customers access to the cloud provides a more cost-effective, reliable and secure communications and IT experience, and relieves them of the capital and support burdens associated with more traditional services. Additionally, customers can reduce costs while adding features and functionality, improving productivity across the enterprise. Fusion is increasingly focused on providing specialized, market-based solutions to important verticals and larger enterprises, matching our advanced solutions to key industry-specific customer requirements.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Business Services
We offer a suite of advanced cloud-based services, including cloud communications, which encompasses cloud voice and unified communications, and cloud connectivity that provides diverse and redundant access to the cloud. Our solutions also include cloud-based applications such as storage, security, and business continuity. Fusion’s services are designed to provide significant benefits to businesses of all sizes, with single or multiple locations. The integration of cloud solutions on our advanced services platform allows customers to seamlessly connect people with the information they need to collaborate effectively through the most efficient medium available, regardless of what device they use.
Our cloud solutions are designed to minimize upfront capital costs, increase the scalability and flexibility of the customer’s communications network and service environment, provide robust features and functionality to increase productivity and reduce the overall cost of communications.
Our proprietary cloud communications service platform allows us to rapidly respond to market requirements for new or enhanced products and services, as well as customize customer solutions as required for maximum flexibility, avoiding costly licensing fees and increasing our control over the service environment. Fusion’s growing suite of business services includes:
Cloud Voice
Fusion’s Cloud Voice service allows a customer to replace the premise-based office telephone system it owns or leases with a state-of-the-art digital telephone system that is provided by Fusion in the cloud. This feature-rich solution eliminates the need to own and operate a costly, complex telephone system, reducing upfront capital costs, and eliminates the cost of calls between customer locations. The service provides efficiencies for companies with multiple offices or a highly mobile workforce, and for companies that are opening a new office or need to expand or replace existing telephone systems. All business service options can be configured by the user in real time, using a powerful administrative portal, virtually eliminating the costs associated with the labor-intensive reconfiguration of telephone systems on-site. Fusion’s Contact Center solutions provide advanced call center features and functionality that can be seamlessly integrated with our Cloud Voice solutions, reducing operational costs and increasing cost savings and efficiency. CRM integration, call recording and real-time monitoring are built into the solution, increasing agent productivity without increasing costs.
Unified Communications
Fusion’s Unified Communications as a Service (“UCaaS”) complements our Cloud Voice solutions with integrated service features that seamlessly combine audio, video, messaging and web services, immediately connecting people with the information they need to communicate effectively. Our integrated cloud-based UCaaS collaboration suite is device and location agnostic, allowing businesses of all sizes to increase productivity by simplifying communication over the most preferred or available device. Connecting employees with customers and colleagues via conference call or online meeting, sharing documents real-time with a simple click, our UCaaS solution drives efficiencies while at the same time reducing costs.
Cloud Trunking
Fusion’s Cloud Trunking solution allows a customer to retain and use its existing telephone system, while utilizing the Fusion cloud network for its network access, and local, domestic and international long distance inbound and outbound service. Gaining in popularity and usage, Cloud Trunks provide voice channels in any configuration (analog, T1/PRI, or SIP) for businesses efficiently and economically. Customers save on their local, long distance, and international call charges, eliminate traditional line charges, and gain many of the advantages of cloud voice features and functionality, such as advanced call handling and out of area number portability. Burstable voice lines accommodate seasonal traffic fluctuations, marketing campaigns or business continuity requirements. Cloud Trunks also eliminate the cost of interoffice calling, and allow customers to combine their voice and data traffic onto a single broadband access facility for further cost savings without having to abandon their existing technology investment. Fusion’s Cloud Trunking can be shared across customer locations and is enhanced by a proprietary administrative portal, which allows customers to alter call routing in real time, providing increased efficiency and control.
Cloud Connectivity
Fusion’s reliable and secure connections to the cloud ensure high levels of service quality and control. Leveraging our own expanding on-net network, as well as our relationships with U.S.-based and international carriers, we offer business users a full complement of redundant, flexible and scalable network solutions, offering true diversity for built-in business continuity. Services range from dedicated circuits to high speed broadband and are available at all bandwidth levels. Fusion offers reliable, secure and cost-effective Internet access to all users, as well as Ethernet and Multi-Protocol Label Switching (“MPLS”). Fusion’s Quality of Service routers seek to provide the highest quality voice traffic while reducing customer access costs. We believe that in addition to providing secure migration and connection to the cloud, providing a full complement of network services allows us to address a broader set of customer needs, delivering increased value and securing customer loyalty in the process.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Managed Applications in the Cloud
Fusion is introducing a number of advanced SaaS solutions to meet the needs of large enterprises, especially those facing the rigorous demands of regulatory requirements and/or the need to store, secure and move large amounts of customer or patient data. Recently commercialized, we believe that these applications represent significant future revenue potential as we introduce them to our existing enterprise customers and prospects.
Cloud Security
Securing customer networks and data in motion as well as at rest, Fusion’s NSA-certified Stealth cybersecurity solution was developed for the Department of Defense by its partner Unisys and enables secure migration to the cloud. The Stealth security solution renders end points invisible on a network, removing them as a target. Stealth facilitates HIPAA compliance rules for data encryption, protecting sensitive data as it moves across and between locations. The solution is identity-based, creating communities of interest based on user credentials, not location or physical topology. Deployment requires no changes to the user environment or existing applications and can operate over existing customer equipment, providing the same level of data segmentation and security on wireless as well as wired networks, driving cost-saving network efficiencies at the same time.
Cloud-based Storage
Fusion offers a solution that addresses the explosive growth of data across all industries with a cost-effective and secure storage solution hosted in the cloud. This scalable solution is hosted off-premise with built-in redundancy, reducing data center footprints and resource requirements and facilitating additional software-as-a-service solutions that can be accommodated on the same cloud platform. Fusion delivers a storage and data back-up assessment service as part of its complete storage offering, measuring growth and duplication benchmarked against best practices. The solution consolidates requirements across the enterprise, increasing efficiency and achieving economies of scale designed to reduce costs.
Service Plans
Fusion’s business communications services generally offer several different service packages designed to meet the specific needs of customers of all sizes with varying requirements. Base level plans offer a basic service package for a low monthly recurring charge (“MRC”). Additional charges, such as local, long distance, or international calling, are charged at per minute rates. Other packages with a higher MRC may include a specific number of minutes of local or long distance calling or even unlimited local or long distance calling. Optional value-added features for basic services are available for an incremental MRC appropriate for the service. Cloud connectivity services such as Internet access services and/or private line services are charged on the basis of a fixed MRC for the service provided, and are generally based on the bandwidth utilized and the endpoints of the circuit. Cloud computing services are based on a utility pricing model, and charges for managed cloud solutions are generally composed of an upfront charge and an MRC. Fusion’s business customer contracts range from one to three years.
Carrier Services
Fusion’s Carrier Services business segment provides voice traffic termination utilizing primarily VoIP technology. Such traffic typically consists of minutes of domestic and international long distance usage that must be terminated to telephone numbers in the intended destination countries. The majority of this traffic is international traffic, and carrier voice traffic terminates to virtually all countries worldwide. Substantially all of our carrier cost of sales is variable, meaning that variations in revenue, either increases or decreases, are met with a corresponding increase or decrease in the underlying cost of traffic termination.
All voice termination services utilize least cost routing (“LCR”) technology and systems to ensure high quality termination to the final destination at the lowest possible cost, thus maximizing profit on that traffic. Using LCR technology we will often “blend” routes to provide our customers with the optimal mix of price and quality, or to meet unique customer requirements for the termination of voice traffic to specific countries.
We also utilize the termination capacity obtained through our interconnection agreements and other methods of termination to carry the international traffic generated by our Business Services business segment. As we continue to execute our strategy for the growth of our Business Services segment, we expect to use an increasing percentage of our termination capacity for this higher margin traffic. Where needed to meet a specific business customer’s requirements, we also procure Internet access and private line circuits from our network of domestic and international carriers.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
All carrier voice services are priced on a per minute basis, based upon the destination called, the time of day, and the customer’s overall traffic volume. We have reciprocal service agreements with many of our customers, and the pricing in those agreements may also reflect the pricing provided to us for terminating our traffic. Prices for Internet access or private line service provided to carriers, as well as pricing for co-location services, are based on a fixed monthly recurring charge for the services provided.
We have contracts with all of our carrier customers. Our contracts with carriers typically have a one-year renewable term, with no minimum traffic volume per month, and allow the customer to terminate without penalty.
Network
Fusion operates a robust and reliable carrier-grade network and infrastructure that delivers high quality, diverse and secure connections to our cloud services. Our Managed Network Services, Dedicated Internet Access, Ethernet, MPLS and IP Voice solutions can be provided either on-net or off-net, leveraging our own extensive network, and those of our carrier partners, for truly diverse and redundant connections.
Our two network operations centers are manned 24 hours per day, 7 days per week and employ state-of-the-art monitoring and alert systems that are designed to ensure quality of service and a proactive response to any potential customer service issues that might affect our carrier or business customers.
Our carrier-class network employs digitized, packet-switched service platforms capable of interfacing with all Internet protocols, as well as with TDM or circuit-switched systems, and provides the flexibility necessary to seamlessly transport our customers’ voice and data traffic throughout the United States and the world. Internet access is delivered through dedicated and redundant high-speed interconnections to all major Internet backbones.
The network is characterized by its low cost of deployment and low recurring costs. It has been constructed as justified by customer demand with on-net and off-net connections to provide ubiquitous access, delivering maximum cost efficiency without sacrificing quality. Points of presence include New York City, Newark, Philadelphia, Boston, Atlanta, Miami, Chicago, Dallas, Los Angeles, Washington D.C., San Jose, and Little Ferry, N.J.This robust network allows us to provide diverse and redundant network connections with seamless automatic failover.
Key network elements include a Dialogic (Veraz) ControlSwitch, an NBS-developed proprietary cloud communications platform, a BroadSoft cloud communications services platform; Cisco media gateways, routers and switches, and GenBand (formerly Nextone) and Acme Packet communications services platforms. These redundant network elements are interconnected via a dedicated fiber-based gigabit Ethernet backbone. Most network elements are based on software applications that execute entirely on off-the-shelf servers and are built for easy and rapid scalability, as well as security and reliability. The Company has also recently deployed a Global Convergence Solutions routing and rating management solution that is expected to improve routing, rating and invoicing capabilities, facilitate cost savings through overhead reduction and drive efficiencies in route management.
Fusion’s centralized network elements are housed in carrier-grade switching facilities located in secure carrier buildings that house many other carriers and are interconnected to all other major carrier buildings. These locations allow for cost-effective and rapid interconnection and capacity expansion to carrier customers and vendors, as well as major enterprise customers. Fusion believes its choices of location and equipment offer an extensible platform to support our envisioned growth and allow us to quickly embrace emerging technologies as they become available.
Our products and services are delivered over an advanced communications network and cloud services platforms that leverage the latest technology and allow for the rapid introduction of new features, applications, services and solutions. We have also acquired additional service platforms through our acquisition of the Broadvox cloud services business which will be consolidated as part of our integration efforts.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Proprietary Cloud Services Platform.Our proprietary cloud services platform was designed and developed by our own team of experienced programmers over many years using advanced, yet proven technology. Our high availability platform is scalable, flexible and secure, delivering an integrated portfolio of cloud-based communications services that enable businesses of every size to increase productivity and efficiency while controlling costs. Information management, hardware, network and infrastructure are centralized off-premise, hosted and managed by us, allowing customers to rapidly adjust to fluctuating and unpredictable service demands, drive efficiencies in staff and space, and eliminate the need for costly technology upgrades. The platform architecture has been designed to seamlessly integrate additional cloud-based applications from its initial design, either provided by Fusion or through third parties for maximum flexibility. Enhanced functionality and features are continuously being developed, allowing for the integration of new options and advanced technologies as they become tested and proven. Not subject to third party end user licensing fees or technology release constraints, Fusion’s proprietary platform allows faster, easier, more cost-effective introduction of new, business-critical applications, delivering a unique feature set engineered to quickly respond to customer demands and market requirements. We differentiate ourselves from our competitors by combining our robust carrier-grade network services to enable secure connections to the cloud, delivering true diversity and a fully integrated solution for maximum efficiency and cost savings.
The platform has been built using advanced technologies and best of breed equipment designed for a geographically diverse and redundant implementation. Platform solutions are location and device neutral, serving multi as well as single locations nationwide, connecting users to customers and colleagues on desktops, laptops, handsets, tablets and mobile phones, wherever they may be. The platform today lives in two completely different premier carrier data centers. Each data center has a fully functional, redundant system whose databases are constantly in sync. With separate underlying connectivity, should a data center be hit with a catastrophic event, customers would continue to operate with no interruption of service. The result is to ensure a proven, reliable and consistent uptime which is crucial for delivering mission critical solutions. The platform has been designed for scalability as well as resiliency, and can be easily expanded to accommodate any required number of connections and customers.
Developed with experienced in-house programmers, the platform requires no ongoing licensing fees for individual seats or SIP sessions, giving it a competitive advantage against most other platforms. Written in current programming languages and utilizing proven technologies, the system enjoys efficiencies and capabilities not found in older legacy type platforms.
Sales and Marketing
We market and sell our business services to small, medium and large customers primarily through agents and partners who distribute our services. Sales agents and partners are typically paid commissions based on their sales and, thereafter, the continued use of our products by the customers sold by those sales agents and partners. The partner sales organization generally targets smaller to medium size businesses. We currently engage in a direct sales effort that targets the larger enterprise, and are building a direct salesforce to concentrate on middle market and large businesses, focusing on key vertical and geographical markets, increasingly targeting larger enterprise customers. We believe that our cloud platform, infrastructure, systems and connectivity provide a strong competitive advantage in serving the larger enterprise customer, creating real value with specialized solutions that meet their more complex and rigorous requirements. Referrals, strategic relationships and the strength of our corporate relationships are also a key part of our overall sales and marketing plan. We believe that the substantial experience and relationships of our executives and directors will assist us in organically growing our business through the addition of new customers. Our carrier services are sold entirely through a direct sales force.
Currently marketing our combined business services under the NBS brand, we are planning to combine all services and solutions under the Fusion brand, re-vitalizing our image and market presence with a new logo and integrated website in the second quarter of 2014.
Strategy
Fusion has experienced significant momentum in achieving its business goals and objectives this past year. Our recent acquisitions and improved financial performance are important milestones in our strategic roadmap as we work to become the industry’s leading and most successful cloud services provider. Our plans for growth are supported by an experienced and tested management team and staff, our advanced cloud services platforms, and leading edge systems and infrastructure. We believe we are well-positioned to continue to execute on our strategy to organically grow our revenue from the Business Services segment, develop vertically oriented solutions and acquire additional cloud services companies.
Fusion intends to continue to organically grow through direct as well as indirect channel sales efforts; by securing large strategic distribution partners to extend our geographic and vertical market reach; through the upsale and cross-sale of services into our combined base; and by leveraging management, Board and shareholder relationships to help penetrate larger enterprises. The acquisition of the Broadvox cloud services business expanded our sales and marketing resources and will help advance our customer acquisition strategies, driving growth from existing distribution partners through the intensified cross-sale of NBS and Broadvox cloud services into the combined customer base. We also expect to generate substantial growth in the Business Services segment with the introduction and upsale of additional cloud-based services, expanding the number and types of services available and sold to current customers. We believe this upsale effort will further facilitate deeper sales into the existing distribution base, with increased on-site contacts and webinars, and in-depth training on new and enhanced products and services. As we increase our focus on the larger enterprise, we will be expanding our direct sales force and continuing to work with our strategic partners to develop cloud applications to serve their requirements.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
We also intend to increasingly focus our sales and marketing efforts on developing vertically oriented solutions for targeted markets that require the kind of specialized solutions made possible by our advanced, proprietary services platform. Our vertically oriented solutions, with a current focus on healthcare, legal services, hospitality and real estate, offer a substantial opportunity to gain market share and to sell a broad range of our products by focusing on large vertical markets where our experience and relationships are expected to provide a competitive advantage. We intend to accelerate the growth of our Business Services segment with the goal of increasing that portion of our total revenues that is derived from this higher margin and more stable segment. For the year ended December 31, 2013, the Business Services segment accounted for 49.4% of our consolidated revenues, as compared to 15.4% for the year ended December 31, 2012.
Fusion intends to build on its success in identifying, securing and integrating NBS and the Broadvox cloud services business (the "Broadvox Assets") to acquire additional cloud services companies. We believe that the experience gained in integrating people, products, systems and platforms and customers positions us well to advance our growth. We will continue to look to acquire companies that can expand our customer base and distribution capability, add additional cloud-based products and services and help us increase our scale of operations.
In addition to lower underlying costs of termination, we believe that our Carrier Services business supports the growth of the Business Services segment by providing enhanced service offerings for its business customers and by strengthening its relationships with major service providers throughout the world.
We intend to manage our Carrier Services business segment through leveraging technology and systems improvements, enhancing product stability through stronger bi-lateral vendor relationships, and increasing sales to non-traditional carriers such as cable television providers, Internet search engine companies, and large IP telephone companies. We believe the revenue streams from such entities will be more predictable and will offer better margins than the revenues from traditional domestic and international carriers.
Intellectual Property and Trademarks
We have several trademarks and service marks which are supported by a combination of common law and statutory protection. The following trademarks are registered with the United States Patent and Trademark Office; however, they are not registered at the international level:
| | ● | V.o.I.C.E. the one that works!® |
Applications covering the following trademarks and service marks have been filed, or are in the process of being filed, with the United States Patent and Trademark Office. The Company intends to complete the registration process and secure registration of these trademarks and service marks as soon as possible:
The telecommunications and VoIP markets have recently been characterized by substantial litigation regarding patent and other intellectual property rights. Litigation, which could result in substantial cost and diversion of our efforts, may be necessary to enforce trademarks and/or service marks issued to us or to determine the enforceability, scope and validity of the proprietary rights of others. Legal proceedings to enforce our intellectual property or defend ourselves against third-party claims of infringement can be time consuming and costly. Adverse determinations in any litigation or interference proceeding could subject us to costs related to changing names, a loss of established brand recognition, or the need to change the technologies utilized in our services.
Competition
The cloud services industry, including the provisioning of cloud communications services, cloud connectivity, cloud storage and cloud computing, as well as carrier voice and data services, is highly competitive, rapidly evolving and subject to constant technological change and intense marketing by providers with similar products and services. We expect that new, smaller but very agile carrier competitors, specializing in providing service to regional and emerging markets at low margin and hence low cost, may have an impact on the carrier market. Similarly, the business services market includes competitors who may be significantly larger and have substantially greater market presence, financial, technical, operational and marketing resources than we do, including Tier 1 carriers, cable companies and premise-based solutions providers. In the event that such a competitor expends significant sales and marketing resources in one or several markets where we compete with them, we may not be able to compete successfully in those markets. Specialized cloud services providers, who focus on one or more cloud service or application, could adopt aggressive pricing and promotion practices that could impact our ability to compete. We also believe that competition will continue to increase, placing downward pressure on prices. Such pressure could adversely affect our gross margins if we are not able to reduce our costs commensurate with the price reductions of our competitors. In addition, the pace of technological change makes it impossible for us to predict whether we will face new competitors using different technologies to provide the same or similar services offered or proposed to be offered by us. If our competitors were to provide better and more cost effective services than ours, we may not be able to increase our revenues or capture any significant market share.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Government Regulation
In the United States, our services are generally subject to varying degrees of federal, state and local regulation, including regulation by the Federal Communications Commission (the “FCC”) and various state public utility commissions or public service commissions. We may also be subject to similar regulation by foreign governments and their telecommunications/regulatory agencies. While these regulatory agencies grant us the authority to operate our business, they typically exercise minimal control over our services and pricing. However, they do require the filing of various reports, compliance with public safety and consumer protection standards and the payment of certain regulatory fees and assessments.
We cannot provide assurance that the U.S. and foreign regulatory agencies exercising jurisdiction over us will grant us the required authority to operate, will allow us to maintain existing authority so we can continue to operate or will refrain from taking action against us if we are found to have provided services without obtaining the necessary authority. Similarly, if our pricing and/or terms or conditions of service are not properly filed or updated with the applicable agencies, or if we are otherwise not fully compliant with the rules of the various regulatory agencies, regulators or other third parties could challenge our actions and we could be subject to forfeiture of our authority to provide service, or to penalties, fines, fees or other costs. We have in the past been delinquent in certain filing and reporting obligations including, but not limited to, filings with the FCC and the filing of Universal Service Fund (“USF”) reports and payments. However, we have worked with these various federal and state regulatory agencies and have completed all outstanding filings and have made the appropriate payments.
As a telecommunications carrier, we are subject to FCC regulation under the Communications Act. We have applied for and received the necessary authority under Section 214 of the Communications Act to operate as a domestic and international carrier. Generally, the Company’s international carrier traffic is subject to minimal regulation by state and local jurisdictions.
The regulatory requirements associated with operating as a VoIP service provider are evolving, and have historically been less clear. For example, the VoIP Regulatory Freedom Act of 2004 exempted VoIP service from state taxes and regulations and defined VoIP services as “lightly regulated information services.” However, the bill reserved the ability for states to require VoIP service providers to provide 911 services, to require them to contribute to state universal service programs, and to require them to pay intrastate access charges to other telecom providers.
In June 2005, the FCC imposed 911 emergency service obligations on providers of “interconnected VoIP services.” The FCC also required interconnected VoIP service providers to register with the FCC, comply with CALEA, and to make USF contributions. The FCC defined interconnected VoIP service as service where the customer was connected to the local PSTN for both origination and termination of telephone calls. Under this definition, Fusion is a provider of interconnected VoIP service. We believe that our services are currently compliant with all applicable requirements of the FCC’s order, and we have made and are making the required contributions to USF. However, should we at some time fail to meet certain requirements or fail to make required contributions, we could be subject to revocation of the Company’s authority to operate or to fines or penalties.
Some states have tried to directly regulate VoIP services on an intrastate basis, but these attempts have, so far, not held up to court challenges. Many states are holding hearings to research and discuss the issues surrounding the regulation of VoIP services. Others are encouraging or even requesting VoIP service providers to subject themselves to public service commission jurisdiction and obtain certification as telephone companies. However, most have adopted a “wait and see” attitude. We are monitoring the actions of the various state regulatory agencies, and are endeavoring to ensure that we are in compliance with the applicable regulations, including any new regulations that may be passed. However, there can be no assurance that we will become aware of all applicable requirements on a timely basis, or that we will always be fully compliant with applicable rules and regulations. Should we fail at any time to be compliant with applicable state regulations, or to file required reports to state regulatory agencies, we could be subject to fines or other penalties.
While we believe VoIP services may be subject to additional federal, state, local, or international regulation in the future, it is uncertain when or how the effects of such regulation could affect us. If additional regulation does occur, it is possible that such regulatory agencies may impose surcharges, taxes or regulatory fees on VoIP service providers. The imposition of any such surcharges, taxes, or regulatory fees could increase the Company’s costs and thus reduce or eliminate any competitive advantage that we might enjoy today.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Employees
As of December 31, 2013, we had 193 full time employees. None of our employees are represented by a labor union or collective bargaining agreement. We consider our employee relations to be good, and, to date, we have not experienced a work stoppage.
All of the Company’s employees have signed confidentiality agreements, and it is our standard practice to require newly hired employees and, when appropriate, independent consultants, to execute confidentiality agreements. These agreements provide that the employee or consultant may not use or disclose confidential information except in the performance of his or her duties for the Company, or in other limited circumstances. The steps taken by us may not, however, be adequate to prevent the misappropriation of our proprietary rights or technology.
Customer Concentrations and Revenues and Assets by Geographic Area
For the year ended December 31, 2013, one customer accounted for more than 10% of the Company’s consolidated revenues. The amount owed to the Company by this customer was approximately $543,000, or 9% of the Company’s consolidated accounts receivable.
For the year ended December 31, 2012, two customers accounted for more than 10% of the Company’s consolidated revenues, and these two customers combined accounted for 36.6% of the Company’s consolidated revenues. At December 31, 2012 the aggregate amount owed to the Company by these customers, both of which are in the Company’s Carrier Services business segment, was approximately $150,000, or 5% of the Company’s consolidated accounts receivable.
During the years ended December 31, 2013 and 2012, 87.7% and 85.2%, respectively, of the Company’s revenue was derived from customers in the United States and 12.3 % and 14.8%, respectively, was derived from international customers. As of December 31, 2013 and 2012 the Company did not have any long-lived assets that were located outside of the United States.
Available Information
We are subject to the informational requirements of the Securities Exchange Commission (“SEC”) and, in accordance with those requirements, file reports, proxy statements and other information with the SEC. You may read and copy the reports, proxy statements and other information that we file with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, DC 20549. Please call 1-800-SEC-0339 for information about the SEC’s Public Reference Room. The SEC also maintains a web site that contains reports, proxy and information statements, and other information regarding registrants that file electronically with the SEC. The address of the SEC’s web site is http://www.sec.gov. The Company’s web site is http://www.fusiontel.com. The information on the Company’s website is neither a part of nor incorporated by reference into this report.
An investment in our securities involves a high degree of risk. You should carefully consider the risks described below before you decide to invest in our securities. If any of the following events actually occur, our business could be seriously harmed. In such case, the value of your investment may decline and you may lose all or part of your investment. You should not invest in our securities unless you can afford the loss of your entire investment.
Risks Related to Our Business
We have a history of operating losses, working capital deficit, and stockholders’ deficit. There can be no assurance that we will ever achieve profitability or have sufficient funds to execute our business strategy.
At December 31, 2013, we had working capital of $1.8 million and stockholders’ equity of approximately $7.0 million. At December 31, 2012, we had a net working capital deficit of $8.3 million and a stockholders’ deficit of $6.1 million. Although we have reduced our operating losses, we continued to sustain losses from operations and for the years ended December 31, 2013 and 2012, we incurred net losses applicable to common stockholders of $5.1 million and $5.2 million, respectively. In addition, we did not generate positive cash flow from operations for the years ended December 31, 2013 and 2012. We may not be able to generate profits in the future and may not be able to support our operations or otherwise establish a return on invested capital. In addition, we may not have sufficient funds to execute our business strategy, requiring us to raise funds from the capital markets or other sources, resulting in dilution of our common stock.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
These losses, among other things, have had and may continue to have an adverse effect on our working capital, total assets and stockholders’ equity.
The effects of natural disasters such as Hurricane Sandy or other events over which we have no control could significantly disrupt our operations and could have a material adverse impact on our business.
Our Carrier Services operations were impacted by the effects of Hurricane Sandy in the Northeast region of the United States in late October of 2012. The severe weather conditions directly affected the ability of many of our customers and vendors to connect to us. As a result, we did not generate the same levels of revenues and gross profit that we believe we would have generated absent these abnormal conditions. Any future disruptions to the operation of our network, including acts of war, terrorism or other force majeure, could have a material adverse impact on our liquidity, financial condition and results of operations. Although we do carry business interruption insurance, we cannot assure you that our losses in the event of a natural disaster or other force majeure event would be completely covered by insurance.
Our acquisitions of the Broadvox Assets and NBS do not provide assurance that the acquired operations will be accretive to our earnings or otherwise improve our results of operations.
Acquisitions, such as our recent acquisition of the Broadvox Assets on December 31, 2013 and of NBS in the fourth quarter of 2012, involve the integration of previously separate businesses into a common enterprise in which it is envisioned that synergistic operations and economies of scale will result in improved financial performance. However, realization of these envisioned results are subject to numerous risks and uncertainties, including but not limited to:
| ● | Diversion of management time and attention from daily operations; |
| ● | Difficulties integrating the acquired business, technologies and personnel into our business; |
| ● | Potential loss of key employees, key contractual relationships or key customers of the acquired business; and |
| ● | Exposure to unforeseen liabilities of the acquired business |
Even though our acquisitions of the Broadvox Assets and NBS have been consummated, there is no assurance that the acquisitions will be or will continue to be accretive to our earnings or otherwise improve our results of operations.
Failure to comply with the financial and other covenants contained in our senior debt agreements is an event of default under these agreements.
Our acquisition of NBS was financed primarily through the issuance of senior notes in the aggregate principal amount of $16.5 million, and our acquisition of the Broadvox Assets resulted in the issuance of additional senior notes in the aggregate principal amount of $25.5 million. The terms of the senior notes contain a number of affirmative and negative covenants, including but not limited to, restrictions on paying indebtedness subordinate to the senior notes, incurring additional indebtedness, making capital expenditures, dividend payments and cash distributions by subsidiaries. In addition, at all times while the senior notes are outstanding, we are required to maintain a minimum cash bank balance of $1 million, in excess of any amounts outstanding under a permitted working capital line of credit as well as any cash held by our Business Services business segment. We are also 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. Failure to comply with any of the restrictive or financial covenants could result in an event of default and accelerated demand for repayment of the senior notes. We do not have the financial resources to repay the senior notes if they are accelerated.
From time to time since May 15, 2013, the Company was not in compliance with the $1.0 million minimum cash balance requirement under the purchase agreement for the senior notes. On August 14, 2013 and November 12, 2013, the Company and the Lenders entered into amendment agreements whereby the lenders agreed to waive compliance with the $1.0 million minimum cash balance requirement and reduced the minimum cash balance requirement from $1.0 million to $0.5 million for certain periods. Under the amendment agreements and the amended and restated purchase agreement, the Company is required to maintain a minimum cash bank balance of no less than $1.0 million, in excess of any and all cash balances held by our Business Services segment, at all times subsequent to December 31, 2013. Although we have been in compliance with this covenant requirement since December 31, 2013, in the event we are unable to comply with this requirement or any of the other restrictive or financial covenants in the future, there can be no assurance that we will be able to continue to get the appropriate waivers and amendments from our senior lenders.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
If we are unable to successfully manage the integration of our acquisitions, we may not benefit from our acquisition strategy.
As part of our growth strategy, we seek to supplement internal growth with targeted acquisitions, including the recent acquisition of the Broadvox Assets. We may not be successful in integrating newly acquired companies into our day-to-day operations for a variety of possible reasons, including (a) our inability to retain the skilled managerial, technical, and sales personnel of acquired companies; (b) our inability to retain the customers of acquired companies; (c) our lack of success in integrating the services offered by acquired companies with our services to achieve a single package of service offerings; (d) our inability to establish and maintain uniform standards, controls, policies and procedures throughout our acquired companies; or (e) our inability to devote the management time required to successfully integrate acquired businesses.
Our Carrier Services revenue performance is subject to both internal and external influences, which have negatively impacted our revenues and may continue to do so in the future.
During 2013 and 2012, the Company's Carrier Services revenue was negatively impacted not only by seasonal and economic market fluctuations, but also by a general decline in the overall market for international communications as a result of current economic conditions. We were also adversely affected by limits on our ability to provide extended payment terms to larger customers. We anticipate that these revenue growth constraints will be eased as the general economic conditions and the Company’s financial condition improve, but there is no assurance that we will be successful in our efforts to increase revenues and margin contribution in this business segment.
Our business is capital intensive, and we do not currently generate sufficient revenues to offset our operating expenses. If we are unable to obtain additional funding if and when required, we may have to significantly curtail or possibly terminate our operations.
We may require future capital in order to continue to fund our operating expenses and to otherwise execute our business plan and growth strategy. If we are unable to obtain additional financing or generate sales revenue sufficient to sustain our operations, we could be forced to significantly curtail or suspend our operations, including laying-off employees, selling assets and other measures. Additional capital may not be available to us when needed on terms that are acceptable to us, or at all.
We have historically funded our working capital requirements through the sale of our equity securities. The sale of equity securities to fund operations is dilutive to the equity ownership of our existing stockholders. In the event we are unable to substantially increase our revenues to fund our operating expenses, we may be required to continue to fund operations through additional sales of our equity securities. Historically, limited cash resources have restricted our Carrier Services business segment’s ability to purchase termination capacity on shorter payment terms than the terms under which it is able to sell to our customers. Should this trend continue, it could limit our ability to grow our revenues and/or margins, or limit our ability to achieve our revenue and/or margin targets.
If we are unable to manage our growth or implement our expansion strategy, we may increase our costs without increasing our revenues.
We may not be able to expand our product offerings, client base and markets, or implement the other features of our business strategy at the rate or to the extent presently planned. Our projected growth will place a significant strain on our administrative, operational, and financial resources and may increase our costs. If we are unable to successfully manage our future growth, continue to upgrade our operating and financial control systems, recruit and hire necessary personnel or effectively manage unexpected expansion difficulties, we may not be able to maximize revenues or achieve profitability.
Our ability to grow our business is dependent upon market developments and traffic patterns, which may lead us to make expenditures that do not result in increased revenues.
Our purchase of network equipment and software will be based in part upon our expectations concerning future revenue growth and market developments. As we expand our network, we will be required to make significant capital expenditures, including the purchase of additional network equipment and software. To a lesser extent our fixed costs will also increase from the ownership and maintenance of a greater amount of network equipment including our switching systems, gateways, routers and other related systems. If our traffic volume were to decrease, or fail to increase to the extent expected or necessary to make efficient use of our network, our costs as a percentage of revenues would increase significantly.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Changes in technology and service offerings could affect the ability of our Business Services segment to compete in the marketplace for cloud communications services.
Our Business Services segment is subject to rapid and significant changes in technology, particularly in the emerging areas of cloud voice, cloud connectivity, cloud storage and cloud computing. Our industry has evolved significantly in these areas over the past few years, and will continue to evolve. Emerging technologies could lead to the development of newer, more convenient, more cost-effective or otherwise more attractive services. In addition, the preferences and requirements of business customers are changing rapidly. Our ability to retain current customers and attract new customers may be highly dependent on whether we choose the technologies that will ultimately have the greatest customer acceptance, are able to adopt these new technologies and offer competitive new services when appropriate, or can compete successfully against other service providers that use these new technologies, many of whom are larger or possess greater financial or technical resources. The development, introduction and marketing of such new services in response to new technologies or new customer demands may require us to increase our capital expenditures significantly. In addition, new technologies may be protected by patents or other intellectual property laws and therefore may only be available to our competitors and not to us.
We may be unable to adapt to rapid technology trends and evolving industry standards, which could lead to our products becoming obsolete.
The cloud services industry is subject to rapid and significant changes due to technology innovation, evolving industry standards and frequent new service and product introductions. New services and products based on new technologies or new industry standards expose us to risks of technical or product obsolescence. We will need to use technologies effectively, continue to develop our technical expertise and enhance our existing products and services in a timely manner to compete successfully in this industry. We may not be successful in using new technologies effectively, developing new products or enhancing existing products and services in a timely manner, and we cannot assure you that any new technologies or enhancements used by us or offered to our customers will achieve market acceptance.
Some of our services are dependent upon multiple service platforms, network elements, and back-office systems that are reliant on third party providers.
We have deployed back-office systems and services platforms that enable us to offer our customers a wide-array of services and features. Sophisticated back office information and processing systems are vital to our growth and our ability to monitor costs, invoice customers, provision client orders, and achieve operating efficiencies. Some of these systems are dependent upon license agreements with third party vendors. These third party vendors may cancel or refuse to renew some of these agreements, and the cancellation or non-renewal of these agreements may harm our ability to invoice customers and provide services efficiently.
We may be impacted by litigation regarding patent infringement to which we were not a party.
On March 8, 2007, a jury in the U.S. District Court for the Eastern District of Virginia ruled that Vonage Holdings had infringed on six patents held by Verizon Communications, and ordered Vonage to pay Verizon $58 million plus a future royalty payment equal to 5.5% of Vonage’s customer sales. The patents related in part to technologies used to connect Internet telephone users to the traditional telephone network. Vonage appealed the decision, but terminated its appeals options in November 2007, when it agreed to pay Verizon approximately $120 million in settlement. The future impact, if any, of this litigation, or of similar litigation that might be initiated by other companies against VoIP service providers, including us, is unclear. If we were restricted from using certain VoIP technologies, it could increase our cost of service or preclude us from offering certain current or future services.
We rely upon certain proprietary rights in our technology, systems and business processes. If our protection of these rights were to be compromised, it could negatively affect our ability to compete or to achieve our projected business and financial results.
Our ability to compete depends in part upon our proprietary rights in our technology, systems and business processes. In general, our technology is based on the integration and use of publicly available hardware components, and is therefore afforded little protection under existing patent law. Some of our software and systems, while developed by us, are generally not unique in such a manner as to allow protection under existing patent law. As a result, we generally rely on a combination of contractual restrictions and the general protection afforded by copyright, trademark and trade secret laws to establish and protect our proprietary rights. Such limited protection could prove insufficient to protect our proprietary rights and thereby subject us to increased competition or impact the business or financial results of our operations.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
It is the Company’s policy to require employees, consultants and, when warranted, certain customers and vendors to execute confidentiality agreements upon the commencement of their relationships with us. These agreements provide that confidential information developed or made known during the course of a relationship with us must be kept confidential and not disclosed to third parties except under certain specific circumstances. If such policies were to prove ineffective in protecting our confidential information, our business or financial performance could be negatively impacted.
The U.S. Patent and Trademark Office has granted Fusion federal registration for two trademarks, and Federal registration of those trademarks will be effective for as long as we continue to use them and renew their registrations. We are also planning to register additional trademarks and other intellectual property rights, although there can be no assurance that our effort to register these trademarks will be successful. Fusion generally does not register any of its copyrights with the U.S. Copyright Office, but relies on the protection afforded to such copyrights by the U.S. Copyright Act, which provides protection to authors of original works whether published or unpublished and whether registered or unregistered.
Breaches in our network security systems may hurt our ability to deliver services and our reputation and result in liability.
We could lose clients or expose ourselves to liability if there are any breaches to our network security systems that jeopardize or result in the loss of confidential information stored in our computer systems. Since our inception, we have experienced two known breaches of network security, which resulted in a temporary failure of certain network operations, but did not result in any losses of confidential customer information or material financial losses. However, a future network security breach could harm our ability to deliver certain services, damage our reputation or subject us to liability.
Our revenue growth is dependent upon our ability to build new distribution relationships and to bring on new customers, for which there can be no assurance.
Our ability to grow through efficient and cost effective deployment of our cloud services is in part dependent upon our ability to identify and contract with local, regional and national entities that will assist in the distribution of our services. If we are unable to identify, contract or maintain such distribution relationships, or if the efforts of these agents are not successful, we may not grow the customer base or achieve the revenues currently envisioned and our results of operations will be adversely impacted.
We are dependent upon our ability to obtain the necessary regulatory approvals and licenses to enter new domestic and international markets in which such approvals are required. Such approvals may or may not occur as planned and may or may not be delayed.
Our entry into new domestic and international markets may in certain cases rely upon our ability to obtain licenses or other approvals to operate in those markets, our ability to establish good working relationships with the relevant telecommunications regulatory authorities in those jurisdictions or our ability to interconnect to the local telephone networks in those markets. If we are not able to obtain the necessary licenses, approvals or interconnections, our ability to enter into new markets may be delayed or prevented.
The cloud services industry is highly competitive and we may be unable to compete effectively.
The cloud services industry, including the provisioning of cloud voice services, cloud connectivity, cloud storage and cloud computing, is highly competitive, rapidly evolving and subject to constant technological change and intense marketing by providers with similar products and services. We also expect that new carrier competitors, as well as “gray market” operators (international carriers who arrange call termination in a manner that bypasses the authorized local telephone company, resulting in high margins for them and substantially lower revenues for the legitimate providers), may have an impact on the market. In addition, many of our current carrier and cloud services competitors are significantly larger and have substantially greater market presence; greater financial, technical, operational and marketing resources; and more experience. In the event that such a competitor expends significant sales and marketing resources in one or several markets where we compete with them, we may not be able to compete successfully in those markets. We also believe that competition will continue to increase, placing downward pressure on prices. Such pressure could adversely affect our gross margins if we are not able to reduce our costs commensurate with the price reductions of our competitors. In addition, the pace of technological change makes it impossible for us to predict whether we will face new competitors using different technologies to provide the same or similar services offered or proposed to be offered by us. If our competitors were to provide better and more cost effective services than ours, we may not be able to increase our revenues or capture any significant market share.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Industry consolidation could make it more difficult for us to compete.
Companies offering cloud voice, cloud connectivity and other cloud services are, in some circumstances, consolidating. We may not be able to compete successfully with businesses that have combined, or will combine, to produce companies with substantially greater financial, technical, sales and marketing resources, or with larger client bases, more extended networks or more established relationships with vendors and distributors. If we were to experience such heightened competitive pressures, there is a risk that our revenues may not grow as expected and the value of our common stock could decline.
Our ability to provide services is often dependent on our suppliers and other service providers who may not prove to be effective.
A majority of the voice calls made by our clients are connected through other communication carriers, which provide us with transmission capacity through a variety of arrangements. Our ability to terminate voice traffic in our targeted markets is an essential component of our ongoing operations. If we do not secure or maintain operating and termination arrangements our ability to increase services to our existing markets, and gain entry into new markets, will be limited. Therefore, our ability to maintain and expand our business is dependent, in part, upon our ability to maintain satisfactory relationships with other domestic carriers, Internet service providers, international carriers, fiber optic cable providers and other service providers, many of which are our competitors, and upon our ability to obtain their services on a cost effective basis. In addition, if a carrier with whom we interconnect does not carry the traffic routed to it, or does not provide the required capacity, we may be forced to route our traffic to, or buy capacity from, a different carrier on less advantageous terms, which could reduce our profit margins or degrade our network service quality. In the event network service quality is degraded, it may result in a loss of customers. To the extent that any of these carriers with whom we interconnect raise their rates, change their pricing structure or reduce the amount of capacity they will make available to us, our revenues and profitability may be adversely affected.
We rely on third party equipment suppliers who may not be able to provide us the equipment necessary to deliver the services that we seek to provide.
We are dependent on third party equipment suppliers for equipment, software and hardware components, including Cisco, Genband, BroadSoft, Dialogic (Veraz), Acme Packet and Global Convergence Solutions. If these suppliers fail to continue product development and research and development or fail to deliver quality products or support services on a timely basis, or if we are unable to develop alternative sources of supply if and as required, it could result in an inability to deliver the services that we currently provide or intend to provide, and our financial condition and results of operations may be adversely affected.
Our Carrier Services business relies on the cooperation of other international carriers and/or postal telephone and telegraph companies (“PTTs”), who may not always cooperate with us in our attempts to serve a specific country or market.
In some cases, the growth of our Carrier Services business requires the cooperation of other international carriers and/or the incumbent PTT in order to provide services to or from specific countries or markets. In the event the PTT, or another in-country international carrier, does not cooperate with us or support us in our efforts to serve that country, our ability to provide service to or from that country may be delayed, or the costs to provide service might increase due to our being forced to use another more expensive carrier. If we are unable to develop and maintain successful relationships with other international carriers and PTTs, our ability to cost-effectively service an important market could be adversely affected.
Because we do business on an international level, we are subject to an increased risk of tariffs, sanctions and other uncertainties that may hurt our revenues.
There are certain risks inherent in doing business internationally, especially in emerging markets, such as unexpected changes in regulatory requirements, the imposition of tariffs or sanctions, licenses, customs, duties, other trade barriers, political risks, currency devaluations, high inflation, corporate law requirements and civil unrest. Many of the economies of these emerging markets we seek to enter are weak and volatile. We may not be able to mitigate the effect of inflation on our operations in these countries by price increases, even over the long-term. Also, deregulation of the communications markets in developing countries may or may not continue. Incumbent service providers, trade unions and others may resist legislation directed toward deregulation and may resist allowing us to interconnect to their networks. The legal systems in emerging markets also frequently have insufficient experience with commercial transactions between private parties, therefore we may not be able to protect or enforce our rights in some emerging market countries. Governments and regulations may change, thus impacting the availability of new licenses or the cancellation or suspension of existing operating licenses. The instability of the laws and regulations applicable to our businesses, as well as their interpretation and enforcement, could materially impact our business in those countries and adversely affect our financial condition or results of operations.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
The regulatory treatment of VoIP outside the United States varies from country to country. Some countries are considering subjecting VoIP services to the regulations applied to traditional telephone companies and they may assert that we are required to register as a telecommunications carrier in that country or impose other more onerous regulations. In such cases, our failure to register could subject us to fines, penalties or forfeiture of our right to do business in that country. Regulatory developments such as these could have a material adverse effect on our international operations.
Additional taxation and government regulation of the cloud communications industry may slow our growth, resulting in decreased demand for our products and services and increased costs of doing business.
As a result of changes in regulatory policy, we could be forced to pay additional taxes on the products and services we provide. We structure our operations and our pricing based on assumptions about various domestic and international tax laws, tax treaties and other relevant laws. Taxation authorities or other regulatory authorities might not reach the same conclusions about taxation that we have reached in formulating our assumptions. We could suffer adverse tax and other financial consequences if our assumptions about these matters are incorrect or the relevant laws are changed or modified.
Generally, in the U.S. our products and services are subject to varying degrees of federal, state and local regulation, including regulation by the Federal Communications Commission (“FCC”) and various state public utility commissions. We may also be subject to similar regulation by foreign governments and their telecommunications and/or regulatory agencies. While these regulatory agencies grant us the authority to operate our business, they typically exercise minimal control over our services and pricing. However, they do require the filing of various reports, compliance with public safety and consumer protection standards, and the payment of certain regulatory fees and assessments.
We cannot assure you that the applicable U.S. and foreign regulatory agencies will grant us the required authority to operate, will allow us to maintain existing authority so we can continue to operate or will refrain from taking action against us if we are found to have provided services without obtaining the necessary authority. Similarly, if our pricing and/or terms and conditions of service are not properly filed or updated with the applicable agencies, or if we are otherwise not fully compliant with the rules of the various regulatory agencies, regulators or other third parties could challenge our actions and we could be subject to forfeiture of our authority to provide service, or to penalties, fines, fees or other costs. We have in the past been delinquent in certain filing and reporting obligations including, but not limited to, filings with the FCC and Universal Service Fund (“USF”) reports and payments. However, we have worked with these various federal and state regulatory agencies to complete the outstanding filings and have resolved the outstanding payment issues.
In addition to new regulations being adopted, existing laws may be applied to the Internet, which could hinder our growth.
New and existing laws may cover issues that include: sales and other taxes; user privacy; pricing controls; characteristics and quality of products and services; consumer protection; cross-border commerce; copyright, trademark and patent infringement; and other claims based on the nature and content of Internet materials. Changes to existing regulations or the adoption of new regulations could delay growth in demand for our products and services and limit the growth of our revenue.
If we do not retain our executive officers and senior management, or if we do not continue to attract and retain qualified personnel and independent sales agents, our ability to execute our business plan could be adversely affected.
Our existing executive officers and senior management have extensive experience in the telecommunications industry, as well as many years of working together as an integrated management team directing our day-to-day operations. As a result, we are dependent on those individuals and the loss of the services of one or more of these individuals could impair our ability to execute our strategy or achieve our business and financial objectives.
We have entered into employment agreements with Matthew Rosen, our Chief Executive Officer, and with Jonathan Kaufman, the President of our Business Services segment. We do not have written employment agreements with any of our other executive officers.
We face competition for qualified personnel, including management, technical, financial and sales personnel. We also rely on independent sales agents to market and sell our services. If we are unable to attract and retain experienced and motivated personnel, including independent sales agents, the growth of our business or the effectiveness of our day-to-day operations may be impacted and we may not be able to grow our customer base or to achieve our business or financial objectives.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Risks Related to our Common Stock
Although our shares are widely dispersed, two voting blocs may influence the outcome of matters submitted to a vote of our stockholders; and the interests of these voting blocs may differ from other stockholders.
Diker GP, LLC (“Diker”) currently beneficially owns 79.2 million shares, or 14.4%, of our outstanding voting stock, and is the second largest single voting bloc in the Company. Additionally, our directors and executive officers as a group are currently the beneficial owners of 139.5 million shares, or approximately 24.2% of our voting stock. As a result, while neither Diker nor our directors and officers as a group have sufficient voting power to control the outcome of matters submitted to a vote of our stockholders, the extent of their ownership enables both groups to influence the outcome of these matters, including the election of directors and extraordinary corporate transactions, including business combinations. The interests of the holders of these voting blocs may differ from those of other stockholders.
In the event we effectuate a reverse split of our outstanding common stock, the market price for our shares may not maintain their post-split market price.
On March 28, 2014, our stockholders empowered our Board of Directors to, subject to certain parameters, effectuate a reverse split of the Company’s outstanding common stock. If undertaken, we cannot be certain that a reverse split will have a long-term positive effect on the market price of our common stock, or increase our ability to consummate acquisitions or financing arrangements in the future. The market price of our common stock is based on factors that may be unrelated to the number of shares outstanding. These factors include our performance, general economic and market conditions and other factors, many of which are beyond our control. The market price for our post-split shares may not rise or remain constant in proportion to the reduction in the number of pre-split shares outstanding before the reverse split. Accordingly, the total market capitalization of our common stock after the reverse split may be lower than the total market capitalization before the reverse split. In addition, the post-split market price of our common stock may not equal or exceed the market price prior to the reverse split.
We are unlikely to pay cash dividends on our common stock in the foreseeable future.
We have never declared or paid any cash dividends on our common stock. We intend to retain any future earnings to finance our operations and expand our business and therefore do not expect to pay any cash dividends in the foreseeable future. Holders of our outstanding preferred stock are entitled to receive dividends prior to the payment of any dividends on our common stock. The payment of dividends is also subject to provisions of Delaware law prohibiting the payment of dividends except out of surplus and certain other limitations, as well as the provisions contained in our senior lending agreement.
Our common stock is subject to price volatility unrelated to our operations.
The market price of our common stock could fluctuate substantially due to a variety of factors, including market perception of our ability to achieve our planned growth, quarterly operating results of other companies in the same industry, trading volume in our common stock, changes in general conditions in the economy and the financial markets or other developments affecting our competitors or us. In addition, the stock market is subject to extreme price and volume fluctuations. This volatility has had a significant effect on the market price of securities issued by many companies for reasons unrelated to their operating performance and could have the same effect on our common stock.
In addition, the market price of our common stock may fluctuate significantly in response to a number of other factors, many of which are beyond our control, including but not limited to the following:
| ● | Ability to obtain securities analyst coverage |
| ● | Changes in securities analysts’ recommendations or estimates of our financial performance |
| ● | Changes in the market valuations of companies similar to us |
| ● | Announcements by us or our competitors of significant contracts, new offerings, acquisitions, commercial relationships, joint ventures, or capital commitments |
| ● | Failure to meet analysts’ expectations regarding financial performance |
Furthermore, companies that have experienced volatility in the market price of their stock have been subject to securities class action litigation. A securities class action lawsuit against us, regardless of its merit, could result in substantial costs and divert the attention of our management from other business concerns, which in turn could harm our business.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
Our common stock may become subject to the “penny stock” rules of the SEC, which will make transactions in our shares cumbersome and may reduce the value of an investment in our shares.
For so long as the trading price of our common stock is less than $5.00 per share, our common stock may be considered a "penny stock," and in such event trading in our common stock would be subject to the requirements of Rule 15g-9 under the Securities Exchange Act of 1934. Under this rule, broker/dealers who recommend low-priced securities to persons other than established customers and accredited investors must satisfy special sales practice requirements. The broker/dealer must make an individualized written suitability determination for the purchaser and receive the purchaser's written consent prior to the transaction.
SEC regulations also require additional disclosure in connection with any trades involving a "penny stock," including the delivery, prior to any penny stock transaction, of a disclosure schedule explaining the penny stock market and its associated risks. These requirements severely limit the liquidity of securities in the secondary market because few brokers or dealers are likely to undertake these compliance activities. In addition to the applicability of the penny stock rules, other risks associated with trading in penny stocks could also be price fluctuations and the lack of a liquid market.
To date, we have not been considered a “penny stock” due to an exemption from Rule 15g-9 for companies with average annual audited revenues for the prior three years of in excess of $6,000,000 per year. However, should the exclusions from the definition of a “penny stock” change, or should our annual revenues fall dramatically, we may become subject to rules applicable to “penny stocks” and the market for our shares may be adversely affected.
The elimination of monetary liability against our directors, officers and employees under our certificate of incorporation and the existence of indemnification rights in favor of our directors, officers and employees may result in substantial expenditures by our Company and may discourage lawsuits against our directors, officers and employees.
Our certificate of incorporation contains provisions which eliminate the liability of our directors for monetary damages to our Company and stockholders to the maximum extent permitted under Delaware corporate law. Our by-laws also require us to indemnify our directors to the maximum extent permitted by Delaware corporate law. We may also have contractual indemnification obligations under our agreements with our directors, officers and employees. The foregoing indemnification obligations could result in our Company incurring substantial expenditures to cover the cost of settlement or damage awards against directors, officers and employees, which we may be unable to recoup. These provisions and resultant costs may also discourage our Company from bringing a lawsuit against directors, officers and employees for breaches of their fiduciary duties, and may similarly discourage the filing of derivative litigation by our stockholders against our directors, officers and employees even though such actions, if successful, might otherwise benefit our Company and stockholders.
Our use of equity to fund operations is dilutive to stockholders and, depending upon the market price for our shares at the time of issuance, we may be required to issue shares at depressed prices.
Historically, we have funded our working capital requirements through the sale of our equity. The use of our equity to fund operations is dilutive to the equity ownership of our securities by our existing stockholders. Unless we are able to generate substantial revenues to fund our operating expenses, we may be required to continue to fund operations through the sale of our equity. Moreover, the dilutive effect on our stockholders of the issuance of new equity shares is directly impacted by the market price for our shares at the time of issuance. If we are required to issue shares at a time when the market price for our shares is depressed, we will issue more shares than if the market price was higher, and the dilutive effect on our stockholders will be greater.
The issuance of our common stock upon the exercise of options or warrants or the conversion of outstanding convertible securities may cause significant dilution to our stockholders and may have an adverse impact on the market price of our common stock.
As of March 31, 2014, there were 304,046,486 common shares outstanding and approximately 239,349,017 shares reserved for issuance upon conversion of outstanding preferred stock, 216,666,760 shares reserved for the exercise of outstanding warrants and 65,615,150 shares reserved for the exercise of outstanding stock options. The issuance of our common shares upon the exercise of stock options or warrants, or conversion of preferred stock, will increase the number of our publicly traded shares, which could depress the market price of our common stock.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
The perceived risk of dilution may cause our stockholders to sell their Shares, which would contribute to a downward movement in the stock price of our Shares. Moreover, the perceived risk of dilution and the resulting downward pressure on our stock price could encourage investors to engage in short sales of our Shares. By increasing the number of Shares offered for sale, material amounts of short selling could further contribute to progressive price declines in our Shares
We could use preferred stock to fund operations or resist takeovers, and the issuance of preferred stock may cause additional dilution.
Our certificate of incorporation authorizes the issuance of up to 10,000,000 shares of preferred stock, of which 5,045 shares of Series A-1, A-2 and A-4 Preferred Stock are currently issued and outstanding, and 22,380 shares of our Series B-2 Preferred Stock are currently issued and outstanding. Our certificate of incorporation gives our board of directors the authority to issue preferred stock without the approval of our stockholders. We may issue additional shares of preferred stock to raise money to finance our operations. We may authorize the issuance of the preferred stock in one or more series. In addition, we may set the terms of preferred stock, including:
| ● | Dividend and liquidation preferences |
| ● | Other privileges and rights of the shares of each authorized series |
The issuance of large blocks of preferred stock could possibly have a dilutive effect to our existing stockholders. It can also negatively impact our existing stockholders’ liquidation preferences. In addition, while we include preferred stock in our capitalization to improve our financial flexibility, we could possibly issue our preferred stock to friendly third parties to preserve control by present management. This could occur if we become subject to a hostile takeover that could ultimately benefit our stockholders and us.
ITEM 1B. UNRESOLVED STAFF COMMENTS.
Not applicable to a smaller reporting company.
We are headquartered in New York, New York and lease offices and space in a number of locations. Below is a list of the Company’s primary leased offices and space as of December 31, 2013.
| Location | Lease Expiration | | Annual Rent | | Purpose | | Approx. Sq. Ft. | |
| 420 Lexington Avenue, Suite 1718, New York, New York 10170 | October 2015 | | $ | 487,000 | | Lease of principal executive offices | | | 9,000 | |
| 75 Broad Street, New York, New York 10007 | November 2015 | | $ | 485,000 | | Lease of network facilities | | | 9,274 | |
| 3565 Piedmont Road, N.E., Atlanta, GA 30305 | August 2017 | | $ | 600,000 | | Lease of network facilities and office space | | | 29,695 | |
| 155 Willowbrook Boulevard, Wayne, NJ 07470 | October 2017 | | $ | 156,000 | | Lease of network facilities and office space | | | 10,715 | |
| 1475 W. Cypress Creek Road, Suite 204, Fort Lauderdale, Florida 33309 | August 2014 | | $ | 150,000 | | Lease of network facilities and office space | | | 9,716 | |
We believe that the Company’s leased facilities are adequate to meet our current and future needs.
ITEM 3. LEGAL PROCEEDINGS.
The Company is from time to time involved in claims and legal actions arising in the ordinary course of business. Management does not expect that the outcome of any such claims or actions will have a material effect on the Company’s liquidity, results of operations or financial condition. In addition, due to the regulatory nature of the telecommunications industry, the Company periodically receives and responds to various inquiries from state and federal regulatory agencies. Management does not expect the outcome of any such claims, legal actions or regulatory inquiries to have a material impact on the Company’s liquidity, financial condition or results of operations.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
PART II
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES.
Market Information
Our common stock is currently listed on the OTCQB Marketplace under the symbol “FSNN.” The following tables list the high and low sales prices for the Company’s common stock for each fiscal quarter during the two preceding fiscal years.
| Year Ended December 31, 2013 | | High | | | Low | |
| First Quarter | | $ | 0.12 | | | $ | 0.06 | |
| Second Quarter | | $ | 0.109 | | | $ | 0.067 | |
| Third Quarter | | $ | 0.1458 | | | $ | 0.06 | |
| Fourth Quarter | | $ | 0.18 | | | $ | 0.09 | |
| | | | | | | | | |
| Year Ended December 31, 2012 | | | | | | | | |
| First Quarter | | $ | 0.21 | | | $ | 0.05 | |
| Second Quarter | | $ | 0.17 | | | $ | 0.06 | |
| Third Quarter | | $ | 0.16 | | | $ | 0.06 | |
| Fourth Quarter | | $ | 0.17 | | | $ | 0.05 | |
The market price for the Company’s common stock is highly volatile and fluctuates in response to a wide variety of factors.
Holders of Record
As of December 31, 2013, there were approximately 460 shareholders of record of the Company’s common stock.
Dividend Policy
We have never declared or paid any cash dividends on our common stock. We do not anticipate paying any cash dividends on our common stock in the foreseeable future. We currently intend to retain future earnings, if any, to finance our operations, and to expand our business. Subject to the rights of holders of preferred stock, any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon our financial condition, operating results, capital requirements, limitations under Delaware law and the terms of our senior debt and other factors that our board of directors considers appropriate.
The holders of the Company’s Series A-1, A-2, and A-4 Preferred Stock are entitled to receive cumulative dividends of 8% per annum payable in arrears, as declared by the Company’s board of directors, on January 1 of each year, commencing on January 1, 2008. The board of directors has not declared any dividends on the Series A-1, A-2, or A-4 Preferred Stock. The holders of our Series B-2 Preferred stock are entitled to receive quarterly dividends at an annual rate of 6% beginning with the quarter ended March 31, 2014. The dividends can be paid, at the option of the Company, either in cash or in common stock.
Recent Sales of Unregistered Securities
None.
ITEM 6. SELECTED FINANCIAL DATA.
Not applicable to smaller reporting companies
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion of the Company’s financial condition and results of operations should be read together with the Company’s consolidated financial statements and the related notes thereto included elsewhere in this Annual Report on Form 10-K. This discussion contains certain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1996. Such statements consist of any statement other than a recitation of historical fact and can be identified by the use of forward-looking terminology such as “may”, “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 (see Item 1A, “Risk Factors”).
OVERVIEW
Our Business
We are a cloud services provider delivering value-added cloud-based solutions to businesses and carriers in the United States and throughout the world. Through our Business Services business segment, we offer business products and services that are device and location agnostic and include cloud-based voice, cloud connectivity and a complement of additional cloud solutions such as storage, security and disaster recovery. Our advanced business services are flexible, scalable and rapidly deployed, lowering customers’ costs of ownership and increasing productivity.
Through our Carrier Services business segment, we offer domestic and international voice termination services to telecommunications carriers throughout the world, with a particular focus on providing services to and from emerging markets in Asia, the Middle East, Africa, Latin America, and the Caribbean. These services primarily utilize VoIP termination. We currently interconnect with over 270 carrier customers and vendors, who include U.S.-based carriers sending voice traffic to international destinations and foreign carriers sending voice traffic to the U.S. and internationally. Our carrier-grade network, advanced switching systems and interconnections with global carriers on six continents also reduce the cost of global voice traffic termination and expand service delivery capabilities for our Business Services segment.
We manage our business segments based on gross profit and gross margin, which represents net revenue less the cost of revenue, and on net profitability after excluding certain non-cash and non-recurring items. The majority of our operations, engineering, information systems and support personnel are assigned to either the Business Services or Carrier Services business segment for segment reporting purposes.
Although we believe that the Carrier Services business segment continues to be of significant value to our long term strategy, our growth strategy is focused primarily on the higher margin Business Services business segment and marketing to small and mid-sized businesses, as well as larger enterprises, using both our direct and partner distribution channels. We anticipate that this will assist us in increasing the percentage of the Company’s total revenues contributed by the Business Services business segment, which we believe will complement the Company’s Carrier Services business segment by providing higher margins and a more stable customer base.
Recent Acquisitions
On December 31, 2013, through our wholly owned subsidiary Fusion BVX LLC (“FBVX”), we completed the acquisition of substantially all of the cloud services assets used by BroadvoxGO!, LLC and its affiliate Cypress Communications, LLC (collectively, the “Broadvox Sellers”) in the operation of their cloud services business. A definitive agreement to purchase these assets, including the assumption of substantially all of the related on-going liabilities incurred in the ordinary course of business (collectively, the “Broadvox Assets”) was entered into on August 30, 2013, and amended on November 15, 2013 and December 16, 2013 (the “BVX Purchase Agreement”). For the year ended December 31, 2013, the business constituted by the Broadvox Assets generated unaudited revenues of approximately $32.7 million.
The purchase price of the Broadvox Assets of $32.1 million was paid in cash at closing (less the $1 million deposit previously delivered to the Sellers). In accordance with the terms of the BVX Purchase Agreement, (a) the purchase price remains subject to adjustment based on certain working capital measurements described in the BVX Purchase Agreement that we expect will be finalized in the second quarter of 2014, and (b) $3.21 million of the Purchase Price is being held in escrow for a period of up to one year as collateral to secure the accuracy of the Broadvox Sellers’ representations, warranties and covenants contained in the BVX Purchase Agreement.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
The Broadvox Assets will be integrated into our existing Business Services business segment. As provided in the BVX Purchase Agreement, we and the Broadvox Sellers entered into a Transitional Services Agreement governing the provision and receipt of certain services between the Company and the Broadvox Sellers for a transition period and covering a range of topics, including our ongoing purchase of VOIP and wholesale services from the Broadvox Sellers; our utilization of the Broadvox Sellers' network infrastructure; temporary use of financial and administrative systems owned by the Broadvox Sellers; the marketing of services offered by the Company by sales representatives of the Broadvox Sellers; and our use of certain of Broadvox Sellers’ office facilities and employees.
Our consolidated balance sheet as of December 31, 2013 includes the Broadvox Assets, and the results of operations generated by the Broadvox Assets will be reflected in the Company’s consolidated statement of operations effective January 1, 2014.
On October 29, 2012, through our wholly owned subsidiary, Fusion NBS Acquisition Corp (“FNAC”), we completed the acquisition of Network Billing Systems, LLC and certain assets and liabilities of its affiliate, Interconnect Services Group II LLC (collectively, “NBS”). NBS is a Unified Communications and cloud services provider offering a wide range of hosted voice and data products, as well as Internet, data networking and cloud services solutions to small, medium and large businesses in the United States. For the year ended December 31, 2013, the NBS customer base contributed approximately $28 million of revenue to our Business Services business segment.
The aggregate purchase price for the outstanding membership interests of NBS and the assets of ISG, net of assumed liabilities, was $19.6 million, consisting of $17.75 million in cash, $0.6 million to be evidenced by promissory notes payable to the sellers of the NBS membership interests (the “Seller Notes”) and 11,363,636 shares of our restricted common stock valued at $1.25 million. The purchase price has been adjusted for certain working capital measurements described in the purchase agreements. As of March 31, 2014, the Seller Notes have been paid in full.
Effective as of the date of the acquisition, NBS became our wholly-owned subsidiary, and during 2013 we completed the integration of our pre-acquisition Business Services business segment into NBS’ existing business. In connection with our acquisition of NBS, we entered into an Employment and Restrictive Covenant Agreement with Jonathan Kaufman, the founder and principal operating officer of NBS, and Mr. Kaufman became the President of our combined Business Services business segment.
The purchase price of the Broadvox Assets and the cash portion of the NBS Purchase Price were primarily financed through the issuance of senior notes by FNAC in the principal amounts of $25.5 million and $16.5 million, respectively (see “Liquidity and Capital Resources”). The acquisition of the Broadvox Assets (the “Broadvox Transaction”) and the acquisition of NBS added approximately 10,000 customer locations to our Business Services segment. These transactions are a significant component of our strategy to increase the percentage of our total revenues contributed by the Business Services business segment, which generally operates at higher profit margins than does our Carrier Services business segment.
Our Performance
Revenues for the year ended December 31, 2013 were $61.5 million, an increase of $17.2 million, or 38.9%, compared to the year ended December 31, 2012. Our operating loss for 2013 was $3.5 million, compared to $4.8 million in 2012, mainly due to the effects of a full year of NBS reflected in our results of operations for the year ended December 31, 2013. Our net loss was $5.1 million in 2013, compared to $5.2 million in 2012.
Our Outlook
We expect that the revenues and gross profit in our Business Services business segment will increase significantly in 2014 as a result of the Broadvox Transaction. However, our ability to achieve positive cash flows from operations and net profitability is dependent upon our ability to grow our revenues and successfully integrate the operations associated with the Broadvox Assets into our existing business. We believe that a successful integration would result in synergistic cost savings and operational efficiencies that would significantly narrow our operating losses.
Revenues from our Carrier Services business have declined over the last few years due in large part to decreases in market rates for the termination of international traffic. We believe these declines in market rates resulted largely from increased competition, deregulation in many of the markets we serve and the use of lower cost, Internet-based technologies. While the market demand for international voice termination has seen a corresponding increase over the last few years, we have been unable to increase our revenues accordingly due to capacity limitations on our network switching platform and liquidity constraints. We are in the process of implementing new systems and equipment which will bring our network capacity to the levels necessary to compete in the current market and allow us to increase our traffic volumes, and we do not believe we will experience the same liquidity constraints that we have in the past. As a result, while we may experience additional declines in revenue during the early part of 2014, we expect to reverse this trend as we move into the second half of the year and see the results of the implementation of our new systems.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
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. GAPP”). 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.
We have identified the policies and significant estimation processes discussed below as critical to our business operations and to the 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 elsewhere in this Annual Report on Form 10-K.
Revenue Recognition
We recognize revenue when persuasive evidence of a sale arrangement exists, delivery has occurred or services have been rendered, the sales price is fixed and determinable, and collectability is reasonably assured. 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 when incurred.
Our revenue is primarily derived from usage fees charged to other telecommunications carriers that terminate voice traffic over the Company’s network, and from the monthly recurring and usage fees charged to customers that purchase our business products and services.
Variable revenue is earned based on the length of a call, as measured by the number of minutes of duration. It is recognized upon completion of the call, and is adjusted to reflect the allowance for billing adjustments. Revenue for each customer is calculated from information received through our network switches. Our customized software tracks the information from the switches and analyzes the call detail records against stored detailed information about revenue rates. This software provides us with the ability to complete a timely and accurate analysis of revenue earned in a period. We believe that the nature of this process is such that recorded revenues are unlikely to be revised in future periods.
Fixed revenue is earned from monthly recurring services provided to the customer, for which the charges are contracted for over a specified period of time. Revenue recognition commences after the provisioning, testing and acceptance of the service by the customer. The recurring customer charges continue 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
Cost of revenues for our Carrier Services business segment is comprised primarily of costs incurred from other domestic and international communications carriers to originate, transport, and terminate voice calls for our carrier customers. Thus the majority of our cost of revenues for this business segment is variable, based upon the number of minutes actually used by our customers and the destinations they are calling. Call activity is tracked and analyzed with customized software that analyzes the traffic flowing through our network switch. During each period, the call activity is analyzed and an accrual is recorded for the revenues associated with minutes not yet invoiced. This cost accrual is calculated using minutes from the system and the variable cost of revenue based upon predetermined contractual rates. Fixed expenses reflect the costs associated with connectivity between our network infrastructure, including our New York switching facility, and certain large carrier customers and vendors.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
For our Business Services business segment, fixed expenses include the monthly recurring charges associated with certain platform services purchased from other service providers, the monthly recurring costs associated with private line services and the cost of broadband Internet access used to provide service to business customers.
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. We did not record any impairment charges for the years ended December 31, 2013 and 2012.
Impairment testing for goodwill is performed annually in our fourth fiscal quarter. 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 if the fair value of the reporting unit is less than its carrying value. We performed a qualitative impairment evaluation on the goodwill acquired on October 29, 2012 (see note 3) and determined that no impairment existed.
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 like than not that we will fail to generate sufficient taxable income to be able to utilize the deferred tax assets.
Property and Equipment
In accordance with Accounting Standards Codification 350-40, Intangibles – Goodwill and Other – Internal-Use Software, we capitalize a portion of our payroll and related costs for the development of software for internal use and amortize these costs over three years. During the years ended December 31, 2013 and 2012, we capitalized costs pertaining to the development of internally used software in the approximate amount of $794,000 and $151,000, respectively.
Recently Issued Accounting Pronouncements
During the years ended 2013 and 2012, there were no new accounting pronouncements adopted by the Company that had a material impact on the Company’s consolidated financial statements. Management does not believe there are any recently issued but not yet effective accounting pronouncements that, if currently adopted, would have a material effect on our consolidated financial statements.
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
2013 ANNUAL REPORT ON FORM 10-K
RESULTS OF OPERATIONS
Our consolidated results of operations for the year ended December 31, 2013 reflect a full year of operations of NBS, while our consolidated results of operations for the year ended December 31, 2012 include the results of NBS subsequent to the October 29, 2012 acquisition date. Therefore, our results of operations for the year ended December 31, 2013, particularly with respect to our Business Services segment, are not comparable to the prior year. The following table summarizes our results of operations for the years ended December 31, 2013 and 2012:
| | | 2013 | | | 2012 | |
| Revenues | | $ | 61,496,620 | | | | 100.0 | % | | $ | 44,287,509 | | | | 100.0 | % |
| Cost of revenues, exclusive of depreciation and amortization | | | 42,717,176 | | | | 69.5 | % | | | 37,662,371 | | | | 85.0 | % |
| Gross profit | | | 18,779,444 | | | | 30.5 | % | | | 6,625,138 | | | | 15.0 | % |
| Operating expenses: | | | | | | | | | | | | | | | | |
| Depreciation and amortization | | | 3,571,974 | | | | 5.8 | % | | | 998,789 | | | | 2.3 | % |
| Selling general and administrative | | | 18,756,325 | | | | 30.5 | % | | | 10,438,967 | | | | 23.6 | % |
| Total operating expenses | | | 22,328,299 | | | | 36.3 | % | | | 11,437,756 | | | | 25.8 | % |
| Operating loss | | | (3,548,855 | ) | | | -5.8 | % | | | (4,812,618 | ) | | | -10.9 | % |
| Interest expense | | | (2,638,249 | ) | | | -4.3 | % | | | (623,460 | ) | | | -1.4 | % |
| Loss on extinguishment of debt | | | (1,105,283 | ) | | | -1.8 | % | | | (335,315 | ) | | | -0.8 | % |
| (Loss) gain on change in fair value of derivative liability | | | (598,292 | ) | | | -1.0 | % | | | 799,500 | | | | 1.8 | % |
| Other (expenses) income | | | (22,997 | ) | | | 0.0 | % | | | (276,695 | ) | | | -0.6 | % |
| Total other (expenses) income | | | (4,364,821 | ) | | | -7.1 | % | | | (435,970 | ) | | | -1.0 | % |
| Gain on extinguishment of accounts payable | | | 2,883,660 | | | | 4.7 | % | | | - | | | | 0.0 | % |
| Provision for income taxes | | | (51,887 | ) | | | -0.1 | % | | | - | | | | 0.0 | % |
| Loss from Continuing Operations | | | (5,081,903 | ) | | | -8.3 | % | | | (5,248,588 | ) | | | -11.9 | % |
| Income from discontinued operations | | | - | | | | 0.0 | % | | | 41,345 | | | | 0.1 | % |
| Net loss | | $ | (5,081,903 | ) | | | | | | $ | (5,207,243 | ) | | | | |
