UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-K
 
x   ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2005

Commission file Number: 000-32421

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
(Exact name of registrant as specified in charter )

Delaware
 
58-2342021
(State or other jurisdiction of
 
(I.R.S. employer
incorporation or organization)
 
identification no.)
     
420 Lexington Avenue, Suite 518
   
New York, New York 10170
 
10170
(Address of principal executive offices)
 
(Zip code)
     
(212) 972-2000
Registrant’s telephone number, including area code:

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class
 
Name of Each Exchange on Which Registered
Common Stock, par value $0.01 per share
 
American Stock Exchange
Redeemable Common Stock Purchase Warrants
 
American Stock Exchange

Securities registered pursuant to Section 12(g) of the Act: None.

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x

Indicate by check mark if he registrant is not required to file reports pursuant to Section 13 or Section 15 (d) of the Act. Yes o No x

Indicate by a check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x No o

Indicate by a check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange act rule 12b-2). Yes o No x

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o No  x .

The aggregate market value of the Common Stock held by non-affiliates of the Registrant based upon the closing price of the common stock as reported by the American Stock Exchange on March 24, 2006, was $49,869,210. Solely for purposes of this calculation, shares beneficially owned by directors and officers of the Registrant and persons owning 5% or more of the Registrant’s common stock have been excluded, in that such persons may be deemed to be affiliates of the Registrant. Such exclusion should not be deemed a determination or admission by the Registrant that such individuals or entities are, in fact, affiliates of the Registrant.

The number of shares outstanding of the Registrant’s capital stock as of March 24, 2006, is as follows:

Title of each Class
 
Number of Shares Outstanding
Common Stock, $0.01 par value
 
26,869,211
Redeemable Common Stock Purchase Warrants
 
7,281,838

DOCUMENTS INCORPORATED BY REFERENCE

The following documents (or parts thereof) are incorporated by reference into the following parts of this Form 10-K. Certain information required in Part III of this Annual Report on Form 10-K is incorporated from the Registrant’s Proxy Statement for the 2005 Annual Meeting of Stockholders to be held in 2006.
 
2005 FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
ANNUAL REPORT ON FORM 10-K
 
TABLE OF CONTENTS

 
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  Index to Consolidated Financial Statements  
F-1
 
 
-2-
 
PART 1

ITEM 1. BUSINESS

Overview  

Fusion Telecommunications International, Inc. (the “Company”, “we”, “our”, “us”) seeks to become a leading provider of Voice over Internet Protocol (VoIP) to, from, in and between emerging markets in Asia, the Middle East, Africa, the Caribbean, and Latin America. We currently market VoIP services to consumers, corporations, government entities, Internet service providers, distribution partners and telecommunications carriers.

Through our key assets of market knowledge, technical expertise and strategic relationships, we believe we are poised to:

·        
Capitalize upon the growth in VoIP, a market that Insight Research Corporation expects to grow from $82 billion in 2005 to nearly $197 billion by 2007 and expand our international penetration of VoIP applications to consumers and corporations;
·        
Deliver a customized VoIP service designed to meet the needs of the emerging markets and communities of interest worldwide;
·        
Expand into the free service market space with the introduction of a new service offering;
·        
Establish our company as an “early mover” in target markets;
·        
Continue to expand the number of partnerships globally to facilitate the distribution of our VoIP services; and
·        
Acquire additional communications licenses through existing and new strategic relationships.

We target markets that we believe have: (i) barriers to entry, (ii) substantial growth prospects, (iii) an increasing number of corporations operating within them, (iv) high cost of telecommunications services, and (v) a substantial quantity of voice and data traffic between the developed world (e.g., the United States and United Kingdom) and other countries within our target markets. In select emerging markets, we will deploy network facilities in order to connect that country to the United States.  

We currently provide services to customers in over 45 countries. We believe that by using local partners in select markets, we can best distribute our services while providing a high level of local customer support.

Services

To date, we derive a significant portion of our revenues primarily from U.S.-based carriers requiring VoIP connectivity to emerging markets. As we continue to execute our strategy, we anticipate a larger number of non-U.S. based customers. We are currently seeking to expand our retail VoIP revenue stream to consumers and corporations by providing our services to, from, in and between emerging markets, which to date, have not generated material revenues for us. We deliver our VoIP services directly to end-users and through partnerships with companies that distribute and support our services locally. We also deliver our services through joint ventures.

We have service contracts with our customers, including carriers, corporations, government entities and consumers. Our contracts with carriers typically have a one-year renewable term, with no minimum volume per month, and allow the customer to terminate without penalty. Our contracts with corporate customers are typically for a one-year term, and have an early cancellation penalty. Our government contracts are typically one year, and are terminable at the government’s option without penalty. For the years ended December 31, 2005, 2004, and 2003, the Telco Group accounted for 11.3%, 13.3%, 13.7%, respectively, of our total revenues. In addition, for the year ended December 31, 2005, Qwest accounted for 15.7% of our total revenues.

We have tailored our service offerings to meet the needs of our target customers requiring services to, from, in and between emerging markets.

·        
VoIP : Our VoIP carrier and VoIP retail services, combined, have accounted for the majority of our revenues in 2005 and 2004. Our retail VoIP service enables customers, typically for a lower cost than traditional telephony, to place voice calls anywhere in the world using their personal computer, Internet protocol phone or regular telephone when accompanied by a hardware device. VoIP services utilize the Internet as opposed to circuit switching (traditional telephony technology), thereby offering cost savings to customers. These services are primarily offered under our retail brand efonica directly to consumers, corporations, distribution partners, carriers or Internet Service Providers around the world. In select cases, we will also provide co-branded and private label solutions. Our services can be used through the PC, an IP phone or a regular phone when connected to an adapter, and are offered to customers located in Asia, the Middle East, Africa, and Latin America, and we are currently expanding into the Caribbean. In the second quarter of 2006, we expect to roll out a free VoIP service designed to meet the needs of the free service segment of the market, as well as other advanced services.
 
 
 
Additionally, we enter into VoIP interconnect agreements with telecommunications carriers worldwide. These agreements enable us to terminate traffic into a country and in some cases originate traffic from that country through the telecommunications carrier. We use capacity on these networks to carry our own retail traffic in addition to selling capacity to other carriers desiring voice termination to that destination. As we grow, we expect to use an increasing percentage of our capacity for higher margin retail traffic.

·        
Internet Access and Managed Private Networks : We offer Internet access and managed private networks on a limited basis. We look to create partnerships with Internet Service Providers to bundle VoIP with Internet access, as well as offer these services to corporations and carriers. We offer peering with multiple tier-one Internet backbone providers utilizing an intelligent routing capability. This ensures efficiency, speed and reliability. The tier-one providers we utilize own or control a national network that trades traffic with other national providers. This traffic trading is referred to as “peering”. A tier-one provider can carry its own Internet traffic across the country and hand it off at any one of the public or private hand-off locations known as “peering points,” metropolitan access points or national access points. In regions where we do not own network facilities, we utilize other carriers’ facilities. We offer managed end-to-end networks that typically connect multi-national corporations in emerging markets with locations in other countries. We also market this service to software developers, call centers, and telemarketing facilities, all of which rely on high quality, reliable service. In markets where we do not have network facilities deployed, we utilize other carriers’ networks, allowing us to provide an integrated global network that can connect a customer to virtually anywhere in the world. We also offer services on a private label basis as a subcontractor for other communication carriers that are seeking Internet access in, or network connectivity to, countries that they do not otherwise service.

·        
Co-location : We offer facility co-location services to other communication service providers, enabling them to co-locate their equipment within our facility, or lease a portion of our equipment. Often, we provide wholesale services to the parties who co-locate with us.

Our segments and their principal activities consist of the following:

Voice Services to Carriers — Voice to Carriers includes VoIP to Carriers, which is the termination of voice telephony minutes by the Internet rather than older circuit-switched technology. VoIP permits a less costly and more rapid interconnection between our network and international telecommunications carriers. This segment also includes Traditional Voice (the termination of voice telephony minutes from or to the countries we serve, utilizing traditional Time Division Multiplexing (TDM) and “circuit-switched” technology). Typically, this will include interconnection with traditional telecommunications carriers either located internationally or those carriers that interconnect with us at its U.S. Points of Presence (POP) and provide service to other destinations. These minutes are sold to carriers on a wholesale basis.

VoIP to Consumers and Corporations — We provide VoIP services targeted to end-users and corporations, primarily through our efonica brand. We offer services that permit consumers or corporations to originate calls via IP telephones or telephone systems that use the Internet for completion to standard telephone lines anywhere in the world. We also provide PC-to-Phone service that utilizes the Internet to allow consumers to use their personal computers to place calls to the telephone of their destination party.

Internet, Private Networks & Other — We provide Internet connectivity to telecommunications carriers, Internet service providers, government entities, and multinational customers via our POPs in the US, India and through our partners elsewhere. We also offer point-to-point private lines, virtual private networking, and call center communications services to customers in our target markets.

Growth Strategy

Strategy : Our strategy is to provide a full suite of VoIP services to consumers and corporations in the emerging markets and to the international communities of interest around the world. We look to create local partnerships to facilitate distribution of our services within our target countries. We also look to create global partnerships to facilitate global distribution of our services.
 

The details of our strategy include:

·        
Market Customized VoIP Calling Plans to Consumers, Corporations and Enterprises

Our key service offering is VoIP, which allows us to offer feature-rich, prepaid and monthly subscription Internet-based telephone services at competitive prices to any consumer or business with broadband or dial-up Internet access. Quality levels, which had once been a significant issue, are fast approaching those associated with traditional voice transmission. We typically market our VoIP services to corporations and consumers through an in-country distribution partner. Many of our target markets have different cultures, calling patterns, and payment options requirements . Our marketing strategy focuses on delivering customized VoIP calling plans, feature packages and payment option to meet the needs of the target market and communities of interest around the world. We intend to build upon our market position in the international VoIP business to selectively market our VoIP services to the enterprise market. We believe that the ability to deliver global Internet access and managed private networks and other Internet-based services to multinational businesses are important capabilities in allowing us to address this market segment.

·        
Establish Local Partners for In-Country Distribution and Support

We believe that working with strong partners allows us to best distribute services and attract, retain and support customers. We seek to develop partnership arrangements in each of our markets. Local partners offer advantages since their existing infrastructure, sales distribution channels, and technical support can be utilized, while simultaneously reducing capital needed to enter the market. We seek to partner with companies that have access to a customer base, whether online or otherwise, such as Internet service providers, wireless Internet access providers, licensed carriers, online retailers, electronics outlets, and hardware manufacturers. We intend to work with our partners to enable them to distribute and support our products and services. In select cases, we offer a co-branded or private label option. Our private label alternative enables our partners to market our products, technology platform and global reach under their own brand. This alternative is ideal for partners that do not have the capital, expertise and technology platform required to deliver our services but want to build their own brand. Local partners also offer critical insights into the regulatory environment and are familiar with the specific cultural nuances of their region. Additionally, we anticipate that prior to the rollout of any new services, our partners will work with us, contributing market intelligence to ensure a successful introduction of new products.

·        
Deploy Proprietary Directed SIP Peer-to-Peer Technology to Provide Free VoIP Calling Between Customers

We are deploying proprietary directed Session Initiated Protocol (SIP). SIP Peer-to-Peer technology will allow us to offer free VoIP calling between customers. This directed peer-to-peer technology will allow Internet phone connections between enabled devices without the need to route the calls through a network of third-party computers, as typically occurs in a peer-to-peer environment. We intend to provide a VoIP service that works with standard SIP equipment. This will enable customers to make calls between any combination of computers, Internet connected telephones, wireless devices, and other SIP-enabled hardware. We believe that this technology provides several advantages when compared to other peer-to-peer telephony approaches. It is based on open standards and is designed to be interoperable with new technologies as they emerge. We plan to offer customers using our free service, a selection of optional features and calling plans for purchase.

·        
Deploy a Carrier Grade Network Infrastructure

We have built a highly scalable network and back office infrastructure to deliver our services. We utilize the latest Softswitch technology for routing VoIP and TDM calls to off-net customers.

We are developing and deploying back-office systems and services platforms that will enable us to offer our customers a wide array of services and features including comprehensive feature packages, pre-paid subscription-based calling plans, and free on-net calling. The development of this extensive scalable back office will also serve to reduce our dependence on other communication carriers. We believe our focus on being a carrier grade VoIP service provider enables us to deliver the quality of service required by our customers.

·        
Develop International Interconnections to Carriers

We seek to enter into relationships with in-country carriers to transport voice traffic to and/or from that country. We believe that we have established our presence in the voice markets due to (i) direct interconnections to postal telephone and telegraph companies and other licensed carriers, which typically provide higher quality transmission than the services offered by gray market operators, and (ii) competitive pricing. We believe that carriers seeking to access these markets will increasingly want to work with companies that have established relationships with postal telephone and telegraph companies and other licensed carriers, as opposed to quasi-legal operators who divert long distance traffic and revenue from those carriers. We believe gray market operators generally provide poorer quality and reliability. In several markets, we receive inbound traffic from the postal telephone and telegraph company and other licensed carriers that tend to produce higher margins than our outbound carrier voice services. We believe this inbound traffic from postal telephone and telegraph companies and other licensed carriers, strengthens our ability to ensure favorable contractual arrangements. We will use capacity on our international voice networks to carry our own retail traffic in addition to selling capacity to other carriers desiring termination to that specific destination. Although there are significant peaks and valleys in the carrier revenue stream, we believe it is important to our success in the retail market to keep our cost basis low and our quality high. As we progress in the execution of our business plan, we intend to use a greater percentage of our network capacity to carry higher margin retail traffic.
 

·        
Exploit Communication Patterns Among and Between Our Markets

We look to provide connectivity to, from, in and between our emerging markets. We seek to create international interconnections with global carriers to carry our international traffic. We are targeting customers in synergistic markets to leverage the communities of interest by providing customized calling and feature service plans designed to meet the needs of ethnic communities around the world. Our regional marketing plan is focused on the emerging market communities of interest around the world. We are also seeing demand from business customers for multi-country connectivity such as a U.S. corporation seeking connectivity to India, China, and the Philippines from one provider. We also believe that traffic among emerging markets is less susceptible to price and margin erosion than traffic among developed countries.

·        
Provide Equipment Customized to Meet Needs of Customers in the Emerging Markets and Communities of Interest

In addition to providing services that work with commonly available VoIP hardware, we are developing a line of VoIP hardware devices with features and functionality customized to meet the needs of the emerging markets and communities of interest. Initially, these include an Asynchronous Terminal Adapter ( ATA), IP Phone, and USB phone. The ATA is planned to be available in the second quarter of 2006, and the other devices will be rolled out subsequently. We also intend to introduce a Wireless Internet Access (Wi-Fi)  Phone and Pocket PC. We believe that we will realize advantages from manufacturing our own hardware since this affords us the opportunity to customize the features, functionality and appearance of the devices to create unique solutions as well as reducing our cost of hardware.

Marketing

Our VoIP marketing strategy focuses on delivering customized calling plans, feature packages and payment options to meet the needs of emerging market and ethnic communities around the world . Our VoIP service works with a broadband or a dial-up connection to the Internet, a capability that we believe has been ignored by many VoIP service providers. We believe this service delivery flexibility is very important since approximately 70% of the world’s Internet users still connect through dial-up.  

We market VoIP services to consumers, corporations, Internet Service Providers, cable operators and carriers through direct sales or distribution partners. Internet access and private network solutions are marketed through direct and alternate distribution channels.

We market our services via a variety of distribution channels, including:

·        
Direct Sales and Regional Management —We have a direct sales force that sells our products and services to corporations and carriers. We also have regional sales management that focuses on Latin America, Asia, Africa, the Middle East and the Caribbean. The regional executives manage and grow existing revenue streams from partners and defined strategic accounts, identify and develop new partnerships, develop strategies for market penetration, identify new market opportunities, and coordinate internal support activities.

·        
Agents — We use independent sales agents to sell our services. Our sales agents are compensated on a commission-based structure. We typically control the product, pricing, branding, technical and secondary level customer support, billing and collections.

·        
Partnerships —We seek to develop partnership arrangements in each of our markets with companies that are able to distribute and support our services. These partners can be ISPs, retail store chains, carriers, cable operators and other distribution companies. In addition to local distribution and support, our partners may provide or arrange for last mile connectivity required for the delivery of local Internet access and private networks. We also focus on the development of global partnerships that have multi-country distribution capabilities.

·        
Strategic Ventures —We enter into agreements with other companies to market and distribute each other’s products and services to the customer and prospect base of the other. The providing party usually will support and bill its own products. Depending on the strategic venture, we may pay or receive a commission, share revenue and/or profits with each other.
 
 

Manufacturing and Distribution Agreement  

In August 2005, we signed an agreement to partner with a leading manufacturer of VoIP and communication hardware technology devices based in Asia to develop a line of branded consumer hardware devices. The partnership will focus on the development and manufacturing of a complete line of branded VoIP hardware devices that will enable consumers and corporations to access our service suite from anywhere in the world. Dealing directly with the manufacturer will give us the ability to more rapidly respond to high volume orders, reduce the cost of the hardware, and address the initial cost hurdle for customer adoption by offering lower priced options. We also intend to customize the hardware design, features and functionality to meet the needs of our customers communicating to, from, in and between the emerging markets. We plan on introducing an ATA by the end of the second quarter of 2006.

Efonica

Efonica was incorporated in the Technology, Electronic Commerce and Media Free Zone in Dubai, United Arab Emirates and entered into a joint venture agreement with us in 2002.

In January 2005, we entered into an agreement to acquire the remaining 49.8% minority interest in Efonica from Karamco, Inc., which was contingent upon the successful completion of our initial public offering by March 1, 2005. As our IPO was completed by this date, the Efonica transaction closed on February 18, 2005. The purchase price was $9,785,700 representing Karamco’s portion of Efonica’s debt owed to us as of the closing date and the $500,000, which was paid in cash in February 2005 to Karamco with the balance paid in shares of common stock. The number of shares issued to Karamco was determined by the $6.45 per share initial price of the common stock at the date of the IPO.

Approximately $4.4 million worth of such common stock (675,581 shares) issued to Karamco is being held in escrow (the “Escrow Shares”). In March 2006, the Escrow Shares were released to Karamco subject to a lock-up period until February 15, 2007.

Out of the shares to be issued to Karamco, we agreed to register for resale 150,000 shares of common stock and a registration statement covering such shares was declared effective on June 21, 2005 (the “Registered Shares”). If the sale of the 150,000 shares that were registered results in less than $1 million of gross proceeds within 365 days of the effectiveness of the registration statement, we are required to pay Karamco the difference between the aggregate gross proceeds of Karamco’s sale of the Registered Shares and $1,000,000. At December 31, 2005, the Company has paid Karamco $430,000 towards the difference payment (“Difference Payment”). In the event the Difference Payment is less than $430,000, Karamco is obligated to reimburse for such excess and this obligation is secured by 50,387   shares held in escrow.

Roger Karam, who became our President of VoIP Services upon the effective date of the IPO, owns Karamco.

Efonica F-Z, LLC is presently integrated with the rest of our organization and efonica is serving as our VoIP division brand name.

iFreedom
 
On November 14, 2005, we entered into an agreement to acquire the assets of iFreedom Communications International Holdings Limited (“iFreedom”), and a number of its subsidiaries, an entity that markets monthly recurring international VoIP service plans geared to meet the needs of consumers and businesses in the emerging markets. The agreement provided for a purchase price of $500,000 in cash, and 1,100,000 shares of stock, of which 750,000 shares were to be held in escrow and were subject to a performance based earn out. Under the terms of the agreement, we would have acquired iFreedom’s customer base as well as operations in Hong Kong, the Philippines, Malaysia, the United Kingdom, and the United States. As certain closing conditions have not yet been met by iFreedom, the parties have been working in good faith to renegotiate the terms and conditions of the transaction and have reached a proposed resolution.  Fusion  now plans to acquire iFreedom's operations in Malaysia and the Philippines.  In addition, Fusion would hire certain of iFreedom’s employees and potentially acquire certain other assets. The purchase price is expected to be $500,000 in cash, which may go towards satisfying certain liabilities iFreedom owes to Fusion as described below, and 750,000 shares of common stock, of which 350,000 shares would be held in escrow subject to a performance based earn out. We anticipate executing a formal agreement documenting this new understanding, although there can be no assurance that such an agreement will be signed, what parties will be included, or that the above stated terms will be included.
 
We have been providing termination services to iFreedom, which services have aggregated charges of approximately $216,000 as of December 31, 2005. iFreedom has entered into a non-interest bearing Note with respect to these charges in the principal amount of $463,098, which will increase for charges subsequent to March 20, 2005. The Security Agreement with respect to the Note has not been entered into. It is expected that up to $500,000 in principal of this Note will be offset at closing in lieu of cash due. We expect to resolve this outstanding receivable at closing, but can make no assurance all or any of the receivable will be paid.
 

Joint Ventures

We enter into formal joint venture agreements with certain partners and have established four joint ventures to market and provide our services. The profits of each joint venture agreement are typically allocated according to percentage of equity ownership.

The terms of each non-joint venture partnership or distribution agreement are different by partner but in general provide for a revenue or profit sharing arrangement.

India  

In March 2000, we entered into a joint venture agreement with Communications Ventures India Pvt. Ltd. to form an entity named Estel Communication Pvt. Ltd. Estel is organized and existing under the laws of India and has its office in New Delhi, India. We own 49% of the joint venture and have voting rights in another 1.01%, which in turn gives us an indirect 50.01% voting control in the joint venture. Estel is in the business of selling and supporting VoIP, private networks and Internet access in India. The joint venture has been funded primarily by us. Our joint venture partner has had a lack of resources necessary to make investments to grow our operations or fund its commitments to us. As of December 31, 2005 and 2004, the amounts due from Estel were approximately $29,000 and $118,000, which is net of an allowance of $834,000 and $644,000, respectively.

Pakistan  

In July 2002, we acquired a 75% equity interest in a joint venture with Turner Hill Investments, L.P. (“Turner Hill”), a foreign limited partnership, to provide VoIP services for calls terminating to the dominant telecommunications carrier in Pakistan. Turner Hill subsequently assigned its interest to Braddon Corporate Holdings Limited (“Braddon”). During 2003 and 2002, we contributed certain telecommunications equipment and advances aggregating approximately $0.3 million and $0.7 million, respectively, to the joint venture in exchange for its equity interest in the new joint venture. The joint venture operated out of facilities provided by Braddon and began providing VoIP service in November 2002.

Due to a change in market conditions, the termination of incoming VoIP traffic into Pakistan was no longer advantageous to us and we decided to cease operations with Braddon.

On November 30, 2005 we terminated the non-exclusive service agreement that we had entered into in connection with the joint venture with Pakistan Telecommunications Ltd. (“PTCL”), a public limited company incorporated under the laws of Pakistan, under which PTCL would provide for the termination of incoming VoIP traffic into Pakistan from the United States and Europe.

We intend to continue to offer our other services in Pakistan.

Jamaica  

On December 16, 2004, we entered into an agreement to acquire 51% of the common stock of a Jamaican telecommunications company in exchange for $150,000. The company currently holds international and domestic carrier license agreements with the Jamaican government, which enable it to operate as an international carrier through 2013 and as a domestic carrier through 2018. The closing of this acquisition took place on January 11, 2005. We deployed equipment in Jamaica in the third quarter of 2005, and are currently operational. We are currently offering select corporate services, and will begin selling our full suite of VoIP and other Internet services once our retail service rollout is complete.

Turkey  

On March 8, 2005, through a wholly owned subsidiary, Fusion Turkey, LLC, we entered into a Stock Purchase Agreement to acquire 75% of the shares of LDTS Uzak Mesafe Telekomikasyon ve Iletisim Hizmetleri San.Tic.A.S. (“LDTS”) from the existing shareholders. The transaction closed on May 6, 2005 following receipt of approval from the Turkish Telecom Authority. Fusion acquired the shares for approximately $131,000 cash and the posting of a bank guarantee of $251,000. LDTS possesses a Type 2 telecommunications license approved by the Turkish Telecom Authority. This license will permit Fusion to offer VoIP services under its efonica brand and other Internet services to corporations and consumers in Turkey. Given the changing dynamics of the Turkish market and regulatory framework, we continue to work towards the deployment of IP services but we have found it unnecessary to build-out a network in Turkey as originally planned. We will begin offering services in Turkey in the second quarter of 2006, once our retail service rollout is launched.
 

Network Strategy  

Our network strategy incorporates a packet switched platform capable of interfacing with Internet protocols and other platforms including Time Division Multiplexing (TDM). This is key to providing the flexibility needed to accommodate the many protocols used to transport voice and data today. We continually evaluate, and where appropriate, deploy additional communications technologies such as Multi-Protocol Label Switching (MPLS) and Any Transport over MPLS ( ATOM ) , which handle information transport in a more efficient fashion than other earlier technologies such as frame relay and ATM.

The core of our network design is a packet-based switching system that accommodates VoIP and traditional voice, Internet, data and video services. Packet-based networking is considerably more efficient than circuit-switched systems because it can disperse packets (information) in many directions and then reassemble them at the destination. This makes much more efficient use of available facilities when compared to circuit-based systems. We believe that this design offers an extensible platform to support envisioned growth. The network design is intended to embrace emerging technologies as they become available. The network architecture is highly distributable and supports geographical expansion outside of the United States and, if necessary, can deliver packet technology to every part of the network.

We are currently using a Veraz “Softswitch”, ECI I-Gate, Cisco, and   Nuera Orca media gateways, and carrier class Cisco routers and switches on a fiber-based gigabit Ethernet backbone to transport voice, data, video, and Internet traffic. Softswitch is a generic term that refers to a new generation of telecommunications switching equipment that is entirely computerized and based on software processes that execute entirely on off-the-shelf servers. This provides us with call control and routing capabilities to further enhance services and performance available to our clients.

We have deployed back-office systems and services platforms that will enable us to offer our customers a wide-array of VoIP services and features, including subscription-based calling plans, free on-net calling via a directed SIP peer-to-peer services platform, advanced feature packages, conferencing, and unified messaging. This development of an extensive scalable back-office will also serve to reduce our dependence on other communication carriers.

We have completed the initial infrastructure build out of the major network elements and are currently in the process of finalizing the development, integration and testing of our new services and have live beta customers using these services. We anticipate that our retail service rollout will be launched prior to the end of the second quarter of 2006.

We recently acquired proprietary intellectual property of a Directed SIP Peer-to-Peer (DSP) technology that will allow us to enter the free service market. This technology allows Directed Peer-to-Peer Internet phone connections between SIP enabled devices without the need to route the call through a network of third-party computers, as typically occurs in peer-to-peer environment.

Benefits of the Fusion Distributed Network Architecture

Historically, most large international communications networks required investment and implementation of self-contained switching hardware that, in turn, could then be connected with other comparable equipment nodes via leased lines or other forms of networking. Examples of these would include equipment such as large traditional carrier switching equipment. All of the intelligence and functionality has to be replicated in each major location.

We, however, have implemented an environment that we believe is far more flexible, adaptable, and less costly than the legacy systems in use by some of our competition. Our Softswitch environment permits us to centrally control our network and service offerings from one location yet deploy gateways that interface with customers and vendors in remote locations. Each remote gateway is able to deliver our service suite even though the intelligence is centrally located in our New York facility. Instead of needing duplicative and expensive infrastructure in every location, we economize by allowing multiple disparate network equipment to be centrally managed. We believe that we can capitalize on market opportunities that would previously have been unadvisable due to the expense of deployment and associated marketplace risks.
 

Capacity

In traditional telecommunications systems, capacity is a function of equipment and software. Because of its modular architecture, Softswitch capacity is much less dependent on hardware. We believe that our Softswitch environment will enable us to expand our capacity to handle traffic and our geographic reach with greater ease in the future.

Ease of Modular Service Creation

Traditional telecommunications switching systems are not easily modified to incorporate new features and functionality. Because our Softswitch environment is entirely computer driven, our systems are flexible and designed for the addition of features. We intend to expand our service offerings by integrating additional hardware and software systems.

Our distributed architecture and flexible technology platform allows us to roll out new services in a shorter period of time than many traditional telecommunication companies.

Ease of Deployment

As we continue to penetrate emerging markets, we will seek to establish regional points of presence that are then connected to our New York facility. To facilitate this, we have created a standard concept for the deployment of a point of presence in a remote region. These regional points of presence will enable our VoIP services set to be offered and delivered from remote locations while the intelligence and management of the services are in our New York facility. This modular approach allows us to respond and deploy our services rapidly. We currently maintain one point of presence in the Caribbean, Latin America and the Middle East, two points of presence in the United States and five points of presence in Asia. We are generally required to establish additional points of presence where the partner or vendor does not have the necessary equipment, where it is a requirement pursuant to a license agreement or where we garner a large user base in a given country.

Competition

The international communications industry is highly competitive and significantly affected by regulatory changes, technology evolution, marketing strategies, and pricing decisions of the larger industry participants. In addition, companies offering Internet, data and communications services are, in some circumstances, consolidating. We believe that service providers compete on the basis of price, customer service, product quality, brand recognition and breadth of services offered. Additionally, carriers may compete on the basis of technology. Recently, we have seen carriers competing on their ability to carry VoIP. As technology evolves and legacy systems become an encumbrance, we expect carriers to compete on the basis of technological agility, their ability to adapt to, and adopt, new technologies.

In the area of VoIP we compete with companies such as Vonage, 8X8, Deltathree, Net2Phone, Skype, Dialpad and Mediaring. This business segment is marketing-intensive and does not have high barriers to entry. While we believe our distribution relationships and marketing skills provide us with a competitive advantage, our competitors generally have more resources and more widely recognized brand names.

We compete with several emerging international carriers, many of whom are in or entering the VoIP market, among which are Primus Telecommunications Group, Teleglobe International Holdings Ltd (which completed its merger with IP-telephony pioneer ITXC in May 2004), and IDT Corporation. We also compete with non-U.S. based emerging carriers. For example, in India, we compete with Bharti Tele-Ventures, Reliance Telecom and Data Access, all of which are larger, better capitalized and have broader name recognition than Fusion. Many of these competitors are becoming increasingly focused on emerging markets as they seek to find higher margin opportunities. Many of these carriers are also focused on voice carriage but may become increasingly focused on providing private networks and other Internet protocol services.

We also compete within the “Free Service” segment of the VoIP market, which is also a rapidly growing market segment. The current market leader in this segment is Skype. Other major players moving into this segment include Yahoo, Google, and MSN. Each of these companies offers an instant messenger (IM) service that incorporates the ability to make free computer-to-computer voice calls between registered users. By comparison, we are targeting individuals who are more focused on telephony applications than enhanced IM applications, and will offer the ability to make calls between any combination of computer, IP phones, and analog phones connected to an ATA device. In fact, there is no need to have a computer turned on, or even own a computer, to use our free service. We believe that this service will not only generate significant interest among users, but that it will also generate a steady stream of customers interested in upgrading to enhanced capabilities (e.g. voice mail or off-net calling) or to our subscription service offerings.
 

In each country where we operate, there are numerous competitors, including VoIP service providers, wireline, wireless and cable competitors. We believe that as international telecommunications markets continue to deregulate, competition in these markets will increase, similar to the competitive environment that has developed in the United States following the AT&T divestiture in 1984 and the Telecommunications Act of 1996. Prices for long distance voice calls in the markets in which we compete have been declining and are likely to continue to decrease. In addition, many of our competitors are significantly larger, control larger networks, and have substantially greater financial, technical and marketing resources.

We compete with business-oriented Internet access providers, including AT&T, Verizon, Qwest, and Cable & Wireless. These providers may offer both wholesale and retail Internet connectivity and are considerably larger than us and have greater brand recognition.

We have been unable to identify any direct and comprehensive competitors that deliver the same suite of services to the same markets with the same marketing strategy as we do. We compete with many different providers in various aspects of our Business Plan, but have found none that directly offer the same breadth of services focused on emerging markets. Some of our competitive advantages include:

·        
A full suite of services that complement our VoIP service offerings as opposed to a single offering;

·        
The ability to offer prepaid, monthly recurring service plans and free service to customers using broadband or dial-up Internet access;

·        
Our focus on emerging markets in Latin America, Asia, the Middle East, Africa, and the Caribbean;

·        
Customers will be able to make calls between any combination of computers, Internet connected telephones, wireless devices, and other SIP-enabled hardware;

·        
An international partnership and distribution model which provides for faster service deployment, reduced capital requirements and cost-efficient service delivery;

·        
Recently acquired Directed SIP Peer-to-Peer technology that allows us to expand our existing suite of paid service offerings and incorporate a free call service to accommodate that growing market segment; and,

·        
A strategy of using local partners to enable us to access new markets, secure or obtain communication licenses, enhance distribution and provide local customer support.

At this time, we are unable to provide quantified disclosure regarding our market share in the markets in which we operate. As is common with emerging markets, the aggregate market for our products and services is usually not known until feasibility studies containing a wide range of demographic variables are conducted. We are not aware of any studies that presently exist which provide sufficient data for us to determine our market share.

Government Regulation  

Generally, in the United States, we are subject to varying degrees of federal, state and local regulation and licensing, including that of the Federal Communications Commission. Internationally we also encounter similar regulations from foreign governments and their telecommunications/regulatory agencies. At each of these levels, there are significant regulations, fees and taxes imposed on the provision of telecommunications services in our business.

We cannot assure that the applicable U.S. and foreign regulatory agencies will grant required authority or refrain from taking action against us if we are found to have provided services without obtaining the necessary authorizations or pursuant to applicable regulations. If authority is not obtained or if our pricing, and/or terms or conditions of service, are not filed, or are not updated, or otherwise do not fully comply with the rules of these agencies, third parties or regulators could challenge these actions and we could be subject to forfeiture of our license, penalties, fines, fees and costs.

The U.S. Federal Government and state authorities have the power to revoke our regulatory approval to operate internationally, interstate, or intrastate, or to impose financial penalties, statutory interest and require us to pay back taxes or fees if we fail to pay, or are delinquent in paying, telecommunications taxes or regulatory fees or fail to file necessary tariffs or mandatory reports. We are currently, and have been, delinquent in such financial, filing and reporting obligations and required filings in the past including, but not limited to, Federal Communications Commission and Universal Service Fund reports and payments.
 

During July 2004, the United States Senate continued to consider how it might apply regulations to VoIP. The VoIP Regulatory Freedom Act of 2004 exempts VoIP service from state taxes and regulations and defines it as a lightly regulated information service for U.S. government regulators. This does not, however, remove the uncertainty of regulatory impact within the United States. For example, the bill reserves the ability for states to require VoIP to provide 911 services, to require VoIP providers to contribute to state universal service programs, and to pay intrastate access charges to other telecom providers.

On April 24, 2004, the FCC rendered a decision on the AT&T Petition for Declaratory Ruling (WC Docket No. 02-361) pending before them. The FCC determined that where 1+ calls were made from regular telephones, converted into an Internet protocol format, transported over the AT&T Internet backbone, and then converted back from IP format and delivered to the called party through the local exchange carrier local business lines (not Feature Group D trunks), the service was a “telecommunications service” for which terminating access charges were due the local exchange carrier. In its decision, the Commission stated that, under the current rules, the service provided by AT&T is a “telecommunications service” upon which interstate access charges may be assessed against AT&T. The FCC limited its decision to the specific facts of the AT&T case where the type of service involved ordinary Customer Premise Equipment (CPE) with no enhanced functionality, the calls originated and terminated on the public switched telephone network, and the calls underwent no net protocol conversion and provided no enhanced functionality to the end user due to the provider’s use of Internet protocol technology. In fact, in the AT&T case the customer was completely unaware of AT&T’s use of IP technology in transporting the call.

Although the FCC determined the services provided by AT&T to be a telecommunications service subject to interstate access charges rather than information services not subject to such charges, they did not make a determination regarding the regulatory status of phone-to-phone VoIP or its exposure to Universal Service Fund (USF), 911, Communications Assistance for Law Enforcement Act (CALEA) or any other public policy issues. The FCC further qualified the decision by stating that they “in no way intend to preclude the Commission from adopting a different approach when it resolves the IP-Enabled Services rulemaking proceeding or the Intercarrier Compensation rule making proceeding.” (Developing a Unified Intercarrier Compensation Regime, CC Docket No. 01-92, Notice of Proposed Rulemaking, 16 FCC Rcd 9610 (2001) (Intercarrier Compensation)).

As of March 2006, certain VoIP services that we plan to offer within the United States (Interstate) might be subject to USF charges or other public policy regulation. These services will be subject to 911/E911 and CALEA regulations, for which we have purchased the necessary equipment in order to be in compliance.

Some states have tried to directly regulate VoIP services on an intrastate basis, but these attempts have, so far, not held up to court challenges. Many states are holding forums to research the issues surrounding VoIP. Some are encouraging or even requesting that VoIP providers subject themselves to public service commission jurisdiction and obtain certification as telephone companies. Most are hesitant to act until a final determination is made by the FCC, but some have voluntarily done so.

It is uncertain when or how the effects of such regulation would affect us, nor is it understood if other countries will seek to follow suit. If additional regulation does occur, the FCC, any state or any country may impose surcharges, taxes or additional regulations upon providers of VoIP. The imposition of any such additional fees, charges, taxes and regulations on Internet protocol service providers could materially increase our costs and may limit or eliminate the competitive pricing we currently enjoy.

Intellectual Property and Trademarks  

On February 15, 2006, we entered into an Intellectual Property Transfer Agreement with Xtreme VoIP Corp pursuant to which we purchased a software application and other intellectual property rights relating to a VoIP software solution that will allow Directed Peer-to-Peer Internet phone connections between SIP-enabled devices without the need to route the calls through a network of third-party computers, as typically occurs in a peer-to-peer environment.

The purchase price was $600,000, of which $60,000 is payable in cash, $180,000 is payable in cash or stock on or before the third anniversary of the Agreement, depending upon the attainment of subscriber milestones. On the fourth anniversary of the Agreement, we have the option of either paying the remaining consideration or reverting the Agreement and the Intellectual Property back to Xtreme while retaining a perpetual non-exclusive, paid-up, royalty free license to utilize and sub-license the Intellectual Property. Any royalties paid to Xtreme or gains in the market value of stock received by Xtreme based on the last closing price of an aggregate of 30 days during the four year period when Xtreme is free to sell such shares with the highest market value, shall be applied to the remaining consideration. In the event that we license the Intellectual Property as a product to third parties, but not a sale of the Intellectual Property in its entirety, until the sixth (6 th ) anniversary of this Agreement, Xtreme will be entitled to receive a royalty equal to 20% of software sales sold by us.

We intend to seek intellectual property coverage on this application.
 
 
We have several trademarks and service marks, all of which are of material importance to us.

The following trademarks and service marks are registered with the United States Patent Trademark Office:

1.  
Fusion Telecommunications International
2.  
FTI
3.  
Diamond / Block Logo
4.  
Diamond Logo
5.  
Fusion
6.  
Fusion Telecom
7.  
efonica (logo)
8.  
Efonica

The following trademarks and service marks are filed with the United States Patent Trademark Office and are currently in registration process:

1.  
Fusion Tel
2.  
Fusion (logo)
3.  
HEAR THE DIFFERENCE

The telecommunications markets have been characterized by substantial litigation regarding patent and other intellectual property rights. Litigation, which could result in substantial cost to and diversion of our efforts, may be necessary to enforce trademarks issued to us or to determine the enforceability, scope and validity of the proprietary rights of others. Adverse determinations in any litigation or interference proceeding could subject us to costs related to changing names and a loss of established brand recognition.

Employees

As of December 31, 2005, we had 92 employees in Fusion Telecommunications International, Inc., and none of our employees are represented by a labor union. We consider our employee relations to be good, and we have never experienced a work stoppage.

Confidentiality Agreements

All our 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.

Revenues and Assets by Geographic Area  

During the years ended December 31, 2005 and 2004, 89.5% and 93.3%, respectively, of our revenue was derived from customers in the United States and 10.5% and 6.7%, respectively, from international customers. As of December 31, 2005 and 2004, 5.4% and 3.5%, respectively, of our long-lived assets were located out of the United States. For more information concerning our geographic concentration, see Note 19 of the Notes to Consolidated Financial Statements included elsewhere in this report.

Available Information

We are subject to the informational requirements of the Securities Exchange Commission and in accordance with those requirements file reports, proxy statements and other information with the Securities and Exchange Commission. You may read and copy the reports, proxy statements and other information that we file with the Commission under the informational requirements of the Securities Exchange Act at the Commission’s Public Reference Room at 450 Fifth Street N.W., Washington, DC 20549. Please call 1-800-SEC-0339 for information about the Commission’s Public Reference Room. The Commission also maintains a web site that contains reports, proxy and information statements and other information regarding registrants that file electronically with the Commission. The address of the commission’s web site is http://www.sec.gov. Our web site is http://www.fusiontel.com. We make available through our web site, free of charge, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q. Current reports on Form 8-K and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Commission. Information contained on our web site is not a part of this report.
 

ITEM 2. PROPERTIES

We are headquartered in New York, New York and lease offices and space in a number of locations. Below is a list of our leased offices and space as of March 31, 2006.

Location
 
Lease expiration
 
Annual Rent
 
Purpose
 
Approx. sq. ft
 
420 Lexington Avenue, Suite 1718-22
New York, New York 10170
   
October 2015
 
$
428,000(1
)
 
Lease of principal
executive offices
   
9,000
 
75 Broad Street
New York, New York 10007
   
March 2010
 
$
615,000 (2
)
 
Lease of network
facilities
   
15,000
 
1475 W. Cypress Creek Road
Suite 204
Fort Lauderdale, Florida 33309
   
May 2014
 
$
164,000 (3
)
 
Lease of network
facilities and office space
   
13,100
 
Premises GO2- GO3
Building No. 9
Dubai Internet City
Dubai, United Arab Emirates
   
December 2006
 
$
42,000
   
Lease of office space
   
1,300
 
Kingston, Jamaica
30-36 Knutsford Boulevard
Kingston 5, Jamaica
   
May 2010
 
$
31,000 (4
)
 
Lease of office space
   
5,600
 
                           
(1)
This lease is subject to gradual increase to $509,000 from years 2007 to 2015.
(2)
This lease is subject to gradual increase to $673,000 from years 2007 to 2010.
(3)
This lease is subject to gradual increase to $215,000 from years 2007 to 2014.
(4)
This lease is subject to increase from May 2006 by 10% more than the change in the CPI, or the previous lease year provided that no increase shall exceed 12.5% of the previous years’ rent or fall below 5% of the previous years’ rent.

We believe that our leased facilities are adequate to meet our current needs and that additional facilities are available to meet our development and expansion needs in existing and projected target markets.

ITEM 3. LEGAL PROCEEDINGS

On May 28, 2003, Jack Grynberg, et al., an investor in one of our private offerings, filed a complaint with the Denver District Court, State of Colorado ( Jack Grynberg, et al v. Fusion Telecommunications International, Inc., et al, 03-CV-3912) seeking damages in the amount of $400,000 for the purchase of an interest in Fusion’s 1999 private placement offering of subordinated convertible notes through Joseph Stevens & Company, Inc., a registered broker dealer. This complaint asserted the following claims for relief against us: Breach of Fiduciary Duty, Civil Theft, Deceptive Trade Practices, Negligent Misrepresentation, Deceit Based on Fraud, Conversion, Exemplary Damages and Prejudgment Interest. On June 25, 2004, we filed with the Court our Motion to Dismiss, which was granted. We were awarded attorneys’ fees by the court. The plaintiffs have filed an appeal of the motion, which is pending.
 
On March 30, 2006, an equipment vendor, filed a complaint with the Circuit Court in Broward County, State of Florida seeking damages in the amount of $1,379,502 allegedly due on two promissory notes plus accrued interest through March 1, 2006 and attorney costs. Management will assert a counterclaim against the vendor and intends to vigorously defend the action. Our legal counsel has advised that, at this stage, they cannot accurately predict the likelhood of an unfavorable outcome or quantify the amount or range of potential loss, if any. Accordingly, with the exception of amounts previoulsy accrued by us under the capital lease arrangement, no adjustment that may result from resolution of these uncertainties has been made in our accompanying financial statements.
 
Due to the regulatory nature of the industry, we are periodically involved in various correspondence and inquiries from state and federal regulatory agencies. Management does not expect the outcome of these inquiries to have a material impact on our operations or financial condition.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

There were no matters submitted to a vote of security holders in the fourth quarter of the fiscal year ended December 31, 2005.
 

PART II

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS

Market Information

Our common stock is currently listed on the American Stock Exchange under the symbol “FSN”, and our redeemable common stock purchase warrants are listed on the American Stock Exchange under the symbol “FSN.WS”.

Prior to February 15, 2005, there was no established trading market for our common stock and redeemable common stock warrants.
 
Common Stock
 
Year Ended December 31, 2005
 
High
 
Low
 
            
First Quarter
 
$
7.70
 
$
4.90
 
Second Quarter
 
$
5.11
 
$
4.05
 
Third Quarter
 
$
4.70
 
$
3.51
 
Fourth Quarter
 
$
3.70
 
$
2.30
 

Redeemable Common Stock Purchase Warrants

Year Ended December   31, 2005
 
High
 
Low
 
           
First Quarter
 
$
1.42
 
$
0.85
 
Second Quarter
 
$
0.95
 
$
0.45
 
Third Quarter
 
$
0.64
 
$
0.40
 
Fourth Quarter
 
$
0.53
 
$
0.23
 

On March 24, 2006, the last reported sale price for our common stock on the American Stock Exchange was $2.75 per share and the last reported sale price for our redeemable common stock purchase warrants were $0.43 per warrant. The market price for our stock and warrants is highly volatile and fluctuates in response to a wide variety of factors.

Holders  

As of March 24, 2006, we had approximately 2,051 holders of record of our common stock and 1,399 holders of record of our redeemable common stock purchase warrants. This does not reflect persons or entities that hold their stock in nominee or “street” name through various brokerage firms.

Dividend Policy

We have never declared or paid any cash dividends on our 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. Any future determination to pay cash dividends will be at the discretion of our board of directors and will be dependent upon our financial condition, operating results, capital requirements and other factors that our board of directors considers appropriate.

Issuer Purchases of Equity Securities

There have been no purchases of equity securities by the company required to be disclosed herein.
 

Use of Proceeds

The Company’s Registration Statement filed with the Securities and Exchange Commission on Form S-1 (Registration No. 333-120412) to register 3,600,000 shares of common stock and 3,600,000 redeemable common stock purchase warrants convertible into shares of common stock was declared effective on February 8, 2005. The offering commenced on January 18, 2005, and terminated on February 12, 2005. Upon completion, the underwriters managed by Kirlin Securities, Inc., successfully sold 3,600,000 shares of common stock and 3,600,000 redeemable common stock purchase warrants at $6.45 and $0.05, respectively, for an aggregate offering price of $6.50. On March 30, 2005, the underwriters exercised their over-allotment and purchased an additional 480,000 shares of common stock and 540,000 purchase warrants. The net proceeds of the offering, including the over-allotment, totaled $23,300,000 which we are using for the build-out of its retail infrastructure, purchase of additional equipment for expanded capacity and service offerings, international deployment, our marketing and advertising and working capital.

The Registration Statement also registered 3,141,838 redeemable common stock purchase warrants to be offered for sale by certain selling security holders. The Company will not receive any proceeds from the sales of such warrants.

As of December 31, 2005, approximately $2.5 million of the net proceeds received by the Company were used to repay outstanding debt and capital leases, and $0.6 million was used to repay accrued interest. Approximately $1.9 million was used to purchase property and equipment and $1.0 million was used in connection with the Company’s purchase of the minority interest in its Efonica joint venture and the Company’s investment in a Turkey joint venture. In addition, the Company used approximately $1.8 million of the net proceeds to fund operations.

Of these payments, principal and accrued interest in respect of indebtedness to the Company was repaid as follows: approximately $1.1 million to Marvin S. Rosen, Chairman of the Board and former Chief Executive Officer, $0.8 million to Philip Turits, Secretary, Treasurer and Director, $0.2 million to Evelyn Langlieb Greer, Director.

Karamco, Inc., a corporation of which Roger Karam, our President of VoIP Division, is the sole shareholder, received $910,000 with respect to the Company’s purchase of the minority interest in Efonica.

Equity Compensation Plans  

The following table provides certain aggregate information with respect to all of our equity compensation plans in effect for year ended December 31, 2005:
               
Plan category  
Number of securities to
be issued upon exercise of
outstanding options,
warrants and rights
 
Weighted average
exercise price of
outstanding options,
warrants and rights
 
Number of securities
remaining available
for future issuance
 
Equity compensation plans approved by security holders
   
2,042,799
 
$
4.05
   
638,058
 
Equity compensation plans not approved by security holders
   
—
   
—
   
—
 
Total
   
2,042,799
 
$
4.05
   
638,058
 
 
 

ITEM 6. SELECTED FINANCIAL DATA

The following table sets forth selected historical financial data as of and for each of the periods ended December 31, 2005, 2004, 2003, 2002 and 2001. The selected financial data are derived from the audited consolidated financial statements of Fusion Telecommunications International, Inc. The consolidated financial statements, and the report thereon, as of December 31, 2005 and 2004, and for the three year period ended December 31, 2005 which are included elsewhere in this Annual Report on Form 10-K. The following financial information should be read in conjunction with “Management’s Discussion and Analysis and Results of Operations” and our consolidated financial statements and related notes appearing elsewhere in this Annual Report.
 
     
Years Ended December 31,
 
   
2005
   
2004
   
2003
   
2002
   
2001
 
Revenues
 
$
49,364,542
 
$
49,557,973
 
$
32,018,471
 
$
25,537,163
 
$
28,142,302
 
Operating expenses:
                           
Cost of revenues
   
45,048,917
   
42,927,994
   
27,855,508
   
23,638,447
   
23,139,984
 
Depreciation and amortization
   
1,510,172
   
1,804,184
   
1,981,805
   
2,361,495
   
1,948,823
 
Loss on impairment
   
—
   
—
   
375,000
   
467,765
   
2,825,149
 
Selling, general and administrative expenses
   
11,939,001
   
9,804,405
   
8,575,807
   
9,626,160
   
10,085,468
 
Total Operating Expenses
   
58,498,090
   
54,536,583
   
38,788,120
   
36,093,867
   
37,999,424
 
Operating loss
   
(9,133,548
)
 
(4,978,610
)
 
(6,769,649
)
 
(10,556,704
)
 
(9,857,122
)
                                 
Other income (expense):
                               
Interest income (expense), net
   
39,360
   
(2,228,060
)
 
(846,896
)
 
(1,058,345
)
 
(543,754
)
Gain (loss) on settlements of debt
   
(75,927
)
 
2,174,530
   
3,918,295
   
1,812,092
   
—
 
Gain (loss) from investment in Estel
   
(541,876
)
 
(519,728
)
 
(746,792
)
 
326,367
   
(1,711,352
)
Other
   
(195,346
)
 
(15,965
)
 
(97,766
)
 
98,626
   
—
 
Minority interests
   
175,353
   
(7,654
)
 
157,617
   
19,440
   
—
 
Total other income (expense)
   
(598,436
)
 
(596,877
)
 
2,384,458
   
1,198,180
   
(2,255,106
)
Loss from continuing operations
   
(9,731,984
)
 
(5,575,487
)
 
(4,385,191
)
 
(9,358,524
)
 
(12,112,288
)
                                 
Discontinued operations:
                             
Income (loss) from discontinued operations
   
336,910
   
545,215
   
208,620
   
—
   
(7,029,511
)
Net loss
 
$
(9,395,074
)
$
(5,030,272
)
$
(4,176,571
)
$
(9,358,524
)
$
(19,141,739
)
 
Losses applicable to common stockholders:                                
Loss from continuing operations
 
$
(9,731,984
)
$
(5,575,487
)
$
(4,385,191
)
$
(9,358,524
)
$
(12,112,228
)
Preferred stock dividends
   
—
   
(385,918
)
 
(635,254
)
 
(642,552
)
 
—
 
Net loss applicable to common stockholders from continuing operations:
   
(9,731,984
)
 
(5,961,405
)
 
(5,020,445
)
 
(10,001,076
)
 
(12,112,228
)
Income (loss) from discontinued operations
   
336,910
   
545,215
   
208,620
   
—
   
(7,029,511
)
Net loss applicable to common stockholders
 
$
(9,395,074
)
$
(5,416,190
)
$
(4,811,825
)
$
(10,001,076
)
$
(19,141,739
)
                                 
Basic and diluted net loss per common share:
 
Loss from continuing operations
 
$
(0.39
)
$
(0.35
)
$
(0.37
)
$
(1.01
)
$
(1.30
)
Income (loss) from discontinued operations
   
0.01
   
0.03
   
0.02
   
—
   
(0.76
)
Net loss applicable to common stockholders
 
$
(0.38
)
$
(0.32
)
$
(0.35
)
$
(1.01
)
$
(2.06
)
                                 
Weighted average shares outstanding
                               
Basic and diluted
   
24,965,080
   
16,707,114
   
13,616,803
   
9,885,901
   
9,305,857
 
 
   
Years Ended December 31,
 
   
2005
 
2004
 
2003
 
2002
 
2001
 
Operating data:
                      
Capital expenditures
 
$  
(1,877,252
)
$  
(627,219
)
$  
(582,149
)
$  
(427,057
)
$  
(346,452
)
Summary Cash Flow Data:
                               
Net cash used in operating activities
   
(7,980,651
)
 
(4,874,834
)
 
(4,884,543
)
 
(4,265,500
)
 
(9,424,534
)
Net cash used in investing activities
   
(2,396,445
)
 
(250,460
)
 
(744,071
)
 
(983,453
)
 
(830,843
)
Net cash provided by financing activities
   
20,798,874
   
6,288,375
   
8,097,832
   
5,985,380
   
10,084,405
 
                                 
Balance Sheet Data (at period end):
 
Cash
 
$
14,790,504
 
$
4,368,726
 
$
3,205,645
 
$
736,427
 
$
—
 
Restricted cash
   
—
   
380,276
   
736,626
   
1,051,182
   
784,000
 
Property and equipment
   
12,459,595
   
11,022,330
   
10,078,806
   
10,623,109
   
11,715,389
 
Property and equipment, net
   
4,516,271
   
3,271,474
   
3,743,293
   
5,649,787
   
8,281,089
 
Total assets
   
34,385,779
   
13,662,117
   
11,681,625
   
10,992,016
   
12,624,810
 
Total debt
   
1,577,615
   
5,687,631
   
4,644,904
   
9,151,925
   
11,729,653
 
Redeemable preferred stock
   
—
   
9,716,026
   
3,466,538
   
—
   
—
 
Total stockholders’ equity (deficit)
   
17,721,641
   
(13,290,029
)
 
(9,866,927
)
 
(14,867,407
)
 
(11,581,006
)
 
 

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion of our financial condition and results of operations should be read together with our consolidated financial statements and the related notes thereto included in another part of this Annual Report. This discussion contains certain forward-looking statements; within the meaning of the Private Securities Litigation Reform Act of 1995, that involve substantial risks and uncertainties. When used in this report the words “anticipate,” “believe,” “estimate,” “expect” and similar expressions as they relate to our management or us are intended to identify such forward-looking statements. Our actual results, performance or achievements could differ materially from those expressed in, or implied by, these forward-looking statements. Historical operating results are not necessarily indicative of the trends in operating results for any future period.

Overview

We are an international communications carrier delivering VoIP, private networks, Internet access, and other advanced services to, from, in and between emerging markets in Asia, the Middle East, Africa, Latin America, and the Caribbean. Our corporate strategy focuses our resources on customizing VoIP services to meet the demands of international communities of interest in the emerging markets and around the world. We seek to gain early entry in high growth emerging markets, often in partnership with local organizations that have strong distribution channels, regulatory experience, market intelligence, the ability to deliver local loops and the capability of providing customer service support. This approach enables us to introduce our Internet protocol communications services in these markets, thereby benefiting from the time-to-market advantages, expanded geographic reach and reduced capital requirements that local partnerships afford. Additionally, we have worked over the last 12 months to build a carrier grade retail infrastructure to expand our VoIP service and feature options and to better support the growth of our VoIP services to consumers and corporations.

The following table summarizes our results of operations for the periods indicated:

 
 
Years Ended December 31,
 
 
 
2005
 
2004
 
2003
 
Revenues
 
$
49,364,542
 
$
49,557,973
 
$
32,018,471
 
Operating expenses:
                 
Cost of revenues
   
45,048,917
   
42,927,994
   
27,855,508
 
Depreciation and amortization
   
1,510,172
   
1,804,184
   
1,981,805
 
Loss on impairment
   
—
   
—
   
375,000
 
Selling, general and administrative
   
11,939,001
   
9,804,405
   
8,575,807
 
Operating loss
   
(9,133,548
)
 
(4,978,610
)
 
(6,769,649
)
                 
Other income (expense):
             
Interest income (expense), net
   
39,360
   
(2,228,060
)
 
(846,896
)
Gain (loss) on settlements of debt
   
(75,927
)
 
2,174,530
   
3,918,295
 
Loss from investment in Estel
   
(541,876
)
 
(519,728
)
 
(746,792
)
Other
   
(195,346
)
 
(15,965
)
 
(97,766
)
Minority interests
   
175,353
   
(7,654
)
 
157,617
 
  Total other income (expense)
   
(598,436
)
 
(596,877
)
 
2,384,458
 
Loss from continuing operations
   
(9,731,984
)
 
(5,575,487
)
 
(4,385,191
)
Gain from discontinued operations
   
336,910
   
545,215
   
208,620
 
Net loss
 
$
(9,395,074
)
$
(5,030,272
)
$
(4,176,571
)
                   
 
 

The following table presents our historical operating results as a percentage of revenues for the periods indicated:

 
 
Years Ended December 31,
 
 
 
2005
 
2004
 
2003
 
Revenues
   
100.0
%
 
100.0
%
 
100.0
%
Operating expenses:
                 
      Cost of revenues
   
91.3
%
 
86.6
%
 
87.0
%
      Depreciation and amortization
   
3.1
%
 
3.6
%
 
6.2
%
      Loss on impairment
   
0.0
%
 
0.0
%
 
1.2
%
      Selling, general and administrative
   
24.2
%
 
19.8
%
 
26.8
%
Operating loss
   
(18.6
)%
 
(10.0
)%
 
(21.1
)%
 
               
Other income (expense):
             
      Interest expense, net
   
0.1
%
 
(4.5
)%
 
(2.6
)%
      Gain (loss) on settlement of debt
   
(0.2
)%
 
4.4
%
 
12.2
%
      Loss on equity investment
   
(1.1
)%
 
(1.0
)%
 
(2.3
)%
      Other
   
(0.4
)%
 
0.0
%
 
0.3
%
      Minority interests
   
0.4
%
 
0.0
%
 
0.5
%
  Total other income (expense)
   
(1.2
)%
 
(1.2
)%
 
7.4
%
Loss from continuing operations
   
(19.8
)%
 
(11.3
)%
 
(13.7
)%
Gain from discontinued operations
   
0.7
%
 
1.1
%
 
0.7
%
Net loss
   
(19.1
)%
 
(10.2
)%
 
(13.0
)%
                     
Revenues

Historically, we have generated the majority of our revenues from voice traffic sold to other carriers, with a primary focus in the last several years on VoIP terminations to the emerging markets. We focus on growing our existing customer base, which is primarily U.S. based, as well as the addition of new customers, and the establishment of direct VoIP terminating arrangements with telecommunication carriers in emerging markets and around the world. Although we believe that this business continues to be of value to our strategy, ongoing competitive and pricing pressures have caused us to increase our focus on higher margin, value-added services (primarily VoIP to consumers and businesses), and market them to, or in conjunction with, distribution partners on a direct, co-branded or private label basis.

In an effort to further increase margins, expand our retail customer base, and develop more stable revenue streams, we have begun to focus significant effort and resources to build our VoIP business to consumers and corporations. While this does not yet represent a significant portion of our revenue base, we expect to continue to increase our emphasis in this area. We believe that this will complement our carrier business with a higher margin and more stable customer base.

In 2002, we established Efonica F-Z, LLC, as a retail services company marketing VoIP products to consumer and corporate customers in emerging markets. Beginning in the Middle East, Asia and Africa, then extending into Latin America, Efonica’s services are primarily sold through distribution channels on a pre-paid basis. Efonica’s customers can place calls from anywhere in the world to any destination using a personal computer, Internet protocol telephone or regular telephone when accompanied by a hardware device that may be purchased through Efonica. We believe that the introduction of advanced features such as voicemail, call waiting and call forwarding will enhance this value-added offering. We expect to add these features by the second quarter of 2006. In February 2005, we closed on the purchase of the 49.8% minority interest in Efonica.

Our increased focus on VoIP services to enterprise customers resulted in a growing upward trend for this product segment. During the years ended December 31, 2005, 2004, and 2003, VoIP services to consumers and corporations accounted for 7.6%, 6.3% and 1.0%, respectively, of our total consolidated revenue.
  
We manage our revenues by product and customer. We manage our costs by provider (vendor). We track total revenue at the customer level because our sales force has to manage the revenue generation at the customer level, and invoices are billed to and collected at the customer level. We also have to track the same revenues by product, because different products have different billing and payment terms, and individual customers may have multiple billing and payment terms if they purchase multiple products from us.

We manage our revenue segments based on gross margin, which is net revenues less cost of revenues, rather than on net profitability, due to the fact that our infrastructure is built to support all products, rather than individual products. This applies both to the capital investments made (such as switching and transmission equipment), and to Selling, General and Administrative resources. The majority of our sales and operations personnel support all product lines within their market segment, i.e. carrier, and are not separately hired to support individual product segments. For segment reporting purposes, all expenses below cost of revenues are allocated based on percentage of revenues unless the items can be specifically identified to one of the product segments.
 

OPERATING EXPENSES

Our operating expenses are categorized as cost of revenues, depreciation and amortization, loss on impairment, and selling, general and administrative expenses.

Cost of revenues includes costs incurred with the operation of our leased network facilities, and the purchase of voice termination and Internet protocol services from other telecommunications carriers and Internet service providers. We continue to work to lower the variable component of the cost of revenue through the use of least cost routing, and continual negotiation of usage-based and fixed costs with domestic and international service providers.

Depreciation and amortization includes depreciation of our communications network equipment, amortization of leasehold improvements of our switch locations and administrative facilities, and the depreciation of our office equipment and fixtures. In 2005, it also includes amortization of the Efonica customer list.

Selling, general and administrative expenses include salaries and benefits, commissions, occupancy costs, sales, marketing and advertising, professional fees and other administrative expenses.

COMPANY HIGHLIGHTS

The following summary of significant events during the three years ended December 31, 2005, highlights the accomplishments and events that have influenced our performance during that time period.

2005

·  
Capital Fund-Raising — In February 2005, we closed on our initial public offering of securities of 3,600,000 shares of common stock at a price of $6.45 per share and 3,600,000 redeemable common stock purchase warrants at $.05 per warrant. Net proceeds of the offering were approximately $20.4 million. On March 30, 2005, our underwriters exercised their over-allotment option and purchased an additional 480,000 shares of common stock and 540,000 purchase warrants. We received an additional $2.9 million in net proceeds from the closing on the over-allotment option.

·  
Debt Reduction — Upon completion of our IPO we repaid approximately $1.5 million in outstanding debt. In addition, $2.5 million of convertible debt was converted into 651,515 shares of common stock. During May 2005, we repaid an additional $0.2 million of debt.

·  
Conversion of Series C Preferred Stock — The $10.0 million liability related to the 109,962 shares of outstanding Series C Preferred Stock was converted into equity (3,141,838 shares of common stock).

·  
VoIP to Consumers and Corporations Revenue Growth — Revenue in our retail VoIP to consumers and corporations segment grew 20.7% during 2005 over 2004. This segment’s revenue is expected to increase significantly once our new VoIP products and services are rolled out.

·  
Purchase of a Jamaica Entity — In January 2005, we concluded the purchase of a 51.0% interest in Convergent Technologies, which has international and domestic license agreements with the Jamaican government.

·  
Purchase of Efonica — In February 2005, we acquired the remaining 49.8% interest in our Efonica joint venture.

·  
Turkey Purchase Agreement — In May 2005, we closed on the stock purchase agreement with an entity in Turkey to acquire 75% of the shares from the existing shareholders. This subsidiary will enable us to provide VoIP services under our Efonica brand and other Internet services to corporations and consumers in Turkey.

·  
Manufacturing and Distribution Agreement — In August 2005, we signed an agreement to partner with a leading manufacturer of VoIP and communication technology hardware devices. This partnership will focus on the development and manufacturing of a complete line of branded VoIP hardware devices that will enable consumers and corporations to access our service suite from anywhere in the world. The manufacturer has also agreed to work with us on the distribution of our efonica VoIP services plans, and plans to market its VoIP hardware devices pre-configured or set-up with our efonica service in a revenue sharing arrangement.
 
 

 
·  
iFreedom —   On November 14, 2005, we entered into an agreement to acquire the assets of iFreedom Communications International Holdings Limited (“iFreedom”), and a number of its subsidiaries, an entity that markets monthly recurring international VoIP service plans geared to meet the needs of consumers and businesses in the emerging markets. The agreement provided for a purchase price of $500,000 in cash, and 1,100,000 shares of stock, of which 750,000 shares were to be held in escrow and were subject to a performance based earn out. Under the terms of the agreement, we would have acquired iFreedom’s customer base as well as operations in Hong Kong, the Philippines, Malaysia, the United Kingdom, and the United States. As certain closing conditions have not yet been met by iFreedom, the parties have been working in good faith to renegotiate the terms and conditions of the transaction and have reached a proposed resolution. Fusion now plans to acquire iFreedom's operations in Malaysia and the Philippines. In addition, Fusion would hire certain of iFreedom’s employees and potentially acquire certain other assets. The purchase price is expected to be $500,000 in cash, which may go towards satisfying certain liabilities iFreedom owes to Fusion as described below, and 750,000 shares of common stock, of which 350,000 shares would be held in escrow subject to a performance based earn out. We anticipate executing a formal agreement documenting this new understanding, although there can be no assurance that such an agreement will be signed, what parties will be included, or that the above stated terms will be included.
 
2004  
 
·  
Revenue Growth — Revenue grew 54.8% in 2004 over 2003.

·  
Reduced SG&A — As a percentage of revenue, SG&A decreased from 26.8% in 2003 to 19.8% in 2004.

·  
Purchase of Veraz Softswitch — In April of 2004, we invested in excess of $0.8 million in a Veraz Softswitch, which became operational in July 2004.

·  
Payable & Debt Reduction — We further reduced our payables by negotiating in excess of $2.0 million in reductions of outstanding vendor obligations through settlements. In addition, the Company converted $0.6 million of debt to Series C Convertible Preferred Stock and converted $0.1 million of outstanding vendor obligations to common stock.

·  
Capital Fund-Raising — We raised $4.6 million to complete the second tranche of a Series C Convertible Preferred Stock offering that had been initiated in November of 2003. Additionally, we raised $1.3 million from a common stock offering that was initiated in 2003.

2003

·  
Revenue Growth — Revenue grew $6.5 million, or 25.4%, from the prior year, excluding discontinued operations.

·  
Successful Bid of Government Contracts — We were awarded a subcontractor bid to be the provider for Internet access for seventeen U.S. Embassies and Consulates located in Asia and the Middle East, and we also were awarded a bid to supply a private network for the U.S. Department of Defense in the Persian Gulf.

·  
Addition of San Jose Point of Presence — In November of 2003, we added network equipment and a point of presence in San Jose, California, to support service to Asia.

·  
Reduced SG&A — We reduced SG&A by $1.1 million, or 10.9%, from the prior year, while total revenues increased 25.4%.

·  
Debt Reduction — We further reduced debt by negotiating $3.9 million in reduction of outstanding vendor obligations through settlements. We also converted $3.2 million in debt to preferred and common stock.

·  
Capital Fund-Raising — In November 2003, we initiated a Convertible Preferred Stock offering, with the first of the two stock closings occurring in December 2003. In the first closing, we raised $2.5 million. We also raised $3.0 million from common stock purchases in 2003 initiated with the private placement from 2002, and we raised an additional $3.8 million from common stock purchases in 2003 associated with an equity offering initiated in 2003.
 
 

The information in our period-to-period comparisons below represents only our results from continuing operations.

Year Ended December 31, 2005 Compared with Year Ended December 31, 2004.

Revenues

Consolidated revenues remained fairly consistent between the two years ($49.4 million during 2005 compared to $49.6 million during 2004). An increase in our revenues for VoIP services to consumers and corporations was net with decreases in our voice to carriers revenues and Internet, managed private networks & other revenues.

Revenues for VoIP services to consumers and corporations represented a larger percentage of our revenues during 2005 (7.6% of our consolidated revenues during 2005 compared to 6.3% during 2004). This increase from $3.1 million in 2004, to $3.8 million in 2005, was mainly due to the growth of our efonica branded retail services. Once our new retail VoIP products and services are rolled out, we expect this segment’s revenues to grow significantly during the next few years.

Revenues for voice services sold to carriers decreased $0.6 million or 1.4% in 2005 versus 2004. During the year ended 2005, these revenues were impacted by a combination of technical difficulties associated with the migration to the new Softswitch, and the peaks and valleys of the carrier business, downward pricing pressure on average rate per minute. Additionally, the time and effort spent in upgrading the infrastructure impacted the productivity of the carrier business.

Revenues from our Internet, private network & other services decreased $0.2 million from $2.2 million in 2004 to $2.0 million in 2005, primarily due to the cancellation of a government contract.

Cost of Revenues

Consolidated cost of revenues increased $2.1 million or 4.9% to $45.0 million in 2005, from $42.9 million in 2004. Approximately $2.1 million of this increase was attributable to an increase in voice services to carriers.

The cost of revenues for VoIP services to consumers and corporations grew $0.5 million or 20.0% from $2.3 million in 2004 to $2.8 million in 2005, due primarily to the growth in that revenue base. Cost of revenues for Internet, private network & other services decreased $0.3 million or 22.1% to $1.2 million for 2005 from $1.5 million for 2004, due to the cancellation of a government contact and negotiated cost reductions related to the government contracts.

Consolidated gross margin decreased $2.3 million for 2005 over 2004. Gross margin for total voice services to carriers decreased by $2.6 million, which was partially offset by an improvement in the gross margin for VoIP services to consumers and corporations of $0.2 million, and an improvement for Internet, private networks and other of $0.1 million.

The decline in gross margin for voice services to carriers was primarily related to a more competitive wholesale market, slightly higher network costs as a percentage of revenue, and technical difficulties associated with the migration to the Softswitch technology. The migration difficulties adversely impacted our ability to route traffic to the least cost provider, specifically for the first quarter of 2005.

Operating Expenses

Depreciation and Amortization. Depreciation and amortization decreased by $0.3 million or 16.3% to $1.5 million during the year ended 2005, from $1.8 million during 2004. Although our fixed assets increased significantly as a result of assets added during 2005, including the new Softswitch and our new retail infrastructure currently in process, our depreciation decreased as a result of many our assets being fully depreciated during all or a part of 2005.

Selling, General and Administrative. Selling, general and administrative expenses increased $2.1 million or 21.8 % to $11.9 million during 2005, from $9.8 million during 2004. This increase is primarily attributed to increased salaries and benefits, as more personnel have been required to support the growth and expansion of our infrastructure. Also, increasing as a result of our growth becoming a public company in February 2005, have been our legal and professional fees (including expenses associated with Sarbanes Oxley), advertising/marketing expenses, travel related expenses, occupancy costs, and insurance expense. As a percentage of revenues, selling, general and administrative expenses increased from 19.8 % during 2004, to 24.2 % during 2005. We believe that as we execute our business strategies, selling, general and administrative expenses as a percentage of revenues will begin to decline.
 
 
Operating Loss. Our operating loss increased $4.1 million or 83.5% to a loss of $9.1 million during 2005, from a loss of $5.0 million during 2004. The increase in operating loss was primarily attributable to both the decrease in gross margin and the increase in selling, general and administrative expenses associated with infrastructure growth and public company compliance requirements.

Other Income (Expense). Total other income (expense) remained consistent at a net expense of $0.6 million during both years. During 2005, we had interest expense of $0.4 million in contrast to interest expense of $2.2 million during 2004. The $2.2 million of interest expense during 2004, included accretion of $1.7 million (in accordance with SFAS 150) related to the then outstanding Series C Preferred Stock. The $0.4 million interest expense for 2005 included only $0.3 million of accretion since all the Series C Preferred Stock was converted to common stock in connection with our February 2005 IPO. Consequently, accretion ceased and 2005 interest expense only includes accretion for the period between January 1, 2005 and February 17, 2005. In addition, interest expense was higher during 2004, as the Company had significant outstanding debt throughout all of 2004. A significant portion of this debt was repaid during February 2005 in connection with our IPO. We also had increased interest income during 2005 of $0.5 million versus $26,000 during 2004, as a result of the investment of the IPO proceeds. Gain (loss) on debt settlements changed from a net gain of $2.2 million in 2004 to a net loss of $0.1 million during 2005. The 2004 gain on debt forgiveness was attributed to $0.2 million of settlements of capital lease obligations, $0.4 million of settlement of general obligations and $1.6 million of settlements of network obligations. The loss from investment in Estel remained consistent at $0.5 million. Minority interest increased approximately $183,000 to $175,000 during the 2005 from $(7,000) during 2004. The 2005 minority interests balance is attributed to the losses incurred in connection with our Jamaica and Turkey joint ventures.

Net Loss. The primary factors impacting our net loss for the year ended December 31, 2005, were a decrease in gross margin, an increase in selling, general and administrative expenses, and the reduction in forgiveness of debt net with a decrease in interest expense and an increase in interest income.
 
Year Ended December 31, 2004 Compared with Year Ended December 31, 2003
 
Revenues  
 
Consolidated revenues increased $17.6 million or 54.8% to approximately $49.6 million in 2004 compared to $32.0 million in 2003. $13.8 million of this revenue increase was from voice sold to carriers, resulting from our increased focus on VoIP services. This growth in revenues was impacted during the third and fourth quarters of 2004 when we experienced a temporary decline in revenues during, and immediately following, our migration to the new Softswitch technology. Growth from our existing customer base contributed 59.7% of the increase in the revenues for our voice services to carriers and 40.3% of the increase was attributable to the addition of new carrier customers.
 
Revenues for VoIP services to consumers and corporations represented $2.8 million of the consolidated revenue growth, increasing from $0.3 million in 2003 to $3.1 million in 2004, mainly due to the growth of Efonica. Additionally, revenues from our Internet, private network & other services represented the remaining $0.9 million of the growth, increasing 71.8% from $1.3 million in 2003 to $2.2 million in 2004. Growth in this area was primarily due to the addition of Government related contracts that were awarded in the latter part of 2003.
 
Cost of Revenues  
 
Consolidated cost of revenues increased $15.1 million or 54.1% to $42.9 million in 2004 from $27.9 million in 2003. $12.2 million of this increase was attributable to an increase in voice services to carriers, which grew from $26.9 million in 2003 to $39.1 million in 2004. These increases are consistent with the increases in revenues from the higher volumes discussed above.
 
The cost of revenues for VoIP services to consumers and corporations grew $2.2 million in 2004, from $0.2 million to $2.4 million, due primarily to the rapid growth in that revenue base. Cost of revenues for Internet, private network & other services grew $0.7 million, from $0.8 million in 2003 to $1.5 million in 2004.
 
Gross margin increased $2.5 million or 59.3% for 2004 over 2003, fueled by the continuing shift to higher margin VoIP and Internet private network & other services. The margin for voice to carriers increased $1.6 million or 45.7% from the previous year. The gross margin for VoIP services to consumers and corporations grew $0.7 million, or 584.4% year over year, and Internet, private network & other services margin grew $0.2 million as well, which was a 36.5% increase.
 
 
Operating Expenses
 
Depreciation and Amortization . Depreciation and amortization decreased $0.2 million or 9.0% during 2004 to $1.8 million from $2.0 million during 2003 primarily due to certain assets becoming fully depreciated during 2004, the impairment of our old switch at the end of 2003 which was later replaced with our new Softswitch, and the disposal of assets during 2004.  
 
Loss on Impairment . No loss on impairment occurred during 2004. Our 2003 loss on impairment of $375,000 related to management’s decision to sell certain switching equipment to a third-party, which has since been replaced by upgraded equipment.
 
Selling, General and Administrative . Selling, general and administrative expenses increased $1.2 million or 14.3% to $9.8 million in 2004 from $8.6 million in 2003. This increase is primarily attributed to increased bad debt expense of approximately $0.7 million and an increase in salaries and benefits in our Efonica joint venture of $0.3 million as more back office personnel were required to support its growth, and a small increase in salaries in Fusion of $0.2 million. Selling, general and administrative expenses have declined as a percentage of revenue from 26.8% during 2003 to 19.8% during 2004. We believe that as we execute our business strategies, selling, general and administrative expenses as a percentage of revenue will continue to decline.
 
Operating Loss . Our operating loss decreased $1.8 million or 26.5% to a loss of $5.0 million during 2004 from a loss of $6.8 million during 2003. The decrease in operating loss was primarily attributable to the increase in revenue and gross margin.
 
Other Income (Expense) . Total other income (expense) decreased $3.0 million to a $0.6 million expense in 2004 from a $2.4 million income in 2003. Interest expense increased $1.4 million to $2.2 million in 2004 from $0.8 million in 2003, primarily attributable to the adoption of SFAS 150 during 2003. SFAS 150 resulted in our recording $1.7 million in interest expense during 2004 related to dividends and accretion on the Series C Convertible Preferred Stock subject to mandatory redemption. This interest accretion ceased in February 2005 when our Series C Preferred Stock was converted into common stock. We also recorded $0.2 million in interest expense during 2004 related to a beneficial conversion feature on convertible debt issued in November 2004. These increases are offset with a decrease in interest expense of $0.5 million during 2004 resulting from the reduction of average outstanding debt. Gain on debt forgiveness decreased in 2004 by $1.7 million to $2.2 million from $3.9 million during 2003. The 2004 gain on debt forgiveness is attributed to $0.2 million of settlements of capital lease obligations, $0.2 million of settlements of general obligations and $1.8 million of settlements of network obligations. The loss from investment in Estel decreased by $0.2 million, due to a reduced loss from the previous period. Minority interest due from joint venture partners changed $165,000 to an $8,000 loss in 2004 from $158,000 in income during 2003.
 
Net Loss . The primary factors impacting our 2004 net loss were an increase in gross margin net with an increase in interest expense and a reduction in forgiveness of debt from 2003 (see discussions above). Our 2004 net loss attributable to common stockholders was $5.4 million after giving effect to $0.4 million in dividends applicable to common stockholders. This was an improvement of $0.6 million from the prior year’s net loss applicable to common stockholders of $4.8 million.
 
Liquidity and Capital Resources

Since our inception, we have incurred significant operating and net losses. In addition, we are not generating positive cash flows from operations. As of December 31, 2005, we had stockholders’ equity of approximately $17.7 million (in comparison to a stockholders’ deficit of $13.3 million at December 31, 2004) and working capital of approximately $6.8 million (in comparison to a working capital deficit of $8.5 million at December 31, 2004). These improvements are a result of the February 2005 closing of our initial public offering of securities of 3,600,000 shares of common stock at a price of $6.45 per share and 3,600,000 redeemable common stock purchase warrants at $0.05 per warrant. Gross proceeds of the offering were approximately $23,400,000. Total estimated offering costs were approximately $3,000,000, which resulted in net proceeds of $20,400,000. On March 30, 2005, our underwriters exercised their over-allotment option and purchased an additional 480,000 shares of common stock and 540,000 purchase warrants. We received an additional $2,900,000 in net proceeds from the closing on the over-allotment option. The net proceeds from this offering were immediately used to repay a significant portion of our debt that was outstanding. The proceeds have been and will continue to be used for working capital and general corporate purposes, international deployment, and to fund the purchase of equipment for expanded capacity and service offerings. We may seek additional financing through the sale of debt or equity securities, although we have no commitments to do so.
 
 
Below is a summary of our cash flows for the periods indicated. These cash flow results are consistent with prior years in that we continued to use significant cash in connection with our operating and investing activities and had significant cash provided by financing activities.

A summary of our cash flows for the periods indicated is as follows:

 
 
Year Ended
 
Year Ended
 
Year ended
 
 
 
December 31,
 
December 31,
 
December 31,
 
 
 
2005
 
2004 (1)
 
2003
 
Cash used in operating activities
 
$
(7,980,651
)
$
(4,874,834
)
$
(4,884,543
)
Cash used in investing activities
   
(2,396,445
)
 
(250,460
)
 
(744,071
)
Cash provided by financing activities
   
20,798,874
   
6,288,375
   
8,097,832
 
Increase in cash and cash equivalents
   
10,421,778
   
1,163,081
   
2,469,218
 
Cash and cash equivalents, beginning of period
   
4,368,726
   
3,205,645
   
736,427
 
Cash and cash equivalents, end of period
 
$
14,790,504
 
$
4,368,726
 
$
3,205,645
 
                     
(1)
These figures include an aggregate of approximately $2.2 million that was paid during the period to satisfy past obligations.

Our cash flow results were and continue to be impacted by the costs associated with implementing our corporate strategy focusing our resources on VoIP and the emerging international markets, as we completed our exit from the more highly competitive, infrastructure dependent business that previously characterized our business. We completed our migration of customers to our Softswitch in August 2004 and began to rely on it in October 2004. Therefore, we have only recently completed the deployment of our packet-based network infrastructure including the latest Softswitch technology. Because certain of our costs are fixed, we expect that as our revenues increase, total expenses will represent a smaller percentage of our revenues. In addition, our cash flows have been impacted during 2005 by costs associated with our new retail infrastructure, which is being developed and, is expected to be completed during the second quarter of 2006.

Source of Liquidity

As of December 31, 2005, we had cash and cash equivalents of approximately $14.8 million. In addition, as of December 31, 2005, we had approximately $0.2 million of cash restricted from withdrawal and held by banks as certificates of deposits securing letters of credit (equal to the amount of the certificates of deposit).

From our inception through December 31, 2005, we financed our operations from cash provided from financing activities. These activities were primarily through net proceeds of approximately $23.3 million from our February 2005 IPO, and the private placement of approximately $50.8 million of equity securities, $1.6 million from the exercise of stock options and warrants, and $21.6 million from the issuance of notes. In addition, since inception we have financed the acquisition of $7.7 million of fixed assets through capital leases.

Although we believe the net proceeds from our February 2005 IPO, together with our existing cash and cash equivalents will be sufficient to meet our working capital and capital expenditure needs for the next 12 months, our long-term liquidity is dependent on our ability to attain future profitable operations. We cannot predict if and when we will be able to attain future profitability.

Uses of Liquidity  

Our short-term and long-term liquidity needs arise primarily from interest and principal payments related to our capital lease obligations, capital expenditures, working capital requirements as may be needed to support the growth of our business, and any additional funds that may be required for business expansion opportunities.

Our cash capital expenditures were approximately, $1.9 million during 2005 and $0.6 million during both 2004 and 2003. We expect our cash capital expenditures to be approximately $4.5 million for the year ending December 31, 2006. The 2006 estimated capital expenditures primarily consist of the completion of our retail infrastructure buildout, purchase of additional software for expanded product offerings, and international deployment.

Cash used in operations was approximately $8.0 million during 2005 and $4.9 million during 2004 and 2003. The cash used in our operations has historically been a function of our net losses, gains on forgiveness of debt, and changes in working capital as a result of the timing of receipts and disbursements. Our net cash used in operating activities increased significantly during 2005 primarily attributed to the increase in our net loss. Our net cash used in operating activities included in our December 31, 2005, 2004 and 2003 cash flows statements include a significant amount of cash payments and (forgiveness of debt in 2004 and 2003) that relates to liabilities from prior periods. Consequently, the resulting net cash used in operating activities during these periods was negatively impacted. Now that we have paid and settled a significant amount of these old liabilities, and expect to see an improvement in our operating results once our retail infrastructure buildout is operational, we expect our net cash used in operating activities to improve during future periods. We intend to continue to use our working capital raised from the IPO proceeds for general corporate overhead purposes, including marketing, salaries, capital expenditure requirements, and other expenses associated with the business needs.
 

In some situations, we may be required to guarantee payment or performance under agreements, and in these circumstances we would need to secure letters of credit or bonds to do so. Subsequent to December 31, 2005, in connection with our future relocation of our New York executive office during 2006, the lease amendment required us to provide a Letter of Credit in favor of the landlord in the amount of approximately $428,000. The Letter of Credit was obtained in January 2006, and is secured by $239,000 in money market funds. We also received a line of credit for $189,000 that would be drawn down upon should we default on the lease terms.

Debt Service Requirements

At December 31, 2005, we had approximately $1.6 million of current and long-term debt. Most of this balance is current and relates to our capital leases. Subsequent to our IPO in February 2005, we repaid $1.5 million of debt as well as $0.6 million of interest and converted $2.5 million of debt into common stock. Since then, we have not incurred any additional debt other than some new capital leases.

Our interest expense decreased significantly during 2005 compared to 2004 due to the following factors:

1.  
We recorded $1.7 million of accretion to interest expense related to our Series C Preferred Stock during 2004. This Series C Preferred Stock was converted to common stock during February 2005, and consequently, accretion ceased on this date (accretion was approximately $0.3 million during 2005). Although the accretion represented a non-cash charge to interest expense during 2004 and a portion of 2005, approximately $0.7 million in cash dividends were paid during January 2005, in connection with the Series C Preferred Stock.

2.  
As discussed above, subsequent to the IPO, we repaid approximately $1.5 million of debt and $2.5 million in debt was converted into equity. This reduction in our debt balances during February 2005, resulted in a significant reduction in our cash interest expense during 2005, which is expected to continue in 2006 and future years.

Capital Instruments

At December 31, 2005, we did not have any outstanding preferred stock. The only outstanding preferred stock we had as of December 31, 2004, was our Series C Preferred Stock, which provided for the payment of dividends at a rate equal to 8.0% per annum. The dividends were payable in cash annually, commencing on the first anniversary of the initial closing of the Series C Preferred Stock offering, unless the Series C Preferred Stock was converted into common stock upon the completion of an offering, in which case no dividend would be due. Since we did not go public until February 2005, cash dividends of approximately $0.7 million were paid in January 2006. So long as our common stock or other securities into which Series C Preferred Stock was convertible, was not publicly traded, at any time after the second anniversary of the initial closing of this offering, the holders of the Series C Preferred Stock may have required us to redeem their respective shares of the Series C Preferred Stock for cash equal to 112% of the stated value plus payment of accrued and unpaid dividends. Each share of the Series C Preferred Stock was convertible, at the option of the holder at any time, at the conversion price of $3.15 per share. As previously discussed, upon the closing of our IPO in February 2005, the Series C Preferred Stock automatically converted into 3,141,838 shares of our common stock. The holders of the Series C Preferred Stock also received a redeemable common stock purchase warrant.
 

Summary of Contractual Obligations

As of December 31, 2005

 
 
Less than
         
  More than
     
 
 
1 year
 
1-3 years
 
3-5 years
 
5 years
 
Total
 
Contractual obligations:
 
 
 
 
 
 
 
 
 
 
 
Debt maturing within one year
 
$
150,000
 
$
—
 
$
—
 
$
—
 
$
150,000
 
Capital leases
   
1,419,965
   
7,650
   
—
   
—
   
1,427,615
 
Operating leases
   
1,289,000
   
2,590,000
   
2,189,000
   
3,069,000
   
9,137,000
 
Minimum purchase commitments
   
444,685
   
—
   
—
   
—
   
444,685
 
Total contractual cash obligations
 
$
3,303,650
 
$
2,597,650
 
$
2,189,000
 
$
3,069,000
 
$
11,159,300
 

Critical Accounting Policies and Estimates

We have identified the policies and significant estimation processes below as critical to our business operations and the understanding of our results of operations. The listing is not intended to be a comprehensive list. In many cases, the accounting treatment of a particular transaction is specifically dictated by accounting principles generally accepted in the United States, with no need for management’s judgment in their application. In other cases, management is required to exercise judgment in the application of accounting principles with respect to particular transactions. The impact and any associated risks related to these policies on our business operations is discussed throughout “Management’s Discussion and Analysis of Financial Condition and Results of Operations” where such policies affect reported and expected financial results. For a detailed discussion on the application of these and other accounting policies, see Note 2 in the Notes to Consolidated Financial Statements for the year ended December 31, 2005, included in this Annual Report on Form 10-K. Our preparation of our consolidated financial statements requires us to make estimates and assumptions that affect the reported amount of assets and liabilities, disclosure of contingent assets and liabilities at the date of our consolidated financial statements, and the reported amounts of revenue and expenses during the reporting periods. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. There can be no assurance that actual results will not differ from those estimates and such differences could be significant.

Revenue Recognition — Our revenue is primarily derived from fees charged to terminate voice services over our network, retail sales to consumers and corporations through our efonica brand, and from monthly recurring charges associated with Internet and private line services.

Variable revenue is earned based on the number of minutes during a call and is recognized upon completion of a call, adjusted for allowance for doubtful accounts receivable and billing adjustments. Revenue for each customer is calculated from information received through our network switches. Customized software has been designed to track the information from the switch and analyze the call detail records against stored detailed information about revenue rates. This software provides us the ability to do a timely and accurate analysis of revenue earned in a period. Consequently, the recorded amounts are generally accurate and the recorded amounts are unlikely to be revised in the future.

Fixed revenue is earned from monthly recurring services provided to the customer that are fixed and recurring in nature, and are contracted for over a specified period of time. The initial start of revenue recognition is after the provisioning, testing and acceptance of the service by the customer. The charges continue to bill until the expiration of the contract, or until cancellation of the service by the customer.

Additionally, the majority of our VoIP services to consumers and corporations are prepaid. The revenue received from the prepayments that is related to VoIP termination services in the current month is booked to the current month’s revenue, and the remainder of the prepayments is booked to deferred revenue, until usage occurs.

Accounts Receivable — Accounts receivable are recorded net of an allowance for doubtful accounts. On a periodic basis, we evaluate our accounts receivable and record an allowance for doubtful accounts, based on our history of past write-offs and collections and current credit conditions. Specific customer accounts are written off as uncollectible if the probability of a future loss has been established and payments are not expected to be received.

Cost of Revenues and Cost of Revenues Accrual — Cost of revenues is comprised primarily of costs incurred from other domestic and international communications carriers to originate, transport and terminate calls. The majority of our cost of revenue is variable, based upon the number of minutes of use, with transmission and termination costs being the most significant expense. Call activity is tracked and analyzed with customized software that analyzes the traffic flowing through our network switches. Each period the activity is analyzed and an accrual is recorded for minutes not invoiced. This cost accrual is calculated using minutes from the system and the variable cost of revenue based upon predetermined contractual rates.
 

In addition to the variable cost of revenue, there are also fixed expenses. One category of fixed expenses are those associated with the network backbone connectivity to our switch facilities. These would consist of hubbing charges at our New York switch facility that allow other carriers to send traffic to our switch, satellite or cable charges to connect to our international network, or Internet connectivity charges to connect customers or vendors to Fusion’s switch via the public Internet, a portion of which are variable costs. The other category of fixed expenses is associated with charges that are dedicated point-to-point connections to specific customers (both private line and Internet access).

Intangible Assets and Goodwill Impairment Testing — Absent any circumstances that warrant testing at another time, we test for goodwill and non-amortizing intangible asset impairment as part of our year-end closing process. Impairment losses are recorded when indicators of impairment are present based primarily upon estimated future cash flows.

Income Taxes — We account for income taxes in accordance with the provisions of SFAS No. 109, “Accounting for Income Taxes” (“SFAS 109”). SFAS 109 requires companies to recognize deferred tax liabilities and assets for the expected future income tax consequences of events that have been recognized in our consolidated financial statements. Deferred tax liabilities and assets are determined based on the temporary differences between the consolidated financial statements carrying amounts and the tax bases of assets and liabilities, using enacted tax rates in the years in which the temporary differences are expected to reverse. In assessing the likelihood of utilization of existing deferred tax assets and recording a full valuation allowance, we have considered historical results of operations and the current operating environment.

Recently Issued Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) (“SFAS 123(R)”), “Share-Based Payment” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 123(R) supersedes APB No. 25, and amends SFAS No. 95, “Statement of Cash Flows.” Generally, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values determined at the date of grant. Pro forma disclosure is no longer an alternative. On April 14, 2005, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for SFAS 123(R). Under the new rule, we adopted SFAS 123(R) on January 1, 2006.
 
As permitted by SFAS No. 123, prior to January 1, 2006, we accounted for share-based payments to employees using the intrinsic value method and, as such, generally recognized no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R)’s fair value method will have an impact on our results of operations, although it will have no impact on our overall financial position. The impact of the adoption of SFAS No. 123(R) cannot be predicated at this time because it will depend on levels of share-based payments granted in the future. However, had we adopted SFAS No. 123(R) in prior years, the impact of that adoption would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net loss and proforma net loss per share in the table included in Note 2 to our consolidated financial statements.

In December 2004, the FASB issued SFAS No. 153 “Exchange of Non-monetary Assets” an amendment of APB Opinion No. 29 “Accounting for Non-monetary Transactions”. The amendments made by SFAS No. 153 are based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for non-monetary exchanges of similar productive assets and replace it with a broader exception for exchanges of non-monetary assets that do not have commercial substance. SFAS No. 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for non-monetary asset exchanges occurring in fiscal periods after the date of issuance. The provisions of SFAS No. 153 shall be applied prospectively. We do not believe the adoption of SFAS No. 153 will have a significant impact on our overall results of operations or financial position.  

In March 2005, the FASB issued FASB Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations.” FIN 47 clarifies the term conditional asset retirement obligation as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations.” Our adoption of FIN 47 did not have a material impact on our Consolidated Financial Statements.

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. This Standard retained accounting guidance related to changes in estimates, changes in reporting entity and error corrections. However, changes in accounting principles must be accounted for retrospectively by modifying the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. We do not believe adoption of this SFAS will have a material impact on our financial condition or results of operations.
 

Inflation

We do not believe inflation has a significant effect on our operations at this time.

RISK FACTORS

In addition to the other information included in this annual report, you should consider the following risk factors. This annual report contains forward-looking statements covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve risks and uncertainties that may affect our business and prospects. Our results may differ significantly from the results discussed in the forward-looking statements as a result of certain factors that are listed below or discussed elsewhere in this Annual Report and our other filings with the Securities and Exchange Commission.

Risks Related to Business  

We have a history of operating losses and, prior to our IPO, a 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.

There can be no assurance that any of our business strategies will be successful or that we will ever achieve profitability. At December 31, 2005, we had working capital of approximately $6.8 million and stockholders’ equity of approximately $17.7 million as a result of our February 2005 IPO. We have continued to sustain losses from operations and for the years ended December 31, 2005, 2004 and 2003, we have incurred a net loss applicable to common stockholders of approximately $9.4 million, $5.4 million, and $4.8 million, respectively. In addition, we have not generated positive cash flow from operations for the years ended December 31, 2005, 2004 and 2003. We may not be able to generate future profits and may not be able to support our operations, or otherwise establish a return on invested capital. Om addition , we may not have sufficient funds to execute our business strategy, requiring us to raise funds from capital markets, consequently, diluting our common stock.

If we are unable to manage our growth or implement our expansion strategy, we may increase our costs without maximizing our revenues.

We may not be able to expand our product offerings, our client base and markets, or implement the other features of our business strategy at the rate or to the extent presently planned. Our projected growth will place a significant strain on our administrative, operational and financial resources and may increase our costs. If we are unable to successfully manage our future growth, establish and continue to upgrade our operating and financial control systems, recruit and hire necessary personnel or effectively manage unexpected expansion difficulties, we may not be able to maximize revenues or profitability.

The success of our planned expansion is dependent upon market developments and traffic patterns, which will lead us to make expenditures that may not result in increased revenues.

Our purchase of network equipment and software will be based in part on our expectations concerning future revenue growth and market developments. As we expand our network, we will be required to make significant capital expenditures, including the purchase of additional network equipment and software, and to add additional employees. To a lesser extent our fixed costs will also increase from the ownership and maintenance of a greater amount of network equipment including our Softswitch, gateways, routers, satellite equipment, and other related systems. If our traffic volume were to decrease, or fail to increase to the extent expected or necessary to make efficient use of our network, our costs as a percentage of revenues would increase significantly.

We may be unable to adapt to rapid technology trends and evolving industry standards, which could lead to our products becoming obsolete.

The communications industry is subject to rapid and significant changes due to technology innovation, evolving industry standards, and frequent new service and product introductions. New services and products based on new technologies or new industry standards expose us to risks of technical or product obsolescence. We will need to use technologies effectively, continue to develop our technical expertise and enhance our existing products and services in a timely manner to compete successfully in this industry. We may not be successful in using new technologies effectively, developing new products or enhancing existing products and services in a timely manner or that any new technologies or enhancements used by us or offered to our customers will achieve market acceptance.
 

We are pursuing new lines of business, and introducing new services. In some cases, the technology for these services and/or the market for those services are untested. Thus, there can be no assurance of our ability to introduce these services on a timely basis or our ability to derive significant revenues from them.

Our ability to deploy new products and services may be hampered by technical and operational issues which could delay our ability to derive profitable revenue from these service offerings. In addition, certain service offerings such as those derived from our Directed SIP Peer-to-Peer Technology are relatively new in our industry, and the market potential is generally untested. Additionally, our ability to market these services may prove more difficult than anticipated, including factors such as our ability to competitively price such services. To date, we have not introduced these new services, and there can be no assurance that we will be able to do so, or that we will be able to derive significant revenue from these services.

Our new services are dependent upon multiple service platforms, network elements, and back-office systems, as well as the successful integration of these items. There can be no assurance of the success of this development and integration.

We have completed the infrastructure build out of the major network elements and are currently finalizing the development, integration and testing of our new services. We cannot ensure that these systems will be completed at all, or that, once completed, they will perform as expected. The failure to complete our infrastructure by the end of the second quarter of 2006 on schedule would impact our ability to market our service offerings. Our ability to effectuate our business plan is dependent on the successful rollout of this infrastructure.

We are also developing and deploying back-office systems and services platforms that will enable us to offer our customers a wide-array of services and features including subscription-based calling plans, free on-net calling via our Directed SIP Peer-to-Peer Technology, feature packages, conferencing, and unified messaging. There can be no assurance that this development of an extensive scalable back office will be completed on time or produce the desire results.

There can be no assurance that the planned migration of existing VoIP service customers onto our new infrastructure will be successful.

We will be moving existing VoIP service customers onto our new infrastructure, instead of continuing to use our existing outsourced service providers for such customers. We cannot ensure that we will be successful in moving these customers to the new infrastructure. The failure to successfully transition these customers onto our new infrastructure could result in the loss of those existing customers and negatively impact our ability to acquire new customers.

If our information and processing systems for billing and client service are not properly implemented, it could harm our ability to bill and provide services effectively.

Sophisticated back office information and processing systems are vital to our growth and our ability to monitor costs, bill clients, provision client orders, and achieve operating efficiencies. Our plans for the development and implementation of these systems rely, for the most part, on having the capital to purchase and maintain required software, choosing products and services offered by third party vendors, and integrating such products and services with existing systems. We also may require customized systems in order to meet our requirements, which may delay implementation and increase expenses. These systems must also integrate with our network infrastructure. In the event that these systems do not integrate with our network infrastructure, our ability to manage our operational or financial systems will be inhibited. We cannot ensure that they will be implemented at all, or that, once implemented, they will perform as expected. Furthermore, our right to use some of these systems is dependent upon license agreements with third party vendors.

These third-party vendors may cancel or refuse to renew some of these agreements, and the cancellation or non-renewal of these agreements may harm our ability to bill and provide services efficiently .

Some of our new services depend on proprietary technology. There can be no assurance that others will not develop similar or competing technology, or that we will be successful in establishing intellectual property rights.

We purchased a software application and other intellectual property rights relating to a VoIP software solution that will allow Directed Peer-to-Peer Internet phone connections between Session Initiated Protocol (SIP)-enabled devices without the need to route the calls through a network of third-party computers, as typically occurs in a peer-to-peer environment. There can be no assurance that others will not develop similar or competing technology. While we are taking steps to establish intellectual property rights, there can be no assurance that our efforts to establish such rights will be successful. In addition, there can be no assurance that these intellectual property rights will not be subject to challenge, or if challenged, that we will be successful in maintaining them.

If we do not operate our new Softswitch technology effectively, many of the potential benefits of the new technology may not be realized.

We have made a fundamental change in our business operations by migrating to new Softswitch technology. There are inherent risks associated with using such a relatively new technology. We may be required to spend additional time or money on integration of this technology, which could otherwise be spent on developing our services. We have experienced problems in the operation of our Softswitch. If we do not operate the technology effectively or if our technical staff and we spend too much time on operational issues, it could result in increased costs without the corresponding benefits.
 

Breaches in our network security systems may hurt our ability to deliver services and our reputation, and result in liability.

We could lose clients and expose ourselves to liability if there are any breaches to our network security systems, which could jeopardize the security of confidential information stored in our computer systems. In the last four years we experienced two known breaches of network security, which resulted in a temporary failure of network operations. Any network failure could harm our ability to deliver certain services, our reputation and subject us to liability.

Our growth is dependent upon our ability to build new distribution relationships, and to bring on new customers, of which there can be no assurance.

Our ability to grow through quick and cost effective deployment of our VoIP services is dependent upon our ability to identify and contract with local entities that will assist in the distribution of our products. This will include local sales agents that sell our retail, efonica-branded services, resellers that private label and sell our wholesale VoIP services, and referral entities such as web portals that refer potential customers to us. If we are unable to identify or contract for such distribution relationships, we may not generate the customers or revenues currently envisioned.

Our entry into new markets will rely upon our ability to obtain licenses to operate in those countries, and our ability to establish good working relationships with postal telephone and telegraph companies in order to interconnect to the telephone networks. There can be no assurance of our ability to accomplish either.

The rapid growth of our network and the growth of our international distribution capabilities are dependent upon our ability to apply for and receive licenses to operate in the foreign markets we intend to enter. They are also dependent upon our ability to establish positive working relationships with foreign postal telephone and telegraph companies, and other licensed carriers, and to negotiate and execute the agreements necessary for us to interconnect with their local networks. While we will diligently pursue these relationships, we might not be able to obtain the necessary licenses and interconnections within the time frame envisioned or not at all.

The communications services industry is highly competitive and we may be unable to compete effectively.

The communications industry, including Internet and data services, is highly competitive, rapidly evolving, and subject to constant technological change and intense marketing by providers with similar products and services. We expect that new competitors, as well as gray market operators (operators who arrange call termination in a manner that bypasses the postal telephone and telegraph company, resulting in high margins for the gray market operator and substantially lower revenues for the postal telephone and telegraph company), are likely to join existing competitors in the communications industry, including the market for VoIP, Internet and data services. Many of our current competitors are significantly larger and have substantially greater market presence as well as greater financial, technical, operational, marketing and other resources and experience than we do. In the event that such a competitor expends significant sales and marketing resources in one or several markets we may not be able to compete successfully in such markets. We believe that competition will continue to increase, placing downward pressure on prices. Such pressure could adversely affect our gross margins if we are not able to reduce our costs commensurate with such price reductions. In addition, the pace of technological change makes it impossible for us to predict whether we will face new competitors using different technologies to provide the same or similar services offered or proposed to be offered by us. If our competitors were to provide better and more cost effective services than ours, we may not be able to increase our revenues or capture any significant market share.

Industry consolidation could make it more difficult for us to compete.

Companies offering Internet, data and communications services are, in some circumstances, consolidating. We may not be able to compete successfully with businesses that have combined, or will combine, to produce companies with substantially greater financial, sales and marketing resources, larger client bases, extended networks and infrastructures and more established relationships with vendors, distributors and partners than we have. With these heightened competitive pressures, there is a risk that our revenues may not grow as expected and the value of our common stock could decline.
 

Our ability to provide services is often dependent on our suppliers and other service providers who may not prove to be effective.

A majority of the voice calls made by our clients are connected through other communication carriers, which provide us with transmission capacity through a variety of arrangements. Our ability to terminate voice traffic in our targeted markets is an essential component of our ongoing operations. If we do not secure or maintain operating and termination arrangements, our ability to increase services to our existing markets, and gain entry into new markets, will be limited. Therefore, our ability to maintain and expand our business is dependent, in part, upon our ability to maintain satisfactory relationships with incumbent and other licensed carriers, Internet service providers, international exchange carriers, satellite providers, fiber optic cable providers and other service providers, many of which are our competitors, and upon our ability to obtain their services on a cost effective basis, as well as the ability of such carriers to carry the traffic we route to their networks or provide network capacity. If a carrier does not carry traffic routed to it, or provide required capacity, we may be forced to route our traffic to, or buy capacity from, a different carrier on less advantageous terms, which could reduce our profit margins or degrade our network service quality. In the event network service is degraded it may result in a loss of customers. To the extent that any of these carriers raise their rates, change their pricing structure, or reduce the amount of capacity they will make available to us, our revenues and profitability may be adversely affected.

We rely on third party equipment suppliers who may not be able to provide us the equipment necessary to deliver the services that we seek to provide.

We are dependent on third party equipment suppliers for equipment software and hardware components, including Cisco, Nuera, Juniper Networks, Nextone and Veraz. If these suppliers fail to continue product development and research and development or fail to deliver quality products or support services on a timely basis, or we are unable to develop alternative sources, if and as required, it could result in our inability to deliver the services that we currently and intend to provide.

We rely on the cooperation of postal telephone and telegraph companies who may hinder our operations in certain markets.

In some cases we will require the cooperation of the postal telephone and telegraph company or another carrier in order to provide services under a license or partnership agreement. In the event the postal telephone and telegraph company or another carrier does not cooperate, our service rollout may be delayed, or the services we offer could be negatively affected. If we acquire a license for a market and the postal telephone and telegraph company or incumbent carrier desires to negatively affect our business in the area, they may be in a position to significantly delay our ability to provide services in that market and ultimately make it not worth pursuing.

If we are unable to develop and maintain successful relationships with our joint venture partners, we could fail in an important market.

We are engaged in certain joint ventures where we share control or management with a joint venture partner. If we are unable to maintain a successful relationship with a joint venture partner, the joint venture’s ability to move quickly and respond to changes in market conditions or respond to financial issues, can erode and reduce the potential for value creation and return on investment. For example, our joint venture partner in India has been unable to pay us in a timely manner for services rendered. Further, the joint ventures may also restrict or delay our ability to make important financial decisions, such as repatriating cash to us from such joint ventures. This uncertainty with our joint ventures could result in a failure in an important market.

Service interruptions could result in a loss of revenues and harm our reputation.

Portions of our network may be shut down from time to time as a result of disputes with postal telephone and telegraph companies, vendors, carriers or general service providers due to billing disputes, late payments, or other issues. Any future network shut downs can have a significant negative impact on revenue and cash flows, as well as hurting our reputation. In addition, there is no assurance that we will be able to quickly resolve disputes, if ever, which could result in a permanent loss of revenues.

Because we do business on an international level we are subject to an increased risk of tariffs, sanctions and other uncertainties that may hurt our revenues.

There are certain risks inherent in doing business internationally, especially in emerging markets, such as unexpected changes in regulatory requirements, the imposition of tariffs or sanctions, licenses, customs, duties, other trade barriers, political risks, currency devaluations, high inflation, corporate law requirements, and even civil unrest. Many of the economies of these emerging markets are weak and volatile. We may not be able to mitigate the effect of inflation on our operations in these countries by price increases, even over the long-term. Further, expropriation of private businesses in such jurisdictions remains a possibility, whether by outright seizure by a foreign government or by confiscatory tax or other policies. Deregulation of the communications markets in developing countries may not continue. Incumbent providers, trade unions and others may resist legislation directed toward deregulation and may resist allowing us to interconnect to their network switches. The legal systems in emerging markets frequently have insufficient experience with commercial transactions between private parties. Consequently, we may not be able to protect or enforce our rights in any emerging market countries. Governments and regulations may change resulting in availability of licenses and/or cancellations or suspensions of operating licenses, confiscation of equipment and/or rate increases. The instability of the laws and regulations applicable to our businesses and their interpretation and enforcement in these markets could materially and adversely affect our business, financial condition, or results of operations.
 

Regulatory treatment of VoIP outside the United States varies from country to country. Some countries including the U.S. 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 regulations. In such cases, our failure to register could subject us to fines, penalties, or forfeiture. Regulatory developments such as these could have a material adverse effect on our international operations.

The success of our business depends on the acceptance of the Internet in emerging markets that may be slowed by limited bandwidth, high bandwidth costs, and other technical obstacles.

The ratio of telephone lines per population, or teledensity, in most emerging countries is low when compared to developed countries. Bandwidth, the measurement of the volume of data capable of being transported in a communications system in a given amount of time, remains very expensive in these regions, especially when compared to bandwidth costs in the United States. Prices for bandwidth capacity are generally set by the government or incumbent telephone company and remain high due to capacity constraints among other things. While this trend tends to diminish as competitors roll out new bypass services, these rollouts may be slow to occur. Further, constraints in network architecture limit Internet connection speeds on conventional dial-up telephone lines, and are significantly less than the up to 1.5 megabits per second connection speed on direct satellite link or digital subscriber lines and cable modems in the United States. These speed and cost constraints may severely limit the quality and desirability of using the Internet in emerging countries and can be an obstacle to us entering emerging markets.

Additional taxation and the regulation of the communications industry may slow our growth, resulting in decreased demand for our products and services and increased costs of doing business.

We could have to pay additional taxes because our operations are subject to various taxes. We structure our operations based on assumptions about various tax laws, U.S. and international tax treaty developments, international currency exchange, capital repatriation laws, and other relevant laws by a variety of non-U.S. jurisdictions. Taxation or other authorities might not reach the same conclusions we reach. We could suffer adverse tax and other financial consequences if our assumptions about these matters are incorrect or the relevant laws are changed or modified.

We are subject to varying degrees of international, federal, state, and local regulation. Significant regulations imposed at each of these levels govern the provision of some or all of our services and affect our business. We cannot assure you that our joint venture partners, or we have, or, will receive the international, United States Federal Communications Commission (“FCC”), or state regulatory approvals they or we require. Nor can we provide you with any assurance that international, FCC or state regulatory authorities will not raise material issues with respect to our compliance with applicable regulations or that the cost of our compliance will not have a materially adverse effect on our revenues and profitability.

The U.S. Federal Government and state authorities have the power to revoke our regulatory approval to operate internationally, interstate, or intrastate, or to impose financial penalties if we fail to pay, or are delinquent in paying, telecommunications taxes or regulatory fees or fail to file necessary tariffs or mandatory reports. We are currently, and have been, delinquent in such financial obligations and required filings in the past. Furthermore, delays in receiving required regulatory approvals or the enactment of new and adverse legislation, regulations or regulatory requirements could also have a materially adverse affect on our condition. In addition, future legislative, judicial and regulatory agency actions could alter competitive conditions in the markets in which we intend to operate, to our detriment.

In addition to new regulations being adopted, existing laws may be applied to the Internet, which could hamper our growth.

New and existing laws may cover issues that include: sales and other taxes; user privacy; pricing controls; characteristics and quality of products and services; consumer protection; cross-border commerce; copyright, trademark and patent infringement; and other claims based on the nature and content of Internet materials. This could delay growth in demand for our products and services and limit the growth of our revenue.
 

Risks Related to our Common Stock  

Voting Control by Principal Stockholders

As of March 31, 2006, our executive officers and directors collectively control approximately 33.2% of our outstanding common stock and, therefore are able to significantly influence the vote on matters requiring stockholder approval, including the election of directors.

We Do Not Intend to Pay Dividends.

We have never declared or paid any cash dividends on our common stock. We intend to retain any future earnings to finance our operations and to expand our business and, therefore, do not expect to pay any cash dividends in the foreseeable future .

Forward Looking Statements

Certain statements contained herein may constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Because such statements include risks and uncertainties, actual results may differ materially from those expressed or implied by such forward-looking statements. Factors that could cause actual results to differ materially include, but are not limited to, risks associated with the integration of businesses following an acquisition, concentration of revenue from one source, competitors with broader product lines and greater resources, emergence into new markets, the termination of any of the Company’s significant contracts or partnerships, the Company’s inability to maintain working capital requirements to fund future operations or the Company’s inability to attract and retain highly qualified management, technical and sales personnel .

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKS

Quantitative and Qualitative Disclosures About Market Risk

We are exposed to certain market risks that are inherent in our financial instruments. These instruments arise from transactions in the normal course of business.

At December 31, 2005, the majority of our cash balances were held primarily in the form of a short-term highly liquid investment grade money market fund in a major financial institution. Due to the short-term nature of our investments, we believe that we are not subject to any material interest or market rate risks.

At December 31, 2005, all of our outstanding debt has fixed interest rates. As such, we are not subject to interest rate risk on any of our debt. As such, we currently believe that our interest rate risk is very low.

We currently do not conduct any significant amount of business in currencies other than the United States dollar. The reporting and functional currency for our Dubai international subsidiary is the United States dollar. Our Jamaican and Turkey subsidiaries currently do not have any significant operations that would provide foreign currency risk. However, in the future, we likely will conduct a larger percentage of our business in other foreign currencies that could have an adverse impact on our future results of operations.

ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Our Consolidated Financial Statements required by this Item are included in Item 14 of this report on pages F-1 through F-33.

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

None.

ITEM 9A. CONTROLS AND PROCEDURES

(a) Evaluation of Disclosure Controls and Procedures. Our principal executive officer and principal financial officer, after evaluating the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this Annual Report on Form 10-K, have concluded that, based on such evaluation, our disclosure controls and procedures were adequate and effective to ensure that material information relating to us, including our consolidated subsidiaries, was made known to them by others within those entities, particularly during the period in which this Annual Report on Form 10-K was being prepared.
 

(b) Changes in Internal Controls. There were no changes in our internal control over financial reporting, identified in connection with the evaluation of such internal control that occurred during our last fiscal year, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

(c) Limitations. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurances that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple errors or mistakes. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with its policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected. We periodically evaluate our internal controls and make changes to improve them.
 

PART III

ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT

The information required by this Item is incorporated herein by reference to the sections entitled “Management” and “Principal Stockholders” in the proxy statement for our 2005 Annual Meeting of Stockholders.

On November 1, 2004, we adopted a Corporate Code of Conduct and Ethics applicable to all employees and directors of Fusion, including our principal executive officer and principal financial and accounting officer. A copy of the Code of Conduct and Ethics is posted on our website at www.fusiontel.com . We intend to post on our website any amendments to, or waivers from, our Code of Conduct and Ethics that apply to our principal executive officer and principal financial and accounting officer.

ITEM 11. EXECUTIVE COMPENSATION

The information required by this Item is incorporated herein by reference to the section entitled “Executive Compensation” in the proxy statement for our 2005 Annual Meeting of Stockholders.

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this Item is incorporated herein by reference to the section entitled “Principal Stockholders” in the proxy statement for our 2005 Annual Meeting of Stockholders.

ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS

The information required by this Item is incorporated herein by reference to the section entitled “Related Party Transactions” in the proxy statement for our 2005 Annual Meeting of Stockholders.

ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES

The information required by this Item is incorporated herein by reference to the section entitled “Principal Accounting Fees and Services” in the proxy statement for our 2005 Annual Meeting of Stockholders.

PART IV

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

(a)(1) Financial Statements.

The Consolidated Financial Statements filed as part of this Annual Report on Form 10-K are identified in the Index to Consolidated Financial Statements on page F-1 hereto.

(a)(2) Financial Statement Schedules.

Schedule II - Valuation and Qualifying Accounts is included on page F-32 hereto. All other financial statement schedules have been omitted because the information required to be set forth therein is not applicable or is shown on the financial statements or notes thereto.

(a)(3) Exhibits.

The following exhibits are filed herewith or are incorporated by reference to exhibits previously filed with the Securities and Exchange Commission.
 
 
Exhibit
   
No.
 
Description
     
3.1
 
Certificate of Incorporation, as amended (*)
     
3.1
 
(a) Certificate of Designation of Series C Convertible Redeemable Preferred Stock (*)
     
3.2
 
Bylaws (*)
     
10.1
 
1998 Stock Option Plan (*)
     
10.2
 
Employment Agreement between registrant and Matthew Rosen (*)
     
10.21
 
Amended and Restated Employment Agreement between registrant and Matthew Rosen (3)
     
10.3
 
Master Service Agreement between registrant and Terremark Worldwide, Inc., dated May 29, 2003 (*)
     
10.4
 
Agreement between registrant and Pakistan Telecommunications Company, Ltd, dated May 20, 2002 (*)
     
10.4.1
 
Agreement between Registrant and Pakistan Telecommunications Company, Ltd, dated September 1, 2004 (2)
     
10.4.2
 
Letter terminating Agreement between Registrant and Pakistan Telecommunications Company, Ltd dated November 30, 2005 (4)
     
10.5
 
Joint Venture Agreement between registrant and Karamco, Inc., dated December 12, 2002 (*)
     
10.6
 
Agreement between Fusion registrant and Communications Ventures PVT. LTD, dated May 13, 2004 (*)
     
10.7
 
Form of Warrant to Purchase Common Stock (*)
     
10.8
 
Lease Agreement between registrant and SLG Graybar Sublease, LLC for the 420 Lexington Avenue, New York, NY office (*)
     
10.8.1
 
Lease Modification Agreement dated November 1, 2005, between registrant and SLG Graybar Sublease, LLC for the 420 Lexington Avenue, New York, NY office (4)
     
10.8.2
 
Lease Modification Agreement dated November 1, 2005, between registrant and SLG Graybar Sublease, LLC for the 420 Lexington Avenue, New York, NY office (4)
     
10.8.3
 
Lease Agreement dated November 1, 2005, between registrant and SLG Graybar Sublease, LLC for the 420 Lexington Avenue, New York, NY office (4)
     
10.9
 
Lease Agreement between registrant and 67 Broad Street LLC for the 75 Broad Street, New York, NY office (*)
     
10.10
 
Lease Agreement between registrant and Fort Lauderdale Crown Center, Inc. for the Fort Lauderdale, Florida office, as amended (*)
     
10.10.11
 
Amendment dated February 10, 2006, to Lease Agreement between registrant and Fort Lauderdale Crown Center, Inc., for the Fort Lauderdale, Florida office, as amended (4)
     
10.11
 
Lease Agreement between Efonica FZ- LLC and Dubai Internet City for Dubai offices (4)
     
10.12
 
Agreement between registrant and Dennis Mehiel, dated November 10, 2004 and attached Promissory note of even date therewith (*)
     
10.13
 
Shareholders Joint Venture Agreement between registrant and Communications Ventures Index Pvt. Ltd., dated March 11, 2000 (*)
   
10.14
 
Convertible Subordinated Note issued by registrant to Marvin Rosen, dated April 9, 1999 (*)
     
10.15
 
Demand note issued by registrant to Marvin Rosen, dated March 28, 2001 (*)
 
 
 
 
Exhibit
   
No.
 
Description
     
10.16
 
Demand note issued by registrant to Marvin Rosen, dated April 13, 2001 (*)
     
10.17
 
Demand note issued by registrant to Marvin Rosen, dated December 4, 2000 (*)
     
10.18
 
Demand note issued by registrant to Marvin Rosen, dated May 24, 2001 (*)
     
10.19
 
Warrant to Purchase Common Stock issued by registrant to Marvin Rosen, dated July 31, 2002 (*)
     
10.20
 
Convertible Subordinated Note issued by registrant to Philip Turits, dated April 9, 1999 (*)
     
10.21
 
Demand note issued by registrant to Philip Turits, dated January 31, 2003 (*)
     
10.22
 
Demand note issued by registrant to Philip Turits, dated October 14, 2002 (*)
     
10.23
 
Demand note issued by registrant to Philip Turits, dated December 31, 2002 (*)
     
10.24
 
Demand note issued by registrant to Philip Turits, dated July 31, 2002 (*)
     
10.24
 
Demand note issued by registrant to Philip Turits, dated September 24, 2002 (*)
     
10.27
 
Demand note issued by registrant to Evelyn Langlieb Greer, dated July 10, 2002 (*)
     
10.28
 
Non-Competition Agreement between registrant and Marvin Rosen (*)
     
10.29
 
Stock Purchase Agreement between registrant, Convergent Technologies, Ltd. and the stockholders listed on Schedule 1 Attached thereto, dated December 16, 2004, as amended and restated, dated January 11, 2005 (*)
     
10.30
 
Employment Agreement between registrant and Roger Karam (*)
     
10.31.1
 
Stock Purchase Agreement between registrant, Efonica FZ-LLC and Karamco, Inc., dated January 11, 2005 and the amendment thereto (*)
     
10.31.2
 
Amendment to Stock Purchase Agreement between registrant, Efonica FZ-LLC and Karamco, Inc., dated March 24, 2006 (4)
     
10.32
 
Carrier Service Agreement for International Terminating Traffic between the registrant and Qwest Communications Corporation, dated May 17, 2000 (*)
     
10.33
 
Carrier Service Agreement between registrant and Telco Group, Inc. dated April 3, 2001, as amended (*)
     
10.34
 
Colocation License Agreement between the registrant and Telco Group, dated January 28, 2002.(*)
     
10.35
 
International VoIP Agreement, dated April 25, 2002, as amended (*)
     
10.36.1
 
Stock Purchase Agreement dated March 8, 2005 between FUSION TURKEY, L.L.C., LDTS UZAK MESAFE TELEKOMÜNIKASYON VE .ILETIS,IM HIZMETLERI SAN.TIC.A.S. and Bayram Ali BAYRAMOGLU; Mecit BAYRAMOGLU Mehmet; Musa BAYSAN; Yahya BAYRAMOGLU and Özlem BAYSAN.(1)
     
10.37
 
Lease Agreement dated April 28, 2005, between Convergent Technologies Limited and Oceanic Digital Jamaica Limited **
     
10.38
 
Promissory Note issued by iFreedom Communications International Holdings, Limited; iFreedom Communications Corporation; iFreedom Communications (Malaysia) Sdn. Bhd.; iFreedom Communications, Inc.; iFreedom Communications Hong Kong Limited and iFreedom UK, Ltd., jointly and severally, to Registrant.(4)
     
14
 
Code of Ethics of Registrant (4)
 
 
 
Exhibit
   
No.
 
Description
     
21.1
 
List of Subsidiaries (4)
     
31.1
 
Certification of Chief Executive Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (4)
     
31.2
 
Certification of Principal Accounting Officer Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (4)
     
32
 
Certification Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (4)
     
*
Originally filed with our Registration Statement no. 33-120412 and incorporated herein by reference.
**
Originally filed with our Registration Statement no. 33-120206 and incorporated herein by reference.

(1)  
Filed as Exhibit to our Current Report on Form 8-K filed on March 14, 2005 and incorporated herein by reference.
(2)  
Filed as Exhibit to or Annual Report on Form 10-K filed March 31, 2005 and incorporated herein by reference.
(3)  
Filed as Exhibit to our Current Report on Form 8-K filed on March 17, 2006, and incorporated herein by reference.
(4)  
Filed herewith.

(b) Reports on Form 8-K.

We furnished a report on Form 8-K dated March 14, 2005, reporting under Item 1.01 the entry into a Stock Purchase Agreement between FUSION TURKEY, L.L.C., LDTS UZAK MESAFE TELEKOMÜNIKASYON VE .ILETIS,IM HIZMETLERI SAN.TIC.A.S. and Bayram Ali BAYRAMOùGLU; Mecit BAYRAMOùGLU Mehmet; Musa BAYSAN; Yahya BAYRAMOùGLU and Özlem BAYSAN.

We furnished a report on Form 8-K dated May 12, 2005, reporting under Item 8.01 the issuance of a press release regarding the execution of a partnership agreement with NetVoices, LLC. for distribution and support of our efonica brand of VoIP services in the Ukraine.

We furnished a report on Form 8-K dated November 14, 200,5 reporting under Item 1.01 the entry into an agreement to acquire the assets of iFreedom Communications International Holdings Limited.

We furnished a report on Form 8-K dated January 4, 2006, reporting under Item 5.02 the appointment of Gordon Hutchins, Jr. as Executive Vice President - International Operations.

We furnished a report on Form 8-K dated January 10, 2006, reporting under Item 5.02 the appointment of Charles Whiting as Senior Vice President - Operations, Engineering and Information Systems.

We furnished a report on Form 8-K dated January 13, 2006, reporting under Item 8.01 the issuance of a press release entitled “Fusion to Present Conference Session at Pacific Telecommunications Council (PTC)’06 Conference”.

We furnished a report on Form 8-K dated February 14, 2006, reporting under Item 8.01 the mailing of a letter to shareholders.

We furnished a report on Form 8-K dated February 28, 2006, reporting under Item 8.01 the issuance of a press release entitled “Fusion Acquires Proprietary SIP Peer-to-Peer Technology That Avoids Routing Internet Phone Calls Through Network Of Users’ Computers.”

We furnished a report on Form 8-K dated March 7 , 2006, reporting under Item 8.01 the issuance of a press release entitled   “Fusion Announces Partnership With AnchorFree to Market VoIP Services to Users of Large Free WI-FI Network.”

We furnished a report on Form 8-K dated March 17, 2006 reporting under Item 5.02 the appointment of Matthew Rosen as Chief Executive Officer.
 

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
     
  FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
 
  		 
  		 
 
Date: March 31, 2006 By:   /s/ Matthew D. Rosen
 
 
Name:   Matthew D. Rosen
Title:     President and Chief Executive Officer
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the registrant and in the capacities and on the dates indicated have signed this report.

Name
 
Title
 
Date
 
 
     
/s/ Marvin S. Rosen
 
Chairman of the Board
 
March 31, 2006
Marvin S. Rosen
 
 
   
 
 
 
   
/s/ Matthew D. Rosen
 
President and Chief Executive Officer
 
March 31, 2006
Matthew D. Rosen
       
 
 
     
/s/ Barbara Hughes
 
Vice President of Finance and Principal Accounting and Financial Officer
 
March 31, 2006
Barbara Hughes
 
 
   
 
 
 
   
/s/ Philip Turits
 
Secretary, Treasurer, and Director
 
March 31, 2006
Philip Turits
 
 
   
 
 
 
   
/s/ E. Alan Brumberger
 
Director
 
March 31, 2006
E. Alan Brumberger
 
 
   
         
/s/ Michael Del Giudice
 
Director
 
March 31, 2006
 Michael Del Giudice
 
 
   
         
 /s/ Julius Erving
 
Director
 
March 31, 2006
Julius Erving
 
     
         
/s/ Evelyn Langlieb Greer
 
Director
 
March 31, 2006
Evelyn Langlieb Greer
 
     
         
/s/ Fred P. Hochberg
 
Director
 
March 31, 2006
Fred P. Hochberg
 
 
   
         
/s/ Raymond E. Mabus
 
Director
 
March 31, 2006
 Raymond E. Mabus
 
 
   
 
 
     
/s/ Manuel D. Medina
 
Director
 
March 31, 2006
Manuel D. Medina
 
 
   
         
/s/ Dennis Mehiel
 
Director
 
March 31, 2006
Dennis Mehiel
 
 
   
         
 /s/ Paul C. O’Brien
 
Director
 
March 31, 2006
Paul C. O’Brien
 
     
 
 
-40-
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
CONSOLIDATED FINANCIAL STATEMENTS

Table of Contents
   
 
Page
 
 
F-2
F-3
F-4
F-5
F-6
F-8
 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Stockholders of Fusion Telecommunications International, Inc. and Subsidiaries

We have audited the accompanying consolidated balance sheets of Fusion Telecommunications International, Inc. and Subsidiaries (the “Company”) as of December 31, 2005 and 2004, and the related consolidated statements of operations, changes in stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Fusion Telecommunications International, Inc. and Subsidiaries as of December 31, 2005 and 2004, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2005, in conformity with  accounting principles generally accepted in the United States of America.

In connection with our audits of the financial statements referred to above, we audited the financial statement schedule on page F-32. In our opinion, the financial statement schedule, when considered in relation to the consolidated financial statements taken as a whole, presents fairly, in all material respects, the information stated therein.


/s/ Rothstein, Kass & Company, P.C.
Roseland, New Jersey
March 10, 2006, except for paragraph 6 of Note 21 which is as of March 30, 2006
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Balance Sheets
       
   
December 31,
 
 
 
2005
 
2004
 
ASSETS
 
Current assets
 
Cash and cash equivalents
 
$
14,790,504
 
$
4,368,726
 
Accounts receivable, net of allowance for doubtful accounts of approximately $414,000
in 2005 and 2004
   
2,952,760
   
3,145,535
 
Restricted cash
   
—
   
145,000
 
Prepaid expenses and other current assets
   
1,242,266
   
889,761
 
Total current assets
   
18,985,530
   
8,549,022
 
Property and equipment, net
   
4,516,271
   
3,271,474
 
Other assets
Security deposits
   
331,891
   
902,028
 
Restricted cash
   
218,176
   
235,276
 
Goodwill
   
5,118,640
   
—
 
Intangible assets, net
   
4,861,012
   
—
 
Other assets
   
354,259
   
704,317
 
Total other assets
   
10,883,978
   
1,841,621
 
TOTAL ASSETS
 
$
34,385,779
 
$
13,662,117
 
               
LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
Current liabilities
Long-term debt, related parties, current portion
 
$
—
 
$
1,739,025
 
Long-term debt, current portion
   
150,000
   
2,660,281
 
Capital lease/equipment financing obligations, current portion
   
1,419,965
   
1,131,830
 
Accounts payable and accrued expenses
   
9,269,341
   
10,274,688
 
Investment in Estel
   
771,182
   
140,821
 
Liabilities of discontinued operations
   
620,809
   
1,116,090
 
Total current liabilities
   
12,231,297
   
17,062,735
 
Long-term liabilities
Capital lease/equipment financing obligations, net of current portion
   
7,650
   
156,495
 
Other long-term liabilities
   
4,357,497
   
—
 
Preferred Stock, Series C, subject to mandatory redemption (liquidation preference in the aggregate of approximately $10,932,000 in 2004)
   
—
   
9,716,026
 
Total long-term liabilities
   
4,365,147
   
9,872,521
 
Commitments and contingencies
             
Minority interests
   
67,694
   
16,890
 
Stockholders’ equity (deficit)
Common stock, $.01 par value, 105,000,000 shares authorized, 11,114,962 and 0 shares issued and 10,439,381 and 0 shares outstanding in 2005 and 2004, respectively
   
104,394
   
—
 
Common stock, Class A, $.01 par value, 21,000,000 shares authorized, 15,739,963 and 17,479,993 shares issued and outstanding in 2005 and 2004, respectively
   
157,400
   
174,800
 
Capital in excess of par value
   
105,447,041
   
65,127,291
 
Accumulated deficit
   
(87,987,194
)
 
(78,592,120
)
Total stockholders’ equity (deficit)
   
17,721,641
   
(13,290,029
)
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY (DEFICIT)
 
$
34,385,779
 
$
13,662,117
 

See accompanying notes to consolidated financial statements.
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC
AND SUBSIDIARIES
Consolidated Statements of Operations
       
   
Years ended December 31,
 
 
 
  2005
 
2004
 
2003
 
                
Revenues
 
$
49,364,542
 
$
49,557,973
 
$
32,018,471
 
Operating expenses:
Cost of revenues, exclusive of depreciation and amortization
shown separately below
   
45,048,917
   
42,927,994
   
27,855,508
 
Depreciation and amortization
   
1,510,172
   
1,804,184
   
1,981,805
 
Loss on impairment
   
—
   
—
   
375,000
 
Selling, general and administrative expenses
   
11,939,001
   
9,804,405
   
8,575,807
 
Total operating expenses
   
58,498,090
   
54,536,583
   
38,788,120
 
Operating loss
   
(9,133,548
)
 
(4,978,610
)
 
(6,769,649
)
 
Other income (expense):
Interest income (expense), net
   
39,360
   
(2,228,060
)
 
(846,896
)
Gain (loss) on settlements of debt
   
(75,927
)
 
2,174,530
   
3,918,295
 
Loss from investment in Estel
   
(541,876
)
 
(519,728
)
 
(746,792
)
Other
   
(195,346
)
 
(15,965
)
 
(97,766
)
Minority interests
   
175,353
   
(7,654
)
 
157,617
 
Total other income (expense)
   
(598,436
)
 
(596,877
)
 
2,384,458
 
Loss from continuing operations
   
(9,731,984
)
 
(5,575,487
)
 
(4,385,191
)
                     
Discontinued operations:
Income from discontinued operations
   
336,910
   
545,215
   
208,620
 
Net loss
 
$
(9,395,074
)
$
(5,030,272
)
$
(4,176,571
)
Losses applicable to common stockholders:
Loss from continuing operations
 
$
(9,731,984
)
$
(5,575,487
)
$
(4,385,191
)
Preferred stock dividends
   
—
   
(385,918
)
 
(635,254
)
Net loss applicable to common stockholders from continuing operations:
   
(9,731,984
)
 
(5,961,405
)
 
(5,020,445
)
Income from discontinued operations
   
336,910
   
545,215
   
208,620
 
Net loss applicable to common stockholders
 
$
(9,395,074
)
$
(5,416,190
)
$
(4,811,825
)
 
Basic and diluted net loss per common share:
Loss from continuing operations
 
$
(0.39
)
$
(0.35
)
$
(0.37
)
Income from discontinued operations
   
0.01
   
0.03
   
0.02
 
Net loss applicable to common stockholders
 
$
(0.38
)
$
(0.32
)
$
(0.35
)
Weighted average shares outstanding
Basic and diluted
   
24,965,080
   
16,707,114
   
13,616,803
 
 
 
See accompanying notes to consolidated financial statements
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES

Consolidated Statements of Changes in Stockholders’ Equity (Deficit)
Years Ended December 31, 2005, 2004 and 2003
                                       
   
Redeemable
                                  
   
Preferred
 
  Preferred
 
Preferred
     
Common
 
Capital in
 
Stock
         
   
Stock
 
  Stock
 
Stock
 
Common
 
Stock
 
Excess of
 
Dividend
 
Accumulated
     
 
Series C
 
  Series A
 
Series B
 
Stock
 
Class A
 
Par Value
 
Distributable
 
Deficit
 
Total
 
Balances , January 1, 2003
 
$
—
 
$
4,072
 
$
735
 
$
116,863
 
$
—
 
$
52,732,476
 
$
—
 
$
(67,721,553
)
$
(14,867,407
)
Proceeds from sale of common stock,  net of investment expenses
   
—
   
—
   
—
   
26,964
   
—
   
6,819,923
   
—
   
—
   
6,846,887
 
Proceeds from sale of Series C Preferred Stock, net of investment expenses
   
2,526,299
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
—
 
Conversion of long-term  debt to common stock
   
—
   
—
   
—
   
6,232
   
—
   
2,273,932
   
—
   
—
   
2,280,164
 
Conversion of long-term debt  to Series C Preferred Stock
   
930,239
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
—
 
Common stock issued for  the assumption of letter of credit
   
—
   
—
   
—
   
168
   
—
   
49,832
   
—
   
—
   
50,000
 
Conversion of advances to  Series C Preferred Stock
   
10,000
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
—
 
Stock dividends declared
   
—
   
—
   
—
   
—
   
—
   
—
   
1,277,806
   
(1,277,806
)
 
—
 
Stock dividends issued
   
—
   
—
   
—
   
3,185
   
—
   
721,383
   
(724,568
)
 
—
   
—
 
Net loss
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
(4,176,571
)
 
(4,176,571
)
Balances , December 31, 2003
   
3,466,538
   
4,072
   
735
   
153,412
       
62,597,546
   
553,238
   
(73,175,930
)
 
(9,866,927
)
Proceeds from sales of common stock,  net of investment expenses
   
—
   
—
   
—
   
4,299
   
—
   
1,272,771
   
—
   
—
   
1,277,070
 
Proceeds from sales of Series C Preferred Stock, net of  investment expenses
   
4,630,626
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
—
 
Conversion of long-term debt to Series C Preferred Stock
   
406,740
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
—
 
Conversion of advances to Series C Preferred Stock
   
176,620
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
—
 
Common stock issued in settlement of accounts payable
   
—
   
—
   
—
   
197
   
—
   
101,873
   
—
   
—
   
102,070
 
Conversion of Series A&B Preferred Stock to common stock
   
—
   
(4,072
)
 
(735
)
 
13,735
   
—
   
(8,928
)
 
—
   
—
   
—
 
Conversion of common stock to Class A Common Stock
   
—
   
—
   
—
   
(174,800
)
 
174,800
   
—
   
—
   
—
   
—
 
Issuance of convertible debt with beneficial conversion feature
   
—
   
—
   
—
   
—
   
—
   
228,030
   
—
   
—
   
228,030
 
Stock dividend declared
   
—
   
—
   
—
   
—
   
—
   
—
   
385,918
   
(385,918
)
 
—
 
Stock dividend issued
   
—
   
—
   
—
   
3,157
   
—
   
935,999
   
(939,156
)
 
—
   
—
 
Accretion of Series C Preferred Stock
   
1,035,502
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
—
 
Net loss
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
(5,030,272
)
 
(5,030,272
)
Balances , December 31, 2004
   
9,716,026
   
—
   
—
   
—
   
174,800
   
65,127,291
   
—
   
(78,592,120
)
 
(13,290,029
)
Proceeds from sale of common stock,  net of investment expenses
   
—
   
—
   
—
   
40,800
   
—
   
23,229,720
   
—
   
—
   
23,270,520
 
Conversion of convertible notes to common stock, net of debt offering costs
   
—
   
—
   
—
   
6,515
   
—
   
2,437,880
   
—
   
—
   
2,444,395
 
Conversion of Preferred Stock to common stock
   
(10,003,141
)
 
—
   
—
   
31,418
   
—
   
9,971,723
   
—
   
—
   
10,003,141
 
Common Stock paid for minority interest in Efonica joint venture
   
—
   
—
   
—
   
7,641
   
—
   
4,920,559
   
—
   
—
   
4,928,200
 
Cash difference payment related for purchase of minority interest in Efonica joint venture
   
—
   
—
   
—
   
—
   
—
   
(430,000
)
 
—
   
—
   
(430,000
)
Restricted stock issued for  consulting services
   
—
   
—
   
—
   
114
   
—
   
49,886
   
—
   
—
   
50,000
 
Common stock issued for options
   
—
   
—
   
—
   
214
   
—
   
50,036
   
—
   
—
   
50,250
 
Class A common stock issued  for warrants
   
—
   
—
   
—
   
—
   
292
   
84,858
   
—
   
—
   
85,150
 
Accretion of Series C Preferred Stock
   
287,115
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
—
 
Amortization of stock options granted to consultant
   
—
   
—
   
—
   
—
   
—
   
5,088
   
—
   
—
   
5,088
 
Conversion of Class A Common Stock to common stock
   
—
   
—
   
—
   
17,692
   
(17,692
)
 
—
   
—
   
—
   
—
 
Net loss
   
—
   
—
   
—
   
—
   
—
   
—
   
—
   
(9,395,074
)
 
(9,395,074
)
Balances , December 31, 2005
 
$
—
 
$
—
 
$
—
 
$
104,394
 
$
157,400
 
$
105,447,041
 
$
—
 
$
(87,987,194
)
$
17,721,641
 
 
 
See accompanying notes to consolidated financial statements.
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES

Consolidated Statements of Cash Flows
         
     
Years ended December 31,
 
Cash flows from operating activities    
2005
   
2004
   
2003
 
Net loss
 
$
(9,395,074
)
$
(5,030,272
)
$
(4,176,571
)
Adjustments to reconcile net loss to net cash used in
operating activities:
               
Loss on impairment
   
—
   
—
   
375,000
 
Loss from sale/disposal of fixed assets
   
158,525
   
18,421
   
101,838
 
Depreciation and amortization
   
1,510,172
   
1,804,184
   
1,981,805
 
Bad debt expense
   
350,434
   
780,479
   
183,735
 
Beneficial conversion feature on convertible debt
   
—
   
228,030
   
—
 
(Gain) loss on settlements of debt
   
75,927
   
(2,174,530
)
 
(3,918,295
)
Non-cash compensation expense
   
38,422
   
—
   
—
 
Gain on discontinued operations
   
(336,910
)
 
(556,904
)
 
—
 
Accretion of Series C Preferred Stock
   
287,115
   
1,035,502
   
—
 
Loss from investment in Estel
   
541,876
   
519,728
   
746,792
 
Minority interests
   
(175,353
)
 
7,654
   
(157,617
)
Increase (decrease) in cash attributable to changes in operating assets and liabilities:
               
Accounts receivable
   
96,952
   
(1,627,047
)
 
(752,779
)
Prepaid expenses and other current assets
   
(205,471
)
 
(1,207,139
)
 
(105,666
)
Other assets
   
49,254
   
32,737
   
(22,045
)
Accounts payable and accrued expenses
   
(818,149
)
 
1,307,946
   
1,261,261
 
Liabilities of discontinued operations
   
(158,371
)
 
(13,623
)
 
(402,001
)
Net cash used in operating activities
   
(7,980,651
)
 
(4,874,834
)
 
(4,884,543
)
                     
Cash flows from investing activities:
Purchase of property and equipment
   
(1,877,252
)
 
(627,219
)
 
(582,149
)
Proceeds from sale of property and equipment
   
—
   
36,850
   
15,000
 
Advances to Estel
   
(205,520
)
 
(262,398
)
 
(219,926
)
Payments from Estel
   
104,102
   
—
   
—
 
Returns of (payments for) security deposits
   
570,137
   
245,957
   
(271,552
)
Repayments of restricted cash
   
162,100
   
356,350
   
314,556
 
Purchase of Jamaican joint ventures net of cash acquired
   
(146,486
)
 
—
   
—
 
Purchase of minority interest in Efonica joint venture, net of
cash acquired
   
(480,555
)
 
—
   
—
 
Difference Payment related to purchase of minority interest in
Efonica joint venture
   
(430,000
)
 
—
   
—
 
Purchase of Turkey joint venture, net of cash acquired
   
(92,971
)
 
—
   
—
 
Net cash used in investing activities
   
(2,396,445
)
 
(250,460
)
 
(744,071
)
                     
Cash flows from financing activities
Proceeds from sale of common stock and warrants, net
   
23,884,533
   
1,277,070
   
6,846,887
 
Proceeds from sale of Series C Preferred Stock, net
   
—
   
4,630,626
   
2,526,299
 
Proceeds from exercise of stock options
   
50,250
             
Proceeds from exercise of warrants
   
85,150
             
Repayments of escrow advances
   
—
   
(73,060
)
 
(1,130,500
)
Proceeds from long-term debt
   
—
   
1,330,000
   
2,091,696
 
Payments of long-term debt and capital lease/equipment
financing obligations
   
(2,538,464
)
 
(836,090
)
 
(2,340,706
)
Payment of dividends on Preferred C Stock
   
(664,634
)
           
Contributions from (to) minority stockholders of joint Ventures
   
(17,961
)
 
(40,171
)
 
104,156
 
Net cash provided by financing activities
   
20,798,874
   
6,288,375
   
8,097,832
 
Net increase in cash and cash equivalents
   
10,421,778
   
1,163,081
   
2,469,218
 
Cash and cash equivalents, beginning of year
   
4,368,726
   
3,205,645
   
736,427
 
Cash and cash equivalents, end of year
 
$
14,790,504
 
$
4,368,726
 
$
3,205,645
 
 
 
See accompanying notes to consolidated financial statements
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Consolidated Statements of Cash Flows (continued)

 
 
Years ended December 31,
 
 
 
2005
 
2004
 
2003
 
Supplemental disclosure of cash flow information:
 
Cash paid during the years for interest
 
$
621,789
 
$
302,860
 
$
187,600
 
 
Supplemental disclosure of noncash investing and financing activities:
Acquisition of capital leases/equipment financing obligations
 
$
918,716
 
$
760,417
 
$
373,200
 
Conversion of accounts payable to common stock
 
$
—
 
$
102,070
 
$
—
 
Note issued in settlement agreement
 
$
—
 
$
150,000
 
$
—
 
Conversion of Series A and B Preferred stock to common stock
 
$
—
 
$
13,735
 
$
—
 
Credits received from sale of property and equipment
 
$
—
 
$
—
 
$
15,000
 
Conversion of long-term debt to common stock
 
$
—
 
$
—
 
$
2,280,164
 
Conversion of convertible notes payable and related debt offering costs
 
$
2,444,395
 
$
—
 
$
—
 
Conversion of Series C Preferred Stock to common stock
 
$
10,003,141
 
$
—
 
$
—
 
Conversion of prepaid offering costs to additional paid in capital
 
$
614,008
 
$
—
 
$
—
 
Common stock issued for the assumption of a letter of credit
 
$
—
 
$
—
 
$
50,000
 
Conversion of long-term debt to Series C Preferred Stock
 
$
—
 
$
406,740
 
$
930,239
 
Conversion of escrow advances to Series C Preferred Stock
 
$
—
 
$
176,620
 
$
10,000
 
Conversion of interest payable to debt
 
$
—
 
$
108,333
 
$
—
 
Stock dividends issued
 
$
—
 
$
939,156
 
$
724,568
 
Stock dividends declared
 
$
—
 
$
385,918
 
$
1,277,806
 
Conversion of long-term debt to deferred revenue
 
$
—
 
$
—
 
$
555,000
 
                     
Supplemental disclosure of joint venture acquisition activities:
                   
Fair value of tangible assets, net of cash acquired
 
$
654,791
 
$
—
 
$
—
 
Fair value of identifiable intangible assets
   
4,877,900
   
—
   
—
 
Efonica Difference Payment
   
430,000
   
—
   
—
 
Goodwill acquired
   
5,118,640
   
—
   
—
 
Liabilities acquired
   
(401,504
)
           
Minority interest acquired
   
(244,118
)
 
—
   
—
 
Common stock issued or to be issued
   
(9,285,697
)
 
—
   
—
 
Cash paid for acquisition of joint ventures, net of cash acquired
 
$
1,150,012
 
$
—
 
$
—
 
 
 
See accompanying notes to consolidated financial statements.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

1.        
Nature of operations

Fusion Telecommunications International, Inc. and Subsidiaries (collectively the “Company”) is a Delaware corporation, incorporated in September 1997. The Company is an international communications carrier delivering Voice over Internet Protocol (“VoIP”) and other Internet services to, from, in and between emerging markets in Asia, the Middle East, Africa, Latin America, and the Caribbean. With its lead product, VoIP services, the Company currently provides a full suite of communications services to corporations, consumers, communication carriers, Internet service providers and government entities.

2.        
Summary of significant accounting policies

Principles of Consolidation

The consolidated financial statements include the accounts of Fusion Telecommunications International, Inc. and its wholly owned and majority owned subsidiaries. All material intercompany accounts and transactions have been eliminated in consolidation.

Stock Split

On November 1, 2004, the Board of Directors, as approved by the shareholders on December 10, 2004, authorized a 3.5 to 1 reverse stock-split applicable to all outstanding shares of the Company’s common stock. All transactions and disclosures in the 2003 consolidated financial statements, related to the Company’s common stock have been restated to reflect the effect of the reverse stock-split.

Revenue Recognition

The Company recognizes revenue when persuasive evidence of a sales arrangement exists, delivery has occurred or services have been rendered, the sales price is fixed and determinable and collectibility is reasonably assured. When significant, the Company records provisions against revenue for billing adjustments, which are based upon estimates derived from factors that include, but are not limited to, historical results, analysis of credits issued, current economic trends and changes in demand. The provisions for revenue adjustments are recorded as a reduction of revenue when incurred or ratably over a contract period, as applicable.

The Company derives revenue principally from international voice, including VoIP, private networks and Internet services. Variable revenue derived from international voice services is recognized upon completion of a call and is based upon the number of minutes of traffic carried. Revenue from monthly recurring service from long distance, private networks and Internet services are fixed and recurring in nature and are contracted over a specific period of time. Advanced billings for monthly fees are reflected as deferred revenues and are recognized as revenue at the time the service is provided. VoIP services enables customers, typically international corporations or cable operators, to place voice calls anywhere in the world using their personal computer. The majority of the Company’s VoIP services to consumers are prepaid which is initially recorded as deferred revenue. Revenues from VoIP services to consumers are recognized based upon the usage of minutes by the consumer.

Cash and Cash Equivalents

The Company considers all highly liquid debt instruments purchased with maturities of three months or less to be cash equivalents.

Accounts Receivable

The Company values its accounts receivable net of an allowance for doubtful accounts. On a periodic basis, the Company evaluates its accounts receivable and establishes an allowance for doubtful accounts, based on a history of past write-offs and collections and current credit conditions. Specific customer accounts are written off as uncollectible if the probability of a future loss has been established and payments are not expected to be received.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

2.        
Summary of significant accounting policies (continued)

Fair Value of Financial Instruments

The fair value of the Company’s assets and liabilities, which qualify as financial instruments under Statement of Financial Accounting Standards (“SFAS”) No. 107, “Disclosures About Fair Value of Financial Instruments,” approximate the carrying amounts presented in the accompanying Consolidated Balance Sheets.

Goodwill and other Intangible Assets

Goodwill represents the excess of the purchase price of an acquired business over the amounts assigned to assets acquired and liabilities assumed. In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” goodwill is not being amortized but is reviewed for impairment on an annual basis. Other intangible assets consist primarily of the trade name and trademarks associated with the Company’s wholly-owned subsidiary, Efonica FZ, LLC (“Efonica”). These long-lived assets are not amortized because they have indefinite lives. The remaining intangible asset acquired in the Efonica transaction is a customer list, which is being amortized using the straight-line method over the 10 year estimated useful life.

Impairment of Long-Lived Assets and Impairment Charges

The Company complies with SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets,” which requires impairment losses to be recorded on long-lived assets used in operations when indicators of impairment are present and undiscounted cash flows estimated to be generated by those assets are less than the assets’ carrying amount. The Company continually evaluates whether events and circumstances have occurred that indicates the remaining estimated useful life of long-lived assets, such as property and equipment may warrant revision, or the remaining balance may not be recoverable.

During 2003, the Company recorded an impairment of $375,000 related to management’s decision to lease certain switching equipment, which was replaced with upgraded equipment. In accordance with the provisions of SFAS No. 144, the Company evaluated the present value of the future cash flows that were expected to be generated from such lease and determined that the present value of the future cash flows were less than the carrying value of the equipment, thus there was an impairment on the switching equipment. The Company was unable to lease this equipment and continued to utilize the switching equipment in 2003 and in 2004. The Company ceased using the equipment during 2005 and initiated plans to sell the equipment. The Company reduced the carrying value of the asset to the net realizable value less costs to sell, recording a loss of approximately $118,000. In February 2006, the asset was sold for proceeds of $45,000. The losses recorded in connection with the replaced switching equipment relate to the voice to carriers segment.

Property and Equipment

Property and equipment are stated at cost and are depreciated or amortized on the straight-line method over the estimated useful lives of the assets as follows:

 
 
Estimated
 
Asset
 
Useful Lives
 
Network equipment
   
5-7 Years
 
Furniture and fixtures
   
3-7 Years
 
Computer equipment and software
   
3-5 Years
 
Leasehold improvements
   
Lease terms
 
 
Maintenance and repairs are charged to operations, while betterments and improvements are capitalized.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

2.
Summary of significant accounting policies (continued)

Advertising

Advertising costs are charged to operations as incurred and were approximately $162,000, $82,000 and $59,000 for 2005, 2004 and 2003, respectively.

Income Taxes

The Company complies with SFAS No. 109, “Accounting for Income Taxes,” which requires an asset and liability approach to financial reporting for income taxes. Deferred income tax assets and liabilities are computed for differences between the financial statement and tax bases of assets and liabilities that will result in future taxable or deductible amounts, based on enacted tax laws and rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred income tax assets to the amount expected to be realized.

Foreign Currency Conversion

The Company’s subsidiaries enter into foreign currency transactions. Conversion gains or losses resulting from these foreign currency transactions are included in the accompanying Consolidated Statements of Operations.

Comprehensive Income

The Company complies with SFAS No. 130, “Reporting Comprehensive Income. ” SFAS No. 130 establishes rules for the reporting and display of comprehensive income and its components. Comprehensive loss was equal to the net loss amounts presented for the respective periods in the accompanying Consolidated Statements of Operations.

Earnings Per Share

SFAS No. 128, “Earnings Per Share,” requires dual presentation of basic and diluted income per share for all periods presented. Basic income per share excludes dilution and is computed by dividing income available to common stockholders by the weighted-average number of common shares outstanding during the period. Diluted income per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared in the income of the Company.

Unexercised stock options to purchase 2,042,799, 1,848,578, and 656,207 shares of the Company’s common stock as of December 31, 2005, 2004 and 2003, respectively, were not included in the computation of diluted earnings per share because the exercise of the stock options would be anti-dilutive to earnings per share.

Unexercised warrants to purchase 7,462,435, 286,578, and 252,758, shares of the Company’s common stock as of December 31, 2005, 2004 and 2003, respectively, were not included in the computation of diluted earnings per share because the exercise of the warrants would be anti-dilutive to earnings per share.

Non-converted debt to purchase 97,998, and 47,215 shares of the Company’s common stock as of December 31, 2004 and 2003, respectively were not included in the computation of diluted earnings per share because the conversion of the debt would be anti-dilutive to earnings per share. Had the debt been converted, interest expense would have been reduced by approximately $49,000 and $30,000 during the years ended December 31, 2004 and 2003, respectively.

Stock-Based Compensation

The Company follows SFAS No. 123, “Accounting for Stock-Based Compensation”. The provisions of SFAS No. 123 allow companies to either expense the estimated fair value of stock options or to continue to follow the intrinsic value method set forth in Accounting Principles Board Opinion 25, “Accounting for Stock Issued to Employees” (“APB 25”) but disclose the pro forma effect on net income (loss) had the fair value of the options been expensed. For the year ended December 31, 2005 and prior, the Company elected to apply APB 25 in accounting for its stock option incentive plans and, accordingly, recognized no compensation expense for the stock option grants.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

2.
Summary of significant accounting policies (continued)

If compensation expense for the Company’s stock option plan had been determined based on the fair value at the grant dates as calculated in accordance with SFAS No. 123, the Company’s net loss attributable to common stockholders and net loss per common share would approximate the pro forma amounts below:

 
 
2005
 
2004
 
2003
 
Net loss applicable to common stockholders, as reported
 
$
(9,395,074
)
$
(5,416,190
)
$
(4,811,825
)
Deduct: total stock-based compensation expense under fair value method for awards, net of related tax effect
   
(2,152,765
)
 
(771,852
)
 
(99,911
)
Net loss applicable to common stockholders, pro forma
 
$
(11,547,839
)
$
(6,188,042
)
$
(4,911,736
)
Earnings per share:
                 
Basic and diluted net loss applicable to common stockholders, as reported
 
$
(0.38
)
$
(0.32
)
$
(0.35
)
Basic and diluted net loss applicable to common stockholders, pro forma
 
$
(0.46
)
$
(0.37
)
$
(0.36
)

The Company calculated the fair value of each common stock option grant on the date of grant using the black scholes option pricing model method with the following assumptions:

 
 
2005
 
2004
 
2003
 
Dividend yield
   
0.0
%
 
0.0
%
 
0.0
%
Average risk free interest rate
   
4.26
%
 
4.50
%
 
4.43
%
Average option term
   
4.0
   
4.0
   
4.0
 
Stock volatility
   
82.0
%
 
0.0
%
 
0.0
%

Recently Issued Accounting Pronouncements

On December 16, 2004, the Financial Accounting Standards Board issued SFAS No. 123 (revised 2004) (“SFAS 123(R)”), “Share-Based Payment” which is a revision of SFAS No. 123, “Accounting for Stock-Based Compensation.” SFAS 123(R) supersedes APB No. 25, and amends SFAS No. 95, “Statement of Cash Flows.” Generally, SFAS 123(R) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the statement of operations based on their fair values determined at the date of grant. Pro forma disclosure is no longer an alternative. On April 14, 2005, the Securities and Exchange Commission adopted a new rule that amends the compliance dates for SFAS 123(R). Under the new rule, the Company adopted SFAS 123(R) on January 1, 2006.
 
As permitted by SFAS No. 123, prior to January 1, 2006, the Company accounted for share-based payments to employees using the intrinsic value method and, as such, generally recognized no compensation cost for employee stock options. Accordingly, the adoption of SFAS 123(R)’s fair value method will have an impact on the Company’s results of operations, although it will have no impact on the Company’s overall financial position. The impact of the adoption of SFAS No. 123(R) cannot be predicated at this time because it will depend on levels of share-based payments granted in the future. However, had the Company adopted SFAS No. 123(R) in prior years, the impact of that adoption would have approximated the impact of SFAS No. 123 as described in the disclosure of pro forma net loss and proforma net loss per share in the preceding table.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

2.
Summary of significant accounting policies (continued)

In December 2004, the FASB issued SFAS No. 153 “Exchange of Non-monetary Assets” an amendment of APB Opinion No. 29 “Accounting for Non-monetary Transactions”. The amendments made by SFAS No. 153 are based on the principle that exchanges of non-monetary assets should be measured based on the fair value of the assets exchanged. Further, the amendments eliminate the narrow exception for non-monetary exchanges of similar productive assets and replace it with a broader exception for exchanges of non-monetary assets that do not have commercial substance. SFAS No. 153 is effective for non-monetary asset exchanges occurring in fiscal periods beginning after June 15, 2005. Earlier application is permitted for non-monetary asset exchanges occurring in fiscal periods after the date of issuance. The provisions of SFAS No. 153 shall be applied prospectively. The Company does not believe the adoption of SFAS No. 153 will have a significant impact on the Company’s overall results of operations or financial position.  

In March 2005, the FASB issued FASB Interpretation No. 47 (FIN 47), “Accounting for Conditional Asset Retirement Obligations.” FIN 47 clarifies the term conditional asset retirement obligation as used in FASB Statement No. 143, “Accounting for Asset Retirement Obligations.” The Company’s adoption of FIN 47 did not have a material impact on the consolidated financial statements

In May 2005, the FASB issued SFAS No. 154, “Accounting Changes and Error Corrections”, which replaces APB Opinion No. 20, “Accounting Changes” and SFAS No. 3, “Reporting Accounting Changes in Interim Financial Statements”. This Standard retained accounting guidance related to changes in estimates, changes in reporting entity and error corrections. However, changes in accounting principles must be accounted for retrospectively by modifying the financial statements of prior periods unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company does not believe adoption of this SFAS will have a material impact on its financial condition or results of operations.

Use of Estimates  

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the year. Actual results could differ from those estimates.

Reclassifications

Certain reclassifications have been made to the 2004 and 2003 consolidated financials statements to conform to the 2005 presentation .

3.
Joint ventures, acquisitions and divestitures

Estel

In March 2000, the Company entered into a joint venture agreement with Communications Ventures India Pvt. Ltd. to form an entity named Estel Communication Pvt. Ltd. (“Estel”). Estel is organized and exists under the laws of India and has its office in New Delhi, India. The Company directly owns 49% of the joint venture and has voting rights in another 1.01%, which in turn gives the Company a 50.01% voting control in the joint venture. Estel was established to engage in the business of selling and supporting Internet service protocol operations. Basically, Estel is in business as an Internet & VoIP service provider in India. The joint venture has been funded primarily by the Company, which has also provided certain equipment for the establishment of the required technology platforms.

Pakistan

In July 2002, the Company acquired a 75% equity interest in a joint venture with Turner Hill Investments, L.P. (“Turner Hill”) to provide VoIP services for calls terminating in Pakistan. Turner Hill subsequently assigned its interest to Braddon Corporate Holdings Limited (“Braddon”). During 2003 and 2002, the Company contributed certain telecommunications equipment and advances to the joint venture in exchange for its equity interest in the new joint venture. This joint venture operated out of facilities provided by the joint venture partner and began providing VoIP service in November 2002. The investment by Braddon was fully absorbed by its pro-rata share of losses during January 2005. The Company has continued to fund 100% of the operations and as a result, the Company has recorded 100% of the losses since January 2005.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

3.
Joint ventures, acquisitions and divestitures (continued)

In connection with this joint venture, in May 2002 the Company entered into a Service Agreement (the “Agreement”) with Pakistan Telecommunications Company Limited (“PTCL”), under which PTCL provided for the termination of incoming international traffic into Pakistan focusing on VoIP services from the United States and Europe. The Agreement provided for an initial term of one year, with additional one-year extensions terms. The Company had exercised its option to extend the agreement, which was in effect through August 31, 2004. The Agreement provided for the Company to place all necessary switching equipment in Pakistan, the United States and Europe (which it had done through the Pakistan joint venture formed with Braddon). Under the terms of the Agreement, the Company paid PTCL a maximum service charge of $0.19 per minute for all calls terminating in Pakistan using the Company’s VolP platform. The Agreement also required the Company to guarantee a minimum of three million minutes a month to terminate to Pakistan. The Company was also required to keep on deposit with PTCL, a one month rolling advance equal to the number of minutes terminated during the preceding month, times the prevailing termination rate charged by PTCL to the Company.

On September 1, 2004, a new Agreement was consummated. The term was one year from September 1, 2004, renewable upon mutual consent. This agreement stipulated that the switching equipment installed in Pakistan by the Company through its Pakistan joint venture was to be owned and operated by PTCL. In addition, PTCL had the right to terminate the agreement if the Company did not deliver a minimum of traffic over a three-month period. The agreement also required the Company to put up a $1,000,000 bank guarantee, which never occurred as it was pending the resolution of advances totaling $415,000 owed to the Company by PTCL as of December 31, 2005. During February 2006, PTCL returned $389,000 of the rolling advance, which was reflected in prepaids and other current assets in the December 31, 2005 Consolidated Balance Sheet. The remaining balance is currently being disputed.

In connection with the joint venture agreement with Braddon, the joint venture was required to pay a management fee to Braddon equal to the number of minutes terminating in Pakistan on a monthly basis times a fixed rate per minute. For the years ended December 31, 2005, 2004, and 2003 the joint venture incurred management fees to Braddon of approximately $25,000, $314,000, and $361,000, respectively.

For the years ended December 31, 2005, 2004 and 2003 the Company incurred approximately $971,000, $8,545,000, and $9,327,000, respectively, of termination charges under these agreements. Due to a change in market conditions during 2005, the termination of incoming VoIP traffic into Pakistan was no longer advantageous to the Company and thus, the Company decided to cease operations with Braddon. Consequently, the termination charges and the management fee both decreased significantly during 2005. The Company terminated the service agreement on November 30, 2005.

Efonica
 
In December 2002, the Company acquired a 50.2% equity interest in a joint venture with Karamco, Inc. to provide various VoIP services throughout the emerging markets. Operations of the joint venture began during 2003.
 
During February 2005, the Company closed on its agreement to acquire the remaining 49.8% minority interest in Efonica from Karamco, Inc. This acquisition was completed to better enable Efonica to serve as the retail VoIP services division of Fusion, offering a full suite of VoIP solutions to customers in Asia, the Middle East, Africa, Latin America and the Caribbean. With 100% control, the Company can better leverage the significant experience and relationships of Efonica. The operating results for the 49.8% minority interest acquired are included in the Consolidated Statement of Operations from the date of acquisition.
 
Under its original terms, the purchase price ranged between a minimum of $5.4 million and a maximum of $14.3 million. At closing, Karamco, Inc. received cash of $500,000 and shares equal to the Base Purchase Price determined by the initial price of common stock at the date of the Company’s IPO. The Base Purchase Price was equal to 49.8% of the initial estimated valuation of Karamco Inc or approximately $9.8 million. At the date of the IPO, approximately 1.44 million of shares were issued under this agreement of which Karamco received approximately 765,000 of shares and approximately 676,000 shares were held in escrow. During 2005, approval was given to release the shares being held in escrow. Consequently, the value of these shares of approximately $4.4 million is reflected as goodwill and as a long-term liability in the December 31, 2005 Consolidated Balance sheet (See Note 21 for subsequent events).
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

3.
Joint ventures, acquisitions and divestitures (continued)
 
Out of the shares issued to Karamco, the Company agreed to register for resale 150,000 shares of common stock in a registration statement. Karamco was restricted from selling in excess of $1 million worth of common stock during the one-year period following the IPO Prospectus Date. If the sale of the 150,000 shares registered resulted in less than $1 million of gross proceeds, the Company is required to pay Karamco the difference between the aggregate gross proceeds of Karamco’s sale of the registered shares and $1 million (the “Difference Payment”). At December 31, 2005, the Company has paid Karamco $430,000 towards the Difference Payment which is reflected as capital in excess of par value in the accompanying Consolidated Balance Sheet. In the event the Difference Payment is less than $430,000, Karamco is obligated to reimburse the Company for such excess. This obligation is secured by 50,387 shares held in escrow. The time period for the difference payment, under an amendment to the purchase agreement was extended to March 2007 (see Note 21).
 
During the years ended December 31, 2005 and 2004, the proforma impact of the acquisition on the Consolidated Statement of Operations would be a reduction in the loss of approximately $18,000 and $43,000, respectively, and an increase in the net loss during the year ended December 31, 2003 net of $19,000.
 
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed, including $20,316 of related acquisition costs at the date of acquisition:
         
Cash
 
$
39,581
 
Accounts receivable
   
64,709
 
Prepaid expenses and other current assets
   
175,040
 
Property and equipment, net
   
50,651
 
Intangible assets
   
4,877,900
 
Goodwill
   
4,971,221
 
Accounts payable, accrued expenses and other
   
(373,269
)
Common stock issued or to be issued
   
(9,285,697
)
Total cash paid (excludes Difference Payment)
 
$
520,136
 
 
The initial purchase price allocations were based upon an independent appraisal. The intangible assets acquired were allocated $4,579,100 to the Efonica trade name and trademarks and $298,800 were allocated to the customer list. In determining the purchase price allocation, the trademark was determined based upon the income approach through the application of the relief from royalties method and the customer list was determined based upon the income approach through the application of the excess earnings method. The rate used to discount the net cash flows to present values was based upon a weighted average cost of capital of approximately 28%. The excess of the purchase price over the fair values of the assets acquired and liabilities assumed was allocated to goodwill.
 
Jamaica

On December 16, 2004, the Company entered into an agreement to acquire 51% of the common stock of a Jamaican company for $150,000. This acquisition was completed to establish the Company as a licensed carrier operation in Jamaica providing the Company an entrance into this emerging market. The Company will begin selling its full suite of VoIP and other Internet services during the second quarter of 2006, once its retail service roll-out is complete. The Jamaican joint venture did not have any results of operations until the second quarter of 2005. The pro-forma effect of this acquisition is not material. The closing of this acquisition took place on January 11, 2005.
         
Cash
 
$
3,514
 
Prepaid expenses and other current assets
   
17,385
 
Property and equipment, net
   
25,800
 
Other assets
   
100,000
 
Goodwill
   
147,419
 
Minority interest
   
(144,118
)
Total cash paid
 
$
150,000
 
 
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

3.
Joint ventures, acquisitions and divestitures (continued)

The investment by the minority interest partners was fully absorbed by its pro-rata share of losses during December 2005. The Company has continued to fund 100% of the Jamaican operations and as a result, the Company has started recording 100% of the losses during December 2005.

Turkey

On March 8, 2005, a new wholly owned subsidiary of the Company, Fusion Turkey, LLC entered into a Stock Purchase Agreement to acquire 75% of the shares of LDTS Uzak Mesafe Telekomikasyon ve Iletism Hizmetleri San. Tic. A.S. (“LDTS”), from the existing shareholders. LDTS possesses a telecommunications license approved by the Turkish Telecom Authority. This license will permit the Company to offer VoIP services under its efonica brand and other Internet services to corporations and consumers in Turkey. Given the changing dynamics of the Turkish market and regulatory framework, the Company continues to work towards the deployment of IP services but has found it unnecessary to build-out a network in Turkey as originally planned. The Company will begin offering services in Turkey in the second quarter of 2006, once its retail service rollout is complete.

The closing of the acquisition took place on May 6, 2005. The following table summarized the estimated fair value of the assets and liabilities acquired and the minority interest on May 6, 2005:

Cash
 
$
997
 
Prepaid expense and other current assets
   
1,880
 
Other assets
   
219,326
 
Accounts payable and accrued liabilities
   
(28,235
)
Minority interest
   
(100,000
)
   
$
93,968
 
 
The primary net asset acquired was the license (included in other assets), which was issued on March 17, 2004, and is valid for 15 years. Consequently, the license is being amortized over the remaining term. As the transaction closed on May 6, 2005, the Consolidated Statements of Operations for the year ended December 31, 2005, includes activity related to this subsidiary since May 6, 2005. The pro-forma effect of this acquisition is not material.

All joint ventures identified above, excluding Estel, have been accounted for under the consolidation method of accounting as the Company maintained a majority equity ownership in the aforementioned joint ventures.

Since the Company maintains operations in foreign countries through its joint ventures, the Company may be subject to exchange control regulations or other impediments to convert foreign currencies into U.S. dollars. In addition, the Company may generate earnings, which may be unable to be repatriated outside the country in which they are earned. As of December 31, 2005, the Company’s joint ventures have not generated profits that would be subject to such restrictions.

iFreedom

On November 14, 2005, the Company entered into an agreement to acquire the assets of iFreedom Communications International Holdings Limited (“iFreedom”), and a number of its subsidiaries, an entity that markets monthly recurring international VoIP service plans geared to meet the needs of consumers and businesses in the emerging markets. The agreement provided for a purchase price of $500,000 in cash, and 1,100,000 shares of stock, of which 750,000 shares were to be held in escrow and were subject to a performance based earn out. Under the terms of the agreement, the Company would have acquired iFreedom’s customer base as well as operations in Hong Kong, the Philippines, Malaysia, the United Kingdom, and the United States. As certain closing conditions have not yet been met by iFreedom, the parties have been working in good faith to renegotiate the terms and conditions of the transaction and have reached a proposed resolution. The Company now plans to acquire iFreedom's operations in Malaysia and the Philippines. In addition, the Company would hire certain of iFreedom's employees and potentially acquire certain other assets. The purchase price is expected to be $500,000 in cash, which may go towards satisfying certain liabilities iFreedom owes to the Company as described below, and 750,000 shares of common stock, of which 350,000 shares would be held in escrow subject to a performance based earn out. The Company anticipates executing a formal agreement documenting this new understanding, although there can be no assurance that such an agreement will be signed, what parties will be included, or that the above stated terms will be included.
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

3.
Joint ventures, acquisitions and divestitures (continued)

The Company has been providing termination services to iFreedom, which services have aggregated charges of approximately $216,000 as of December 31, 2005. iFreedom has entered into a non interest bearing Note with respect to charges through March 20, 2006 in the principal amount of $463,098 which will increase as charges accrue. The Security Agreement with respect to the Note has not been entered into. It is expected that up to $500,000 in principal amount of this Note will be offset at closing in lieu of cash due. The Company expects to resolve this outstanding receivable at closing, but can make no assurance all or any of the receivable will be paid.


4.        
Investment in Estel

As of December 31, 2005 and 2004, the loss in excess of investment in Estel of approximately $771,000 and $141,000, respectively, represents the Company’s 49% investment in Estel (See Note 3 for further discussion). Loss from investment in Estel was approximately ($542,000), ($520,000) and ($747,000) for the years ended December 31, 2005, 2004 and 2003, respectively. Summarized financial data of Estel is below.
 
   
Years Ended December 31,
 
   
2005
 
2004
 
Current assets
 
$
449,000
 
$
599,000
 
Non-current assets
   
546,000
   
1,147,000
 
Current liabilities
   
1,684,000
   
1,893,000
 
Total stockholders’ equity (deficit)
   
(689,000
)
 
(147,000
)
 
   
Years Ended December 31,
 
   
2005
 
2004
 
2003
 
Net revenues
 
$
2,191,000
 
$
2,280,000
 
$
2,119,000
 
Net loss
   
(542,000
)
 
(520,000
)
 
(747,000
)

The investment by the other shareholder of Estel was fully absorbed by its pro rata share of losses during 2001. The Company has continued to fund 100% of Estel’s operations and as a result, the Company has recorded 100% of Estel’s losses for the years ended December 31, 2005, 2004 and 2003 as loss from investment in Estel.

For the years ended December 31, 2005, 2004, and 2003, revenues included approximately $201,000, $321,000, and $412,000, respectively, for VoIP and IP services provided to Estel. At December 31, 2005 and 2004, the amounts due from this joint venture were approximately $29,000 and $118,000, which is net of an $834,000 and $644,000 allowance respectively. These receivables are non-interest bearing, due on demand, and are included in Investment in Estel on the accompanying balance sheets.

In considering, EITF No. 96-16, “Investor’s Accounting for an Investee When the Investor Has a Majority of the Voting Interest but the Minority Shareholder or Shareholders Have Certain Approval or Veto Rights”, management has evaluated the facts and circumstances underlying each joint venture relationship such as the financial dependence of the minority shareholders on the Company and corporate governance of each joint venture. Based upon these facts and circumstances, the Company has determined that the minority shareholder of Estel has substantive rights that prohibit the consolidation of this joint venture. As a result, the Company has accounted for this joint venture under the equity method of accounting.

5.        
Goodwill and identifiable intangible assets

The Company’s goodwill relates primarily to the VoIP to Consumers and Corporations reporting segment. The changes in the amount of goodwill for the year ended December 31, 2005,is as follows:

   
  Goodwill
 
Balance as of January 1, 2005
 
$
—
 
Goodwill for Jamaican acquisition
   
147,419
 
Goodwill for purchase of Efonica minority interest
   
4,971,221
 
Balance as of December 31, 2005
 
$
5,118,640
 
 
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

5.        
Goodwill and identifiable intangible assets (continued)

Identifiable intangible assets, net, as of December 31, 2005, are composed of:
         
Trademarks
 
$
4,584,632
 
Customer list, net of accumulated amortization of $22,420
 
276,380
 
   
$
4,861,012
 

These identifiable intangible assets were acquired in connection with the Company's purchase of the 49.8% minority interest in its Efonica joint venture. The trademarks are not subject to amortization as they have an indefinite life. Amortization on the customer list during the year ended December 31, 2005, was $22,420. There was no customer list amortization during 2004. The following table presents estimated amortization expense for each of the succeeding calendar years.
       
2006
 
$
29,880
 
2007
   
29,880
 
2008
   
29,880
 
2009
   
29,880
 
2010
   
29,880
 
Thereafter
   
126,980
 
   
$
276,380
 

6.        
Discontinued operations

During 2001, management of the Company decided to cease the operations of its domestic retail telecommunication services business lines. In connection with this decision, the Company abandoned an office located in Miami, which was being used to house the switching equipment. The office was being leased under a non-cancelable operating lease agreement. In January 2005, the Company and the landlord reached a settlement agreement whereby the remaining liability under the operating lease was reduced to $132,500, which was paid in January 2005. For the year ended December 31, 2004, included in gain from discontinued operations is approximately $588,000 related to this settlement. During 2005, the Company continued its efforts to settle and pay certain of these remaining liabilities. As a result of these efforts as well as revisions to past estimates, the Company recognized a gain of approximately $337,000 during the year ended December 31, 2005. The remaining liability at December 31, 2005 and 2004, of approximately $621,000 and $984,000 relates to trade payables and accrued expenses associated with the discontinued retail telecommunications services.

During the year ended December 31, 2003, certain trade payables, associated with the discontinuation of the Company’s retail services, were determined to be not payable to a vendor, which resulted in a gain on trade payable reductions of approximately $209,000.

7.        
Property and equipment

At December 31, 2005 and 2004, property and equipment is comprised of the following:

   
2005
 
2004
 
Network equipment, including $1,799,236 and $1,743,269 under capital and equipment financing leases in 2005 and 2004, respectively
 
$
6,970,002
 
$
7,478,487
 
Furniture and fixtures
   
120,377
   
92,298
 
Computer equipment and software, including $67,116 under capital and
equipment financing leases in 2005
   
968,525
   
741,326
 
Leasehold improvements
   
2,710,219
   
2,710,219
 
Assets in progress, including $996,504 under capital and equipment financing leases in 2005
   
1,690,472
   
—
 
 
   
12,459,595
   
11,022,330
 
Less accumulated depreciation and amortization, including $921,163 and  $951,966 under capital and equipment financing leases in 2005 and 2004, respectively
   
(7,943,324
)
 
(7,750,856
)
   
$
4,516,271
 
$
3,271,474
 
 
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

8.        
Restricted cash

As of December 31, 2005 and 2004, the Company had approximately $218,000 and $380,000, respectively, of cash restricted from withdrawal and held by banks as certificates of deposit securing letters of credit (equal to the amount of the certificates of deposit). A significant portion of this restricted cash is required as security deposits for certain of the Company’s non-cancelable operating leases for office facilities.

9.        
Accounts payable and accrued expenses

Accounts payable and accrued expenses consist of the following at December 31, 2005 and 2004:

   
  2005
 
2004
 
Trade accounts payable
 
$
6,134,373
 
$
5,662,058
 
Accrued expenses
   
1,892,216
   
2,050,175
 
Interest payable
   
334,869
   
814,262
 
Dividends payable on Series C Preferred Stock
   
—
   
664,635
 
Deferred revenue
   
810,837
   
971,456
 
Other to be issued
   
97,046
   
112,102
 
   
$
9,269,341
 
$
10,274,688
 

The deferred revenue balance at December 31, 2005, includes approximately $466,000 related to a debt settlement agreement with a domestic carrier. The provisions of the agreement provided that $555,000 due to the carrier would be resolved with a service agreement whereby the carrier will receive a reduced rate for certain minutes of traffic that is passed through the Company’s network through December 2005. The Company and the carrier have continued to comply with the terms of this agreement past December 2005. During the years ended December 31, 2005 and 2004, approximately $4,000 and $86,000, respectively, of revenue were recognized in connection with this service agreement.

10.        
Long-term debt and capital lease/equipment financing obligations

At December 31, 2005 and 2004, components of long-term debt and capital lease/equipment financing obligations of the Company are comprised of the following:

 
 
 
2005
 
2004
 
Convertible notes payable
   
(a)
$
—
 
$
250,000
 
Demand notes payable
   
(b)
 
—
   
898,931
 
Promissory notes payable
   
(c)
 
150,000
   
150,000
 
Demand notes payable
   
(d)
 
—
   
81,790
 
Promissory notes payable
   
(e)
 
—
   
150,000
 
Promissory notes payable
   
(f)
 
—
   
25,000
 
Promissory notes payable
   
(g)
 
—
   
102,000
 
Promissory notes payable
   
(h)
 
—
   
233,252
 
Convertible notes payable
   
(i)
 
—
   
2,508,333
 
Capital lease/equipment financing obligations
   
(j)
 
1,427,615
   
1,288,325
 
Total long-term debt and capital lease/equipment financing obligations
     
1,577,615
   
5,687,631
 
Less current portion
     
(1,569,965
)
 
5,531,136
 
       
$
7,650
 
$
156,495
 
 

(a)   Balance at December 31, 2004, represented two convertible subordinated note agreements. Interest rate was 9.25% at December 31, 2004, payable semi-annually on January 31 and July 31. During February 2005, these notes were paid in full upon completion of the Company’s IPO.

(b)    Two officers of the Company entered into various loan agreements with the Company in exchange for demand notes payable. The interest rates ranged from 4.00%-4.75% per annum and were due on demand. During February 2005, these notes were paid in full upon completion of the Company’s IPO.
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

10.
Long-term debt and capital lease/equipment financing obligations (continued)

(c)   During February 2004, the Company entered into a settlement agreement for $600,000. In the same month, the Company paid $450,000 and agreed to make 12 monthly payments for the remaining $150,000. The debt has not been repaid as of December 31, 2005, as the other party to the settlement agreement has not complied with the terms of the agreement.

(d)   Balance at December 31, 2004, represented promissory notes to three stockholders. The interest rates ranged from 4.75%-12.00% per annum and were due on demand. During February 2005, these notes were paid in full upon completion of the Company’s IPO.

(e)   Balance at December 31, 2004, related to various promissory notes. Interest rate was 4.75% per annum. During February 2005, these notes were paid in full upon completion of the Company’s IPO.

(f)   Balance at December 31, 2004, represented promissory note, which bore interest at 4.5% per annum. Principal and interest were payable in one lump sum on the earlier of 15 days from the completion of an IPO or September 1, 2005. During February 2005, this note was repaid in full upon completion of the Company’s IPO.

(g)   Balance at December 31, 2004, represented a loan agreement, which bore interest at 15%. During February 2005, the note was repaid in full upon completion of the Company’s IPO.

(h)   The balance at December 31, 2004, related to promissory notes to various stockholders for the purpose of resolving the Company’s capital lease debt service contract with the lessor of the equipment under lease. The notes accrued interest at 8% per annum. The balance also related to an equipment lease with a non-related party. These notes were all repaid during the year ended December 31, 2005.

(i)   Balance at December 31, 2004, represented two convertible notes, which bore interest at 6.50% per annum. In February 2005, these notes were automatically converted into 651,515 common shares (based upon a conversion price of $3.85 per share) upon the completion of the Company’s IPO.

(j)   During the years ended December 31, 2005 and 2004, the Company entered into several capital lease/equipment financing agreements totaling approximately $937,000 and $760,000, respectively. Of the $1.7 million of agreements entered into during 2004 and 2005, all (excluding approximately $275,000) are payable every 90 days over a 12-18 month period. The Company has imputed an interest rate of 10.0% related to these agreements. During December 31, 2004, approximately $193,000 of capital lease/equipment financing obligations had been forgiven and recorded to forgiveness of debt (see Note 16 for further discussion). At December 31, 2005 and 2004, approximately $720,000 of the capital lease obligations were in default and accordingly have been classified as currently due.

Future aggregate principal payments on long-term debt and capital lease/equipment financing obligations in the years subsequent to December 31, 2005, are as follows:

Year ending December 31,
     
            2006
 
$
1,916,189
 
            2007
   
7,837
 
Total minimum payments
   
1,924,026
 
Less amount representing interest
   
(346,411
)
Present value of minimum payments
   
1,577,615
 
Less current portion
   
(1,569,965
)
   
$
7,650
 
 

 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

11.
Income taxes

Due to the operating losses incurred, the Company has no current income tax provision for the years ended December 31, 2005, 2004 and 2003. The provision for income taxes consists of the following:

   
2005
 
2004
 
2003
 
Deferred
 
 
 
 
 
 
 
Federal
 
$
2,883,000
 
$
(1,662,000
)
$
(1,728,000
)
State
   
(277,000
)
 
(56,000
)
 
(19,000
)
 
   
2,606,000
   
(1,718,000
)
 
(1,747,000
)
Change in valuation allowance
   
(2,606,000
)
 
1,718,000
   
1,747,000
 
   
$
—
 
$
—
 
$
—
 

The following reconciles the Federal statutory tax rate to the effective income tax rate:

 
 
2005
 
2004
 
2003
 
 
 
%
 
%
 
%
 
Federal statutory rate
   
34.0
   
34.0
   
34.0
 
State, net of federal tax
   
2.9
   
1.1
   
0.3
 
Other
   
(1.9
)
 
(0.1
)
 
7.5
 
Change in valuation allowance
   
(35.0
)
 
(35.0
)
 
(41.8
)
Effective income tax rate
   
—
   
—
   
—
 

The components of the Company’s deferred tax assets and liability consist of approximately the following at December 31, 2005 and 2004, respectively:

Deferred tax assets
 
2005
 
2004
 
Net operating losses
 
$
20,463,000
 
$
24,912,000
 
Allowance for doubtful accounts
   
499,000
   
423,000
 
Accrued liabilities and other
   
534,000
   
446,000
 
Property and equipment
   
1,580,000
   
—
 
 
   
23,076,000
   
25,781,000
 
Deferred tax liability
           
      Property and equipment
   
—
   
(99,000
)
Deferred tax asset, net
   
23,076,000
   
25,682,000
 
      Less valuation allowance
   
(23,076,000
)
 
(25,682,000
)
   
$
—
 
$
—
 

The Company has available at December 31, 2005 and 2004, approximately $60,184,000 and $73,269,000, respectively, of unused net operating loss carry forwards that may be applied against future taxable income, which expire in various years from 2012 to 2025. Under the Tax Reform Act of 1986, the amounts of and benefits from net operating loss carry forwards and credits may be impaired or limited in certain circumstances. Events which cause limitations in the amount of net operating losses that the Company may utilize in any one year include, but are not limited to, a cumulative ownership change of more than 50%, as defined, over a three year period. The amount of such limitation, if any, has not been determined.

Management of the Company had decided to fully reserve for its net deferred tax assets, as it is more likely than not that the Company will not be able to utilize these deferred tax assets against future taxable income, coupled with certain limitations on the utilization of the net operating losses due to various changes in ownership over the past several years.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

12.
Commitments and contingencies

The Company has various non-cancelable operating lease agreements for office facilities. A summary of the lease commitments under non-cancelable leases at December 31, 2005, is approximately as follows:

Year ending December 31,
      
2006
 
$
1,289,000
 
2007
   
1,275,000
 
2008
   
1,315,000
 
2009
   
1,352,000
 
2010
   
837,000
 
Thereafter
   
3,069,000
 
   
$
9,137,000
 

Rent expense for all operating leases was approximately $1,309,000, $1,145,000 and $1,238,000 for the years ended December 31, 2005, 2004 and 2003, respectively. Certain of the Company’s leases include fixed rent escalation schedules or rent escalations based upon a fixed percentage. The Company recognizes rent expense (including escalations) on a straight-line basis over the lease term.

The Company has entered into agreements to relocate its New York executive offices and expand its Fort Lauderdale office during 2006. The revised lease terms for both of these offices are reflected in the above lease commitment schedule.

As of December 31, 2005, the Company has outstanding purchase commitments of approximately $445,000.

Legal Matters

On May 28, 2003, Jack Grynberg, et al., an investor in one of our private offerings; filed a complaint with the Denver District Court, State of Colorado (Jack Grynberg, et al v. Fusion Telecommunications International, Inc., et al, 03-CV-3912) seeking damages in the amount of $400,000 for the purchase of an interest in Fusion’s 1999 private placement offering of subordinated convertible notes through Joseph Stevens & Company, Inc., a registered broker dealer. This complaint asserted the following claims for relief against us: Breach of Fiduciary Duty, Civil Theft, Deceptive Trade Practices, Negligent Misrepresentation, Deceit Based on Fraud, Conversion, Exemplary Damages and Prejudgment Interest. On June 25, 2004, we filed with the Court our Motion to dismiss, which was granted. We were awarded attorneys’ fees by the court. The plaintiffs have filed an appeal of the motion, which is pending.

The Company is involved in other claims and legal actions arising in the normal course of business. Management does not expect that the outcome of these cases will have a material effect on the Company’s financial position or results of operations. Due to the regulatory nature of the industry, the Company is periodically involved in various correspondence and inquiries from state and federal regulatory agencies. Management does not expect the outcome of these inquiries to have a material impact on the operations or the financial condition of the Company.

13.
Preferred stock

The Company has authorized 10,000,000 shares of its stock for the issuance of Preferred Stock. The Company has designated 1,100,000, 1,500,000 and 110,000 shares of $10 Series A Convertible Redeemable Preferred Stock (“Series A Preferred Stock”), $10 Series B Convertible Redeemable Preferred Stock (“Series B Preferred Stock”) and $90 Series C Convertible Redeemable Preferred Stock (“Series C Preferred Stock”), respectively (collectively “Preferred Stock”).

During May 2004, each outstanding share of Series A and Series B Preferred Stock was converted to common stock at a conversion rate of $3.50 per share. Consequently as of December 31, 2004, there were no shares outstanding of Series A and Series B Preferred Stock.
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

13.
Preferred Stock (continued)

At December 31, 2004, there were 109,962 shares of the Series C Preferred Stock outstanding. The holders of the Series C Preferred Stock were entitled to receive cumulative dividends of 8% per share per annum which were payable annually beginning on December 18, 2004, and were payable in cash, unless the Company completed its IPO before December 18, 2004. Since the IPO was not completed until February 2005, the dividends on the Series C Preferred Stock of approximately $665,000 were paid on January 18, 2005. Upon the closing of the Company’s initial public offering during February 2005, the 109,962 outstanding shares of the Series C Preferred Stock were automatically converted into 3,141,838 shares of the Company’s common stock and 3,141,838 Redeemable Common Stock Purchase Warrants. There was no beneficial conversion feature associated with this conversion.

Dividends

The holders of Series A Preferred Stock were entitled to receive cumulative dividends of 12% per share per annum, which were payable annually in arrears beginning on August 31, 2002 and were payable (at the Company’s option) in cash or shares of the Company’s common stock at a rate equal to the conversion rate in effect at the date of declaration of the dividend. The holders of Series B Preferred Stock were entitled to a cumulative dividend of 11.5% per share per annum, which were payable annually in arrears beginning on March 31, 2003, and were payable (at the Company’s option) in cash or shares of the Company’s common stock at a rate equal to the conversion rate in effect at the date of declaration of the dividend. The holders of Series C Preferred Stock were entitled to receive cumulative dividends of 8% per share per annum which were payable annually beginning on December 18, 2004, and were payable in cash, unless the Company completed its IPO before December 18, 2004. Since the IPO was not completed until February 2005, the dividends on the Series C Preferred Stock of approximately $665,000 were paid on January 18, 2005.

In January 2003, the Company’s Board of Directors (the “Board”) declared a stock dividend payable on the outstanding shares of Series A and Series B Preferred Stock (due on August 31, 2002 and March 31, 2003, respectively). The Board elected to issue shares of the Company’s common stock in lieu of cash at a conversion rate equal to $2.28 per share times the aggregate dividends due to the holders of both Series A and Series B Preferred Stock at the date of record (August 15, 2002 and March 15, 2003, respectively). During the year ended December 31, 2003, 318,491 shares of the Company’s common stock valued at approximately $725,000 were recorded and issued as a dividend to the Series A and Series B Preferred shareholders.

In December 2003, the Board declared a stock dividend payable on the outstanding shares of Series A and Series B Preferred Stock (due on August 31, 2003 and March 31, 2004, respectively). The Board elected to issue shares of the Company’s common stock in lieu of cash at a conversion rate equal to $2.98 per share times the aggregate dividends due to the holders of both Series A and Series B Preferred Stock at date of record (August 15, 2003 and March 15, 2004, respectively). At December 31, 2003, the Company recorded a stock dividend distributable of approximately $553,000 for the issuance of 185,962 shares of common stock to the holders of the Company’s Series A and Series B Preferred Stock. These shares were issued during the year ended December 31, 2004, along with an additional 6,708 shares of common stock for dividends on Series B Preferred Stock totaling approximately $20,000.

In connection with the conversion of the Series A and Series B Preferred Stock into common stock, accrued dividends from September 1, 2003 and April 1, 2004 to the date of the respective conversions were issued in the form of common stock. These common stock dividends aggregated 123,012 additional shares of common stock and were issued during September 2004.

Redemption

The Company had the right to redeem the outstanding shares of Series A and Series B Preferred Stock at any time (with 30 days prior notice) for a redemption price of $10 per share plus accrued, but unpaid dividends. The Company had the right to redeem the outstanding shares of Series C Preferred Stock, commencing on the first anniversary of the first issuance of Series C Preferred Stock, at a price per share equal to 115% of the stated value of $90, plus pro rata accrued and unpaid dividends due through the date of redemption.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

13.
Preferred Stock (continued)

As previously discussed, the Series C Preferred Stock was converted to common stock in February 2005. Had the conversion not occurred after the second anniversary of the first issuance of the Company’s Series C Preferred Stock (December 18, 2005) and so long as all classes of the Company’s stock were not publicly traded and a liquidation had not occurred, each holder of Series C Preferred Stock may have, at its option, required the Company to redeem its shares at a price equal to 112% of the stated value of the stock, plus pro rata accrued and unpaid dividends due through the date of redemption. At December 31, 2004, the redemption value of the Series C Preferred Stock was approximately $10,932,000.

At various times during 2005, all the holders of the Company’s Series A and Series B Preferred Stock, elected to convert their shares into common stock.

Voting

No holders of Preferred Stock had voting rights, except as provided by law.

14.
Stock options and warrants

Under the Company’s 1998 stock option plan (as amended), the Company has reserved 2,680,857 shares of common stock for issuance to employees at exercise prices determined by the Board of Directors. Options under the plan typically vest in annual increments over a three or four year period, expire ten years from the date of grant and are issued at exercise prices no less than 100% of the fair market value at the time of grant. As discussed in Note 2, through December 31, 2005, the Company has elected to adopt the disclosure-only provisions of SFAS No. 123 and has accounted for its stock-based employee compensation plans in accordance with APB No. 25. As a result, no compensation cost for its stock option plan has been recognized in the periods presented.

On July 14, 2004, the Company’s Stock Option Committee approved a recommendation to issue 446,057 options to its employees who had been previously granted stock options. Each employee received new options equal to 50% of their existing options priced at $3.15 per share and 50% at $4.38 per share, both with a four year vesting period and furthermore received credit for the vesting time on previously issued options, and the original options were cancelled if not exercised within six months and one day of the issuance of the new options (approximately 480,000 options were cancelled on January 14, 2005).

On December 19, 2005, the Nominating and Compensation Committee of the Company accelerated the vesting schedule on all stock options granted prior to November 18, 2005 to be fully vested as of December 19, 2005.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements


14.
Stock Options and Warrants (continued)

A summary of the Company’s stock option plan as of December 31, 2005, 2004 and 2003, and changes during the years ended on those dates is as follows:
 
 
Number
of
Shares
 
Per Share
Option Price
 
Weighted
Average
Option
Price
 
Shares under options at January 1, 2003
   
1,009,771
 
$
2.35 -$14.00
 
$
7.39
 
Granted in 2003
   
9,771
   
8.75 -8.75
   
8.75
 
Expired in 2003
   
(363,335
)
 
2.35 -14.00
   
5.11
 
Shares under options at December 31, 2003
   
656,207
   
2.35 -11.66
   
8.72
 
Granted in 2004
   
1,337,764
   
3.15 -8.75
   
4.21
 
Expired in 2004
   
(145,393
)
 
2.35 -11.66
   
9.26
 
Shares under options at December 31, 2004
   
1,848,578
   
2.35 - 8.75
   
5.42
 
Granted in 2005
   
772,566
   
2.46-6.45
   
3.86
 
Exercised in 2005
   
(21,429
)
 
2.35-2.35
   
2.35
 
Expired/cancelled in 2005
   
(556,916
)
 
3.15-8.75
   
8.41
 
Shares under options at December 31, 2005
   
2,042,799
 
$
2.46-$8.75
 
$
4.05
 
 
               
 
Number
of
Shares
 
Per Share
Option Price
 
Weighted
Average
Option
Price
 
Options exercisable at December 31, 2003
   
452,315
 
$
2.35-$11.66
 
$
8.58
 
Options exercisable at December 31, 2004
   
440,049
 
$
2.35-$8.75
 
$
8.44
 
Options exercisable at December 31, 2005
   
1,548,307
 
$
3.15-$8.75
 
$
4.50
 

The following table summarizes information about stock options outstanding at December 31, 2005:
 
   
  Options Outstanding
 
Options Exercisable
 
Exercise Prices
 
  Number
Outstanding
 
Weighted Average Remaining
Contractual Life
 
Weighted-Average
Exercise Price
 
Number
E xercisable
 
Weighted
Average
Exercise Price
 
$2.46-2.46
   
431,450
   
4.69 years
 
$
2.46
   
—
 
$
—
 
$2.65-3.75
   
283,560
   
8.40 years
   
3.20
   
255,880
   
3.23
 
$4.38-4.38
   
1,078,607
   
6.33 years
   
4.38
   
1,045,586
   
4.38
 
$4.40-6.45
   
249,110
   
9.12 years
   
6.30
   
246,823
   
6.31
 
$8.75-8.75
   
72
   
0.22 years
   
8.75
   
18
   
8.75
 
 
   
2,042,799
             
1,548,307
     
                                 
 
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

14.
Stock Options and Warrants (continued)

The Company, as part of various debt and other agreements, have issued warrants to purchase the Company’s common stock. The following summarizes the information relating to warrants issued and the activity during 2005, 2004 and 2003:
 
           
Weighted
 
   
Number
     
Average
 
   
of
 
Per Share
 
Warrant
 
   
Shares
 
Warrant Price
 
Price
 
Shares under warrants at January 1, 2003
   
159,217
 
$
0.04 -8.75
 
$
3.57
 
Issued in 2003
   
93,541
   
2.98 -3.57
   
3.01
 
Shares under warrants at December 31, 2003
   
252,758
   
0.04 -8.75
   
3.33
 
Issued in 2004
   
33,820
   
2.28 -8.75
   
5.53
 
Shares under warrants at December 31, 2004
   
286,578
   
0.04 -8.75
   
3.61
 
Issued in 2005
   
7,281,838
   
6.45
   
6.45
 
Exercised in 2005
   
(28,572
)
 
2.98
   
2.98
 
Expired in 2005
   
(77,409
)
 
2.98-8.75
   
4.15
 
Shares under warrants at December 31, 2005
   
7,462,435
 
$
0.04-6.45
 
$
6.37
 

All warrants are fully exercisable upon issuance other than the IPO warrants, which could not be exercised until the first anniversary of the date of the IPO.

15.
Equity transactions

On February 17, 2005, the Company closed its initial public offering of securities of 3,600,000 shares of common stock at a price of $6.45 per share and 3,600,000 redeemable common stock purchase warrants at $0.05 per warrant. Gross proceeds of the offering were approximately $23,300,000. Total estimated offering costs were approximately $3,000,000, which resulted in net proceeds to the Company of $20,400,000. On March 30, 2005, the Company’s underwriters exercised their over-allotment option and purchased an additional 480,000 shares of common stock and 540,000 purchase warrants. The Company received an additional $2,900,000 in net proceeds from the closing on the over-allotment option.
 
Subsequent to the IPO, the Company had two classes of outstanding common stock. The holders of the Class A Common Stock had identical rights and privileges as the regular common stock, except that they were not able to transfer shares of Class A Common Stock until the first anniversary of the date of the prospectus, which was February 11, 2005. After the date of the IPO, the Class A Common Stock could have been converted at the option of the holder, without the consent of the underwriters, if the holder executed and delivered a lock up agreement preventing the public sale of the common stock until the first anniversary of the date of the IPO. The Class A Common Stock will be automatically converted into the regular common stock on the first anniversary of the date of the IPO (See Note 21).

Upon completion of the IPO, $2,508,333 million of convertible debt was converted into 651,515 shares of common stock. In addition, 1,439,643 shares of common stock were issued (of which 675,581 shares were held in escrow at December 31, 2005) in connection with the Company’s acquisition of the 49.8% minority interest in Efonica (see Note 3 for further discussion). In accordance with SFAS No. 141, since 675,581 of these shares are held in escrow, they were not reflected as outstanding as of December 31, 2005. In addition, as discussed in Note 13, all outstanding Series C Preferred Stock was converted into common stock.

During the second quarter of 2005, a director exercised stock options which resulted in the issuance of 21,429 shares of common stock and two individuals exercised warrants, which resulted in the issuance of 28,572 shares of Class A Common Stock.

On April 19, 2005, the Company entered into a consulting service agreement. In connection with this agreement, the Company issued 11,363 shares of restricted common stock based upon a price of $4.40 per share. During the second quarter of 2005, the restricted shares were released in accordance with the agreement. The $50,000 expense associated with these shares is being amortized over the one-year term of the agreement.
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

15.
Equity transactions (continued)

On November 1, 2004, the Board of Directors, upon approval of the stockholders, increased the authorized number of common shares to 126,000,000, which includes 105,000,000 shares of common stock and 21,000,000 shares of Class A Common Stock. The stockholders approved this increase on December 10, 2004. On December 10, 2004, the stockholders approved the amendment to the Company’s Certificate of Incorporation to automatically convert each share of the Company’s outstanding common stock (except for shares of common stock issuable upon conversion of Series C Preferred Stock) into one share of Class A Common Stock. The Class A Common Stock could not be converted into common stock until February 17, 2006, which is one year after the completion of the Company’s initial public offering, unless the holder agreed to exercise a one-year lock up agreement. See subsequent events Note 21 regarding the conversion of these shares. The rights of a Class A shareholder were identical in all respects to the common stock other than the shares of Class A Common Stock were not transferable for a period of one year following the February 2005 closing of the Company’s IPO.

In October 2004, the Company issued 19,048 shares of common stock at $5.25 per share in lieu of cash to the Saif Telecom (Pvt) Ltd for management fees related to the Pakistan joint venture.

At various times through the first six months of 2004, all the shareholders of the Company’s Series A Preferred Stock, elected to convert their shares into common stock at a conversion rate of $3.50 per share. This conversion resulted in the issuance of 1,163,500 shares of common stock. In connection with this conversion accrued dividends from September 1, 2003 to the date of the respective conversions were issued in the form of common stock. These common stock dividends resulted in the issuance of 119,479 additional shares of common stock.

At various times through the first six months of 2004, all the shareholders of the Company’s Series B Preferred Stock, elected to convert their shares into common stock at a conversion rate of $3.50 per share. This conversion resulted in the issuance of 210,000 shares of common stock. In connection with this conversion accrued dividends from April 1, 2004 to the date of the respective conversions were issued in the form of common stock. These common stock dividends resulted in the issuance of 3,533 additional shares of common stock.

During March 2004, certain investors elected to convert approximately $407,000 of their notes and $177,000 of escrow advances into shares of the Company’s Series C Preferred Stock at a conversion rate of $90 a share. The conversion resulted in the issuance of 6,504 additional shares of Series C Preferred Stock.

In December 2003, certain note holders elected to convert their notes and related accrued interest, totaling approximately $930,000, into shares of the Company’s Series C Preferred Stock at a conversion rate of $90 per share, resulting in the issuance of 10,336 shares of Series C Preferred Stock. Also during December 2003, a $10,000 advance from a potential investor in a proposed Asian joint venture (which did not materialize) was converted into 111 shares of Series C Preferred Stock at a conversion rate of $90 per share.

In November 2003, the Company commenced a private placement for the purpose of raising working capital for the Company’s operations. The private placement provided for the issuance of a maximum of 110,000 shares of the Company’s Series C Preferred Stock at $90 per share. The private placement was valid through December 15, 2003, but was extended for an additional 107 days. The total number of shares of Series C Preferred Stock issued in this private placement during 2003 was 33,542 shares, for which proceeds of approximately $2,526,000 were received, net of expenses of approximately $492,000. During 2004, an additional 59,470 shares of Series C Preferred Stock were issued in a final closing of this private placement. The proceeds were approximately $4,631,000, which is net of expenses of approximately $724,000.

In June 2003, the Company commenced a private placement for the purpose of raising working capital for the Company’s operations. The private placement provided for the issuance of a maximum of 5,714,286 shares of the Company’s $0.01 par value common stock at $2.98 per share. The private placement was valid through September 15, 2003, but was extended for an additional 90 days. The total number of shares of common stock issued in this private placement was 1,342,844 shares for which proceeds of approximately $3,774,000 were received, net of expenses of approximately $247,000. During the year ended December 31, 2004, an additional 430,252 shares were issued in this private placement for which proceeds of approximately $1,277,000 were received, which is net of expenses of approximately $3,000.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

15.
Equity transactions (continued)

At various times during the year ended December 31, 2003, certain note holders elected to convert approximately $2,280,000 (in the aggregate) of their notes and accrued interest into common stock at conversion rates ranging between $2.28 and $5.25 per share. The conversions resulted in the issuance of an additional 623,234 shares of common stock. Also during 2003, the Company issued 16,807 shares of its common stock, at $2.98 per share for the assumption of a $50,000 letter of credit in the name of and secured by a shareholder of the Company.

16.
Settlements of debt

During the year ended December 31, 2005, the Company recognized both gains and a loss on debt settlements. The net of these settlements was a loss of approximately $76,000. The two significant settlements comprising this balance relates to a loss on settlement of debt of approximately $134,000 related to an international venture the Company was involved with during prior years. In addition, the Company entered into a settlement agreement with a vendor, which resulted in forgiveness of debt of approximately $43,000.

During 2004, the Company recorded approximately $2,175,000 related to forgiveness of debt. As of December 31, 2003, the Company had an outstanding capital lease obligation aggregating approximately $238,000. In January 2004, the Company entered into an agreement whereas the Company agreed to pay the sum of $45,000 resulting in a $193,000 forgiveness of debt. In addition, during 2004, the Company recorded approximately $1,982,000 of additional forgiveness of debt primarily related to settlements of network and general obligations.

During 2003, the Company had three outstanding capital lease obligations with lessors, aggregating approximately $1,974,000. During 2003, the Company entered into settlement agreements whereas the Company agreed to pay the sum of $695,000 and agreed to issue 14,286 shares of common stock at $2.28 per share, resulting in approximately $1,247,000 forgiveness of debt. For the year ended December 31, 2003, the Company recorded approximately $3,918,000 of forgiveness of debt, including approximately $2,671,000 of settled accounts payable disputes.

17.
Profit sharing plan
   
The Company has a defined contribution profit sharing plan, which covers all employees who meet certain eligibility requirements. Contributions to the plan are made at the discretion of the Board. No contributions to the profit sharing plan were made for the years ended December 31, 2005, 2004 and 2003.

18.
Related party transactions

At December 31, 2004, the Company had an aggregate of approximately $1,700,000 of long-term debt due to stockholders of the Company. In addition, the Company had approximately $539,000 of accrued interest outstanding on this related debt as of December 31, 2004. This debt and all interest accrued on the date of repayment was repaid during 2005. Interest expense related to this debt was approximately $18,000, $230,000, and $416,000 for the years ended December 31, 2005, 2004, and 2003, respectively.

19.
Concentrations

Major Customers

During 2005, six customers of the Company accounted for revenues exceeding 53% in total and at least 5% individually of the Company’s total revenues for 2005. During 2004, two customers of the Company accounted for revenues exceeding 21% in total and at least 5% individually of the Company’s total revenues for 2004. During 2003, eight customers of the Company accounted for revenues exceeding 59% in total and at least 5% individually of the Company’s total revenues for 2003. These customer revenues were all in the traditional voice and VoIP to carrier segments. Revenues earned from these customers were approximately $26,051,000 in 2005, $10,479,000 in 2004, and $18,816,000 in 2003. At December 31, 2005, 2004 and 2003, the amounts owed to the Company by these customers were approximately $1,951,000, $1,429,000, and $1,004,000, respectively.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

19.
Concentrations (continued)

Geographic Concentrations

The Company’s operations are significantly influenced by economic factors and risks inherent in conducting business in foreign countries, including government regulations, currency restrictions and other factors that may significantly affect management’s estimates and the Company’s performance.

During 2005, 2004 and 2003, the Company generated approximate revenue from continuing operations from customers in the following countries:

 
2005
 
2004
 
2003
 
United States
 
$
44,166,000
 
$
46,248,000
 
$
31,350,000
 
Other
   
5,199,000
   
3,310,000
   
668,000
 
   
$
49,365,000
 
$
49,558,000
 
$
32,018,000
 

At December 31, 2005 and 2004, the Company had foreign long-lived assets in foreign countries as follows:.

 
 
2005
 
2004
 
Pakistan
 
$
—
 
$
115,000
 
Jamaica
 
$
245,000
 
$
—
 

Revenues by geographic area are based upon the location of the customers. The foreign long-lived assets by geographic area represent those assets physically used in the operations in each geographic area.

20.
Segment Information

The Company adopted SFAS No. 131, “Disclosures about Segments of an Enterprise and Related Information”. SFAS No. 131 requires disclosures of segment information on the basis that is used internally for evaluating segment performance and deciding how to allocate resources to segments.

The Company has three reportable segments that it operates and manages which are organized by products and services. The Company measures and evaluates its reportable segments based on revenues and cost of revenues. This segment income excludes unallocated corporate expenses and other adjustments arising during each period. The other adjustments include transactions that the chief operating decision makers exclude in assessing business unit performance due primarily to their non-operational and/or non-recurring nature. Although such transactions are excluded from the business segment results, they are included in reported consolidated earnings. Each segment is managed according to the products, which are provided to the respective customers, and information is reported on the basis of reporting to the Company’s Chief Operating Decision Maker. In previous years, the Company had four reportable segments with Voice To Carriers being broken out into two separate segments. Since the Company’s Chief Operating Decision Maker currently reviews these two segments as one, the segment disclosures for the year ended December 31, 2004 have been presented in a consistent manner.

The Company’s segments and their principal activities consist of the following:

Voice to Carriers — Voice to Carriers includes VoIP to Carriers, which is the termination of voice telephony minutes by the Internet rather than the older circuit-switched technology. VoIP permits a less costly and more rapid interconnection between the Company and international telecommunications carriers. This segment also includes traditional voice (the termination of voice telephony minutes from or to the countries served by the Company utilizing Time Division Multiplexing (TDM) and “circuit-switched” technology). Typically, this will include interconnection with traditional telecommunications carriers either located internationally, or those carriers that interconnect with the Company at its U.S. Points of Presence (POP) and provide service to other destinations. These minutes are sold to carriers on a wholesale basis.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

20.
Segment Information (continued)

VoIP to Consumers and Corporations — The Company provides VoIP services targeted to end-users and corporations, primarily through its efonica brand. The Company offers services that permit consumers or corporations to originate calls via IP telephones or telephone systems that use the Internet for completion to standard telephone lines anywhere in the world. The Company also provides PC-to-phone service that utilizes the Internet to allow consumers to use their personal computers to place calls to the telephone of their destination party.

Internet, Managed Private Networks & Other — The Company provides Internet connectivity to telecommunications carriers, Internet service providers, government entities, and multinational customers via its POPs in the U.S. and India, and through its partners elsewhere. The Company also offers point-to-point private lines, virtual private networking, and call center communications services to customers in its target markets.

Operating segment information for 2005 and 2004 is summarized as follows:
 
   
Year ended December 31, 2005
 
           
Internet,
         
       
VoIP to
 
Managed
         
   
Voice to
 
Consumers and
 
Private Networks
 
Corporate &
     
   
Carriers
 
Corporations
 
& Other
 
Unallocated
 
Consolidated
 
Revenues
 
$
43,608,538
 
$  
3,775,054
 
$  
1,980,950
 
$  
—
 
$
49,364,542
 
Cost of revenues (exclusive of depreciation and amortization)
 
$
(41,070,944
)
$
(2,820,792
)
$
(1,157,181
)
$  
—
 
$
(45,048,917
)
Depreciation and amortization
 
$
(1,262,870
)
$
(58,281
)
$
(53,619
)
$
(135,402
)
$
(1,510,172
)
Selling, general and administrative
 
$
(5,196,778
)
$
(1,845,475
)
$
(594,166
)
$
(4,302,582
)
$
(11,939,001
)
Other income (expense)
 
$
(741,771
)
$
(23,730
)
$
(33,359
)
$
200,424
 
$
(598,436
)
Loss from continuing operations
 
$
(4,663,825
)
$
(973,224
)
$
142,625
 
$
(4,237,560
)
$
(9,731,984
)
Income from discontinued operations
 
$
336,910
 
$
—
 
$  
—
 
$  
—
 
$
336,910
 
Net income (loss)
 
$
(4,326,915
)
$
(973,224
)
$
142,625
 
$
(4,237,560
)
$
(9,395,074
)
Assets
 
$
7,516,881
 
$
10,453,247
 
$
322,176
 
$
16,093,475
 
$
34,385,779
 
Capital Expenditures
 
$
1,492,525
 
$
129,203
 
$
67,799
 
$
187,725
 
$
1,877,252
 
                                 
 
   
Year ended December 31, 2004
 
           
Internet,
         
       
VoIP to
 
Managed
         
   
Voice to
 
Consumers and
 
Private Networks
 
Corporate &
     
 
Carriers
 
Corporations
 
& Other
 
Unallocated
 
Consolidated
 
Revenues
 
$
44,226,875
 
$
3,128,719
 
$
2,202,379
 
$
—
 
$
49,557,973
 
Cost of revenues (exclusive of depreciation and amortization)
 
$
(39,091,544
)
$
(2,350,310
)
$
(1,486,140
)
$
—
 
$
(42,927,994
)
Depreciation and amortization
 
$
(1,519,466
)
$
(26,363
)
$
(91,965
)
$
(166,390
)
$
(1,804,184
)
Selling, general and administrative
 
$
(5,847,052
)
$
(595,140
)
$
(413,702
)
$
(2,948,511
)
$
(9,804,405
)
Other income (expense)
 
$
1,910,491
 
$
600
 
$
(1,758
)
$
(2,506,210
)
$
(596,877
)
Income (loss) from continuing operations
 
$
(320,696
)
$
157,506
 
$
208,814
 
$
(5,621,111
)
$
(5,575,487
)
Income from discontinued Operations
 
$
545,215
 
$
—
 
$
—
 
$  
—
 
$
545,215
 
Net Income (loss)
 
$
224,519
 
$
157,506
 
$
208,814
 
$
(5,621,111
)
$
(5,030,272
)
Assets    
 
$
6,638,538
 
$
547,588
 
$
433,707
 
$
6,042,284
 
$
13,662,117
 
Capital Expenditures
 
$
503,735
 
$
32,450
 
$
28,312
 
$
62,722
 
$
627,219
 
                                 
 
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

20.
S egment Information (continued)

The Company employs engineering and operations resources that service across multiple product lines. Depreciation and indirect operating expenses were allocated to each product line based upon their respective revenues. The amounts reflected as Corporate & Unallocated represent those expenses that were not appropriate to allocate to each product line.

21.
Subsequent events

In connection with the Company’s relocation of its New York executive office during 2006, the lease amendment required the Company to provide a Letter of Credit in favor of the landlord in the amount of approximately $428,000. The Letter of Credit was obtained in January 2006, and is secured by $239,000 in money market funds. The Company also received an $189,000 line of credit that would be drawn down, should the Company default on the lease terms.

On February 15, 2006, the Company entered into an Intellectual Property Transfer Agreement with Xtreme VoIP Corp., pursuant to which the Company purchased a software application and other intellectual property rights relating to a VoIP software solution. The purchase price was $600,000, of which $60,000 is payable in cash, $180,000 is payable in cash or stock (at the Company’s option) on or before the third anniversary of the Agreement, depending upon the attainment of subscriber milestones. On the fourth anniversary of the Agreement, the Company has the option of either paying the remaining consideration or reverting the Agreement and the Intellectual Property back to Xtreme, while retaining a perpetual non-exclusive, paid up, royalty free license to utilize and sub-license the Intellectual Property. Any royalties paid to Xtreme or gains in the market value of the stock received by Xtreme, based on the last closing price of an aggregate of 30 days during the four year period when Xtreme is free to sell such shares with the highest market value, shall be applied to the remaining consideration. In the event that the Company licenses the Intellectual Property as a product to third parties, but not a sale of the Intellectual Property in its entirety, until the sixth (6 th ) anniversary of this Agreement, Xtreme will be entitled to receive a royalty equal to 20% of the software sales sold by the Company.

On February 17, 2006, the 15,739,963 shares of Class A Common Stock outstanding were automatically converted into shares of common stock.

In March 2006, under an amendment to the Efonica Purchase Agreement, the escrowed shares were released to Karamco, subject to a lock-up period until February 15, 2007, and the Difference Payment was extended to March 2007 (see Note 3 for further details regarding the purchase agreement). The release of the 675,581 shares in escrow resulted in an increase to stockholders equity of approximately $4.4 million and a reduction to the long-term liability, which was recorded as of December 31, 2005.

During March 2006, 14,286 shares of Common Stock were issued upon the exercise of a warrant to purchase the shares at a price of $0.035 per share.
 
On March 30, 2006, an equipment vendor, filed a complaint with the Circuit Court in Broward County, State of Florida seeking damages in the amount of $1,379,502 allegedly due on two promissory notes plus accrued interest through March 1, 2006, and attorneys costs. Management will assert a counterclaim against the vendor and intends to vigorously defend the action.  The Company's legal counsel has advised that, at this stage they cannot accurately predict the likelihood of an unfavorable outcome or quantify the amount or range of potential loss, if any.  Accordingly, with the exception of amounts previously accrued by the Company under the capital lease arrangement, no adjustment that may result from resolution of these uncertainties has been made in the accompanying financial statements.
 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
AND SUBSIDIARIES
Notes to Consolidated Financial Statements

22.
Selected quarterly results (unaudited)

   
2005
 
   
First
 
Second
 
Third
 
Fourth
 
   
Quarter
 
Quarter
 
Quarter
 
Quarter
 
                   
Revenues
 
$
11,929,052
 
$
19,259,891
 
$
9,123,742
 
$
9,051,857
 
Operating loss
 
$
(2,206,802
)
$
(1,910,167
)
$
(2,369,072
)
$
(2,647,507
)
Interest income (expense), net
 
$
(275,803
)
$
91,380
 
$
107,276
 
$
116,507
 
Gain (loss) on settlements of debt
 
$
—
 
$
5,340
 
$
52,539
 
$
(133,806
)
Net loss
 
$
(2,465,591
)
$
(1,900,881
)
$
(2,341,140
)
$
(2,687,462
)
Basic and diluted net loss per
                 
common share applicable to
                     
common stockholders
 
$
(0.12
)
$
(0.07
)
$
(0.09
)
$
(0.10
)


   
2004
 
   
First
 
Second
 
Third
 
Fourth
 
   
Quarter
 
Quarter
 
Quarter
 
Quarter
 
                   
Revenues
 
$
10,187,664
 
$
16,117,765
 
$
13,023,371
 
$
10,229,173
 
Operating loss
 
$
(1,101,341
)
$
(639,021
)
$
(911,750
)
$
(2,326,498
)
Interest expense, net
 
$
285,131
 
$
538,389
 
$
552,739
 
$
851,801
 
Gain on settlements of debt
 
$
1,819,412
 
$
157,184
 
$
197,934
 
$
—
 
Net income (loss)
 
$
265,427
 
$
(1,122,493
)
$
(1,369,749
)
$
(2,803,457
)
Preferred stock dividends
 
$
(19,957
)
$
(365,961
)
$
—
 
$
—
 
Net income (loss) applicable to
common stockholders
$
245,470
 
$
(1,488,454
)
$
(1,369,749
)
$
(2,803,457
)
Basic net income (loss) per
                 
common share applicable to
                     
common stockholders
 
$
0.02
 
$
(0.09
)
$
(0.08
)
$
(0.16
)
Diluted net income (loss) per common share applicable to common stockholders
 
$
0.03
 
$
(0.09
)
$
(0.08
)
$
(0.16
)
 

 

FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
SCHEDULE II
VALUATION AND QUALIFYING ACCOUNTS
                   
 
Balance at
beginning of
period
 
Additions
charged to
expense
 
Deductions
from Reserves
 
Balance at end
of period
 
Allowance for Doubtful Accounts for the Years Ended:                  
December 31, 2005 (1)
 
$
1,058,414
 
$
350,434
 
$
161,313
 
$
1,247,535
 
December 31, 2004 (1)
   
687,490
   
780,479
   
409,555
   
1,058,414
 
December 31, 2003
   
517,409
   
183,735
   
13,654
   
687,490
 
                           
Tax Valuation Account for the Years Ended:
                   
December 31, 2005
 
$
25,682,000
 
$
—
 
$
2,606,000
 
$
23,076,000
 
December 31, 2004
   
23,964,000
   
1,718,000
   
—
   
25,682,000
 
December 31, 2003
   
22,217,000
   
1,747,000
   
—
   
23,964,000
 
 
                 
(1)
Additions charged to expense and balance at end of period includes amounts associated with the Company’s equity investment in Estel. This allowance is net against the liability balance that is included in Investment in Estel on the Company’s Consolidated Balance Sheets.
 
 
F-32
 
MODIFICATION OF LEASE AGREEMENT


  MODIFICATION OF LEASE AGREEMENT dated as of the 11th day of November, 2005 between SLG GRAYBAR SUBLEASE LLC, having an office c/o SL Green Realty Corp., 420 Lexington Avenue, New York, New York 10170 (hereinafter referred to as “Landlord”) and FUSION TELECOMMUNICATIONS, INC., having an office at 420 Lexington Avenue, New York, New York 10170 (hereinafter referred to as “Tenant”).

WITNESSETH:

WHEREAS, Landlord and Tenant have previously entered into that certain lease agreement dated January 19, 2000 (the “Lease”) covering the premises known as Rooms 518-25, as more particularly described in the Lease, (the “Premises”) in the building known as the Graybar Building and located at 420 Lexington Avenue, New York, New York 10170 (the “Building”), under the terms and conditions contained therein; and

WHEREAS, Landlord has agreed to modify the Lease in order to allow Tenant a one (1) time option to cancel the Lease, subject to the terms and conditions as set forth at length below;
 
    NOW, THEREFORE, in consideration of the mutual covenants contained herein, the parties agree as follows:

1. Tenant shall have the one (1) time option to cancel the Lease in its entirety (the “Cancellation Option”), provided that (i) Tenant delivers written notice to Owner of its intention to exercise the Cancellation Option (the “Cancellation Notice”) no less than forty-five (45) days (time being of the essence) prior to the effective date of such cancellation (the “Cancellation Date”), (ii) the Cancellation Date shall occur no earlier than February 1, 2006 and no later than July 30, 2006 (time being of the essence) (the “Cancellation Period”), (iii) the Cancellation Date shall occur on the last day of a calendar month during the Cancellation Period, (iv) Tenant is not in default of any of the terms, covenants and conditions of this Lease after notice, (a) on the date that the Cancellation Notice is delivered by Tenant to Landlord, and (b) the Cancellation Date, and (v) Tenant delivers to Landlord possession of the Premises vacant and broom clean, free of all personal property, occupancies, liens and encumbrances on the Cancellation Date. Tenant’s failure to timely and fully comply with aforementioned sections (i) through (iv) of this Article 1, shall constitute a waiver of the Cancellation Option. Landlord shall have the right, in its sole discretion, to waive any or all of the foregoing conditions to Tenant’s exercise of the cancellation of the Lease hereunder.

2. Notwithstanding any cancellation by Tenant in accordance with the provisions of this Article, Tenant shall remain liable to satisfy any and all of its obligations under the terms, covenants and conditions of this Lease which have accrued through the Cancellation Date, which obligations shall survive such cancellation.

1



3 .   Tenant’s Representations and Warranties . Tenant hereby represents and warrants to Landlord, its successors and assigns, that: (i) the Lease has not been assigned, pledged or encumbered, (ii) except for Tenant, the Premises are currently free of all occupancies, (iii) Tenant has not created or suffered any occupancies by third parties in and/or to the Premises through and including the date of this agreement and (iv) no materials or fixtures presently in the Premises (“Property”) are subject to any lien, encumbrance, chattel mortgage, title retention or security agreement and no action has been taken or suffered by Tenant as a result of which either the Premises or any Property shall or might be subject thereto. Tenant covenants and agrees that it shall not at any time hereafter create, suffer or permit the creation of any such rights or encumbrances in or to the Premises or the Property contained therein. Any Property left in the Premises by Tenant after the Cancellation Date shall be deemed to have been abandoned by Tenant, and Landlord shall have the right to retain or dispose of such Property at the expense of Tenant without any obligation to account to Tenant therefor.

4 . Rental Arrears. Notwithstanding the cancellation of the Lease contemplated in this agreement and notwithstanding anything to the contrary contained in this agreement, Tenant shall to remain liable for any unpaid rent, additional rent and charges accruing under the Lease through and including the Cancellation Date.

5.   Successors/Assigns . This agreement shall be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns.

6.   Entire Agreement. This agreement represents the entire understanding between the parties with regard to the matters addressed herein and may only be modified by written agreement executed by all parties hereto. All prior understandings or representations between the parties hereto, oral or written, with regard to the matters addressed herein, other than the Lease, are hereby merged herein.

      7 . Effectiveness . This agreement shall not be binding upon Landlord until executed and delivered by both Landlord and Tenant.

8.   Ratification. Except as specifically modified herein, all other terms, covenants and conditions of the Lease are and shall remain in full force and effect through the Cancellation Date and are hereby ratified and confirmed.

9. No Brokers/Indemnification . Tenant covenants, represents and warrants that Tenant has had no dealings or negotiations with any broker or agent in connection with the consummation of this agreement other than SL Green Leasing (the “Broker”) and Tenant covenants and agrees to defend, hold harmless and indemnify Landlord from and against any and all cost, expense (including reasonable attorneys' fees) or liability for any compensation, commissions or charges claimed by any other broker or agent other than the Broker, with respect to this Agreement or the negotiation thereof.

 

2




10.   Miscellaneous .

A. The captions in this agreement are for convenience only and are not to be considered in construing this agreement.

B. This agreement shall be construed without regard to any presumption or other rule requiring construction against the party causing this agreement to be drafted.

C. Terms used in this agreement and not otherwise defined herein shall have the respective meanings ascribed thereto in the Lease.

  [REMAINDER OF THIS PAGE IS INTENTRIONALLY LEFT BLANK]

 
 

3




D. If any provision of this agreement or its application to any person or circumstances is invalid or unenforceable to any extent, the remainder of this agreement, or the applicability of such provision to other persons or circumstances, shall be valid and enforceable to the fullest extent permitted by law and shall be deemed to be separate from such invalid or unenforceable provisions and shall continue in full force and effect.
 
     
  SLG GRAYBAR SUBLEASE LLC , as Landlord
 
  		 
  		 
 
  By:    
  Name:  
  Title:  
   

Witness:      
       
Name:
Title:
   
       
 
     
  FUSION TELECOMMUNICATIONS, INC ., as Tenant
 
  		 
  		 
 
  By:    
  Name:  
  Title:  
   

Witness:      
       
Name:
Title:
   
       

4

LEASE MODIFICATION AGREEMENT


LEASE MODIFICATION AGREEMENT (this “ Agreement ”) dated as of the 11th day of November, 2006 between SLG Graybar Sublease, LLC, having an office c/o SL Green Realty Corp., 420 Lexington Avenue, New York, New York (hereinafter referred to as “ Landlord ”) and Fusion Telecommunications International, Inc., having an office at 420 Lexington Avenue, Room 1718-1722, New York, New York (hereinafter referred to as “ Tenant ”).

WITNESSETH:
 
WHEREAS, Landlord and Tenant, entered into that certain lease agreement dated as of November 1, 2005 (the “ Lease ”) covering certain space located on the seventeenth (17 th ) floor commonly known as Room 1718-1722 as more particularly described in said lease agreement (the “ Premises ”), in the building known as 420 Lexington Avenue, New York, New York (the “ Building ”) under the terms and conditions contained therein; and
 
WHEREAS, Landlord and Tenant wish to modify the Lease in order to allow Tenant the option of furnishing the security deposit required under the Lease in the form of a letter of credit, subject to the terms, covenants and conditions of the Lease, as modified by this Agreement.
 
NOW, THEREFORE, in consideration of the mutual agreements herein contained and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the parties hereby agree as follows :

1.   Security Deposit/Letter of Credit.  
 
  Effective as of the date hereof, Article 31 of the Lease shall be modified by adding the following verbiage:

31.06   Notwithstanding anything contained herein to the contrary, in lieu of a cash deposit, Tenant shall be permitted to deliver to Landlord as and for security hereunder a clean, irrevocable and unconditional letter of credit in an amount equal to the security required to be deposited by Tenant pursuant hereto which shall comply and conform in all material respects with the form annexed hereto and made apart hereof as Exhibit A (hereinafter called the "Credit"), to be held, used and drawn upon solely under the security provisions of this Lease, which Credit shall be issued by a bank which is a member of the New York Clearing House Association, in the amount of $428,390.55, naming Landlord (or its successor as Landlord) as beneficiary. The Credit shall be transferable. All transfer fees shall be payable by Tenant.

31.07   If during the term of this Lease, the Credit and/or the proceeds of all or part of said Credit become less than the full amount of the security hereinabove required, then and in such event Tenant shall, upon demand, deposit with Landlord the amount of any security/Credit theretofore used or applied by Landlord pursuant to the terms hereof in order that Landlord shall have the full security on hand at all times during the term of this Lease. If at the expiration of the term of this Lease, Landlord holds all or part of said Credit, and Tenant is not in default under any of the terms, covenants and conditions of this Lease, then Landlord will turn over said Credit to Tenant or assign it to the designee of Tenant.
 

31.08 It shall be the obligation of Tenant during the term of this Lease to deliver to Landlord at least sixty (60) days prior to the expiration date of the then existing Credit, a renewal or extension of said Credit or a substitute Credit (each fully complying with the foregoing). If for any reason Landlord has not received such renewal or extension or substitute Credit within sixty (60) days prior to the expiration date of the then existing Credit, then and in such event Landlord shall be free to draw on the Credit and hold and use and apply the proceeds thereof in accordance with the security deposit provisions of this Lease. Tenant agrees to reimburse Landlord for any reasonable attorneys' fees incurred by Landlord, after the commencement of the term of this Lease, in connection with reviewing the Credit and any renewals, extensions or substitutions therefor, ensuring that the provisions of the Credit and any renewals, extensions or substitutions therefor comply with the provisions of this Article, drawing down upon the proceeds of Credit, or any renewals, extensions or substitution therefor, or ensuring that the security/Credit is maintained as required under this Lease.”

2.   Successors and Assigns .

This agreement shall be binding upon and inure to the benefit of the parties and their respective successors and permitted assigns.

3.   Entire Agreement; Effectiveness; Ratification .

The Lease, as modified by this Agreement, represents the entire understanding between the parties with regard to the matters addressed herein and may only be modified by written agreement executed by all parties hereto. All prior understandings or representations between the parties hereto, oral or written, with regard to the matters addressed herein, other than the Lease, are hereby merged herein. This agreement shall not be binding upon Landlord and Tenant until executed and delivered by both Landlord and Tenant. Except as specifically modified herein, all other terms, covenants and conditions of the Lease are and shall remain in full force and effect and are hereby ratified and confirmed.

4.   No Brokers/Indemnification.

Tenant covenants, represents and warrants that Tenant has had no dealings or negotiations with any broker or agent in connection with the consummation of this agreement other than SL Green Leasing, LLC and Tenant covenants and agrees to defend, hold harmless and indemnify Landlord from and against any and all cost, expense (including reasonable attorneys' fees) or liability for any compensation, commissions or charges claimed by any broker or agent with respect to this Agreement or the negotiation thereof.
 

5.   Miscellaneous .

The captions in this Agreement are for convenience only and are not to be considered in construing this agreement. This Agreement may not be modified except in a writing signed by Landlord and Tenant. This Agreement shall be construed without regard to any presumption or other rule requiring construction against the party causing this agreement to be drafted. Terms used in this Agreement and not otherwise defined herein shall have the respective meanings ascribed thereto in the Lease. If any provision of this Agreement or its application to any person or circumstances is invalid or unenforceable to any extent, the remainder of this agreement, or the applicability of such provision to other persons or circumstances, shall be valid and enforceable to the fullest extent permitted by law and shall be deemed to be separate from such invalid or unenforceable provisions and shall continue in full force and effect.

IN WITNESS WHEREOF, Landlord and Tenant have duly executed this Agreement as of the day and year first above written.
 
    SLG GRAYBAR SUBLEASE LLC, as Landlord  
     
    By:_______________________________________  
    Name:  
    Title:  
Witness:      
__________________________      
Name:      
Title:      
    FUSION TELECOMMUNICATIONS   
    INTERNATIONAL, INC., as Tenant  
     
    By:_______________________________________  
    Name:  
    Title:  
Witness:      
__________________________      
Name:      
Title:      
 
 
 
 


Execution Counterpart



AGREEMENT OF LEASE


between

SLG Graybar Sublease LLC


Landlord


and


Fusion Telecommunications International, Inc.


Tenant


Dated as of November 1, 2005



Room 1718-1722
420 Lexington Avenue
New York, New York







TABLE OF CONTENTS


TABLE OF CONTENTS
I  
ARTICLE 1
DEMISE; PREMISES AND PURPOSE
1
ARTICLE 2
TERM
2
ARTICLE 3
RENT AND ADDITIONAL RENT
2
ARTICLE 4
ASSIGNMENT/SUBLETTING
3
ARTICLE 5
DEFAULT
10
ARTICLE 6
RELETTING, ETC.
11
ARTICLE 7
LANDLORD MAY CURE DEFAULTS
12
ARTICLE 8
ALTERATIONS
12
ARTICLE 9
LIENS
16
ARTICLE 10
REPAIRS
17
ARTICLE 11
FIRE OR OTHER CASUALTY
17
ARTICLE 12
END OF TERM
18
ARTICLE 13
SUBORDINATION AND ESTOPPEL, ETC.
19
ARTICLE 14
CONDEMNATION
21
ARTICLE 15
REQUIREMENTS OF LAW
21
ARTICLE 16
CERTIFICATE OF OCCUPANCY
22
ARTICLE 17
POSSESSION
22
ARTICLE 18
QUIET ENJOYMENT
23
ARTICLE 19
RIGHT OF ENTRY
23
ARTICLE 20
INDEMNITY
24
ARTICLE 21
LANDLORD'S LIABILITY, ETC.
24
ARTICLE 22
CONDITION OF PREMISES
25
ARTICLE 23
CLEANING
25
ARTICLE 24
JURY WAIVER
26
ARTICLE 25
NO WAIVER, ETC.
26
ARTICLE 26
OCCUPANCY AND USE BY TENANT
27
 
 
i
 
ARTICLE 27
NOTICES
28
ARTICLE 28
WATER
28
ARTICLE 29
SPRINKLER SYSTEM
29
ARTICLE 30
HEAT, ELEVATOR, ETC.
29
ARTICLE 31
SECURITY DEPOSIT
29
ARTICLE 32
TAX ESCALATION
31
ARTICLE 33
RENT CONTROL
34
ARTICLE 34
SUPPLIES
35
ARTICLE 35
AIR CONDITIONING
35
ARTICLE 36
SHORING
37
ARTICLE 37
EFFECT OF CONVEYANCE, ETC.
37
ARTICLE 38
RIGHTS OF SUCCESSORS AND ASSIGNS
38
ARTICLE 39
CAPTIONS
38
ARTICLE 40
BROKERS
38
ARTICLE 41
ELECTRICITY
39
ARTICLE 42
LEASE SUBMISSION
44
ARTICLE 43
INSURANCE
44
ARTICLE 44
SIGNAGE
47
ARTICLE 45
RIGHT TO RELOCATE
47
ARTICLE 46
FUTURE CONDOMINIUM CONVERSION
48
ARTICLE 47
MISCELLANEOUS
49
ARTICLE 48
COMPLIANCE WITH LAW
49
ARTICLE 49
LANDLORD’S CONTRIBUTION
50
RULES AND REGULATIONS
54  
 
 
ii

 
INDEX OF DEFINED TERMS
 

TERM
PAGE
Additional Rent
2
Alterations
14
Base Tax Year
32
Brokers
38
Building
1
Building Cleaning Contractor
25
Building Project
32
Commencement Date
2
Comparative Year
32
Cooling Season
36
Declaration
49
Delivery Personnel
1
ERIF
39
excess electricity
40
Existing HVAC Equipment
36
Expiration Date
2
Fixed Annual Rent
2
HVAC System
36
Landlord
1
Landlord’s Electrical Consultant
40
Landlord’s Relocation Work
48
Landlord’s Restoration Work
17
Landlord's Contribution
50
Lease
1
Leaseback Area
4
Ordinary Business Hours
39
Ordinary Equipment
39
Premises
1
Qualified Renovations
50
Real Estate Taxes
32
Recapture Date
4
Relocation Effective Date
47
Relocation Notice
47
Relocation Space
47
Rent
2
Requisition
50
Retainage
51
Security
29
Supplemental Systems
36
Tenant
1
Tenant Cleaning Services
25
Tenant’s Initial Alteration Work
50
 
 
iii
 
Tenant’s Recapture Offer
4
Tenant’s Share
32
Term
2
Work Cost
50
 

iv



LEASE (this “ Lease ”) made as of the 1 st day of November 2005 between SLG Graybar Sublease LLC having an office c/o SL Green Realty Corp., at 420 Lexington Avenue, New York, New York, 10170, hereinafter referred to as "Landlord", and Fusion Telecommunications International, Inc., a Delaware corporation having an office at 420 Lexington Avenue, New York, NY, 10170, hereinafter referred to as "Tenant".


WITNESSETH

Landlord and Tenant, in consideration of the mutual agreements herein contained and other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, hereby covenant and agree as follows:


ARTICLE 1
 
DEMISE; PREMISES AND PURPOSE

1.01   Landlord hereby leases and demises to Tenant, and Tenant hereby hires and takes from Landlord, those certain Premises located on and comprising a rentable portion of the seventeenth (17th) floor designated as Room 1718-22, approximately as indicated by hatch marks on the plan annexed hereto and made a part hereof as “Exhibit A” (the “ Premises ”) in the building known as and located at 420 Lexington Avenue, New York, New York (the “ Building ”) subject to the provisions of this Lease.

1.02   The Premises shall be used and occupied for executive and general office use consistent with that found in Class “A” high-rise office buildings located in midtown Manhattan only and for no other purpose.

1.03   Neither the Premises, nor the halls, corridors, stairways, elevators or any other portion of the Building shall be used by the Tenant or the Tenant's servants, employees, licensees, invitees or visitors in connection with the aforesaid permitted use or otherwise so as to cause any congestion of the public portions of the Building or the entranceways, sidewalks or roadways adjoining the Building whether by trucking or by the congregating or loitering thereon of the Tenant and/or the servants, employees, licensees, invitees or visitors of the Tenant.

1.04   Tenant shall not permit messengers, delivery personnel or other individuals providing such services to Tenant (“ Delivery Personnel ”) to: (i) assemble, congregate or to form a line outside of the Premises or the Building or otherwise impede the flow of pedestrian traffic outside of the Premises or Building or (ii) park or otherwise leave bicycles, wagons or other delivery carts outside of the Premises or the Building except in locations outside of the Building designated by Landlord from time-to-time. Tenant shall require all Delivery Personnel to comply with rules promulgated by Landlord from time-to-time regarding the use of outside messenger services.


1


ARTICLE 2
 
TERM

2.01   The Premises are leased for a term of ten (10) years (the " Term ") which shall commence on November 1, 2005 (the “ Commencement Date ”) and shall end on October 31, 2015 (the “ Expiration Date ”) or on such earlier date upon which the Term shall expire, be canceled or terminated pursuant to any of the conditions or covenants of this Lease or pursuant to law.


ARTICLE 3
 
RENT AND ADDITIONAL RENT

3.01   Tenant shall pay fixed annual rent without electricity (the “ Fixed Annual Rent ”) at the rates provided for in the schedule annexed hereto and made a part hereof as “Exhibit B” in equal monthly installments in advance on the first (1 st ) day of each calendar month during the Term, except that the first (1 st ) monthly installment of Fixed Annual Rent shall be paid by Tenant upon its execution of this Lease. All sums other than Fixed Annual Rent payable hereunder shall be deemed to be " Additional Rent " and shall be payable on demand, unless other payment dates are hereinafter provided. Tenant shall pay all Fixed Annual Rent and Additional Rent due hereunder at the office of Landlord or such other place as Landlord may designate, payable in United States legal tender, by cash, or by good and sufficient check drawn on a New York City bank which is a member of the New York Clearing House or a successor thereto, and without any set off or deduction whatsoever. The term " Rent " as used in this Lease shall mean Fixed Annual Rent and Additional Rent. Landlord may apply payments made by Tenant towards the payment of any item of Fixed Annual Rent and/or Additional Rent payable hereunder notwithstanding any designation by Tenant as to the items against which any such payment should be credited.

3.02   Subject to the provisions hereof, if and so long as Tenant is not in material default under this Lease after notice and the expiration of any applicable cure period , the first (1 st ) three (3) monthly installments of Fixed Annual Rent (without electricity) accruing under the Lease shall each be abated by the amount of $35,699.21 (for an aggregate abatement in the sum of $107,097.63). Anything contained hereinabove to the contrary notwithstanding, if Tenant at any time during the term of the Lease, breaches any material covenant, condition or provision of the Lease and fails to cure such breach within any applicable grace period, and provided that the Lease is terminated by Landlord because of such material default, then, in addition to all other damages and remedies herein provided and to which Landlord may be otherwise entitled, Landlord shall also be entitled to the repayment in full of all Rent which has theretofore been abated under the provisions of this Lease, which repayment Tenant shall make upon demand therefore, provided, however, that for purposes of this subsection, said payment shall equal the product obtained by multiplying said credit by a fraction, the numerator of which is the number of months, and portions thereof, remaining in the term of this Lease after such breach, and the denominator of which is one hundred twenty (120).


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ARTICLE 4
 
ASSIGNMENT/SUBLETTING

4.01   Neither Tenant nor Tenant's legal representatives or successors in interest by operation of law or otherwise, shall assign, mortgage or otherwise encumber this Lease, or sublet or permit all or part of the Premises to be used by others, without the prior written consent of Landlord in each instance, which consent shall not be unreasonably withheld, denied or delayed in accordance with Section 4.07 herein. Subject to the provisions of Section 4.09 hereof, the transfer of a majority of the issued and outstanding capital stock of any corporate tenant or sublessee of this Lease or a majority of the total interest in any partnership tenant or sublessee or company, however accomplished, and whether in a single transaction or in a series of related or unrelated transactions, the conversion of a tenant or sublessee entity to either a limited liability company or a limited liability partnership or the merger or consolidation of a corporate tenant or sublessee, shall be deemed an assignment of this Lease or of such sublease. The transfer of issued and outstanding capital stock, for purposes of this Article, shall not include the public sale of such stock (i) by persons who are not those deemed "insiders" within the meaning of the Securities Exchange Act of 1934 as amended, and which sale is (ii) effected through the "over-the-counter market" or through any legitimate stock exchange recognized in the United States. If this Lease is assigned, or if the Premises or any part thereof is underlet or occupied by anybody other than Tenant, Landlord may, after default by Tenant, collect rent from the assignee, undertenant or occupant, and apply the net amount collected to the rent herein reserved, but no assignment, underletting, occupancy or collection shall be deemed a waiver of the provisions hereof, the acceptance of the assignee, undertenant or occupant as tenant, or a release of Tenant from the further performance by Tenant of covenants on the part of Tenant herein contained. The consent by Landlord to an assignment or underletting shall not in any way be construed to relieve Tenant from obtaining the express consent in writing of Landlord to any further assignment or underletting, as provided herein. In no event shall any permitted sublessee assign or encumber its sublease or further sublet all or any portion of its sublet space, or otherwise suffer or permit the sublet space or any part thereof to be used or occupied by others, without Landlord's prior written consent in each instance, as provided herein. A modification, amendment or extension of a sublease shall be deemed a sublease. The listing of the name of a party or entity other than that of Tenant on the Building or floor directory or on or adjacent to the entrance door to the Premises shall neither grant such party or entity any right or interest in this Lease or in the Premises nor constitute Landlord's consent to any assignment or sublease to, or occupancy of the Premises by, such party or entity. If any lien is filed against the Premises or the Building of which the same form a part for brokerage services claimed to have been performed for Tenant in connection with any such assignment or sublease, whether or not actually performed, the same shall be discharged within twenty-five (25) days after Tenant receives or has actual notice thereof, at Tenant's expense, by filing the bond required by law, or otherwise, and paying any other necessary sums, and Tenant agrees to indemnify Landlord and its agents and hold them harmless from and against any and all claims, losses or liability resulting from such lien for brokerage services rendered.

3


4.02   If Tenant desires to assign this Lease or to sublet all or any portion of the Premises, it shall first submit in writing to Landlord the documents described in Section 4.06 hereof, and shall offer in writing (“ Tenant’s Recapture Offer ”), (i) with respect to a prospective assignment, to assign this Lease to Landlord without any payment of moneys or other consideration therefor, or, (ii) with respect to a prospective subletting, to sublet to Landlord the portion of the Premises involved (“ Leaseback Area ") for the term specified by Tenant in its proposed sublease or, at Landlord's option for the balance of the term of the Lease less one (1) day, and at the lower of (a) Tenant's proposed subrental or (b) the rate of Fixed Annual Rent and Additional Rent, and otherwise on the same terms, covenants and conditions (including provisions relating to escalation rents), as are contained herein and as are allocable and applicable to the portion of the Premises to be covered by such subletting. Tenant’s Recapture Offer shall specify the date when the Leaseback Area will be made available to Landlord, which date shall be in no event earlier than thirty (30) days nor later than ninety (90) days following the acceptance of Tenant’s Recapture Offer (the “ Recapture Date ”). If an offer of sublease is made, and if the proposed sublease will result in all or substantially all of the Premises being sublet, then Landlord shall have the option to extend the term of its proposed sublease for the balance of the term of this Lease less one (1) day. Landlord shall have a period of thirty (30) days from the receipt of such Tenant’s Recapture Offer to either accept or reject Tenant’s Recapture Offer or to terminate this Lease.

4.03.   If Landlord exercises its option to terminate this Lease, then (i) the term of this Lease shall end at the election of Landlord either (x) on the date that such assignment or sublet was to become effective or commence, as the case may be, or (y) on the Recapture Date and (ii) Tenant shall surrender to Landlord and vacate the Premises on or before such date in the same condition as is otherwise required upon the expiration of this Lease by its terms, (iii) the Rent and Additional Rent due hereunder shall be paid and apportioned to such date, and (iv) Landlord shall be free to lease the Premises (or any portion thereof) to any individual or entity including, without limitation, Tenant’s proposed assignee or subtenant.

4


4.04.   If Landlord shall accept Tenant’s Recapture Offer Tenant shall then execute and deliver to Landlord, or to anyone designated or named by Landlord, an assignment or sublease, as the case may be, in either case in a form reasonably satisfactory to Landlord's counsel.

If a sublease is so made it shall expressly:

(i)   permit Landlord to make further subleases of all or any part of the Leaseback Area and (at no cost or expense to Tenant) to make and authorize any and all changes, alterations, installations and improvements in such space as necessary;

(ii)   provide that Tenant will at all times permit reasonably appropriate means of ingress to and egress from the Leaseback Area;

(iii)   negate any intention that the estate created under such sublease be merged with any other estate held by either of the parties;

(iv)   provide that Landlord shall accept the Leaseback Area "as is" except that Landlord, at Tenant's expense, shall perform all such work and make all such alterations as may be required physically to separate the Leaseback Area from the remainder of the Premises and to permit lawful occupancy, it being intended that Tenant shall have no other cost or expense in connection with the subletting of the Leaseback Area;

(v)   provide that at the expiration of the term of such sublease Tenant will accept the Leaseback Area in its then existing condition, subject to the obligations of Landlord to make such repairs thereto as may be necessary to preserve the Leaseback Area in good order and condition, ordinary wear and tear excepted.
     
4.05   Landlord shall indemnify and save Tenant harmless from all obligations under this Lease as to the Leaseback Area during the period of time it is so sublet, except for Fixed Annual Rent and Additional Rent, if any, due under the within Lease, which are in excess of the rents and additional sums due under such sublease. Subject to the foregoing, performance by Landlord, or its designee, under a sublease of the Leaseback Area shall be deemed performance by Tenant of any similar obligation under this Lease and any default under any such sublease shall not give rise to a default under a similar obligation contained in this Lease, nor shall Tenant be liable for any default under this Lease or deemed to be in default hereunder if such default is occasioned by or arises from any act or omission of the tenant under such sublease or is occasioned by or arises from any act or omission of any occupant holding under or pursuant to any such sublease.

5


4.06   If Tenant requests Landlord's consent to a specific assignment or subletting, it shall submit in writing to Landlord (i) the name and address of the proposed assignee or sublessee, (ii) a duly executed counterpart of the proposed agreement of assignment or sublease, (iii) reasonably satisfactory information as to the nature and character of the business of the proposed assignee or sublessee and as to the nature of its proposed use of the space, and (iv) banking, financial or other credit information relating to the proposed assignee or sublessee reasonably sufficient to enable Landlord to determine the financial responsibility and character of the proposed assignee or sublessee.

4.07.   If Landlord shall not have accepted Tenant’s Recapture Offer and Landlord shall not have terminated this Lease, as provided for in Section 4.02 hereof, then Landlord will not unreasonably withhold or delay its consent to Tenant's request for consent to such specific assignment or subletting for the use permitted under this Lease, provided that:

(i)   The Premises shall not, without Landlord's prior consent, have been listed or otherwise publicly advertised for assignment or subletting at a rental rate lower than the higher of (a) the Fixed Annual Rent and all Additional Rent then payable, or (b) the then prevailing rental rate for other space in the Building;

(ii)   The proposed assignee or subtenant shall have a financial standing, be of a character, be engaged in a business, and propose to use the Premises, in a manner consistent with the permitted use and in keeping with the standards of the Building;

(iii)   The proposed assignee or subtenant shall not then be a tenant, subtenant, assignee or occupant of any space in the Building, nor shall the proposed assignee or subtenant be a person or entity who has dealt with Landlord or Landlord's agent (directly or through a broker) with respect to space in the Building during the four (4) months immediately preceding Tenant's request for Landlord's consent;

(iv)   The character of the business to be conducted in the Premises by the proposed assignee or subtenant shall not be likely to increase operating expenses or the burden on existing cleaning services, elevators or other services and/or systems of the Building;

(v)   In case of a subletting, the subtenant shall be expressly subject to all of the obligations of Tenant under this Lease and the further condition and restriction that such sublease shall not be assigned, encumbered or otherwise transferred or the Premises further sublet by the subtenant in whole or in part, or any part thereof suffered or permitted by the subtenant to be used or occupied by others, without the prior written consent of Landlord in each instance;

6



(vi)   No subletting shall end later than one (1) day before the Expiration Date nor shall any subletting be for a term of less than two (2) years unless it commences less than two (2) years before the Expiration Date;

(vii)   At no time shall there be more than two (2) occupants, including Tenant, in the Premises;

(viii)   Tenant shall reimburse Landlord on demand for any reasonable costs, including attorneys' fees and disbursements, that may be incurred by Landlord in connection with said assignment or sublease;

(ix)   The character of the business to be conducted in the Premises by the proposed assignee or subtenant shall not require any alterations, installations, improvements, additions or other physical changes to be performed, or made to, any portion of the Building or the Real Property other than the Premises; and

(x)   The proposed assignee or subtenant shall not be any entity which is entitled to diplomatic or sovereign immunity or which is not subject to service of process in the State of New York or to the jurisdiction of the courts of the State of New York and the United States located in New York County.

4.08   Any consent of Landlord under this Article shall be subject to the terms of this Article and conditioned upon there being no default by Tenant, beyond any grace period, under any of the terms, covenants and conditions of this Lease at the time that Landlord's consent to any such subletting or assignment is requested and on the date of the commencement of the term of any proposed sublease or the effective date of any proposed assignment. Tenant acknowledges and agrees that no assignment or subletting shall be effective unless and until Tenant, upon receiving any necessary Landlord's written consent (and unless it was theretofore delivered to Landlord) causes a duly executed copy of the sublease or assignment to be delivered to Landlord within ten (10) days after execution thereof. Any such sublease shall provide that the sublessee shall comply with all applicable terms and conditions of this Lease to be performed by the Tenant hereunder. Any such assignment of this Lease shall contain an assumption by the assignee of all of the terms, covenants and conditions of this Lease to be performed by the Tenant.

4.09.   Anything hereinabove contained to the contrary notwithstanding, Landlord will not unreasonably withhold or delay its consent to an assignment of this Lease, or sublease of all or part of the Premises, to the parent of Tenant or to a wholly-owned subsidiary of Tenant or of said parent of Tenant, provided the net worth of transferor or sublessor, after such transaction, is not less than its net worth as of (a) the Commencement Date or (b) the day immediately prior to such transaction, whichever is greater, and provided also that any such transaction complies with the other provisions of this Article.

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4.10   If Landlord shall not have elected to terminate this Lease in accordance with Section 4.02 hereof, and Tenant effects any assignment or subletting (other than pursuant to Section 4.09 above), then Tenant thereafter shall pay to Landlord a sum equal to fifty (50%) percent of (a) any rent or other consideration payable to Tenant by any subtenant (after deducting the cost of Tenant, if any, in effecting the subletting or assignment, for reasonable alteration costs, advertising expenses, brokerage commissions, reasonable rent concessions and legal fees) which is in excess of the rent allocable to the subleased space which is then being paid by Tenant to Landlord pursuant to the terms hereof, and (b) any other profit or gain realized by Tenant (after deducting the cost of Tenant, if any, in effecting the subletting or assignment, for reasonable alteration costs, advertising expenses, brokerage commissions, reasonable rent concessions and legal fees not previously deducted pursuant to subsection a above) from any such subletting or assignment. The foregoing amounts shall be payable to Landlord only if, as and when, the same are received by Tenant from said assignee or sublessee.

4.11.   In no event shall Tenant be entitled to make, nor shall Tenant make, any claim, and Tenant hereby waives any claim, for money damages (nor shall Tenant claim any money damages by way of set-off, counterclaim or defense) based upon any claim or assertion by Tenant that Landlord has unreasonably withheld or unreasonably delayed its consent or approval to a proposed assignment or subletting as provided for in this Article. Tenant's sole remedy shall be an action or proceeding to enforce any such provision, or for specific performance, injunction or declaratory judgment.

4.12 Notwithstanding anything contained herein to the contrary, Tenant shall be permitted to license to third parties, free of any termination right of Landlord hereunder and without seeking the prior consent of Landlord, up to thirty (30%) percent of the Premises for “desk space” for uses permitted under this Lease only, provided that (i) any such “desk space” so licensed by Tenant does not have separate means of ingress to or egress from the Premises to the public corridors of the Building, and (ii) Landlord is delivered advance written notice of each such “desk space” license agreement entered into by Tenant along with a copy of same which is, by its express terms, made subject to this Lease, and comprehensive identification and contact information of each proposed licensee. In the event of a licensing of “desk space” by Tenant in accordance with the provisions of this Section, any “recapture” and termination rights of Landlord under this Article 4 shall not apply, but the remaining provisions of this Article 4, exclusive of the provisions of 4.10, shall apply thereto as if all references therein to a “sublease” or “assignment” were, instead, to a “license”.

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4.13 Solely with respect to the provisions of Article 4 of this Lease, i f a dispute arises between the parties which cannot be resolved by negotiation, they shall submit the matter to binding arbitration before the American Arbitration Association or any successor organization, in accordance with the rules, regulations and/or procedures for expedited proceedings then obtaining of the American Arbitration Association or such successor organization. The parties shall jointly designate an independent arbitrator (the "Arbitrator"). In the event that the parties shall be unable to jointly agree on the designation of the Arbitrator within five (5) days after written request by either party, the parties shall allow the American Arbitration Association, or any successor organization, to designate the Arbitrator in accordance with the rules, regulations and/or procedures for expedited proceedings then obtaining of the American Arbitration Association or such successor organization. The arbitration shall be held at New York, New York, on seven (7) days notice, within seven (7) days of the appointment of the Arbitrator. The Arbitrator shall conduct such hearings, discovery and investigations as he/she may deem appropriate, provided that they shall be concluded within thirty (30) days after the date of designation of the Arbitrator. Within ten (10) after the conclusion thereof, the Arbitrator shall issue a determination. The determination of the arbitrator shall be conclusive and binding upon the parties and shall be set forth, along and with the Arbitrator's rationale for such determination, in a written report delivered to the parties. Each party shall pay its own counsel fees and expenses, if any, in connection with any arbitration under this Article. The Arbitrator appointed pursuant to this Article shall be an independent real estate construction professional with at least ten (10) years' experience in commercial real estate /commercial leasing. The Arbitrator shall not have the power to add to, modify or delete any of the provisions of this Agreement. The sole function of the Arbitrator shall be to determine whether Landlord has acted reasonably and whether to require Landlord to grant such consent or approval; the Arbitrator may not award damages or grant any other monetary award or relief.

4.14   Anything hereinabove contained to the contrary notwithstanding, the "recapture" provisions of this Article and the provisions of Section 4.10 hereof shall not apply in connection with, and Landlord's consent shall not be required for (a) an assignment of this Lease, or sublease of all or part of the Premises for the uses permitted hereunder, to a Related Entity or (b) in connection with a deemed assignment of this Lease resulting from a transfer of a majority of the issued and outstanding shares of capital stock or ownership interests of Tenant provided that such transfer shall be for a legitimate business purpose and not principally for the purpose of transferring this Lease, and provided further, with respect to both clauses (a) and (b), to the extent applicable, that: (i) Landlord is given prior notice thereof and reasonably satisfactory proof that the requirements of this Article 4 (to the extent applicable to the transaction) have been met and Tenant agrees to remain primarily liable, jointly and severally, with any assignee, for the obligations of Tenant under this Lease and (ii) in Landlord's reasonable judgment the proposed assignee or subtenant is engaged in a business and the Premises, or the relevant part thereof, will be used in a manner which (x) is in keeping with the standards of the Building and (y) would not adversely affect or increase Landlord's cost in the operation of the Building.

4.14   For purposes of this Article:

A. a " Related Entity " shall mean:

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(x) a wholly-owned subsidiary of Tenant or any corporation or entity which controls or is controlled by Tenant or is under common control with Tenant, or

(y) any entity (a " Successor Entity ") (i) to which substantially all the assets of Tenant are transferred, or (ii) into which Tenant may be merged or consolidated, provided that in either such case both the net worth and ratio of current assets to current liabilities (exclusive of good will) of such transferee or of the resulting or surviving corporation or other business entity, as the case may be, as certified by the certified public accountants of such transferee or the resulting or surviving business entity in accordance with generally accepted accounting principles, consistently applied, is not less than Tenant's net worth and ratio of current assets to current liabilities (exclusive of good will), as so certified, as of the day immediately prior to such transaction and provided also that any such transaction complies with the other provisions of this Article; and

B. the term " control " shall mean, in the case of a corporation or other entity, ownership or voting control, directly or indirectly, of at least fifty (50%) percent of all of the general or other partnership (or similar) interests therein and the power to determine the actions of such entity.

 
ARTICLE 5
 
DEFAULT

5.01   Landlord may terminate this Lease on five (5) business days' notice: (a) if Fixed Annual Rent or Additional Rent is not paid within five (5) business days after written notice from Landlord; or (b) if Tenant shall have failed to cure a default in the performance of any covenant of this Lease (except the payment of Rent), or any rule or regulation hereinafter set forth, within twenty (20) days after written notice thereof from Landlord, or if default cannot be completely cured in such time, if Tenant shall not promptly proceed to cure such default within said twenty (20) days, or shall not complete the curing of such default with due diligence; or (c) when and to the extent permitted by law, if a petition in bankruptcy shall be filed by or against Tenant or if Tenant shall make a general assignment for the benefit of creditors, or receive the benefit of any insolvency or reorganization act; or (d) if a receiver or trustee is appointed for any portion of Tenant's property and such appointment is not vacated within thirty (30) days; or (e) if an execution or attachment shall be issued under which the Premises shall be taken or occupied or attempted to be taken or occupied by anyone other than Tenant; or (f) if the Premises become and remain abandoned for a period of twenty-five (25) days; or (g) if Tenant shall default beyond any grace period under any other lease between Tenant and Landlord. At the expiration of the five (5) business day notice period, this Lease and any rights of renewal or extension thereof shall terminate as completely as if that were the date originally fixed for the expiration of the Term of this Lease, but Tenant shall remain liable as hereinafter provided.

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5.02   In the event that Tenant is in arrears for Fixed Annual Rent or any item of Additional Rent, Tenant waives its right, if any, to designate the items against which payments made by Tenant are to be credited and Landlord may apply any payments made by Tenant to any items which Landlord in its sole discretion may elect irrespective of any designation by Tenant as to the items against which any such payment should be credited.

5.03   Tenant shall not seek to remove and/or consolidate any summary proceeding brought by Landlord with any action commenced by Tenant in connection with this Lease or Tenant's use and/or occupancy of the Premises.

5.04   In the event of a default by Landlord hereunder, no property or assets of Landlord, or any principals, shareholders, officers, directors, partners or members of Landlord, whether disclosed or undisclosed, other than the Building in which the Premises are located and the land upon which the Building is situated, shall be subject to levy, execution or other enforcement procedure for the satisfaction of Tenant's remedies under or with respect to this Lease, the relationship of Landlord and Tenant hereunder or Tenant's use and occupancy of the Premises.

ARTICLE 6
 
RELETTING, ETC.

6.01   If Landlord shall re-enter the Premises on the default of Tenant, by summary proceedings or otherwise: (a) Landlord may re-let the Premises or any part thereof, as Tenant's agent, in the name of Landlord, or otherwise, for a term shorter or longer than the balance of the term of this Lease, and may grant concessions or free rent; (b) Tenant shall pay Landlord any deficiency between the rent hereby reserved and the net amount of any rents collected by Landlord for the remaining term of this Lease, through such re-letting. Such deficiency shall become due and payable monthly, as it is determined. Landlord shall have no obligation to re-let the Premises, and its failure or refusal to do so, or failure to collect rent on re-letting, shall not affect Tenant's liability hereunder. In computing the net amount of rents collected through such re-letting, Landlord may deduct all reasonable expenses incurred in obtaining possession or re-letting the Premises, including legal expenses and fees, brokerage fees, the cost of restoring the Premises to good order, and the cost of all alterations and decorations deemed necessary by Landlord to effect re-letting. In no event shall Tenant be entitled to a credit or repayment for rerental income which exceeds the sums payable by Tenant hereunder or which covers a period after the original term of this Lease; (c) Tenant hereby expressly waives any right of redemption granted by any present or future law. "Re-enter" and "re-entry" as used in this Lease are not restricted to their technical legal meaning. In the event of a breach or threatened breach of any of the covenants or provisions hereof, Landlord shall have the right of injunctive relief. Mention herein of any particular remedy shall not preclude Landlord from any other available remedy; (d) Landlord shall recover as liquidated damages, in addition to accrued rent and other charges, if Landlord's re-entry is the result of Tenant's bankruptcy, insolvency, or reorganization, the full rental for the maximum period allowed by any act relating to bankruptcy, insolvency or reorganization.

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6.02   If Landlord re-enters the Premises for any cause, or if Tenant abandons the Premises, or after the expiration of the term of this Lease, any property left in the Premises by Tenant shall be deemed to have been abandoned by Tenant, and Landlord shall have the right to retain or dispose of such property in any manner without any obligation to account therefor to Tenant. If Tenant shall at any time default hereunder, and if Landlord shall institute an action or summary proceeding against Tenant based upon such default, then Tenant will reimburse Landlord for the legal expenses and fees thereby incurred by Landlord.


ARTICLE 7
LANDLORD MAY CURE DEFAULTS

7.01   If Tenant shall default in performing any covenant or condition of this Lease, Landlord may perform the same for the account of Tenant, and if Landlord, in connection therewith, or in connection with any default by Tenant, makes any expenditures or incurs any obligations for the payment of money, including but not limited to reasonable attorney's fees, such sums so paid or obligations incurred shall be deemed to be Additional Rent hereunder, and shall be paid by Tenant to Landlord within ten (10) business days of rendition of any bill or statement therefor, and if Tenant's lease term shall have expired at the time of the making of such expenditures or incurring of such obligations, such sums shall be recoverable by Landlord as damages.

 
ARTICLE 8
 
ALTERATIONS

8.01   (A) Tenant shall make no decoration, alteration, addition or improvement in the Premises, without the prior written consent of Landlord, and then only by contractors or mechanics and in such manner and time, and with such materials, as reasonably approved by Landlord (notwithstanding the foregoing, however, Landlord’s prior negative experience with, concerns regarding the financial stability of, and any criminal proceedings pending against, any such contractor or mechanic shall be deemed to be a reasonable basis upon which for Landlord to refuse to grant its approval). All alterations, additions or improvements to the Premises, including air-conditioning equipment and duct work, except movable office furniture and trade equipment installed at the expense of Tenant, shall, unless Landlord elects otherwise in writing, become the property of Landlord, and shall be surrendered with the Premises, at the expiration or sooner termination of the term of this Lease. Any such alterations, additions and improvements which Landlord shall designate, shall be removed by Tenant and any damage repaired, at Tenant's expense, prior to the expiration of this Lease, unless written request has been made by Tenant at the time of Tenant’s request for Landlord’s approval of the installation of such item(s) by means of the following sentence in capital letters:

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TENANT REQUESTS THAT LANDLORD NOTIFY TENANT TOGETHER WITH LANDLORD’S CONSENT TO THE ENCLOSED TENANT'S PLANS WHETHER LANDLORD REQUIRES ANY ALTERATION SHOWN ON THE ENCLOSED PLANS TO BE REMOVED FROM THE PREMISES AT THE EXPIRATION OR SOONER TERMINATION OF THE TERM. IF LANDLORD SHALL FAIL TO RESPOND HERETO AT THE TIME OF LANDLORD’S CONSENT TO SUCH ALTERATION AND RESERVE SUCH RIGHT, THEN LANDLORD SHALL BE DEEMED TO HAVE WAIVED LANDLORD’S RIGHT TO REQUIRE SUCH ALTERATION TO BE REMOVED AT THE END OF THE TERM.

Landlord elects by notice to Tenant in response thereto to relinquish Landlord's right thereto and to have them removed by Tenant, in which case, the item(s) shall be removed from the Premises by Tenant, and any resulting damage to the Premises or the Building repaired by Tenant, at Tenant's expense, prior to the expiration of the Lease.

(B) Notwithstanding anything contained in this Lease to the contrary, Tenant shall not be obligated to remove any Alterations (hereinafter defined) hereinafter performed in or to the Premises except for Specialty Alterations. For purposes of this Section 8.01 (B), " Specialty Alterations " shall mean Alterations consisting of kitchens, pantries, executive bathrooms, raised computer floors, server rooms, vaults, libraries, filing systems, internal staircases, dumbwaiters, pneumatic tubes, vertical and horizontal transportation systems, any Alterations which are structural in nature or penetrate or otherwise affects any floor slab, and other Alterations of a similar character which are not customary for general office use in non-institutional office buildings in midtown Manhattan. Tenant shall, at Tenant's cost and expense, remove any Specialty Alteration designated by Landlord, repair any damage to the Premises or the Building due to such removal, cap all electrical, plumbing and waste disposal lines in accordance with sound construction practice and restore the Premises to the condition existing prior to the making of such Specialty Alteration, reasonable wear and tear and damage from casualty excepted. All such work shall be performed in accordance with plans and specifications first approved by Landlord, such approval not to be unreasonably withheld or delayed, and all applicable terms, covenants, and conditions of this Lease. If the Landlord’s insurance premiums increase as a result of any Specialty Alterations, Tenant shall pay each such increase each year as Additional Rent within thirty (30) days after receipt of a bill therefore from Landlord.

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(C) Notwithstanding anything contained herein to the contrary, Tenant shall not be required to obtain Landlord’s prior written consent or approval for any nonstructural, purely decorative, interior improvements to the Premises provided, however that said improvements do not consist of changes or modifications to any Building plumbing, electrical, air conditioning or other Building wide systems and do not affect and are not visible from any portion of the Building outside of the Premises.

8.02   Anything hereinabove to the contrary notwithstanding, Landlord will not unreasonably withhold or delay approval of written requests of Tenant to make nonstructural interior alterations, decorations, additions and improvements (herein referred to as " Alterations ") in the Premises, provided that such Alterations do not affect utility services or plumbing and electrical lines or other systems of the Building and do not affect and are not visible from any portion of the Building outside of the Premises. All Alterations shall be performed in accordance with the following conditions:

(i)   Prior to the commencement of any Alterations costing more than $10,000.00, Tenant shall first submit to Landlord for its approval detailed dimensioned coordinated plans and specifications, including layout, architectural, mechanical, electrical, plumbing and structural drawings for each proposed Alteration. Landlord shall be given, in writing, a good description of all other Alterations.

(ii)   All Alterations in and to the Premises shall be performed in a good and workmanlike manner and in accordance with the Building’s rules and regulations governing Tenant Alterations. Prior to the commencement of any such Alterations, Tenant shall, at its sole cost and expense, obtain and exhibit to Landlord any governmental permit required in connection with such Alterations. In order to compensate Landlord for its general conditions and the costs incurred by Landlord in connection with Tenant’s performance of Alterations in and/or to the Premises (including, without limitation, the costs incurred by Landlord in connection with the coordination of Alterations which may affect systems or services of the Building or portions of the Building outside of the Premises), Tenant shall pay to Landlord a fee equal to Landlord’s actual out of pocket expenses incurred in connection therewith. Such fee shall be paid by Tenant as Additional Rent hereunder within ten (10) days following receipt of an invoice therefor.

(iii)   All Alterations shall be done in compliance with all other applicable provisions of this Lease and with all applicable laws, ordinances, directions, rules and regulations of governmental authorities having jurisdiction, including, without limitation, the Americans with Disabilities Act of 1990 and New York City Local Law No. 57/87 and similar present or future laws, and regulations issued pursuant thereto, and also New York City Local Law No. 76 and similar present or future laws, and regulations issued pursuant thereto, on abatement, storage, transportation and disposal of asbestos and other hazardous materials, which work, if required, shall be effected at Tenant's sole cost and expense, by contractors and consultants approved by Landlord and in strict compliance with the aforesaid rules and regulations and with Landlord's rules and regulations thereon.

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(iv)   All work shall be performed with union labor having the proper jurisdictional qualifications.

(v)   Tenant shall keep the Building and the Premises free and clear of all liens for any work or material claimed to have been furnished to Tenant or to the Premises.

(vi)   Prior to the commencement of any work by or for Tenant, Tenant shall furnish to Landlord certificates evidencing the existence of the following insurance:

(a)   Workmen's compensation insurance covering all persons employed for such work and with respect to whom death or bodily injury claims could be asserted against Landlord, Tenant or the Premises.

(b)   Broad form general liability insurance written on an occurrence basis naming Tenant as an insured and naming Landlord and its designees as additional insureds, with limits of not less than $3,000,000 combined single limit for personal injury in any one occurrence, and with limits of not less than $500,000 for property damage (the foregoing limits may be revised from time to time by Landlord to such higher limits as Landlord from time to time reasonably requires). Tenant, at its sole cost and expense, shall cause all such insurance to be maintained at all time when the work to be performed for or by Tenant is in progress. All such insurance shall be obtained from a company authorized to do business in New York and shall provide that it cannot be canceled without thirty (30) days prior written notice to Landlord. All polices, or certificates therefor, issued by the insurer and bearing notations evidencing the payment of premiums, shall be delivered to Landlord. Blanket coverage shall be acceptable, provided that coverage meeting the requirements of this paragraph is assigned to Tenant's location at the Premises.

(vii)   In granting its consent to any Alterations, Landlord may impose such conditions as to guarantee of completion (including, without limitation, requiring Tenant to post additional security or a bond to insure the completion of such Alterations, payment, restoration or otherwise), as Landlord may reasonably require.

(viii)   All work to be performed by Tenant shall be done in a manner which will not interfere with or disturb other tenants and occupants of the Building.

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(ix)   The review and/or approval by Landlord, its agents, consultants and/or contractors, of any Alteration or of plans and specifications therefor and the coordination of such Alteration work with the Building, as described in part above, are solely for the benefit of Landlord, and neither Landlord nor any of its agents, consultants or contractors shall have any duty toward Tenant; nor shall Landlord or any of its agents, consultants and/or contractors be deemed to have made any representation or warranty to Tenant, or have any liability, with respect to the safety, adequacy, correctness, efficiency or compliance with laws of any plans and specifications, Alterations or any other matter relating thereto.

(x)   Promptly following the substantial completion of any Alterations, Tenant shall submit to Landlord: (a) one (1) sepia and one (1) copy on floppy disk or CD (using a current version of Autocad or such other similar software as is then commonly in use) of final, “as-built” plans for the Premises showing all such Alterations and demonstrating that such Alterations were performed substantially in accordance with plans and specifications first approved by Landlord and (b) an itemization of Tenant’s total construction costs, detailed by contractor, subcontractors, vendors and materialmen; bills, receipts, lien waivers and releases from all contractors, subcontractors, vendors and materialmen; architects' and Tenant's certification of completion, payment and acceptance, and all governmental approvals and confirmations of completion for such Alterations.


ARTICLE 9
 
LIENS

9.01   Prior to commencement of its work in the Premises, Tenant shall obtain and deliver to Landlord a written letter of authorization, in form satisfactory to Landlord's counsel, signed by all architects, engineers and designers to become involved in such work, which shall confirm that any of their drawings or plans are to be removed from any filing with governmental authorities on request of Landlord, in the event that said architect, engineer or designer thereafter no longer is providing services with respect to the Premises. With respect to contractors, subcontractors, materialmen and laborers, and architects, engineers and designers, for all work or materials to be furnished to Tenant at the Premises, Tenant agrees to obtain and deliver to Landlord written and unconditional waiver of mechanics liens upon the Premises or the Building after payments to the contractors, etc., subject to any then applicable provisions of the Lien Law. Notwithstanding the foregoing, Tenant at its expense shall cause any lien filed against the Premises or the Building, for work or materials claimed to have been furnished to Tenant, to be discharged of record within twenty (20) days after notice thereof.

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ARTICLE 10
 
REPAIRS

10.01   Tenant shall take good care of the Premises and the fixtures and appurtenances therein, and shall make all repairs necessary to keep them in good working order and condition, including structural repairs when those are necessitated by the act, omission or negligence of Tenant or its agents, employees, invitees or contractors, subject to the provisions of Article 11 hereof. During the term of this Lease, Tenant may have the use of any air-conditioning equipment servicing the Premises, subject to the provisions of Article 35 of this Lease, and shall reimburse Landlord, in accordance with Article 41 of this Lease, for electricity consumed by the equipment. The exterior walls and roofs of the Building, the mechanical rooms, service closets, shafts, areas above any hung ceiling and the windows and the portions of all window sills outside same are not part of the Premises demised by this Lease, and Landlord hereby reserves all rights to such parts of the Building. Tenant shall not paint, alter, drill into or otherwise change the appearance of the windows including, without limitation, the sills, jambs, frames, sashes, and meeting rails.

 
ARTICLE 11
 
FIRE OR OTHER CASUALTY

11.01   Damage by fire or other casualty to the Building and to the core and shell of the Premises (excluding the tenant improvements and betterments and Tenant's personal property) shall be repaired at the expense of Landlord (“ Landlord’s Restoration Work ”), but without prejudice to the rights of subrogation, if any, of Landlord's insurer to the extent not waived herein. Landlord shall not be required to repair or restore any of Tenant's property or any alteration, installation or leasehold improvement made in and/or to the Premises. If, as a result of such damage to the Building or to the core and shell of the Premises, the Premises are rendered untenantable, the Rent shall abate in proportion to the portion of the Premises not usable by Tenant from the date of such fire or other casualty until Landlord’s Restoration Work is substantially completed. Landlord shall not be liable to Tenant for any delay in performing Landlord’s Restoration Work, Tenant's sole remedy being the right to an abatement of Rent, as provided above. Tenant shall cooperate with Landlord in connection with the performance by Landlord of Landlord’s Restoration Work. If the Premises are rendered wholly untenantable by fire or other casualty and if Landlord shall decide not to restore the Premises, or if the Building shall be so damaged that Landlord shall decide to demolish it or not to rebuild it (whether or not the Premises have been damaged), Landlord may within ninety (90) days after such fire or other cause give written notice to Tenant of its election that the term of this Lease shall automatically expire no less than ten (10) days after such notice is given. Notwithstanding the foregoing, each party shall look first to any insurance in its favor before making any claim against the other party for recovery for loss or damage resulting from fire or other casualty, and to the extent that such insurance is in force and collectible and to the extent permitted by law, Landlord and Tenant each hereby releases and waives all right of recovery against the other or any one claiming through or under each of them by way of subrogation or otherwise. The foregoing release and waiver shall be in force only if both releasors' insurance policies contain a clause providing that such a release or waiver shall not invalidate the insurance and also, provided that such a policy can be obtained without additional premiums. Tenant hereby expressly waives the provisions of Section 227 of the Real Property Law and agrees that the foregoing provisions of this Article shall govern and control in lieu thereof.

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11.02   In the event that the Premises has been damaged or destroyed and this Lease has not been terminated in accordance with the provisions of this Article, Tenant shall (i) cooperate with Landlord in the restoration of the Premises and shall remove from the Premises as promptly as reasonably possible all of Tenant's salvageable inventory, movable equipment, furniture and other property and (ii) repair the damage to the tenant improvements and betterments and Tenant’s personal property and restore the Premises within one hundred eighty (180) days following the date upon which the core and shell of the Premises shall have been substantially repaired by Landlord.

ARTICLE 12
 
END OF TERM

12.01   Tenant shall surrender the Premises to Landlord at the expiration or sooner termination of this Lease in good order and condition, except for reasonable wear and tear and damage by fire or other casualty, and Tenant shall remove all of its property. Tenant agrees it shall indemnify and save Landlord harmless against all costs, claims, loss or liability resulting from delay by Tenant in so surrendering the Premises, including, without limitation, any claims made by any succeeding tenant founded on such delay. The parties recognize and agree that the damage to Landlord resulting from any failure by Tenant timely to surrender the Premises will be substantial, will exceed the amount of monthly Rent theretofore payable hereunder, and will be impossible of accurate measurement. Tenant therefore agrees that if possession of the Premises is not surrendered to Landlord within one (1) day after the date of the expiration or sooner termination of the Term of this Lease, then Tenant will pay Landlord as liquidated damages for each month and for each portion of any month during which Tenant holds over in the Premises after expiration or termination of the Term of this Lease, a sum equal to two (2) times the average Rent and Additional Rent which was payable per month under this Lease during the last six months of the Term thereof. The aforesaid obligations shall survive the expiration or sooner termination of the Term of this Lease. At any time during the Term of this Lease, Landlord may exhibit the Premises to prospective purchasers or mortgagees of Landlord's interest therein. During the last year of the term of this Lease, Landlord may exhibit the Premises to prospective tenants and shall use commercially reasonable efforts to minimize interference with Tenant’s permitted use of the Premises during such entry to the Premises.


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ARTICLE 13
 
SUBORDINATION AND ESTOPPEL, ETC.

13.01   This Lease is and shall be subject and subordinate to all present and future ground leases, underlying leases and to all subleases of the entire premises demised by that certain ground lease (hereinafter referred to as the “Mesne Lease”) dated December 30, 1957 and recorded in the office of the Register of the City of New York in the County of New York on December 31, 1957, in Liber 5024 of Conveyances, Page 430 of which the premises hereby demised form a part (the Mesne Lease and any or all present and future ground leases, underlying leases and subleases of the entire premises demised by the Mesne Lease are hereunder referred to as the "ground leases" and the lessors and lessees thereunder are hereinafter referred to respectively as the "ground lessors" and "ground lessees" ) and to all renewals, modifications, replacements and extensions of the ground leases, and to all present and future mortgages affecting such ground leases (such mortgages are hereinafter referred to as the "mortgages" and the mortgagees thereunder are hereinafter referred to as the "the mortgagees") including, without limitation, that certain Amended and Restated Indenture of Leasehold Mortgage, Security Agreement, Financing Statement, Fixture Filing and Assignment of Leases, Rents and Security Deposits, dated as of May 21, 1999 by and between SLG Graybar Mesne Lease LLC and SLG Graybar Sublease LLC, as mortgagor, and Midland Loan Services, Inc., as mortgagee, and to all renewals, modifications, replacements and extensions of the mortgages.

13.02   Notwithstanding the subordination of this Lease to all ground leases and mortgages, this Lease shall not terminate or be terminable by Tenant by reason of the expiration or earlier termination or cancellation of any ground lease in accordance with its terms or by reason of the foreclosures of any mortgage, except that this lease may be terminated if Tenant is named as a party and served with process in a summary or other proceeding brought by the lessor under the Mesne Lease (hereinafter referred to as the "Mesne Lessor") for the possession of the premises demised by the Mesne Lease or the space occupied by Tenant, or in such proceeding brought with the written consent of the Mesne Lessor delivered to Tenant, and a final order or judgment is entered, and a warrant for possession of such space issued and executed against the defendants or respondents in such proceedings.

13.03   Tenant agrees that if this Lease terminates, expires or is canceled for any reason or by any means whatsoever (other than by a summary or other proceeding brought by the Mesne Lessor or with the Mesne Lessor's written consent delivered to Tenant, in which summary or other proceeding Tenant is made a party and in which a final order or judgment is entered and warrant for possession is issued and executed against Tenant) and Mesne Lessor or a ground lessor so elects by written notice to Tenant, this lease shall automatically be reinstated for the balance of the term which would have remained but for such termination, expiration or cancellation, at the same rental, and upon the same agreements, covenants, conditions, restrictions and provisions herein contained, with the same rental, and upon the same agreements, covenants, conditions, restrictions and provisions herein contained, with the same force and effect as if no such termination, expiration or cancellation had taken place. Tenant covenants to execute and deliver any instrument required to confirm the validity of the foregoing. Anything herein contained to the contrary notwithstanding, this lease shall not be deemed to be automatically reinstated as aforesaid, nor shall Tenant be obligated to execute and deliver any instrument confirming such reinstatement, if Tenant has delivered to the Mesne Lessor and any ground lessor so electing a notice that in Tenant's opinion this lease has so terminated, expired or been canceled, and neither the Mesne Lessor nor such other ground lessor has, within thirty (30) days after receipt of such notice from Tenant, delivered notice to Tenant of its election automatically to reinstate this lease.

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13.04   Tenant hereby consents to any and all assignment of Landlord's interest in this Lease to any ground lessor or mortgagee as collateral security for the payment of the ground rent or monies due under any mortgage. Tenant agrees to attorn to and pay rent to any such ground lessor or mortgagee in accordance with the provisions of any such assignment.

13.05   Tenant agrees that no act, or failure to act, on the part of Landlord, which would entitle Tenant under the terms of this Lease, or by law to be relieved of Tenant's obligations hereunder or to terminate this lease, shall result in a release or termination of such obligations or termination of this lease unless (i) Tenant shall have first given written notice of Landlord's act or failure to act to the ground lessors under all then existing ground leases, to all then existing mortgagees who have requested such notice from Tenant, and to Midland Loan Services, Inc., as mortgagee, at (i) 10851 Mastin, Overland Park, Kansas 66210, Attn.: Philip Frost, Vice President/Portfolio Management, specifying the act or failure to act on the part of Landlord which could or would give basis to Tenant's rights and (ii) the ground lessors and such mortgagees, after receipt of such notice, have failed or refused to correct or cure the condition complained of within a reasonable time thereafter but nothing herein contained shall be deemed to impose any obligation on any ground lessor or such mortgagee to correct or cure any such condition.

13.06   This Lease may not be modified or amended so as to reduce the rent, shorten the term, or otherwise materially affect the rights of Landlord hereunder, or be canceled or surrendered except as provided in Section 13.05 this Article without the prior written consent in each instance of the ground lessors and of any mortgagees whose mortgages shall require such consent. Any such modification, agreement, cancellation or surrender made without such prior written consent shall be null and void.

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13.07   From time to time, Tenant, on at least ten (10) business days' prior written request by Landlord, shall deliver to Landlord a statement in writing certifying that this Lease is unmodified and in full force and effect (or if there shall have been modifications, that the same is in full force and effect as modified and stating the modifications) and the dates to which the Rent and other charges have been paid and stating whether or not, to Tenant’s knowledge, Landlord is in default in performance of any covenant, agreement or condition contained in this Lease and, if so, specifying each such default. In the event that Tenant shall fail to deliver such statement to Landlord within such ten (10) business day period, and provided Landlord gives Tenant a reminder notice of such failure, and Tenant continues to fail to deliver such statement to Landlord within five (5) days after such reminder notice is deemed given, pursuant to Section 27.01 hereof, then such failure by Tenant shall constitute a default of its obligations under this Lease.


ARTICLE 14
 
CONDEMNATION

14.01   If the whole or any substantial part of the Premises shall be condemned by eminent domain or acquired by private purchase in lieu thereof, for any public or quasi-public purpose, this Lease shall terminate on the date of the vesting of title through such proceeding or purchase, and Tenant shall have no claim against Landlord for the value of any unexpired portion of the Term of this Lease, nor shall Tenant be entitled to any part of the condemnation award or private purchase price. If less than a substantial part of the Premises is condemned, this Lease shall not terminate, but Rent shall abate in proportion to the portion of the Premises condemned. Notwithstanding the foregoing, however, Tenant shall not be prohibited from making a claim for the value of its trade fixtures and alterations and for its relocation expenses, leasehold improvements, and non-moveable property or furniture provided that such claim does not in any manner prejudice Landlord’s claims.


ARTICLE 15
 
REQUIREMENTS OF L AW

15.01   Unless such obligation is the obligation of Landlord pursuant to this Lease or of a third party, Tenant at its expense shall comply with all laws, orders and regulations of any governmental authority having or asserting jurisdiction over the Premises, which shall impose any violation, order or duty upon Landlord or Tenant with respect to the Premises or the use or occupancy thereof, including, without limitation, compliance in the Premises with all City, State and Federal laws, rules and regulations on the disabled or handicapped, on fire safety and on hazardous materials. The foregoing shall not require Tenant to do structural work to the Building.

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15.02   Tenant shall require every person engaged by him to clean any window in the Premises from the outside, to use the equipment and safety devices required by Section 202 of the Labor Law and the rules of any governmental authority having or asserting jurisdiction.

15.03   Tenant at its expense shall comply with all requirements of the New York Board of Fire Underwriters, or any other similar body affecting the Premises, and shall not use the Premises in a manner which shall increase the rate of fire insurance of Landlord or of any other tenant, over that in effect prior to this Lease. If Tenant's use of the Premises increases the fire insurance rate, Tenant shall reimburse Landlord for all such increased costs. That the Premises are being used for the purpose set forth in Article 1 hereof shall not relieve Tenant from the foregoing duties, obligations and expenses.

15.04   Unless such compliance is the obligation of Tenant hereunder or any other third party, Landlord shall, at Landlord’s expense, comply with laws, orders and regulations affecting the use and occupancy of the Premises or the Building to the extent that the failure to so comply would interfere with Tenant's permitted use and occupancy of the Premises except to a de minimis extent.


ARTICLE 16
 
CERTIFICATE OF OCCUPANCY

16.01   Tenant will at no time use or occupy the Premises in violation of the certificate of occupancy issued for the Building. The statement in this Lease of the nature of the business to be conducted by Tenant shall not be deemed to constitute a representation or guaranty by Landlord that such use is lawful or permissible in the Premises under the certificate of occupancy for the Building.


ARTICLE 17
 
POSSESSION

17.01   If Landlord shall be unable to give possession of the Premises on the Commencement Date because of the retention of possession of any occupant thereof, alteration or construction work, or for any other reason, Landlord shall not be subject to any liability for such failure. In such event, this Lease shall stay in full force and effect, without extension of its Term. However, the Rent hereunder shall not commence until the Premises are available for occupancy by Tenant. If delay in possession is due to work, changes or decorations being made by or for Tenant, or is otherwise caused by Tenant, there shall be no rent abatement and the Rent shall commence on the date specified in this Lease. If permission is given to Tenant to occupy the Premises or other Premises prior to the date specified as the commencement of the Term, such occupancy shall be deemed to be pursuant to the terms of this Lease, except that the parties shall separately agree as to the obligation of Tenant to pay Rent for such occupancy. The provisions of this Article are intended to constitute an "express provision to the contrary" within the meaning of Section 223(a), New York Real Property Law.

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ARTICLE 18
 
QUIET ENJOYMENT

18.01   Landlord covenants that if Tenant pays the Rent and performs all of Tenant's other obligations under this Lease, Tenant may peaceably and quietly enjoy the Premises, subject to the terms, covenants and conditions of this Lease and to the ground leases, underlying leases and mortgages hereinbefore mentioned.


ARTICLE 19
 
RIGHT OF ENTRY

19.01   Tenant shall permit Landlord to erect, construct and maintain pipes, conduits and shafts in and through the Premises. Landlord or its agents shall have the right to enter or pass through the Premises at all times, by master key and, in the event of an emergency, by reasonable force or otherwise, to examine the same, and to make such repairs, alterations or additions as it may deem necessary or desirable to the Premises or the Building, and to take all material into and upon the Premises that may be required therefor. Landlord shall use reasonable efforts to minimize interference with Tenant’s normal business activities within the premises provided, however, that Tenant acknowledges and agrees that all work shall be performed on normal business days during normal business hours. Notwithstanding the foregoing, in the event that Tenant requests that Landlord make such repairs, alterations or additions during times other than ordinary business hours, and such labor is then available, Tenant shall be responsible for the cost of such overtime or premium labor charges as the case may be. Such entry and work shall not constitute an eviction of Tenant in whole or in part, shall not be grounds for any abatement of Rent, and shall impose no liability on Landlord by reason of inconvenience or injury to Tenant's business. Landlord shall have the right, upon reasonable advance notice (which may be verbal) to Tenant and under such circumstances whereby Tenant shall maintain reasonably comparable access to and use of the Premises, without the same constituting an actual or constructive eviction, and without incurring any liability to Tenant, to change the arrangement and/or location of entrances or passageways, windows, corridors, elevators, stairs, toilets, or other public parts of the Building, and to change the designation of rooms and suites and the name or number by which the Building is known.
 

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ARTICLE 20
 
INDEMNITY

20.01   Tenant shall indemnify, defend and save Landlord harmless from and against any liability or expense arising from the use or occupation of the Premises by Tenant, or anyone on the Premises with Tenant's permission, or from any breach of this Lease.

ARTICLE 21
 
LANDLORD'S LIABILITY, ETC.

21.01   This Lease and the obligations of Tenant hereunder shall not in any way be affected because Landlord is unable to fulfill any of its obligations or to supply any service, by reason of strike or other cause not within Landlord's control. Landlord shall have the right, without incurring any liability to Tenant, to stop any service for a reasonable period of time because of accident or emergency, or for repairs, alterations or improvements, necessary or desirable in the judgment of Landlord, until such repairs, alterations or improvements shall have been completed. Landlord shall not be liable to Tenant or anyone else, for any loss or damage to person, property or business; nor shall Landlord be liable for any latent defect in the Premises or the Building. Neither the partners, entities or individuals comprising the Landlord, nor the agents, directors, or officers or employees of any of the foregoing shall be liable for the performance of the Landlord's obligations hereunder. Tenant agrees to look solely to Landlord's estate and interest in the land and Building, or the lease of the Building or of the land and Building, and the Premises, for the satisfaction of any right or remedy of Tenant for the collection of a judgement (or other judicial process) requiring the payment of money by Landlord, and in the event of any liability by Landlord, no other property or assets of Landlord or of any of the aforementioned parties shall be subject to levy, execution or other enforcement procedure for the satisfaction of Tenant's remedies under or with respect to this Lease, the relationship of Landlord and Tenant hereunder, or Tenant's use and occupancy of the Premises or any other liability of Landlord to Tenant.

21.02   If Landlord fails to make any repair or provide any service Landlord is obligated to provide under this Lease and as a result thereof, Tenant shall be not able to use and shall have discontinued its occupancy of all or any affected portion of the Premises for a period of forty-eight (48) consecutive hours or more after notice thereof to Landlord then, except as provided in Article 10 hereof, Tenant shall be entitled to an abatement of the Fixed Annual Rent and Additional Rent allocable to such portion of the Premises which is not usable and is unoccupied for each day after said forty-eight (48) consecutive hour period until said repair is completed or services restored by Landlord (except if such repair or service restoration cannot be completed in such time or if Landlord shall not promptly proceed to commence said repair or service restoration within said forty-eight (48) consecutive hour period) provided further, however, Tenant shall not be entitled to an abatement of rent in the event that such failure results from (i) any installation, alteration or improvement which is not performed by Tenant in a good workmanlike manner; (ii) Tenant's failure to perform its obligations hereunder; (iii) reasons beyond Landlord’s reasonable control; or (iv) the negligence or tortious conduct of Tenant.

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ARTICLE 22
 
CONDITION OF PREMISES

22.01   The parties acknowledge that Tenant has inspected the Premises and the Building and is fully familiar with the physical condition thereof and Tenant agrees to accept the Premises at the commencement of the Term in its then “as is” condition. Tenant acknowledges and agrees that Landlord shall have no obligation to do any work in or to the Premises in order to make it suitable and ready for occupancy and use by Tenant.

ARTICLE 23
CLEANING

23.01   Landlord shall cause the Premises to be kept clean in accordance with Landlord's customary standards for the Building and pursuant to the cleaning specifications annexed hereto and made a part hereof, provided they are kept in reasonable order by Tenant. Landlord, its cleaning contractor and their employees shall have after-hours access to the Premises and the use of Tenant's light, power and water in the Premises as may be reasonably required for the purpose of cleaning the Premises. Landlord may remove Tenant's extraordinary refuse from the Building and Tenant shall pay the commercially reasonable cost thereof.

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23.02   Tenant acknowledges that Landlord has designated a cleaning contractor for the Building. Tenant agrees to employ said cleaning contractor or such other contractor as Landlord shall from time to time designate (the “ Building Cleaning Contractor ”) to perform all cleaning services required under the Lease to be performed by Tenant within the Premises and for any other waxing, polishing, and other cleaning and maintenance work of the Premises and Tenant's furniture, fixtures and equipment (collectively, “ Tenant Cleaning Services ”) provided that the prices charged by said contractor are comparable to the prices customarily charged by other reputable cleaning contractors employing union labor in midtown Manhattan for the same level and quality of service. Tenant acknowledges that it has been advised that the cleaning contractor for the Building may be a division or affiliate of Landlord. Tenant agrees that it shall not employ any other cleaning and maintenance contractor, nor any individual, firm or organization for such purpose, without Landlord's prior written consent which shall not be unreasonably withheld (notwithstanding the foregoing, however, Landlord’s prior negative experience with, concerns regarding the financial stability of, and any criminal proceedings pending against, any such contractor or mechanic shall be deemed to be a reasonable basis upon which for Landlord to refuse to grant its approval). In the event that Landlord and Tenant cannot agree on whether the prices then being charged by the Building Cleaning Contractor for such cleaning services are comparable to those charged by other reputable contractors as herein provided, then Landlord and Tenant shall each obtain two (2) bona fide bids for such services from reputable cleaning contractors performing such services in comparable buildings in midtown   Manhattan employing union labor, and the average of the four bids thus obtained shall be the standard of comparison. In the event that the Building Cleaning Contractor does not agree to perform such cleaning services for Tenant at such average price, Landlord shall not unreasonably withhold its consent to the performance of Tenant Cleaning Services by a reputable cleaning contractor designated by Tenant employing union labor with the proper jurisdictional qualifications; provided, however, that, without limitation, Landlord's experience with such contractor or any criminal proceedings pending or previously filed against such contractor may form a basis upon which Landlord may withhold or withdraw its consent.


ARTICLE 24
 
JURY WAIVER

24.01   Landlord and Tenant hereby waive trial by jury in any action, proceeding or counterclaim involving any matter whatsoever arising out of or in any way connected with this Lease, the relationship of Landlord and Tenant, Tenant's use or occupancy of the Premises or involving the right to any statutory relief or remedy. Tenant will not interpose any counterclaim of any nature in any summary proceeding.


ARTICLE 25
 
NO WAIVER, ETC.

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25.01   No act or omission of Landlord or its agents shall constitute an actual or constructive eviction, unless Landlord shall have first received written notice of Tenant's claim and shall have had a reasonable opportunity to meet such claim. In the event that any payment herein provided for by Tenant to Landlord shall become overdue for a period in excess of ten (10) days, then at Landlord's option a "late charge" shall become due and payable to Landlord, as Additional Rent, from the date it was due until payment is made, at the following rates: for individual and partnership lessees, said late charge shall be computed at the maximum legal rate of interest; for corporate or governmental entity lessees the late charge shall be computed at two percent per month unless there is an applicable maximum legal rate of interest which then shall be used. No act or omission of Landlord or its agents shall constitute an acceptance of a surrender of the Premises, except a writing signed by Landlord. The delivery or acceptance of keys to Landlord or its agents shall not constitute a termination of this Lease or a surrender of the Premises. Acceptance by Landlord of less than the Rent herein provided shall at Landlord's option be deemed on account of earliest Rent remaining unpaid. No endorsement on any check, or letter accompanying Rent, shall be deemed an accord and satisfaction, and such check may be cashed without prejudice to Landlord. No waiver of any provision of this Lease shall be effective, unless such waiver be in writing signed by the party to be charged. In no event shall Tenant be entitled to make, nor shall Tenant make any claim, and Tenant hereby waives any claim for money damages (nor shall Tenant claim any money damages by way of set-off, counterclaim or defense) based upon any claim or assertion by Tenant that Landlord had unreasonably withheld, delayed or conditioned its consent or approval to any request by Tenant made under a provision of this Lease. Tenant's sole remedy shall be an action or proceeding to enforce any such provision, or for specific performance or declaratory judgment. Tenant shall comply with the rules and regulations contained in this Lease, and any reasonable modifications thereof or additions thereto provided to Tenant in writing before any effective date. Landlord shall not be liable to Tenant for the violation of such rules and regulations by any other tenant. Landlord agrees to enforce the rules and regulations in a uniform and non-discriminatory manner. F ailure of Landlord to enforce any provision of this Lease, or any rule or regulation, shall not be construed as the waiver of any subsequent violation of a provision of this Lease, or any rule or regulation. This Lease shall not be affected by nor shall Landlord in any way be liable for the closing, darkening or bricking up of windows in the Premises, for any reason, including as the result of construction on any property of which the Premises are not a part or by Landlord's own acts.


ARTICLE 26
 
OCCUPANCY AND USE BY TENANT

26.01   If this Lease is terminated because of Tenant’s default hereunder, then, in addition to Landlord's rights of re-entry, restoration, preparation for and rerental, and anything elsewhere in this Lease to the contrary notwithstanding, all Rent and Additional Rent reserved in this Lease from the date of such breach to the expiration date of this Lease shall become immediately due and payable to Landlord and Landlord shall retain its right to judgment on and collection of Tenant's aforesaid obligation to make a single payment to Landlord of a sum equal to the total of all Rent and Additional Rent reserved for the remainder of the original Term of this Lease, subject to future credit or repayment to Tenant in the event of any rerenting of the Premises by Landlord, after first deducting from rerental income all commercially reasonable expenses incurred by Landlord in reducing to judgment or otherwise collecting Tenant's aforesaid obligation, and in obtaining possession of, restoring, preparing for and re-letting the Premises. In no event shall Tenant be entitled to a credit or repayment for rerental income which exceeds the sums payable by Tenant hereunder or which covers a period after the original Term of this Lease.

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ARTICLE 27
 
NOTICES

27.01   Any bill, notice or demand from Landlord to Tenant, may be delivered personally at the Premises or sent by registered or certified mail or by any nationally recognized overnight delivery service and addressed to Tenant at the Premises or at the address first set forth herein. Such bill, notice or demand shall be deemed to have been given at the time of delivery, mailing or receipt by such delivery service. Any notice, request or demand from Tenant to Landlord must be sent by registered or certified mail to the last address designated in writing by Landlord.


ARTICLE 28
 
WATER

28.01   Tenant shall pay the amount of Landlord's cost for all excessive water used by Tenant for any purpose other than ordinary lavatory, cleaning and pantry uses, and any sewer rent or tax based thereon. In the event that Landlord has reason to believe (using reasonable judgment) that Tenant’s water usage has become excessive, Landlord may install a water meter to measure Tenant's water consumption for all purposes and Tenant agrees to pay for the installation and maintenance thereof and for water consumed as shown on said meter at Landlord’s cost therefor. If water is made available to Tenant in the Building or the Premises through a meter which also supplies other Premises, or without a meter, then Tenant shall pay to Landlord a reasonable charge per month for water. If necessary in order to comply with any law or regulation, Landlord reserves the right to discontinue water service to the Premises if either the quantity or character of such service is changed or is no longer available or suitable for Tenant’s requirements or for any other reason without releasing Tenant from any liability under this Lease and without Landlord or Landlord’s agent incurring any liability for any damage or loss sustained by Tenant by such discontinuance of service.

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ARTICLE 29
 
SPRINKLER SYSTEM

29.01   In the event that a sprinkler system shall be installed within the Premises during the term of this Lease and in the event that said sprinkler system serving the Premises is damaged by any act or omission of Tenant or its agents, employees, licensees or visitors, Tenant shall restore the system to good working condition at its own expense. If the New York Board of Fire Underwriters, the New York Fire Insurance Exchange, the Insurance Services Office, or any governmental authority requires the installation of, or any alteration to a sprinkler system by reason of Tenant's particular manner of occupancy or use of the Premises, including any alteration necessary to obtain the full allowance for a sprinkler system in the fire insurance rate of Landlord, or for any other reason, Tenant shall make such installation or alteration promptly, and at its own expense.


ARTICLE 30
 
HEAT, ELEVATOR, ETC.

30.01   Landlord shall provide elevator service during all usual business hours, except on Sundays, State holidays, Federal holidays, or Building Service Employees Union Contract holidays. Landlord shall furnish heat to the Premises during the same hours on the same days in the cold season in each year. If the elevators in the Building are manually operated, Landlord may convert to automatic elevators at any time, without in any way affecting Tenant's obligations hereunder.


ARTICLE 31
 
SECURITY DEPOSIT

31.01   Tenant shall deposit with Landlord the sum of $428,390.55 to be held by Landlord as security (the “ Security ”) for the performance by Tenant of the terms of this Lease. Landlord may use any part of the Security to satisfy any default of Tenant and any expenses arising from such default, including but not limited to reasonable legal fees and any damages or rent deficiency before or after re-entry by Landlord. Tenant shall, upon demand, deposit with Landlord the full amount so used, and/or any amount not so deposited by Tenant, in order that Landlord shall have the full Security on hand at all times during the term of this Lease. If Tenant shall comply fully with the terms of this Lease, the Security shall be returned to Tenant after the date fixed as the end of the Lease. In the event of a sale or lease of the Building containing the Premises, Landlord may transfer the Security to the purchaser or tenant, and Landlord shall thereupon be released from all liability for the return of the Security. This provision shall apply to every transfer or assignment of the Security to a new Landlord. Tenant shall have no legal power to assign or encumber the Security herein described.  

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31.02   In the event that at any time during the Term (i) Tenant shall have a net worth, as determined in accordance with generally accepted accounting principles taking into account contingent and all unmatured liabilities (“ GAAP ”) equal to or in excess of $30,000,000, and (ii) Tenant shall have a debt to equity ratio of 1 to 2, and (iii) Tenant shall have posted at least $10,000,000.00 in profit during the prior twelve (12) month period, then upon at least thirty (30) days prior written notice to Landlord accompanied by reasonable, detailed documentary evidence, consistent with GAAP, which establishes the foregoing to the reasonable satisfaction of Landlord’s chief financial officer or certified public accountant, Tenant may reduce the amount of the Security by the sum of $107,097.66 (the “ Security Reduction ”), provided Tenant has deposited with Landlord the full Security required by Section 31.01, above; the Security Reduction shall be promptly returned to Tenant by Landlord, so that the amount of the Security held by Landlord thereafter shall be $321,292.89, provided further and on condition that Tenant shall not be, or have been in, default in any of its obligations under this Lease after notice at any time during the Term through the effective date of such notice (in which event Tenant’s rights under this Article shall be suspended until the earlier of (a) Tenant’s timely and full cure of the default alleged in any such notice, at which time Tenant’s rights hereunder shall be reinstated, and (b) the expiration of Tenant’s time in which to cure any such default, at which time Tenant’s rights hereunder shall be extinguished). In the event that Landlord shall dispute the debt equity ratio alleged by Tenant in Tenant’s aforementioned notice, then the Security shall not be subject to reduction under this Section, if any, until such time as such dispute is resolved by arbitration pursuant to the provisions of Section 31.05 of this Article.

31.03   Tenant agrees that Landlord shall have the right on one (1) occasion during each calendar year throughout the Term and any renewals and extensions thereof, to require by notice to Tenant that Tenant furnish Landlord with financial statements certified by a certified public accountant and demonstrating with reasonable detail, in accordance with GAAP, the net worth of Tenant, the debt to equity ratio of Tenant and the profits of Tenant. Upon such notice from Landlord, Tenant shall furnish Landlord with such financial statements within twenty (20) days thereafter.

31.04   Notwithstanding any reductions in the Security which may be effected pursuant to the provisions of Sections 31.02, above, at any time during the Term, in the event that there has been a prior reduction of the Security pursuant to Section 31.02, above, and at any time thereafter Tenant’s net worth shall be less than $30,000,000 or Tenant’s debt to equity ratio shall be inferior to 1 to 2 or Tenant’s posted profits shall be less than $10,000,000.00 during the prior twelve (12) month period, then upon ten (10) days notice from Landlord, Tenant shall replenish the Security by the amount of the Security Reduction enjoyed by Tenant pursuant to said Section 31.02, above. Tenant acknowledges that its covenant to furnish financial statements upon request by Landlord pursuant to Section 31.03, above, and its covenant to maintain the required levels of Security, as contemplated in this Section, are material inducements to Landlord to agree to the reductions in Security contemplated in this Article, and Tenant’s failure to timely produce such financial statements or maintain such levels of Security shall constitute a material default under this Lease.

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31.05 If within thirty (30) days after Landlord’s dispute of any entitlement of Tenant to any of the reductions of Security contemplated in this Article, Landlord and Tenant are unable to resolve such dispute, then either party may within ten (10) days thereafter refer the dispute to an independent, third party certified public accounting firm selected by Landlord and reasonably acceptable to Tenant. In connection therewith, Landlord, Tenant and such firm shall enter into a confidentiality agreement, in form and substance reasonably satisfactory to the parties, whereby such parties shall agree not to disclose to any third party any of the information in connection with the prosecution, review and determination of such dispute or of any resulting reconciliation, compromise or resolution. Such firm may request such supporting documentation as it reasonably deems appropriate in order to promptly determine the dispute. The determination of such firm shall be rendered within thirty (30) days after the referral of the dispute, and shall be conclusive and binding upon Landlord and Tenant and shall be set forth in a written determination along with the rationale for the determination; however such firm shall not have the power to add to, modify or delete any of the provisions of this Lease or to award any relief whatsoever to either party, the sole function of said firm being to determine the accuracy of any and all documentation submitted by Tenant hereunder. Landlord and Tenant shall each be responsible for any respective fees and expenses (including, without limitation, attorneys’ fees) incurred in connection with said dispute.


ARTICLE 32
 
TAX ESCALATION

32.01   Tenant shall pay to Landlord, as Additional Rent, tax escalation in accordance with this Article:

(a)   For purposes of this Lease, Landlord and Tenant acknowledge and agree that the rentable square foot area of the Premises shall be deemed to be 8,897 square feet.

(b)   For the purpose of this Article, the following definitions shall apply:

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(i) The term " Tenant’s Share ", for purposes of computing tax escalation, shall mean eight hundred thousandths percent (0.800%). Tenant’s Share has been computed on the basis of a fraction, the numerator of which is the rentable square foot area of the Premises and the denominator of which is the total rentable square foot area of the office and commercial space in the Building Project. The parties acknowledge and agree that the total rentable square foot area of the office and commercial space in the Building Project shall be deemed to be 1,112,424 sq. ft.

(ii) The term the “ Building Project " shall mean the aggregate combined parcel of land on a portion of which are the improvements of which the Premises form a part, with all the improvements thereon, said improvements being a part of the block and lot for tax purposes which are applicable to the aforesaid land.

(iii) The “ Base Tax Year ” shall mean the New York City fiscal tax year commencing on July 1, 2005 through June 30, 2006.

(iv) The term “ Comparative Year ” shall mean the twelve (12) month period following the Base Tax Year, and each subsequent period of twelve (12) months thereafter.

(v) The term " Real Estate Taxes " shall mean the total of all taxes and special or other assessments levied, assessed or imposed at any time by any governmental authority upon or against the Building Project including, without limitation, any tax or assessment levied, assessed or imposed at any time by any governmental authority in connection with the receipt of income or rents from said Building Project to the extent that same shall be in lieu of all or a portion of any of the aforesaid taxes or assessments, or additions or increases thereof, upon or against said Building Project. If, due to a future change in the method of taxation or in the taxing authority, or for any other reason, a franchise, income, transit, profit or other tax or governmental imposition, however designated, shall be levied against Landlord in substitution in whole or in part for the Real Estate Taxes, or in lieu of additions to or increases of said Real Estate Taxes, then such franchise, income, transit, profit or other tax or governmental imposition shall be deemed to be included within the definition of "Real Estate Taxes" for the purposes hereof.

(vi) Where more than one assessment is imposed by the City of New York for any tax year, whether denominated an "actual assessment" or a "transitional assessment" or otherwise, then the phrases herein "assessed value" and "assessments" shall mean whichever of the actual, transitional or other assessment is designated by the City of New York as the taxable assessment for that tax year.

32.02   In the event that the Real Estate Taxes payable for any Comparative Year shall exceed the amount of the Real Estate Taxes payable during the Base Tax Year, Tenant shall pay to Landlord, as Additional Rent for such Comparative Year, an amount equal to Tenant’s Share of the excess. Before or after the start of each Comparative Year, Landlord shall furnish to Tenant a statement of the Real Estate Taxes payable during the Comparative Year. If the Real Estate Taxes payable for such Comparative Year exceed the Real Estate Taxes payable during the Base Tax Year, Additional Rent for such Comparative Year, in an amount equal to Tenant’s Share of the excess, shall be due from Tenant to Landlord, and such Additional Rent shall be payable by Tenant to Landlord within thirty (30) days after receipt of the aforesaid statement. The benefit of any discount for any early payment or prepayment of Real Estate Taxes shall accrue solely to the benefit of Landlord, and such discount shall not be subtracted from the Real Estate Taxes payable for any Comparative Year. In addition to the foregoing, Tenant shall pay to Landlord, within thirty (30) days after receipt of written demand, as Additional Rent, a sum equal to Tenant's Share of any business improvement district assessment payable by the Building Project.

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32.03   Should the Real Estate Taxes payable during the Base Tax Year be reduced by final determination of legal proceedings, settlement or otherwise, then, the Real Estate Taxes payable during the Base Tax Year shall be correspondingly revised, the Additional Rent theretofore paid or payable hereunder for all Comparative Years shall be recomputed on the basis of such reduction, and Tenant shall pay to Landlord as Additional Rent, within thirty (30) days after being billed therefor, any deficiency between the amount of such Additional Rent as theretofore computed and the amount thereof due as the result of such recomputations.
 
32.04   If, after Tenant shall have made a payment of Additional Rent under Section 32.02, Landlord shall receive a refund of any portion of the Real Estate Taxes payable for any Comparative Year after the Base Tax Year on which such payment of Additional Rent shall have been based, as a result of a reduction of such Real Estate Taxes by final determination of legal proceedings, settlement or otherwise, Landlord shall within ten (10) days after receiving the refund pay to Tenant Tenant’s Share of the refund less Tenant’s Share of expenses (including attorneys' and appraisers' fees) incurred by Landlord in connection with any such application or proceeding. In addition to the foregoing, Tenant shall pay to Landlord, as Additional Rent, within ten (10) days after Landlord shall have delivered to Tenant a statement therefor, Tenant’s Share of all expenses incurred by Landlord in reviewing or contesting the validity or amount of any Real Estate Taxes or for the purpose of obtaining reductions in the assessed valuation of the Building Project prior to the billing of Real Estate Taxes, including without limitation, the fees and disbursements of attorneys, third party consultants, experts and others.

32.05   The statements of the Real Estate Taxes to be furnished by Landlord as provided above shall be certified by Landlord and shall constitute a final determination as between Landlord and Tenant of the Real Estate Taxes for the periods represented thereby, unless Tenant within sixty (60) days after they are furnished shall give a written notice to Landlord that it disputes their accuracy or their appropriateness, which notice shall specify the particular respects in which the statement is inaccurate or inappropriate. If Tenant shall so dispute said statement then, pending the resolution of such dispute, Tenant shall pay the Additional Rent to Landlord in accordance with the statement furnished by Landlord.

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32.06   In no event shall the Fixed Annual Rent under this Lease be reduced by virtue of this Article.

32.07   If the Commencement Date of the Term of this Lease is not the first day of the first Comparative Year, then the Additional Rent due hereunder for such first Comparative Year shall be a proportionate share of said Additional Rent for the entire Comparative Year, said proportionate share to be based upon the length of time that the lease Term will be in existence during such first Comparative Year. Upon the date of any expiration or termination of this Lease (except termination because of Tenant's default) whether the same be the date hereinabove set forth for the expiration of the Term or any prior or subsequent date, a proportionate share of said Additional Rent for the Comparative Year during which such expiration or termination occurs shall immediately become due and payable by Tenant to Landlord, if it was not theretofore already billed and paid. The said proportionate share shall be based upon the length of time that this Lease shall have been in existence during such Comparative Year. Landlord shall promptly cause statements of said Additional Rent for that Comparative Year to be prepared and furnished to Tenant. Landlord and Tenant shall thereupon make appropriate adjustments of amounts then owing.

32.08   Landlord's and Tenant's obligations to make the adjustments referred to in Section 32.07 above shall survive any expiration or termination of this Lease. Any delay or failure of Landlord in billing any tax escalation hereinabove provided shall not constitute a waiver of or in any way impair the continuing obligation of Tenant to pay such tax escalation hereunder.


ARTICLE 33
 
RENT CONTROL

33.01   In the event the Fixed Annual Rent or Additional Rent or any part thereof provided to be paid by Tenant under the provisions of this Lease during the Term shall become uncollectible or shall be reduced or required to be reduced or refunded by virtue of any Federal, State, County or City law, order or regulation, or by any direction of a public officer or body pursuant to law, or the orders, rules, code or regulations of any organization or entity formed pursuant to law, whether such organization or entity be public or private, then Landlord, at its option, may at any time thereafter terminate this Lease, by not less than thirty (30) days' written notice to Tenant, on a date set forth in said notice, in which event this Lease and the term hereof shall terminate and come to an end on the date fixed in said notice as if the said date were the date originally fixed herein for the termination of the demised term. Landlord shall not have the right to so terminate this Lease if Tenant within such period of thirty (30) days shall in writing lawfully agree that the rentals herein reserved are a reasonable rental and agree to continue to pay said rentals, and if such agreement by Tenant shall then be legally enforceable by Landlord.


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ARTICLE 34
 
SUPPLIES

34.01   Only Landlord or any one or more persons, firms, or corporations authorized in writing by Landlord (provided that the cost, scope and quality of services offered by such persons, firms or corporations are commercially competitive) shall be permitted to furnish laundry, linens, towels, drinking water, water coolers, ice and other similar supplies and services to tenants and licensees in the Building. Landlord may fix, in its reasonable discretion, from time to time, the hours during which and the regulations under which such supplies and services are to be furnished. Landlord expressly reserves the right to act as or to designate, from time to time, an exclusive supplier of all or any one or more of the said supplies and services provided that the cost, scope and quality of services offered by such supplier are commercially competitive ; and Landlord furthermore expressly reserves the right to exclude from the Building any person, firm or corporation attempting to furnish any of said supplies or services but not so designated by Landlord.

34.02   Only Landlord or any one or more persons, firms or corporations authorized in writing by Landlord shall be permitted to sell, deliver or furnish any food or beverages whatsoever for consumption within the Premises or elsewhere in the Building, provided that the cost, scope and quality of food or beverages offered by such persons, firms or corporations are commercially competitive . Landlord expressly reserves the right to act as or to designate from time to time an exclusive supplier or suppliers of such food and beverages, provided that the cost, scope and quality of food or beverages offered are commercially competitive . Landlord further expressly reserves the right to exclude from the Building any person, firm or corporation attempting to deliver or purvey any such food or beverages, but not so designated by Landlord. It is understood, however, that Tenant or its regular office employees may personally bring food or beverages into the Building for consumption within the Premises by the said employees, but not for resale or for consumption by any other tenant.


ARTICLE 35
 
AIR CONDITIONING

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35.01   Tenant shall be permitted to use the equipment presently supplying air-conditioning service to the Premises (the “ Existing HVAC Equipment ”) Monday to Friday from 8:00 a.m. to 6:00 p.m. and on Saturdays from 9:00 a.m. to 1:00 pm, during the Building’s “ Cooling Season ” (which is currently May 15 through October 15) subject to and in accordance with the provisions of this Article. Landlord shall perform such work as is necessary, if any, in order to place the Existing HVAC Equipment in good working order (“ Landlord’s Initial HVAC Work ”) subject, however, to Tenant’s obligation to thereafter maintain and repair the Existing HVAC Equipment in accordance with the provisions of this Article. Landlord shall perform Landlord’s Initial HVAC Work as promptly as is reasonably practical following the commencement of the Term hereof. Tenant acknowledges and agrees that air-conditioning service to the Premises shall be supplied through equipment operated, maintained and repaired by Tenant and that Landlord has no obligation to operate, maintain or to repair the said equipment or to supply air-conditioning service to the Premises. The Existing HVAC Equipment and all other air conditioning systems, equipment and facilities hereafter located in or servicing the Premises (the “ Supplemental Systems ”) including, without limitation, the ducts, dampers, registers, grilles and appurtenances utilized in connection with both the Existing HVAC Equipment and the Supplemental Systems (collectively hereinafter referred to as the “ HVAC System ”), shall be maintained, repaired and operated by Tenant in compliance with all present and future laws and regulations relating thereto at Tenant’s sole cost and expense. Tenant shall pay for all electricity consumed in the operation of the HVAC System, and Tenant's proportionate share of the electric current (and/or water, gas and steam) for the production of chilled and/or condenser water and its supply to the Premises, if applicable, which shall become the obligation of Tenant subject to the terms of Article 41 of this Lease. Tenant shall pay for all parts and supplies necessary for the proper operation of the HVAC System (and any restoration or replacement by Tenant of all or any part thereof shall be in quality and class at least equal to the original work or installations); provided, however, that Tenant shall not alter, modify, remove or replace the HVAC System, or any part thereof, without Landlord’s prior written consent.

35.02   Without limiting the generality of the foregoing, Tenant shall, at its own cost and expense, (a) cause to be performed all maintenance of the HVAC System, including all repairs and replacements thereto, and (b) commencing as of the date upon which Tenant shall first occupy the Premises for the conduct of its business, and thereafter throughout the Term of the Lease, maintain in force and provide a copy of same to Landlord an air conditioning service repair and full service maintenance contract covering the HVAC System in form satisfactory to Landlord with an air conditioning contractor or servicing organization approved by Landlord. All such contracts shall provide for the thorough overhauling of the HVAC System at least once each year during the Term of this Lease and shall expressly state that (i) it shall be an automatically renewing contract terminable upon not less than thirty (30) days prior written notice to the Landlord (sent by certified mail, return receipt requested) and (ii) the contractor providing such service shall maintain a log at the Premises detailing the service provided during each visit pursuant to such contract. Tenant shall keep such log at the Premises and permit Landlord to review same promptly after Landlord's request. The HVAC System is and shall at all times remain the property of Landlord, and at the expiration or sooner termination of the Lease, Tenant shall surrender to Landlord the HVAC System in good working order and condition, subject to normal wear and tear and shall deliver to Landlord a copy of the service log. In the event that Tenant fails to obtain the contract required herein or perform any of the maintenance or repairs required hereunder, Landlord shall have the right, but not the obligation, to procure such contract and/or perform any such work and charge the Tenant as Additional Rent hereunder the cost of same plus an administrative fee equal to fifteen percent (15%) of such cost which shall be paid for by Tenant on demand.

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35.03 Tenant acknowledges and agrees that any after-hours heat or air conditioning service requested by Tenant shall be furnished for a minimum of three (3) hours per request on weekends and holidays, and a minimum of one (1) hour per request on weekdays. The price charged for after hours heating service as of the date hereof shall be $75.00 per hour for the entire Premises, plus sales tax, if applicable, subject to future increases.
 
ARTICLE 36
SHORING

36.01   Tenant shall permit any person authorized to make an excavation on land adjacent to the Building containing the Premises to do any work within the Premises necessary to preserve the wall of the Building from injury or damage, and Tenant shall have no claim against Landlord for damages or abatement of rent by reason thereof.


ARTICLE 37
EFFECT OF CONVEYANCE, ETC.

37.01   If the Building containing the Premises shall be sold, transferred or leased, or the lease thereof transferred or sold, Landlord shall be relieved of all future obligations and liabilities hereunder and the purchaser, transferee or tenant of the Building shall be deemed to have assumed and agreed to perform all such obligations and liabilities of Landlord hereunder. In the event of such sale, transfer or lease, Landlord shall also be relieved of all existing obligations and liabilities hereunder, provided that the purchaser, transferee or tenant of the Building assumes in writing such obligations and liabilities.


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ARTICLE 38
RIGHTS OF SUCCESSORS AND ASSIGNS

38.01   This Lease shall bind and inure to the benefit of the heirs, executors, administrators, successors, and, except as otherwise provided herein, the assigns of the parties hereto. If any provision of any Article of this Lease or the application thereof to any person or circumstances shall, to any extent, be invalid or unenforceable, the remainder of that Article, or the application of such provision to persons or circumstances other than those as to which it is held invalid or unenforceable, shall not be affected thereby, and each provision of said Article and of this Lease shall be valid and be enforced to the fullest extent permitted by law.


ARTICLE 39
 
CAPTIONS

39.01   The captions herein are inserted only for convenience, and are in no way to be construed as a part of this Lease or as a limitation of the scope of any provision of this Lease.


ARTICLE 40
 
BROKERS

40.01   Tenant covenants, represents and warrants that Tenant has had no dealings or negotiations with any broker or agent in connection with the consummation of this Lease other than SL Green Leasing LLC and Cushman & Wakefeld, Inc. (the " Brokers ") and Tenant covenants and agrees to defend, hold harmless and indemnify Landlord from and against any and all cost, expense (including reasonable attorneys' fees) or liability for any compensation, commissions or charges claimed by any broker or agent with whom Tenant has dealt, with respect to this Lease or the negotiation thereof.

40.02 Landlord covenants, represents and warrants that Landlord has had no dealings or negotiations with any broker or agent in connection with the consummation of this Lease other than the Brokers and Landlord covenants and agrees to defend, hold harmless and indemnify Tenant from and against any and all cost, expense (including reasonable attorneys' fees) or liability for any compensation, commissions or charges claimed by any broker or agent, other than Brokers, claiming to have dealt with Landlord with respect to this Lease or the negotiation thereof. Landlord agrees that it shall be responsible for and shall pay to the Brokers, pursuant to a separate agreement, the commissions payable as a result of this Lease.

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ARTICLE 41
 
ELECTRICITY

41.01   Tenant acknowledges and agrees that electric service shall be supplied to the Premises on a “rent inclusion basis” in accordance with the provisions of this Article 41 (subject to Landlord’s right, in its sole discretion, to furnish such electricity on a “submetering” basis as provided for herein).  

41.02   Electricity and electric service, as used herein, shall mean any element affecting the generation, transmission, and/or distribution or redistribution of electricity, including but not limited to services which facilitate the distribution of service.

41.03   If and so long as Landlord provides electricity to the Premises on a rent inclusion basis, Tenant agrees that the Fixed Annual Rent shall be increased by the amount of the Electricity Rent Inclusion Factor (“ ERIF ”), as hereinafter defined. Tenant acknowledges and agrees (i) that the Fixed Annual Rent hereinabove set forth in this Lease does not yet, but is to include an ERIF of $3.00 per rentable square foot to compensate Landlord for electrical wiring and other installations necessary for, and for its obtaining and making available to Tenant the redistribution of electric current as an additional service, and Tenant shall pay for Tenant’s Share of Building electric current (i.e., all electricity used in lighting the public and service areas, and in operating all the service facilities, of the Building and the parties acknowledge and agree that twenty percent (20%) of the Building's payment to the public utility or other service providers for the purchase of electricity shall be deemed to be payment for Building electric current) which shall be paid for by Tenant in accordance with provisions hereof; and (ii) that said ERIF, which shall be subject to periodic adjustments as hereinafter provided, has been partially based upon an estimate of the Tenant’s connected electrical load, in whatever manner delivered to Tenant, which shall be deemed to be the demand (KW), and hours of use thereof, which shall be deemed to be the energy (KWH), for ordinary lighting and light office equipment and the operation of the usual small business machines, including Xerox or other copying machines (such lighting and equipment are hereinafter called “ Ordinary Equipment ”) during ordinary business hours (“ Ordinary Business Hours ” shall be deemed to mean 50 hours per week), with Landlord providing an average connected load of 4 ½ watts of electricity for all purposes per rentable square foot. Any installation and use of equipment other than Ordinary Equipment and/or any connected load and/or energy usage by Tenant in excess of the foregoing and the charge for Tenant’s Share of Building electric current shall result in adjustment of the ERIF as hereinafter provided. For purposes of this Article, the rentable square foot area of the Premises shall be deemed to be 8,897 square feet.

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41.04   If the cost to Landlord of electricity shall have been, or shall be, increased subsequent to November 1, 2005 (whether such change occurs prior to or during the term of this Lease), by change in Landlord’s electric rates or service classifications, or electricity charges, including changes in market prices, or by an increase, subsequent to the last such electric rate or service classification change or market price change, in fuel adjustments or charges of any kind, or by taxes, imposed on Landlord’s electricity purchases or on Landlord’s electricity redistribution, or for any other such reason, then the aforesaid ERIF portion of the fixed annual rent shall be changed in the same percentage as any such change in cost due to changes in electric rates, service classifications or market prices, and, also Tenant’s payment obligation, for electricity redistribution, shall change from time to time so as to reflect any such increase in fuel adjustments or charges, and such taxes. Any such percentage change in Landlord’s cost due to change in Landlord’s electric rate or service classifications or market prices, shall be computed on the basis of the average consumption of electricity for the Building for the twelve full months immediately prior to the rate change or other such changes in cost, energy and demand, and any changed methods of or rules on billing for same, applied on a consistent basis to the new electric rate or service classification or market price and to the immediately prior existing electric rate or service classification or market price. If the average consumption (energy and demand) for the entire Building for said prior twelve (12) months cannot reasonably be applied and used with respect to changed methods of or rules on billing, then the percentage increase shall be computed by the use of the average consumption (energy and demand) for the entire building for the first three (3) months after such change, projected to a full twelve (12) months, so as to reflect the different seasons; and that same consumption, so projected, shall be applied to the rate and/or service classification or market price which existed immediately prior to the change. The parties agree that a reputable, independent electrical consultant firm, selected by Landlord (“ Landlord’s Electrical Consultant ”), shall determine the percentage change for the changes in ERIF due to Landlord’s changed costs and the charge to Tenant for Tenant’s Share of Building electric current, and that Landlord’s Electrical Consultant may from time to time make surveys in the Premises of the electrical equipment and fixtures and use of current. (i) If such survey shall reflect a connected electrical load in excess of 4 ½ watts of electricity for all purposes per rentable square foot and/or energy usage in excess of Ordinary Business Hours (each such excess hereinafter called “ excess electricity ”) then the connected electrical load and/or the hours of use portion(s) of the then existing ERIF shall be increased by an amount which is equal to a fraction of the then existing ERIF, the numerator of which is the excess electricity (i.e., excess connected load and/or excess usage) and the denominator of which is the connected load and/or the energy usage which was the basis of the then existing ERIF. Such fractions shall be determined by Landlord’s Electrical Consultant. The Fixed Annual Rent shall then be appropriately adjusted, effective as of the date of any such change in connected load and/or usage, as disclosed by said survey. (ii) If such survey shall disclose installation and use of other than Ordinary Equipment, then effective as of the date of said survey, there shall be added to the ERIF portion of Fixed Annual Rent (computed and fixed as hereinbefore described) an additional amount equal to what would be paid under the SC-4 Rate I Service Classification in effect on November 1, 2005 (and not the time-of-day rate schedule) or the comparable rate schedule (and not the time-of-day rate schedule) of any utility other than Con Ed then providing electrical service to the building as same shall be in effect on the date of such survey for such load and usage of electricity, with the connected electrical load deemed to be the demand (KW) and the hours of use thereof deemed to be the energy (KWH), as hereinbefore provided, (which addition to the ERIF shall be increased by all electricity cost changes of Landlord, as hereinabove provided, from November 1, 2005 through the date of billing).

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41.05   In no event, whether because of surveys, rates or cost changes, or for any reason, is the originally specified $3.00 per rentable square foot ERIF portion of the fixed annual rent (plus any net increase thereof by virtue of all electricity rate, service classification or market price changes of Landlord subsequent to November 1, 2005) to be reduced.

41.06   The determinations by Landlord’s Electrical Consultant shall be binding and conclusive on Landlord and Tenant from and after the delivery of copies of such determinations to Landlord and Tenant, unless, within thirty (30) days after delivery thereof, Tenant disputes such determination. If Tenant so disputes the determination, it shall, at its own expense, obtain from a reputable, independent electrical consultant its own determinations in accordance with the provisions of this Article. Tenant’s consultant and Landlord’s consultant then shall seek to agree. If they cannot agree within thirty (30) days they shall choose a third reputable electrical consultant, whose cost shall be shared equally by the parties, to make similar determinations which shall be controlling. (If they cannot agree on such third consultant within ten (10) days, then either party may apply to the Supreme Court in the County of New York for such appointment.) However, pending such controlling determinations Tenant shall pay to Landlord the amount of Additional Rent or ERIF in accordance with the determinations of Landlord’s Electrical Consultant. If the controlling determinations differ from Landlord’s Electrical Consultant, then the parties shall promptly make adjustment for any deficiency owed by Tenant or overage paid by Tenant.

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41.07   If and so long as Landlord provides electricity to the Premises on a submetering basis, Tenant covenants and agrees to purchase the same from Landlord or Landlord’s designated agent at charges, terms and rates set, from time to time, during the term of this Lease by Landlord but not more than those specified in the service classification in effect on January 1, 1970 pursuant to which Landlord then purchased electric current from the public utility corporation serving the part of the city where the Building is located; provided however, said charges shall be increased in the same percentage as any percentage increase in the billing to Landlord for electricity for the entire Building, by reason of increase in Landlord’s electric rates or service classifications, subsequent to January 1, 1970, and so as to reflect any increase in Landlord’s electric charges, including changes in market prices for electricity from utilities and/or other providers, in fuel adjustments or by taxes or charges of any kind imposed on Landlord’s electricity purchases or redistribution, or for any other such reason, subsequent to said date. Any such percentage increase in Landlord’s billing for electricity due to changes in rates, service classifications, or market prices, shall be computed by the application of the average consumption (energy and demand) of electricity for the entire Building for the twelve (12) full months immediately prior to the rate and/or service classification change, or any changed methods of or rules on billing for same, applied on a consistent basis to the new rate and/or service classification or market price, and to the classification and rate in effect on January 1, 1970. If the average consumption of electricity for the entire Building for said prior twelve (12) months cannot reasonably be applied and used with respect to changed methods of or rules on billing, then the percentage shall be computed by the use of the average consumption (energy and demand) for the entire Building for the first three (3) months after such change, projected to a full twelve (12) months, so as to reflect the different seasons; and that same consumption, so projected, shall be applied to the service classification and rate in effect on January 1, 1970. Where more than one meter measures the service of Tenant in the Building, the service rendered through each meter may be computed and billed separately in accordance with the rates herein specified. Bills therefore shall be rendered at such times as Landlord may elect and the amount, as computed from a meter, shall be deemed to be, and be paid as, Additional Rent. In the event that such bills are not paid within five (5) days after the same are rendered, Landlord may, without further notice, discontinue the service of electric current to the Premises without releasing Tenant from any liability under this Lease and without Landlord or Landlord’s agent incurring any liability for any damage or loss sustained by Tenant by such discontinuance of service. If any tax is imposed upon Landlord’s receipt from the sale, resale or redistribution of electricity or gas or telephone service to Tenant by any Federal, State, or Municipal authority, Tenant covenants and agrees that where permitted by law, Tenant’s pro-rata share of such taxes shall be passed on to and included in the bill of, and paid by, Tenant to Landlord.

41.08   If all or part of the submetering Additional Rent or the ERIF payable in accordance with Section 41.03 or 41.04 of this Article becomes uncollectible or reduced or refunded by virtue of any law, order or regulations, the parties agree that, at Landlord’s option, in lieu of submetering Additional Rent or ERIF, and in consideration of Tenant’s use of the Building’s electrical distribution system and receipt of redistributed electricity and payment by Landlord of consultant’s fees and other redistribution costs, the Fixed Annual Rental rate(s) to be paid under this Agreement shall be increased by an “alternative charge” which shall be a sum equal to $3.00 per year per rentable square foot of the Premises, changed in the same percentage as any increase in the cost to Landlord for electricity for the entire Building subsequent to November 1, 2005, because of electric rate, service classification or market price changes, such percentage change to be computed as in Section 41.04 provided.

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41.09   Landlord shall not be liable to Tenant for any loss or damage or expense which Tenant may sustain or incur if either the quantity or character of electric service is changed or is no longer available or suitable for Tenant’s requirements. Tenant covenants and agrees that at all times its use of electric current shall never exceed the capacity of existing feeders to the Building or wiring installation. Any riser or risers to supply Tenant’s electrical requirements, upon written request of Tenant, will be installed by Landlord, at the sole cost and expense of Tenant, if, in Landlord’s sole judgment, the same are necessary and will not cause permanent damage or injury to the Building or the Premises or cause or create a dangerous or hazardous condition or entail excessive or unreasonable alterations, repairs or expense or interfere with or disturb other tenants or occupants. In addition to the installation of such riser or risers, Landlord will also at the sole cost and expense of Tenant, install all other equipment proper and necessary in connection therewith subject to the aforesaid terms and conditions. The parties acknowledge that they understand that it is anticipated that electric rates, charges, etc., may be changed by virtue of time-of-day rates or changes in other methods of billing, and/or electricity purchases and the redistribution thereof, and fluctuation in the market price of electricity, and that the references in the foregoing paragraphs to changes in methods of or rules on billing are intended to include any such changes. Anything hereinabove to the contrary notwithstanding, in no event is the submetering Additional Rent or ERIF, or any “alternative charge”, to be less than an amount equal to the total of Landlord’s payments to public utilities and/or other providers for the electricity consumed by Tenant (and any taxes thereon or on redistribution of same) plus 5% thereof for transmission line loss, plus 15% thereof for other redistribution costs. The Landlord reserves the right, at any time upon thirty (30) days’ written notice, to change its furnishing of electricity to Tenant from a rent inclusion basis to a submetering basis, or vice versa, or to change to the distribution of less than all the components of the existing service to Tenant. The Landlord reserves the right to terminate the furnishing of electricity on a rent inclusion, submetering, or any other basis at any time, upon thirty (30) days’ written notice to the Tenant, in which event the Tenant may make application directly to the public utility and/or other providers for the Tenant’s entire separate supply of electric current and Landlord shall permit its wires and conduits, to the extent available and safely capable, to be used for such purpose, but only to the extent of Tenant’s then authorized load. Any meters, risers, or other equipment or connections necessary to furnish electricity on a submetering basis or to enable Tenant to obtain electric current directly from such utility and/or other providers shall be installed at Tenant’s sole cost and expense. Only rigid conduit or electricity metal tubing (EMT) will be allowed. The Landlord, upon the expiration of the aforesaid thirty (30) days’ written notice to the Tenant may discontinue furnishing the electric current but this Lease shall otherwise remain in full force and effect. If Tenant was provided electricity on a rent inclusion basis when it was so discontinued, then commencing when Tenant receives such direct service and as long as Tenant shall continue to receive such service, the Fixed Annual Rent payable under this Lease shall be reduced by the amount of the ERIF which was payable immediately prior to such discontinuance of electricity on a rent inclusion basis. Notwithstanding the foregoing, provided that Tenant promptly applies for such direct service and diligently pursues such application to completion, Landlord shall not so discontinue such redistributed service until Tenant obtains electric service directly from the public utility, unless required by law.


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ARTICLE 42
 
LEASE SUBMISSION

42.01   Landlord and Tenant agree that this Lease is submitted to Tenant on the understanding that it shall not be considered an offer and shall not bind Landlord in any way unless and until (i) Tenant has duly executed and delivered duplicate originals thereof to Landlord and (ii) Landlord has executed and delivered one of said originals to Tenant.


ARTICLE 43
 
INSURANCE

43.01.   Tenant shall not violate, or permit the violation of, any condition imposed by the standard fire insurance policy then issued for office buildings in the Borough of Manhattan, City of New York, and shall not do, or permit anything to be done, or keep or permit anything to be kept in the Premises which would subject Landlord to any liability or responsibility for personal injury or death or property damage, or which would increase the fire or other casualty insurance rate on the Building or the property therein over the rate which would otherwise then be in effect (unless Tenant pays the resulting premium as hereinafter provided for) or which would result in insurance companies of good standing refusing to insure the building or any of such property in amounts reasonably satisfactory to Landlord.

43.02   Tenant covenants to provide on or before the earlier to occur of (i) the Commencement Date, and (ii) ten (10) days from the date of this Lease, and to keep in force during the term hereof the following insurance coverage which coverage shall be effective on the Commencement Date:

(a)   A comprehensive policy of liability insurance naming Landlord and its designees as additional insureds protecting Landlord, its designees and Tenant against any liability whatsoever occasioned by accident on or about the Premises or any appurtenances thereto. Such policy shall have limits of liability of not less than Five Million ($5,000,000.00) Dollars combined single limit coverage on a per occurrence basis, including property damage. Such insurance may be carried under a blanket policy covering the Premises and other locations of Tenant, if any, provided such a policy contains an endorsement (i) naming Landlord and its designees as additional insureds, (ii) specifically referencing the Premises; and (iii) guaranteeing a minimum limit available for the Premises equal to the limits of liability required under this Lease;

(b)   Fire and extended coverage in an amount adequate to cover the cost of replacement of all personal property, fixtures, furnishings, equipment, improvements and installations located in the Premises.

44



43.03   All such policies shall be issued by companies of recognized responsibility licensed to do business in New York State and rated by Best's Insurance Reports or any successor publication of comparable standing and carrying a rating of A+ VIII or better or the then equivalent of such rating, and all such policies shall contain a provision whereby the same cannot be canceled or modified unless Landlord and any additional insured are given at least thirty (30) days prior written notice of such cancellation or modification.

43.04   Prior to the time such insurance is first required to be carried by Tenant and thereafter, at least fifteen (15) days prior to the expiration of any such policies, Tenant shall deliver to Landlord either duplicate originals of the aforesaid policies or certificates evidencing such insurance, together with evidence of payment for the policy. If Tenant delivers certificates as aforesaid Tenant, upon reasonable prior notice from Landlord, shall make available to Landlord, at the Premises, duplicate originals of such policies from which Landlord may make copies thereof, at Landlord's cost. Tenant's failure to provide and keep in force the aforementioned insurance shall be regarded as a material default hereunder, entitling Landlord to exercise any or all of the remedies as provided in this Lease in the event of Tenant's default. In addition, in the event Tenant fails to provide and keep in force the insurance required by this Lease, at the times and for the durations specified in this Lease, Landlord shall have the right, but not the obligation, at any time and from time to time, and without notice, to procure such insurance and/or pay the premiums for such insurance in which event Tenant shall repay Landlord within five (5) days after demand by Landlord, as Additional Rent, all sums so paid by Landlord and any costs or expenses incurred by Landlord in connection therewith without prejudice to any other rights and remedies of Landlord under this Lease.

43.05   Landlord and Tenant shall each endeavor to secure an appropriate clause in, or an endorsement upon, each fire or extended coverage policy obtained by it and covering the Building, the Premises or the personal property, fixtures and equipment located therein or thereon, pursuant to which the respective insurance companies waive subrogation or permit the insured, prior to any loss, to agree with a third party to waive any claim it might have against said third party. The waiver of subrogation or permission for waiver of any claim hereinbefore referred to shall extend to the agents of each party and its employees and, in the case of Tenant, shall also extend to all other persons and entities occupying or using the Premises in accordance with the terms of this Lease. If and to the extent that such waiver or permission can be obtained only upon payment of an additional charge then, except as provided in the following two paragraphs, the party benefiting from the waiver or permission shall pay such charge upon demand, or shall be deemed to have agreed that the party obtaining the insurance coverage in question shall be free of any further obligations under the provisions hereof relating to such waiver or permission.

45


43.06   In the event that Landlord shall be unable at any time to obtain one of the provisions referred to above in any of its insurance policies, at Tenant's option, Landlord shall cause Tenant to be named in such policy or policies as one of the insureds, but if any additional premium shall be imposed for the inclusion of Tenant as such an insured, Tenant shall pay such additional premium upon demand. In the event that Tenant shall have been named as one of the insureds in any of Landlord's policies in accordance with the foregoing, Tenant shall endorse promptly to the order of Landlord, without recourse, any check, draft or order for the payment of money representing the proceeds of any such policy or any other payment growing out of or connected with said policy and Tenant hereby irrevocably waives any and all rights in and to such proceeds and payments.

43.07   In the event that Tenant shall be unable at any time to obtain one of the provisions referred to above in any of its insurance policies, Tenant shall cause Landlord to be named in such policy or policies as one of the insureds, but if any additional premium shall be imposed for the inclusion of Landlord as such an insured, Landlord shall pay such additional premium upon demand or Tenant shall be excused from its obligations under this paragraph with respect to the insurance policy or policies for which such additional premiums would be imposed.
 
43.08   Subject to the foregoing provisions of this Article, and insofar as may be permitted by the terms of the insurance policies carried by it, each party hereby releases the other with respect to any claim (including a claim for negligence) which it might otherwise have against the other party for loss, damages or destruction with respect to its property by fire or other casualty (including rental value or business interruption, as the case may be) occurring during the Term of this Lease.

43.09   If, by reason of a failure of Tenant to comply with the provisions of this Lease, the rate of fire insurance with extended coverage on the building or equipment or other property of Landlord shall be higher than it otherwise would be, Tenant shall reimburse Landlord, on demand, for that part of the premiums for fire insurance and extended coverage paid by Landlord because of such failure on the part of Tenant.

43.10.   Landlord may, from time to time, require that the amount of the insurance to be provided and maintained by Tenant hereunder be increased so that the amount thereof adequately protects Landlord's interest, but in no event in excess of the amount that would be required of other tenants in other similar office buildings in the borough of Manhattan.

43.11   A schedule or make up of rates for the building or the Premises, as the case may be, issued by the New York Fire Insurance Rating Organization or other similar body making rates for fire insurance and extended coverage for the premises concerned, shall be conclusive evidence of the facts therein stated and of the several items and charges in the fire insurance rate with extended coverage then applicable to such premises.

46


43.12   Each policy evidencing the insurance to be carried by Tenant under this Lease shall contain a clause that such policy and the coverage evidenced thereby shall be primary with respect to any policies carried by Landlord, and that any coverage carried by Landlord shall be excess insurance.
 
ARTICLE 44  

SIGNAGE

44.01   Tenant shall be permitted to affix either sign or plaque on or adjacent to the entrance door to the Premises, subject to the prior written approval of Landlord which shall not be unreasonably withheld subject to the other provisions of this Article, with respect to location, design, size, materials, quality, coloring, lettering and shape thereof, and subject, also, to compliance by Tenant, at its expense, with all applicable legal requirements or regulations. All such signage shall be consistent and compatible with the design, aesthetics, signage and graphics program for the Building as established by Landlord. Landlord may remove any sign installed in violation of this provision, and Tenant shall pay the cost of such removal and any restoration costs.

ARTICLE 45
 
RIGHT TO RELOCATE

45.01   Notwithstanding anything contained in this Lease to the contrary, Landlord shall have the right, subsequent to the first (1 st ) anniversary of the Commencement Date and prior to the ninth (9 th ) anniversary of the Commencement Date, to substitute in lieu of the Premises, alternative space in the Building designated by Landlord (the “ Relocation Space ”) effective as of the date (the “ Relocation Effective Date ”) set forth in a notice given to Tenant (the “ Relocation Notice ”). The Relocation Space shall be reasonably comparable to the Premises with respect to internal configuration, quality of finish (e.g., paint, carpet and floor coverings, ceiling tiles, moldings and millwork, if any, by means of substantially the same materials as existed in the Premises provided that same are then commercially reasonably available to Landlord, and to the extent they are not so available, by means of materials which are substantially similar in nature and of a quality equal or superior to the materials as previously existed in the Premises, in each instance) and rentable square foot area (i.e., plus or minus ten (10%) percent). The Relocation Effective Date shall not be less than ninety (90) days following the date upon which the Relocation Notice is given to Tenant. In the event that Landlord exercises its rights hereunder, (i) Tenant shall deliver to Landlord possession of the Premises on or before the Relocation Effective Date vacant and broom clean, free of all occupancies and encumbrances and otherwise in accordance with the terms, covenants and conditions of the Lease as if the Relocation Effective Date were the expiration date of the Term of this Lease, (ii) effective as of the Relocation Effective Date, the term and estate hereby granted with respect to the Premises originally demised hereunder shall terminate, the Relocation Space shall be deemed to be the Premises and the Fixed Annual Rent and Additional Rent payable under this Lease shall be adjusted, if necessary, so as to reflect any difference between the deemed rentable square foot area of the original Premises and said Relocation Space. Notwithstanding anything contained in this Article 45 to the contrary, Landlord shall not substitute the Premises more than once during the original Term.

47



45.02   Landlord shall (i) at Landlord's cost and expense, remove and reinstall Tenants' personal property, trade fixtures and equipment (including the relocation of Tenant’s then existing telecommunications and voice capabilities) in the Relocation Space (“ Landlord’s Relocation Work ”) and (ii) compensate Tenant for Tenant’s actual, reasonable, out-of-pocket moving and related expenses, including the reasonable cost of reprinting a reasonable amount of Tenant’s stationery necessitated by such relocation, upon Tenant’s submission of paid invoices therefor. Landlord shall complete Landlord’s Relocation Work on or before the Relocation Effective Date provided that Tenant cooperates with Landlord and gives Landlord full access to the Premises to facilitate the performance thereof. Landlord warrants that the physical relocation of Tenant’s fixtures, goods, personality and equipment shall take place after normal business hours on a Friday or on a Saturday or Sunday.

45.03   Following any relocation undertaken pursuant to this Article, Tenant shall promptly execute and deliver an agreement confirming such relocation and fixing any corresponding adjustments in Fixed Annual Rent and Additional Rent payable under this Lease, but any failure to execute such an agreement by Tenant shall not affect such relocation and adjustments as determined by Landlord.

45.04 Notwithstanding anything contained in this Article 45 to the contrary, Landlord shall use reasonable efforts to provide a Relocation Space which has an existing outdoor terrace, however, in the event that Landlord is unable to do so using commercially reasonable efforts, and provided that Tenant is not in default under the terms of this Lease after notice, Landlord shall furnish Tenant with a credit to be applied against the four (4) monthly installments of Fixed Annual Rent accruing immediately following Tenant’s relocation into the Relocation Space in compliance with the terms of this Article 45.

ARTICLE 46
FUTURE CONDOMINIUM CONVERSION

46.01   Tenant acknowledges that the Building and the land of which the Premises form a part may be subjected to the condominium form of ownership prior to the end of the Term of this Lease. Tenant agrees that if, at any time during the Term, the Building and the land shall be subjected to the condominium form of ownership, then, this Lease and all rights of Tenant hereunder are and shall be subject and subordinate in all respects to any condominium declaration and any other documents (collectively, the " Declaration ") which shall be recorded in order to convert the Building and the land of which the Premises form a part to a condominium form of ownership in accordance with the provisions of Article 9-B of the Real Property Law of the State of New York or any successor thereto. If any such Declaration is to be recorded, Tenant, upon request of Landlord, shall enter into an amendment of this Lease in such respects as shall be necessary to conform to such condominiumization, including, without limitation, appropriate adjustments to Real Estate Taxes payable during the Base Tax Year and Tenant's Share, as such terms are defined in Article 32 hereof.

48


 
ARTICLE 47  

MISCELLANEOUS

47.01   This Lease represents the entire understanding between the parties with regard to the matters addressed herein and may only be modified by written agreement executed by all parties hereto. All prior understandings or representations between the parties hereto, oral or written, with regard to the matters addressed herein are hereby merged herein. Tenant acknowledges that neither Landlord nor any representative or agent of Landlord has made any representation or warranty, express or implied, as to the physical condition, state of repair, layout, footage or use of the Premises or any matter or thing affecting or relating to Premises except as specifically set forth in this Lease. Tenant has not been induced by and has not relied upon any statement, representation or agreement, whether express or implied, not specifically set forth in this Lease. Landlord shall not be liable or bound in any manner by any oral or written statement, broker's "set-up", representation, agreement or information pertaining to the Premises, the Building or this Agreement furnished by any real estate broker, agent, servant, employee or other person, unless specifically set forth herein, and no rights are or shall be acquired by Tenant by implication or otherwise unless expressly set forth herein. This Lease shall be construed without regard to any presumption or other rule requiring construction against the party causing this agreement to be drafted.

ARTICLE 48
COMPLIANCE WITH LAW

48.01   If, at any time during the Term hereof, Landlord expends any sums for alterations or improvements to the Building which are required to be made pursuant to any law, ordinance or governmental regulation, Tenant shall pay to Landlord, as Additional Rent, Tenant’s Share of such cost within twenty (20) days after demand therefor; provided, however, that if the cost of such alteration or improvement is one which is required to be amortized over a period of time pursuant to applicable governmental regulations, Tenant shall pay to Landlord, as Additional Rent, during each year in which occurs any part of the Term, Tenant’s Share of the cost thereof amortized on a straight line basis over an appropriate period, but not more than ten (10) years. Notwithstanding anything to the contrary contained herein, in the event that the requirement for the performance of any such alteration or improvement is attributable to the actions, installations, use or manner of use of the Premises by Tenant, then in such event Tenant shall be responsible to pay the entire cost imposed by Landlord with respect to such alteration or improvement.

49


ARTICLE 49
 
LANDLORD’S CONTRIBUTION

49.01   Tenant shall have prepared by a registered architect and/or a licensed professional engineer, at its sole cost and expense, and submit to Landlord for its approval in accordance with the applicable provisions of the Lease, final and complete dimensioned architectural, mechanical, electrical and structural drawings and specifications in a form ready for use as construction drawings for the installation of alterations, installations, decorations and improvements in the Premises to prepare the same for Tenant’s initial occupancy thereof (“ Tenant’s Initial Alteration Work ”). All such construction plans and specifications and all such work shall be effected in accordance with all applicable provisions of the Lease at Tenant’s sole cost and expense. If and so long as Tenant is not in default under the Lease, subject to and in accordance with the provisions of this Article, Landlord shall contribute up to the sum of $355,880.00 (" Landlord's Contribution ") to the cost of labor and materials for the portion of the Tenant’s Initial Alteration Work which constitutes Qualified Renovations. " Qualified Renovations " shall be defined as the labor and materials used by Tenant to construct permanent leasehold improvements and alterations to the Premises in compliance with this Lease after the date hereof and prior to November 1, 2006. Without limitation, for purposes of this Article, Qualified Renovations shall be deemed not to include and Landlord’s Contribution shall not be applied to the cost of interest, late charges, trade fixtures, furniture, furnishings, equipment, professional fees, workstations, work surfaces (whether or not affixed to walls and/or convector covers), related cabinetry, moveable business equipment or any personal property whatsoever, or to the cost of labor, materials or services used to furnish or provide the same.

49.02   “ Requisition " shall mean a request by Tenant for payment from Landlord for Qualified Renovations and shall consist of such documents and information from Tenant as Landlord may require to substantiate the completion of, and payment for, such Qualified Renovations to which the Requisition relates (the “ Work Cost ”) and shall include, without limitation, the following: an itemization of Tenant’s total construction costs, detailed by contractor, subcontractors, vendors and materialmen; bills, receipts, lien waivers and releases from all contractors, subcontractors, vendors and materialmen; architects' and Tenant's certification of completion, payment and acceptance, and all governmental approvals and confirmations of completion for the portion of the Tenant’s Initial Alteration Work theretofore completed and for which Tenant seeks payment.

49.03   From time-to-time, but not more than once a month, Tenant may give Landlord a Requisition for so much of the Work Cost as arose since the end of the period to which the most recent prior Requisition related, or, with respect to the first Requisition, for the initial Work Cost.

50



49.04   If Tenant is not in continuing default under this Lease and provided that all documents and information required by Landlord have been provided, within thirty (30) days after Landlord receives a Requisition, Landlord shall pay Tenant eighty five percent (85%) of the Work Cost reflected in such Requisition and shall withhold the remaining fifteen percent (15%) of Work Cost (the " Retainage "); and provided that Tenant is not in default under this Lease, within thirty (30) days after Tenant furnishes Landlord with (x) a final, stamped set of “as-built” plans for the Premises which demonstrates that Tenant’s Initial Alteration Work has been completed in accordance with plans and specifications first approved by Landlord and (y) its final Requisition which demonstrates that Tenant’s Initial Alteration Work has been completed and paid for in full by Tenant and (z) all documents and information required by Landlord, Landlord shall pay Tenant all the Retainages.

49.05   It is expressly understood and agreed that if the amount of Landlord’s Contribution is less than the cost of Tenant’s Initial Alteration Work, Tenant shall remain solely responsible for the payment and completion of, and in all events shall complete, at its sole cost and expense, Tenant’s Initial Alteration Work on or before November 1, 2006. Any portion of Landlord’s Contribution not required to be disbursed shall be retained by Landlord.

IN WITNESS WHEREOF, the said Landlord, and the Tenant have duly executed this Lease as of the day and year first above written.
     
     
  SLG GRAYBAR SUBLEASE LLC, as Landlord
 
  		 
  		 
 
  By:    
 
 
Name:
Title:
     
 
Witness:      
       
   
Name:
Title:
     
 
     
     
 
FUSION TELECOMMUNICATIONS
INTERNATIONAL, INC., as Tenant
 
  		 
  		 
 
  By:    
 
 
Name:
Title:
     
 
Witness:      
       
   
Name:
Title:
   


51

CLEANING SPECIFICATIONS

A)
GENERAL CLEANING - NIGHTLY

-
Dust sweep all stone, ceramic tile, marble terrazzo, asphalt tile, linoleum, rubber, vinyl and other types of flooring

-
Carpet sweep all carpets and rugs four (4) times per week

-
Vacuum clean all carpets and rugs, once (1) per week

-
Police all private stairways and keep in clean condition

-
Empty and clean all wastepaper baskets, ash trays and receptacles; damp dust as necessary

-
Clean all cigarette urns and replace sand or water as necessary

-
Remove all normal wastepaper and tenant rubbish to a designated area in the premises. (Excluding cafeteria waste, bulk materials, and all special materials such as old desks, furniture etc.)

-
Dust all furniture, and window sills as necessary

-
Dust clean all glass furniture tops

-
Dust all chair rails, trim and similar objects as necessary

-
Dust all baseboards as necessary

-
Wash clean all water fountains

-
Keep locker and service closets in clean and orderly condition

B)
LAVATORIES-NIGHTLY (EXCLUDING PRIVATE & EXECUTIVE LAVATORIES)

-
Sweep and mop all flooring

-
Wipe clean all mirrors, powder shelves and brightwork, including flushometers, piping toilet seat hinges

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-
Wash and disinfect all basins, bowls and urinals

-
Wash both sides of all toilet seats

-
Dust all partitions, tile walls, dispensers and receptacles

-
Empty and clean paper towel and sanitary disposal receptacles

-
Fill toilet tissue holders, soap dispensers and towel dispensers; materials to be furnished by Landlord

-
Remove all wastepaper and refuse to designated area in the premises

C)
LAVATORIES-PERIODIC CLEANING (EXCLUDES PRIVATE & EXECUTIVE LAVATORIES)

-
Machine scrub flooring as necessary

-
Wash all partitions, tile walls, and enamel surfaces periodically, using proper disinfectant when necessary

D)
DAY SERVICES - DUTIES OF THE DAY PORTERS

-
Police ladies' restrooms and lavatories, keeping them in clean condition

-
Fill toilet dispensers; materials to be furnished by Landlord

-
Fill sanitary napkin dispensers; materials to be furnished by Landlord

E)
SCHEDULE OF CLEANING

-
Upon completion of the nightly chores, all lights shall be turned off, windows closed, doors locked and offices left in a neat and orderly condition

-
All day, nightly and periodic cleaning services as listed herein, to be done five nights each week, Monday through Friday, except Union and Legal Holidays

-
All windows from the 2nd floor to the roof will be cleaned inside out quarterly, weather permitting


53



RULES AND REGULATIONS
MADE A PART OF THIS LEASE

1. No animals, birds, bicycles or vehicles shall be brought into or kept in the Premises. The Premises shall not be used for manufacturing or commercial repairing or for sale or display of merchandise or as a lodging place, or for any immoral or illegal purpose, nor shall the Premises be used for a public stenographer or typist; barber or beauty shop; telephone, secretarial or messenger service; employment, travel or tourist agency; school or classroom; commercial document reproduction; or for any business other than specifically provided for in the Tenant’s lease. Tenant shall not cause or permit in the Premises any disturbing noises which may interfere with occupants of this or neighboring Buildings, any cooking or objectionable odors, or any nuisance of any kind, or any inflammable or explosive fluid, chemical or substance. Canvassing, soliciting and peddling in the Building are prohibited, and each tenant shall cooperate so as to prevent the same.

2. The toilet rooms and other water apparatus shall not be used for any purposes other than those for which they were constructed, and no sweepings, rags, ink, chemicals or other unsuitable substances shall be thrown therein. Tenant shall not place anything out of doors, windows or skylights, or into hallways, stairways or elevators, nor place food or objects on outside window sills. Tenant shall not obstruct or cover the halls, stairways and elevators, or use them for any purpose other than ingress and egress to or from Tenant’s Premises, nor shall skylights, windows, doors and transoms that reflect or admit light into the Building be covered or obstructed in any way. All drapes and blinds installed by Tenant on any exterior window of the Premises shall conform in style and color to the Building standard.

3. Tenant shall not place a load upon any floor of the Premises in excess of the load per square foot which such floor was designed to carry and which is allowed by law. Landlord reserves the right to prescribe the weight and position of all safes, file cabinets and filing equipment in the Premises. Business machines and mechanical equipment shall be placed and maintained by Tenant, at Tenant’s expense, only with Landlord’s consent and in settings approved by Landlord to control weight, vibration, noise and annoyance. Smoking or carrying lighted cigars, pipes or cigarettes in the elevators of the Building is prohibited.

4. Tenant shall not move any heavy or bulky materials into or out of the Building or make or receive large deliveries of goods, furnishings, equipment or other items without Landlord’s prior written consent, and then only during such hours and in such manner as Landlord shall approve and in accordance with Landlord’s rules and regulations pertaining thereto. If any material or equipment requires special handling, Tenant shall employ only persons holding a Master Rigger’s License to do such work, and all such work shall comply with all legal requirements. Landlord reserves the right to inspect all freight to be brought into the Building, and to exclude any freight which violates any rule, regulation or other provision of this Lease.

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5. No sign, advertisement, notice or thing shall be inscribed, painted or affixed on any part of the Building, without the prior written consent of Landlord. Landlord may remove anything installed in violation of this provision, and Tenant shall pay the cost of such removal and any restoration costs. Interior signs on doors and directories shall be inscribed or affixed by Landlord at Tenant’s expense. Landlord shall control the color, size, style and location of all signs, advertisements and notices. No advertising of any kind by Tenant shall refer to the Building, unless first approved in writing by Landlord.

6. No article shall be fastened to, or holes drilled or nails or screws driven into, the ceilings, walls, doors or other portions of the Premises, nor shall any part of the Premises be painted, papered or otherwise covered, or in any way marked or broken, without the prior written consent of Landlord.

7. No existing locks shall be changed, nor shall any additional locks or bolts of any kind be placed upon any door or window by Tenant, without the prior written consent of Landlord. Two (2) sets of keys to all exterior and interior locks shall be furnished to Landlord . At the termination of this Lease, Tenant shall deliver to Landlord all keys for any portion of the Premises or Building. Before leaving the Premises at any time, Tenant shall close all windows and close and lock all doors.

8. No Tenant shall purchase or obtain for use in the Premises any spring water, ice, towels, food, bootblacking, barbering or other such service furnished by any company or person not approved by Landlord. Any necessary exterminating work in the Premises shall be done at Tenant’s expense, at such times, in such manner and by such company as Landlord shall require. Landlord reserves the right to exclude from the Building, from 6:00 p.m. to 8:00 a.m., and at all hours on Sunday and legal holidays, all persons who do not present a pass to the Building signed by Landlord. Landlord will furnish passes to all persons reasonably designated by Tenant. Tenant shall be responsible for the acts of all persons to whom passes are issued at Tenant’s request.

9. Whenever Tenant shall submit to Landlord any plan, agreement or other document for Landlord’s consent or approval, Tenant agrees to pay Landlord as Additional Rent, on demand, an administrative fee equal to the sum of the reasonable fees of any architect, engineer or attorney employed by Landlord to review said plan, agreement or document and Landlord’s administrative costs for same.

55



10. The use in the Premises of auxiliary heating devices, such as portable electric heaters, heat lamps or other devices whose principal function at the time of operation is to produce space heating, is prohibited.

11. Tenant shall keep all doors from the hallway to the Premises closed at all times except for use during ingress to and egress from the Premises. Tenant acknowledges that a violation of the terms of this paragraph may also constitute a violation of codes, rules or regulations of governmental authorities having or asserting jurisdiction over the Premises, and Tenant agrees to indemnify Landlord from any fines, penalties, claims, action or increase in fire insurance rates which might result from Tenant's violation of the terms of this paragraph.

12. Tenant shall be permitted to maintain an "in-house" messenger or delivery service within the Premises, provided that Tenant shall require that any messengers in its employ affix identification to the breast pocket of their outer garment, which shall bear the following information: name of Tenant, name of employee and photograph of the employee. Messengers in Tenant's employ shall display such identification at all time. In the event that Tenant or any agent, servant or employee of Tenant, violates the terms of this paragraph, Landlord shall be entitled to terminate Tenant's permission to maintain within the Premises in-house messenger or delivery service upon written notice to Tenant.

13. Tenant will be entitled to three (3) listings on the Building lobby directory board, without charge. Any additional directory listing (if space is available), or any change in a prior listing, with the exception of a deletion, will be subject to a fourteen ($14.00) dollar service charge, payable as Additional Rent.

14. In case of any conflict or inconsistency between any provisions of this Lease and any of the rules and regulations as originally or as hereafter adopted, the provisions of this Lease shall control.

56

EXHIBIT A


57


EXHIBIT B
 
FIXED ANNUAL RENT SCHEDULE


         
DATES
 
FIXED
ANNUAL RENT
 
MONTHLY
INSTALLMENT
 
November 1, 2005- October 31, 2006
 
 
$428,390.55
 
 
$35,699.21
 
November 1, 2006 - October 31, 2007
 
 
$439,100.31
 
 
$36,591.69
 
November 1, 2007 - October 31, 2008
 
 
$450,077.82
 
 
$37,506.49
 
November 1, 2008 - October 31, 2009
 
 
$461,329.77
 
 
$38,444.15
 
November 1, 2009 - October 31, 2010
 
 
$472,863.01
 
 
$39,4054.25
 
November 1, 2010 - October 31, 2011
 
 
$461,463.42
 
 
$38,455.28
 
November 1, 2011 - October 31, 2012
 
 
$473,000.00
 
 
$39,416.67
 
November 1, 2012 - October 31, 2013
 
 
$484,825.00
 
 
$40,402.08
 
November 1, 2013 - October 31, 2014
 
 
$496,945.63
 
 
$41,412.14
 
November 1, 2014 - October 31, 2015
 
 
$509,369.27
 
 
$42,447.44


58

FOURTH AMENDMENT TO LEASE AGREEMENT
 

THIS FOURTH AMENDMENT TO LEASE AGREEMENT (the " Fourth Amendment") is dated the _______ day of February, 2006, by and between FORT LAUDERDALE CROWN CENTER, INC. , a Florida corporation (hereinafter referred to as "Landlord") and FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. , a Delaware corporation (hereinafter referred to as "Tenant").
 
WITNESSETH:
 
WHEREAS , Landlord and Tenant entered into that certain Lease Agreement dated on or about October, 1999 (the "Original Lease"), for approximately 13,502 rentable square feet (the "Original Premises") located on the second (2 nd ) floor in Suite 220 of that certain building known as the "Crown Center" located at 1415 Cypress Creek Road, Fort Lauderdale, Florida 33309 (the "Original Building"); and
 
WHEREAS , the Original Lease was amended by (i) that certain Amendment Number One to Lease Agreement dated December 19, 1999 (the "First Amendment"), and (ii) that certain Second Amendment to Lease Agreement dated April 24, 2003 (the "Second Amendment"); and
 
WHEREAS , Landlord and Tenant entered into that certain Third Amendment to Lease dated April 28, 2004 (the “Third Amendment”) to, inter alia, relocate the Original Premises to the premises containing approximately 9,716 rentable square feet located on the second floor in Suite 204 of the "Crown Center" building located at 1475 Cypress Creek Road, Fort Lauderdale, Florida 33309; and
 
WHEREAS , the Original Lease as amended by the First Amendment, the Second Amendment, and the Third Amendment shall be collectively hereinafter referred to as the "Lease"; and
 
WHEREAS , Landlord and Tenant desire to enter into this Fourth Amendment to expand the Premises, extend the Term, and otherwise amend the Lease as hereinafter set forth.
 
NOW, THEREFORE , for and in consideration of the foregoing premises, the promises hereinafter contained and other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the parties hereto, intending to be legally bound, do hereby agree as follows:
 
1.   Recitals . The foregoing recitations are true and correct and are incorporated herein by this reference.
 
2.   Conflict . In the event of any conflict between the provisions of the Lease and the provisions of this Fourth Amendment, the provisions of this Fourth Amendment shall control. The initial capitalized terms used herein shall have the same meaning given such terms in the Lease, unless otherwise defined herein or unless the context otherwise indicates.
 
3.   Expansion of Premises . Effective upon the date that Landlord substantially completes the Tenant Improvements (as hereinafter defined) and delivers the Expansion Premises (as hereinafter defined) to Tenant (“Expansion Premises Commencement Date”), and throughout the Lease Term, the Premises shall be expanded to include an additional 3,433 rentable square feet on the second (2nd) floor of the Building, as depicted on Exhibit “A” attached hereto and made a part hereof (the “Expansion Premises”). Landlord shall use its best efforts to deliver the Expansion Premises to Tenant on or before May 1, 2006; provided, however, that Tenant expressly acknowledges and agrees that (i) the foregoing estimate may be affected by factors beyond Landlord’s control, including, without limitation, delays in obtaining necessary building permits, and (ii) that Landlord shall have no liability to Tenant and that Landlord shall not be in default under the Lease if, in spite of Landlord’s best efforts, Landlord does not deliver possession of the Expansion Premises to Tenant on or before May 1, 2006. Thereafter, the Premises shall be modified to mean 13,149 rentable square feet of space consisting of the Premises, as expanded by the Expansion Premises, and all references in the Lease to the term “Premises” shall refer to the Premises, including the Expansion Premises. The Expansion Space is subject to all of the terms and conditions of the Lease, as amended.
 
4.   Condition of Expansion Premises. Landlord shall not be responsible for the renovation, construction or installation of any leasehold improvements relating to the Expansion Premises, except as expressly hereinafter set forth. Tenant acknowledges that Landlord has not made any representations or warranties with respect to the condition of the Expansion Premises and neither Landlord nor any assignee of Landlord shall be liable for any latent defect therein. The taking of possession of the Expansion Premises by Tenant shall be conclusive evidence that the Expansion Premises was in good and satisfactory condition at the time such possession was taken. Landlord shall perform the improvements to the Expansion Premises shown on Exhibit “B” attached hereto (the “Tenant Improvements”). All work will be scheduled by Landlord during normal business hours on normal business days in cooperation with Tenant in a manner as to not inconvenience other tenants of the Building. If applicable, Tenant shall be responsible for the movement of any of its equipment and furniture necessary to accommodate Landlord’s work schedule. Landlord and its contractor assume no liability for Tenant’s equipment, furniture or other personal property at the Expansion Premises during the construction of the Tenant Improvements and Tenant shall hold Landlord, its contractors and their respective agents and employees (“Landlord’s Indemnified Parties”) harmless and indemnify same from and against any damage or injury relating to Tenant’s equipment, furniture or personal property left in the Expansion Premises during the construction of the Tenant Improvements, unless caused by the willful misconduct of the Landlord’s Indemnified Parties.

5.   Extended Term . The Term of the Lease shall be extended for a period of eight (8) years from the Expansion Premises Commencement Date (the "Extended Term"), and shall expire at midnight (Eastern Standard Time) on the date immediately preceding the eighth (8 th ) anniversary of the Expansion Premises Commencement Date (the "Extended Expiration Date"), and all references in the Lease to the Expiration Date of the Term of the Lease shall hereafter be deemed to refer to the Extended Expiration Date. Notwithstanding anything set forth in the Lease to the contrary, Tenant shall not have any right or option to extend the Term beyond the Extended Expiration Date, except as hereinafter expressly set forth in this Fourth Amendment.
 
6 .   Base Rent . From the Expansion Premises Commencement Date through June 30, 2006, Tenant shall pay Base Rent to Landlord, plus applicable sales tax thereon, as follows:

Period
Base Rent per RSF
per Annum
Monthly Base Rent
Payments (not
including sales tax)
Expansion Premises Commencement Date through June 30, 2006
$11.96
$13,105.17

Commencing on July 1, 2006, and on each anniversary thereof during the Extended Term, Base Rent shall increase by four percent (4%).
 
7.   Tenant’s Proportionate Share . Effective as of the Expansion Premises Commencement Date and throughout the Extended Term of the Lease, Tenant shall continue to pay to Landlord, in the form of Additional Rent, plus applicable sales tax thereon, Tenant's Proportionate Share of the Operating Expenses of the Building and the Property for the applicable calendar year in accordance with the terms of the Lease. Upon the Expansion Premises Commencement Date and throughout the Extended Term, Tenant's Proportionate Share shall be modified to mean 19.17% (to wit: 13,149/68,608 x 100).
 
8.   Parking . Effective as of the Expansion Premises Commencement Date, Article VI of the Lease shall be deleted in its entirety and the following shall be inserted in lieu thereof:
 
"There shall be available at the Building up to four (4) parking spaces for each 1,000 square feet of rentable square feet contained in the Premises (to wit: fifty-two (52) nonreserved spaces), for the nonexclusive use of Tenant, free of charge. Seven (7) covered parking spaces of these fifty-two (52) parking spaces will be designated reserved for Tenant and located in an area as reasonably designated by Landlord."
 
9.   Right of First Refusal . Section 17 of the Third Amendment is hereby deleted in its entirety and the following is inserted in lieu thereof:
 
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“Provided Tenant is not in default of the Lease and is still occupying the Premises, Landlord shall grant Tenant one (1) right of first refusal on any space located on the second (2nd) floor of the Building (“First Refusal Space”), subject to the rights of existing tenants to such space. The exercise of Tenant’s right of first refusal shall be accomplished as follows: Within five (5) days of Landlord entering into a signed letter of intent with a prospective tenant for the First Refusal Space, Landlord shall provide Tenant with written notice of the same, which notice shall include all of the business terms of such proposed lease (“Landlord’s Notice”). Tenant shall have seven (7) days after receipt of Landlord’s Notice to either accept all of the terms contained in Landlord’s Notice or reject the offer contained in Landlord’s Notice. Tenant’s failure to respond within such time period shall be deemed a waiver of Tenant’s right of first refusal. If Tenant accepts such offer, Landlord and Tenant shall thereafter execute an amendment to the Lease expanding the Premises to include the First Refusal Space upon the terms and conditions contained in Landlord’s Notice. If Tenant rejects the offer, Landlord shall have the right to lease the First Refusal Space to any other tenant (or third party) without regard to the Lease or Tenant’s rights thereunder. Time is of the essence with regard to the notifications in this section.”

10.   Option to Renew . Provided Tenant is not currently in default of any provision of this Lease, and Tenant is still occupying the Premises, Landlord shall grant Tenant one (1) five-year option to renew the Lease (“Option to Renew”) at the conclusion of the Extended Term as to the entire Premises only. Tenant shall notify Landlord of Tenant’s intent to exercise its Option to Renew no later than nine (9) months prior to the expiration of the Extended Term, with time being of the essence as to this notification period. The Base Rent during the renewal term shall equal the then prevailing market rate for comparable buildings in the market in which the Building is located. Notwithstanding anything to the contrary herein, Base Rent for the renewal term shall in no event be less than the Base Rent payable under the Lease during the last year of the Extended Term. Within thirty (30) days after Tenant notifies Landlord of its intent to exercise its Option to Renew, Landlord shall determine the then prevailing market rate for comparable buildings in the market in which the Building is located and shall notify Tenant of the prevailing market rate.

The then prevailing market rate, as determined in accordance with this Section, multiplied by the rentable square feet of the Premises, shall be the annual Base Rent for the Premises for the first year of the renewal term, payable in advance and without notice, in equal monthly installments, commencing on the first day of the renewal term and continuing on the first day of each and every calendar month thereafter during the first year of the renewal term. Commencing with the first month of the second year and each successive year throughout the renewal term thereafter, the annual Base Rent shall be increased over the annual Base Rent for the previous year by four percent (4%) .

11.   Broker . The parties represent and warrant to each other that they have not dealt with any real estate brokers, salesmen, or finders in connection with this Fourth Amendment other than Commercial Property Realty Advisors, LLC (the “Broker”). Landlord shall be responsible to pay a commission to the Broker in accordance with a separate agreement between Landlord and Broker. Other than the Broker, if a claim for commission in connection with this transaction is made by any broker, salesmen, or finder claiming to have dealt through on behalf of one of the parties hereto, such party shall indemnify, defend and hold the other party hereunder harmless from and against all liabilities, damages, claims, costs, fees and expenses (including reasonable attorney's fees and court costs at trial and all appellate levels) with respect to said claim for brokerage.
 
12.   Choice of Law . This Fourth Amendment shall be construed and interpreted in accordance with the laws of the State of Florida, contains the entire agreement of the parties hereto with respect to the subject matter hereof, and may not be changed or terminated orally or by course of conduct, or by any other means except by a written instrument, duly executed by the party to be bound thereby. This Fourth Amendment shall inure to the benefit of and shall be binding upon the parties hereto and their respective successors and assigns.
 
13.   Ratification . Except as modified hereby, the Lease shall remain in full force and effect in accordance with the terms and provisions thereof and Tenant hereby ratifies and affirms all of the terms and conditions thereof.
 
14.   Counterparts . This Amendment may be executed in several counterparts, each of which shall be fully effective as an original and all of which together shall constitute one and the same instrument. Signature pages may be detached from the counterparts and attached to a single copy of this document to physically form one document.
 
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15.   Authority . Each party hereto warrants and represents that it has the authority to enter into this Fourth Amendment without the joinder of any other party; that the person executing this Fourth Amendment of its behalf is authorized to do so; and that this Fourth Amendment is valid, binding and enforceable against such party.

 
IN WITNESS WHEREOF , the undersigned have executed this Fourth Amendment as of the date first above written.
 
   
"LANDLORD"
     
WITNESS:
 
FORT LAUDERDALE CROWN CENTER, INC. , a Florida corporation
     
       
Print Name: __________________________________
 
Print Name: __________________________________
 
By: __________________________________
Print Name: ____________________________
Title: _________________________________
     
   
"TENANT"
     
WITNESS:
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC. , a Delaware corporation
     
     By:
Print Name: __________________________________
 
Print Name: __________________________________  
 
Print Name: _____________________________
Title: __________________________________

4



Amendment to Stock Purchase Agreement
 
This Amendment to the Stock Purchase Agreement dated as of March 24, 2006 (this “Amendment ”), is entered into by and between Karamco, Inc. (“Karamco”), Efonica, FZ-LLC (“Efonica or Company”) and Fusion Telecommunications International, Inc. (“Fusion”).
 
R E C I T A L S :
 
A.    Fusion, Efonica and Karamco have entered into that certain Stock Purchase   Agreement dated January 11, 2005, as amended on February 9, 2005, May 12, 2005 and November 2, 2005 (the “ Agreement ”), pursuant to which Fusion purchased all of Karamco’s shares of Efonica, FZ-LLC (the “Company”).
 
B.    At the present time, Fusion, Efonica and   Karamco request, and all are agreeable to amend the Agreement, subject to the terms and conditions hereinafter set forth.
 
Now, Therefore, in consideration of the premises and other good and valuable consideration, the receipt and adequacy of which are hereby acknowledged, Fusion, Efonica and Karamco hereby agree as follows:
 
A G R E E M E N T S :
 
1.    RECITALS . The foregoing Recitals are hereby made a part of this Amendment.
 
2.    DEFINITIONS . Capitalized words and phrases used herein without definition shall have the respective meanings ascribed to such words and phrases in the Agreement.
 
3.    AMENDMENT TO AGREEMENT . Section 1 of the Agreement is hereby amended in its entirety to read as follows:  
 
“SECTION
1

PURCHASE AND SALE OF THE SHARES

  1.1 Purchase and Sale. Upon the terms and subject to the conditions of this Agreement, at the Closing (as defined below), Karamco agrees to sell to Buyer, and Buyer agrees to purchase from Karamco, the number of Shares owned by Karamco, as set forth opposite its name on Schedule 1 hereto 249 Shares). The aggregate purchase price for the Shares (the "Final Purchase Price") shall be set forth and payable as expressed on Section 1.2.
 
1.2   Purchase Price  
 
Base Purchase Price. The base purchase price for the Shares (the "Base Purchase Price") shall be NINE MILLION SEVEN HUNDRED EIGHTY FIVE THOUSAND SEVEN HUNDRED ($9,785,700) DOLLARS subject to adjustment pursuant to Section 1.2(C)(vii) and Section 8 of the Agreement, and payable as set forth in Section 1.2(C).

C.   Payment at Closing. At Closing, Buyer shall deliver to Karamco:

(i)   Stock.   1,439,463 shares of Buyer’s common stock (the aggregate number of Shares under this Section shall be referred to as the “Base Shares”);

(ii)   Escrow. Buyer’s attorney (the “Escrow Agent”) shall hold 675,581 shares of the Base Shares (not to include the Registered Stock) in escrow (the “Escrowed Stock”) and subject to an Escrow Agreement between the parties and the Escrow Agent, a form of which is attached hereto as Exhibit “D”. The Escrowed Stock will be subject to adjustment pursuant to Section 1.2(C)(vi);

(iii)   Cash Payment. Within three (3) days of the Closing, Buyer will pay Karamco an amount equal to FIVE HUNDRED THOUSAND ($500,000.00) DOLLARS;”

(iv) (a) Registration. Buyer shall use its reasonable efforts to cause 150,000 shares of the Base Shares to be registered (the “Registered Shares”) within 60 days of the Buyer’s initial public offering , unless said date is extended with Karamco’s consent. The date the Registered Shares are effectively registered shall be defined as the “Registration Date.” Fusion shall use its best efforts to keep the registration statement covering the Registered Shares (the “Registration Statement”) effective for the period set forth in this section (iv) (a). Following registration, Karamco may sell up to an aggregate of $1 million in Registered Shares in transactions (including block transactions) that may take place in the over-the-counter market or an exchange including ordinary broker transactions, privately negotiated transaction or through sales to one or more dealers for resale as principals (1/2 of the Registered Shares on the Registration Date and the remaining 1/2 on May 15, 2005). In the event Buyer is unable to cause the Registered Shares to be registered as set forth above, Buyer shall purchase the Registered Shares from Karamco (in the amount Karamco would have been otherwise able to sell as set forth above) at the higher of the IPO price or the average 5 day bid price prior to the date Buyer notifies Karamco that it is unable to cause the registered Shares to be registered. In the event that Karamco’s aggregate gross proceeds of a sale of the Registered Shares as set forth in this Section 1.2C(iv)(a), in the aggregate, and within 635 days following the effective date of the Registration Statement, does not equal $1,000,000, the Buyer shall pay Karamco the difference between the aggregate gross proceeds of Karamco’s sale of the Registered Shares and $1,000,000 (the “Difference Payment”). On April 25, 2005, Fusion made a payment of $150,000 to Karamco and on May 12, 2005 made a payment of $175,000 and on the date hereof, will make an additional payment of $105,000 which payments ($430,000 in the aggregate) shall be deducted from the Difference Payment owed. In the event that the Difference Payment owed, pursuant to this Section 1.2(C)(iv)(a) of the Agreement, is less than $430,000, Karamco shall immediately reimburse Fusion for such excess. The Company retains the right to advance additional funds in its sole discretion.
 
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(b) Karamco’s Obligation to reimburse Fusion for any excess shall be secured by 50,387 shares (the “Escrowed Shares”) of Fusion’s common stock owned by Karamco. Upon execution of this Agreement, Karamco will deliver the Escrowed Shares to the Escrow Agent until such excess is repaid.

(v)   Lock-Up. The unregistered Base Shares issued to Karamco will be subject to a lock-up for a one year period following the effective date of the IPO (“Lock-Up Period”). Karamco agrees to execute an agreement to that effect in the form attached hereto as Exhibit “B” (the “Lock-Up Agreement”). In the event a significant shareholder (owner of 5% or more of the issued and outstanding common stock (“Significant Shareholder”)) is allowed to register all or a portion of his common stock prior to the expiration of the Lock-Up Period, Karamco will be allowed to register its shares on a pro rata basis (will be allowed to sell the same % of shares the Significant Shareholder sells). If any Significant Shareholder shall receive and determine to accept any bona fide offer from a third party (the "Offeror") to purchase all or substantially all of such Significant Shareholders' Shares “a "Tag-Along Offer") prior to expiration of the Lock-Up Period, Karamco shall have the right to participate in such transaction in the manner set forth in this Section.  The Significant Shareholders shall, promptly after receipt of a Tag-Along Offer, send a copy thereof or a summary of the terms of any offer to Karamco.  Karamco shall have the right to cause the Significant Shareholder(s) to condition his or their sale of Shares to an Offeror on the sale of all, or a pro-rata amount (equal to the percentage of the selling Significant Shareholder), of Shares of Karamco to Offeror (the "Tag-Along Shareholder").  The purchase price and payment terms for the Shares of the Tag-Along Shareholder shall be the same price per Share and same payment terms for the Shares as the Significant Shareholders' Shares and as set forth in the Tag-Along Offer.  Should Karamco choose to participate in a sale of Shares pursuant to this Section, it shall pay its proportionate share of any expenses attributable to the sale of Shares hereunder. In the event Karamco sells any stock prior to expiration of the Lock-Up Period, it shall cause the purchaser to be bound by the Lock-up Agreement.

(vi)   Post Closing Adjustments.   On the date hereof, the Escrow Agent shall release the Escrow Shares to Karamco. The released shares shall be subject to a lock -up until February 15, 2007, and Karamco agrees to execute a Lock - Up Agreement to that effect as a condition of such release.
 
3
 
(vii)   Limitation on Sale Following Lock-Up Period. The Lock-Up Agreement will further provide after the Lock-Up Period sales by the Stockholder shall be subject to Rule 144. Both parties acknowledge that the holding period for Karamco’s unregistered shares commences at the time of closing.”
 
4.    REPRESENTATIONS AND WARRANTIES . To induce Karamco to enter into this Amendment, Fusion hereby certifies, represents and warrants to Karamco that:
 
4.1    Authorization . It is duly authorized to execute and deliver this Amendment and is and will continue to perform its obligations under the Agreement, as amended hereby.
 
4.2    No Conflicts . The execution and delivery of this   Amendment and the performance by Fusion of its obligations under the Agreement, as amended hereby, do not and will not conflict with any provision of law or of the articles of incorporation or bylaws/articles of organization or operating agreement, as applicable, of Fusion or of any agreement binding upon Fusion.
 
4.3    Validity and Binding Effect . The Agreement, as amended hereby, is a legal, valid and binding obligation of Fusion, enforceable against Fusion in accordance with its terms, except as enforceability may be limited by bankruptcy, insolvency or other similar laws of general application affecting the enforcement of creditors’ rights or by general principles of equity limiting the availability of equitable remedies.
 
5.    GENERAL .
 
5.1    Governing Law; Severability . This Amendment shall be construed in accordance with and governed by the laws of the State of New York. Wherever possible each provision of the Agreement and this Amendment shall be interpreted in such manner as to be effective and valid under applicable law, but if any provision of the Agreement and this Amendment shall be prohibited by or invalid under such law, such provision shall be ineffective to the extent of such prohibition or invalidity, without invalidating the remainder of such provision or the remaining provisions of the Agreement and this Amendment.
 
5.2    Successors and Assigns . This Amendment shall be binding upon Fusion, Efonica and Karamco and their respective successors and assigns.
 
5.3    Continuing Force and Effect of the Agreement . Except as specifically modified or amended by the terms of this Amendment, all other terms and provisions of the Agreement are incorporated by reference herein, and in all respects, shall continue in full force and effect. Fusion, by execution of this Amendment, hereby reaffirms, assumes and binds itself to all of the obligations, duties, rights, covenants, terms and conditions that are contained in the Agreement
 
4
 
5.4    Expenses . Fusion shall pay all costs and expenses in connection with the preparation of this Amendment.
 
4.5   Counterparts . This Amendment may be executed in any number of counterparts, all of which shall constitute one and the same agreement.
 
In Witness Whereof , the parties hereto have executed this Amendment to the Stock Purchase Agreement as of the date first above written.

  Fusion Telecommunications International, Inc.  
  By: _______________________
    Name: _______________
    Title:   _______________
     
  Karamco, Inc.  
  By: ________________________
    Name: ________________ 
    Title:   ________________
     
  Efonica, FZ-LLC
  By: ________________________
    Name: ________________  
    Title:   ________________ 
 
 
5




PROMISSORY NOTE

$463,097.96
 
 
March 21, 2006
   
FOR VALUE RECEIVED, iFreedom Communications International Holdings, Limited; iFreedom Communications Corporation; iFreedom Communications (Malaysia) Sdn. Bhd.; iFreedom Communications, Inc.; iFreedom Communications Hong Kong Limited and iFreedom UK, Ltd., jointly and severally, (collectively the “Payor”) promise to pay to the order of Fusion Telecommunications International, Inc. (the "Holder"), the amount of $463,097.96 , along with any additional amount owed Holder for services sold to Payor as of March 20, 2006 and other amounts that are or come due from Payor to Holder (collectively the “Indebtedness”).  
 
Section 1.   Payment. Payor shall pay the Indebtedness upon Holder’s written notice (the “Notice”) at which time the Payor shall have four (4) months to pay the entire amount demanded in the Notice in four (4) equal monthly installments (the “Installments”). Payment of the first (1 st ) installment will be due within five (5) days of the Notice and each remaining installment will be due thirty days thereafter from the previous installment due date until the balance is paid in full.
 
Section 2.   Optional   Prepayments . This Note may be prepaid in whole or in part at any time without premium or penalty.
 
Section 3.   Place and Manner of Payment . Payments under this Note are to be made in United States currency to Holder at 420 Lexington Avenue, Suite 518, New York, New York 10170 or at such other location designated in writing by Holder from time to time.
 
Section 4.   Security for Note . This Note is secured by a security agreement by Payor to Holder dated this day on certain property of Payor dated this date ( referred to as “Collateral Agreements”) and all of the terms and conditions of the Collateral Agreements are incorporated herein and made a part hereof.
 
Section 5.   Events of Default; Remedies . If any of the following events (each, an " Event of Default ") shall occur:
 
(a)   Payor shall fail to make any payment due under this Note when due;
 
(b)   Payor shall at any time materially default in the observance or performance of any agreement contained herein;
 
(c)   there shall occur an event of default under any of the Collateral Agreements, the Assets Purchase Agreement between Payor and Holder or any other agreement related thereto;
 
(d)   any of the representations and warranties made or deemed to be made herein or in the Collateral Agreements by Payor shall have been materially untrue as of the date hereof;
 
(e)   Payor shall become insolvent, or file a voluntary petition in bankruptcy, or if a petition in bankruptcy shall be filed against it, fails to pay its debts when due, or if any application for receivership of any nature be filed or a receiver be appointed of its property or assets then, and in any such event, Holder may, at its option, exercise any rights and remedies available under this Note, or at law or in equity. Holder's remedies include the right to declare all principal, interest and other sums outstanding under this Note to be immediately due and payable in full, to increase the rate of interest as provided in this Note to the Default Rate (as defined in Section 6), and to collect all sums owing from Payor as set forth hereunder. Holder's delay or failure to accelerate this Note or to exercise any other available right or remedy shall not impair any such right or remedy, nor shall it be construed to be a forbearance or waiver.
 
(f)   The entire amount due under this Note will accelerate without notice and become immediately due and payable.
 
Section 6.   Default Rate . After the occurrence of an Event of Default and so long as the Event of Default is continuing, in addition to all other rights and remedies, the outstanding principal balance of this Note shall bear interest at the rate equal to fourteen percent (14%) per annum, or such lesser rate which is the maximum rate of interest permitted by law.
 
Section 7.   Collection Costs . If an Event of Default hereunder occurs, Payor shall pay Holder the reasonable attorneys' fees and reasonable costs incurred to collect the unpaid principal balance and interest owing on this Note and otherwise to enforce Holder's rights and remedies under this Note or Collateral Agreements.
 
Section 8.   No Waiver; Remedies Cumulative . No failure or delay in exercising any right or remedy hereunder operates as a waiver thereof. No single or partial exercise of any right or remedy hereunder precludes any other or further exercise of any right or remedy hereunder or thereunder. Except as expressly provided herein, the exercise of any right or remedy hereunder does not preclude the simultaneous or later exercise of any other rights or remedies available at law or in equity. No amendment or waiver of any provision of this Note, nor consent to any departure by Payor herefrom, shall in any event be effective unless the same shall be in writing and signed by Holder, and then such waiver or consent shall be effective only in the specific instance and for the specific purpose for which given.
 
Section 9.   Successors and Assigns ; Change-in-Control of Payor . This Note shall be binding on Payor and its successors and assigns and shall inure to the benefit of Holder and its successors and assigns. Payor shall have no right to assign this Note without the prior written consent of the Holder. The term "Holder" in this Note shall refer to the individual originally holding this Note or to any other future holder of this Note. In the event that there is a change-in-control of the Payor, (as herein defined), the Holder shall have the right to declare all principal, interest and other sums outstanding under this Note to be immediately due and payable in full, to increase the rate of interest as provided in this Note, and to collect all sums owing from Payor. Holder's delay or failure to accelerate this Note or to exercise any other available right or remedy shall not impair any such right or remedy, nor shall it be construed to be a forbearance or waiver. A “change-in-control” of Payor shall mean the occurrence of any of the following events:
 
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(a)   the agreement for or the consummation of any consolidation or merger of the Payor in which the Payor is not the continuing or surviving company; or
 
(b)   other than with the Holder, the agreement for or the consummation of any sale, lease, exchange or other transfer (in one transaction or a series of related transactions) of all, or substantially all, of the assets of the Payor; or
 
(c)   an approval by the shareholders of the Payor of any plan or proposal for the liquidation or dissolution of the Payor.
 
Section 10.   GOVERNING LAW. THIS AGREEMENT AND ALL MATTERS ARISING DIRECTLY OR INDIRECTLY OUT OF THIS AGREEMENT, INCLUDING TORT CLAIMS, SHALL BE GOVERNED BY AND CONSTRUED IN ACCORDANCE WITH THE LAWS OF THE STATE OF FLORIDA WITHOUT REGARD TO THE CONFLICT OF LAWS PRINCIPLES THEREOF.
 
Section 11.   Jurisdiction . Payor hereby irrevocably consents and agrees that any legal action, suit, or proceeding arising out of or in any way connected with this Note shall be instituted or brought only in the courts of the State of Florida, as Holder may elect. Payor further agrees that final judgment against it in any such legal action, suit or proceeding shall be conclusive and may be enforced in any other jurisdiction, within or outside the United States of America, by suit on the judgment, a certified or exemplified copy of which shall be conclusive evidence of the fact and the amount of the liability.
 
Section 12.   Headings . All headings in this Agreement are for convenience of reference only and do not affect the meaning of any provision.
 
Section 13.   Partial Invalidity . If any term or provision of this Note is at any time held to be invalid by any court of competent jurisdiction, such invalidity shall not affect the remaining terms and provisions of this Note, which shall continue to be in full force and effect.
 
Section 14.   Waivers . Payor hereby waives set off, presentment, demand for payment, protect, notice of protest and notice of dishonor of this Note.
 
Section 15.   Waiver of Trial by Jury. THE PAYOR HEREBY WAIVES TRIAL BY JURY IN ANY ACTION.
 
Section 16.   Negotiability. This Note is fully negotiable.
 
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IN WITNESS WHEREOF , Payor has caused this Note to be duly executed as of the date first written above.
 
Date:   ______________
 
PAYOR


iFreedom Communications International Holdings, Ltd
 

By:_________________
 
Title_________________


IFreedom Communications Holding
 

By:_________________
 
Title_________________


IFreedom Communications (Malaysia) Sdn. Bhd.

 
By:_________________
 
Title_________________


 
IFreedom Communications Inc.

 
By:_________________
 
Title_________________



 
-4-
IFreedom Communications Hong Kong Limited

 
By:_________________
 
Title_________________



 
IFreedom UK, Ltd.


By:_________________
 
Title_________________


 
-5-
 




Pak Telecom

Lakhkar Khan
G.M. (Tele-Housing & VoIP)

Pakistan Telecommunications Company Limited
Rizwan Centre, G/Floor, Blue Area, Islamabad
Ph# 92-51 2272021 Fax # 92-52-2201015

No. VoIP/Tech/G-4/Fusion/2005

SUBJECT: TERMINATION OF THE VoIP AGREEMENT

Thank you for your letter dated November 15, 2005 requesting for formal termination of the VoIP Agreement concluded between PTCL & M/s Fusion Telecom.

The PTCL International Wing has been requested to settle all out standing Payments/ Accounts with M/s Fusion Telecom & formally close the Agreement. Termination of the VoIP Agreement will be confirmed as soon as clearance is received from concerned PTCL wings.

The CDRs issue raised by M/s Fusion Telecom is in process and will shortly be finalized.

PTCL have enjoyed the business relationship with M/s Fusion Telecom and looks forward to opportunities to work together again in the future.

GM (Tele-Housing & VoIP)


To

Eric D. RAM
Executive Vice President-International
Fusion Telecommunications International, Inc.
420 Lexington Avenue, Suite 518
New York, NY 10170

Copy to:

1.  
EVP (I/C) PTCL H/Qs Islamabad (for information).
2.  
General Manager (IR), PTCL H/Qs Islamabad.
3.  
Abdul Hameed Khan C.O.O., Saif Telecom Limited.
Fax: 2270372
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
 
CODE OF ETHICS
FOR
THE CHIEF EXECUTIVE OFFICER
SENIOR FINANCIAL OFFICERS
AND
BOARD OF DIRECTORS
 
1. Purpose .
 
The Board of Directors (the “ Board ”, and each member of the Board, a “ Director ”) of Fusion Telecommunications International, Inc., a Delaware corporation (the “ Company ”) has adopted the following Code of Ethics (the “ Code ”) to apply to the Chief Executive Officer, each other principal executive officer, and the Vice President of Finance and Principal Accounting and Finance Officer, Corporate Controller and Controller of each of the Company’s operating divisions (the Vice President of Finance and Principal Accounting and Finance Officer and Controllers are hereinafter referred to as the “ Senior Financial Officers ”), as well as to the Directors of the Company. The Controllers include higher ranking accounting personnel such as the Corporate Controller, Director of Accounting and Assistant Controller (or their equivalents). The Code is intended to promote ethical conduct and compliance with laws and regulations, to provide guidance with respect to the handling of ethical issues, to implement mechanisms to report unethical conduct, to foster a culture of honesty and accountability, to deter wrongdoing and to ensure fair and accurate financial reporting.
 
No code or policy can anticipate every situation that may arise. Accordingly, this Code is intended to serve as a source of guiding principles. You are encouraged to bring questions about particular circumstances that may involve one or more of the provisions of this Code to the attention of the Company’s Corporate Counsel (in-house) or the Chair of the Audit Committee, who may consult with the Company’s outside legal counsel as appropriate.
 
2. Introduction .
 
The Chief Executive Officer, principal executive officers, Senior Financial Officers and Directors are expected to adhere to a high standard of ethical conduct. The reputation and good standing of the Company depend on how the Company’s business is conducted and how the public perceives that conduct. Unethical actions, or the appearance of unethical actions, are not acceptable. In addition to each of the directives set forth below, the Chief Executive Officer, each principal executive officer, each Senior Financial Officer and Director shall be guided by the following principles in carrying out their duties and responsibilities on behalf of the Company:
 
Loyalty, Honesty and Integrity . You must not be, or appear to be, subject to influences, interests or relationships that conflict with the best interests of the Company.
 
Observance of Ethical Standards . When carrying out your duties and responsibilities on behalf of the Company, you must adhere to the high ethical standards described in this Code.
 
Accountability . You are responsible for your own adherence and the adherence of the other officers and Directors to whom this Code applies. Familiarize yourself with each provision of this Code and those set forth in the Company’s Insider Trading Policy.

3. Integrity of Records and Financial Reporting .
 
The Chief Executive Officer and Senior Financial Officers are responsible for the accurate and reliable preparation and maintenance of the Company’s financial records. Accurate and reliable preparation of financial records is of critical importance to proper management decisions and the fulfillment of the Company’s financial, legal and reporting obligations. As a public company, Fusion Telecommunications International, Inc. files annual and periodic reports and makes other filings with the Securities and Exchange Commission (the “ SEC ”). It is critical that these reports be timely and accurate. The Company expects those officers who have a role in the preparation and/or review of information included in the Company’s SEC filings to report such information accurately and honestly. Reports and documents the Company files with or submits to the SEC, as well as other public communications made by the Company, should contain full, fair, accurate, timely and understandable disclosure.
 
The Chief Executive Officer and Senior Financial Officers are responsible for establishing, and together with the Directors or the members of the Company’s Audit Committee, as the case may be, overseeing adequate disclosure controls and procedures and internal controls and procedures, including procedures which are designed to enable the Company to: (a) accurately document and account for transactions on the books and records of the Company and its subsidiaries; and (b) maintain reports, vouchers, bills, invoices, payroll and service records, performance records and other essential data with care and honesty.
 
 
 
 
 
4. Conflicts of Interest .
 
You must not participate in any activity that could conflict with your duties and responsibilities to the Company. A “conflict of interest” arises when one’s personal interests or activities appear to or may influence that person’s ability to act in the best interests of the Company. Any material transaction or relationship that reasonably could be expected to give rise to a conflict of interest should be disclosed to the Company’s Corporate Counsel. In addition, because conflicts of interest are not always obvious, you are encouraged to bring questions about particular situations to the attention of the Company’s Corporate Counsel.
 
This Code does not describe all possible conflicts of interest that could develop.
 
Some of the more common conflicts from which you must refrain are set forth below:
 
Family members . You may encounter a conflict of interest when doing business with or competing with organizations in which you have an ownership interest or your family member has an ownership or employment interest. “Family members” include a spouse, parents, children, siblings and in-laws. You must not conduct business on behalf of the Company with family members or an organization with which your family member is associated, unless such business relationship has been disclosed and authorized by the Chair of the Audit Committee.
 
Improper conduct and activities . You may not engage in any conduct or activities that are inconsistent with the Company’s best interests or that disrupt or impair the Company’s relationship with any person or entity with which the Company has or proposes to enter into a business or contractual relationship.
 
Compensation from non-Company sources . You may not accept compensation in any form for services performed for the Company from any source other than the Company.
 
Gifts . You and members of your immediate family may not accept gifts from persons or entities if such gifts are being made in order to influence you in your capacity as an employee or Director of the Company, or if acceptance of such gifts could create the appearance of a conflict of interest.
 
Personal use of Company assets . You may not use Company assets, labor or information for personal use, other than incidental personal use, unless approved by the Chair of the Audit Committee or as part of a compensation or expense reimbursement program.

5. Corporate Opportunities .
 
The Chief Executive Officer, principal executive officers, Senior Financial Officers and Directors are prohibited from: (a) taking for themselves personally opportunities related to the Company’s business; (b) using the Company’s property, information, or position for personal gain; or (c) competing with the Company for business opportunities; provided , however , if the Company’s disinterested Directors determine the Company will not pursue such opportunity, after disclosure of all material facts by the individual seeking to pursue the opportunity, the individual may do so.
 
6. Confidentiality .
 
You must maintain the confidentiality of information entrusted to you by the Company and any other confidential information about the Company, its business, customers or suppliers, from whatever source, except when disclosure is authorized or legally mandated. For purposes of this Code, “confidential information” includes all non-public information relating to the Company, its business, customers or suppliers.
 
7. Compliance with Laws, Rules and Regulations .
 
It is the policy of the Company to comply with all applicable laws, rules and regulations, and the Company expects its Chief Executive Officer, principal executive officers, Senior Financial Officers and Directors shall carry out their responsibilities on behalf of the Company in accordance with such laws, rules and regulations and to refrain from illegal conduct. Transactions in Company securities are governed by the Company’s Insider Trading Policy.
 
8. Encouraging the Reporting of any Illegal or Unethical Behavior .
 
The Company is committed to operating according to the highest standards of business conduct and ethics and to maintaining a culture of ethical compliance. The Chief Executive Officer, principal executive officers, Senior Financial Officers and Directors should promote an environment in which the Company: (a) encourages employees to talk to supervisors, managers and other appropriate personnel when in doubt about the best course of action in a particular situation; (b) encourages employees to report violations of laws, rules and regulations to appropriate personnel; and (c) informs employees that the Company will not allow retaliation for reports made in good faith.
 
 
 
 
 
9. Fair Dealing .
 
The Chief Executive Officer, principal executive officers, Senior Financial Officers and Directors should deal fairly with the Company’s customers, suppliers, competitors and employees. It is the policy of the Company to prohibit any person from taking unfair advantage of another through manipulation, concealment, abuse of privileged information, misrepresentation of material facts or any other unfair dealing practice.
 
10. Waivers .
 
It is the Company’s policy that waivers of this Code will not be granted except in exigent circumstances. Any waivers of this Code may only be granted by a majority of the Board after disclosure of all material facts by the individual seeking the waiver. Any waiver of this Code will be promptly disclosed as required by law or stock exchange regulation.
 
11. Conclusion .
 
You should communicate any suspected violations of this Code, or any unethical behavior encompassed by this Code, promptly to the Chair of the Audit Committee or to the Company’s Corporate Counsel. Violations will be taken seriously and investigated by the Board or by a person or persons designated by the Board and appropriate disciplinary action will be taken in the event of any violations of the Code.

If there are any questions involving application of this Code, guidance should be sought from the Company’s corporate counsel.

It shall also be the policy of the Company that the Chief Executive Officer, each Director, each Vice President, the Vice President of Finance and Principal Accounting and Finance Officer, Corporate Controller and Controller of each of the Company’s operating divisions acknowledge receipt of and certify their willingness to adhere to the foregoing upon commencement of their service or employment with the Company and file a copy of such certification with the Audit Committee of the Board.
 
 
 
 
EXHIBIT 21.1  
 
FUSION TELECOMMUNICATIONS INTERNATIONAL, INC.
LIST OF SUBSIDIARIES  
 
 
1.   Telecommunications Overseas Fusion Ltd., a company formed under the laws of Mauritius.
 
2.   Efonica, FL-LLC, a company formed under the laws of United Arab Emirates.
 
3.   Fusion Telco S.A., a company formed under the laws of Argentina.
 
4.   African Communications Company S.A., a company formed under the laws of Senegal.
 
5.   Seamless International Communications, LLC.
 
6.   Intercontinental Communications Group, Inc.
 
7.   Fusion Jamaica Limited, a company formed under the laws of Jamaica
 
8.   Fusion Turkey, LLC.
 
9.   Fusion MyA Communications, LLC.
 
10.   International Telecom Partners, LLC.
 
11.   Fusion Caribbean Limited.
 
12.   Fusion VoIP Acquisition Corp., a company formed under the laws of Delaware
 
13.   Fusion Romania Corp., a company formed under the laws of Delaware.
 
14.   Fusion Jordan Corp., a company formed under the laws fo Delaware.
 
15. LDTS UZAK MESAFE TELEKOMUNIKASYON VE ILETISM HIZMETLERI SAN.TIC.A.S. (“ LDTS ”), a company formed under the laws of Turkey.
 
16.   Latin Overseas Communications Corp., a company formed under the laws of Delaware.
 
 
EXHIBIT 31.1  
 
 
CERTIFICATION OF CHIEF EXECUTIVE OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
 
 
   I, Matthew D. Rosen, certify that:
 
   1.   I have reviewed this report on Form 10-K of Fusion Telecommunications, Inc.;
 
   2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
   3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
   4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
         (a)   Designed such disclosure controls and procedures, or caused such controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
         (b)    Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
         (c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
         (d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
   5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
         (a)   All significant deficiencies and material weaknesses in the design or operation of internal controls and procedures for financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
         (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
 
Date:  March 31, 2006
 
 
/s/ Matthew D. Rosen
Matthew D. Rosen
President and Chief Executive Officer
 
EXHIBIT 31.2  
 
CERTIFICATION OF PRINCIPAL ACCOUNTING OFFICER
PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002
 
   I, Barbara Hughes, certify that:
 
   1.    I have reviewed this report on Form 10-K of Fusion Telecommunications, Inc.;
 
   2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;
 
   3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
   4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal controls over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:
 
         (a)   Designed such disclosure controls and procedures, or caused such controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
         (b)    Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
         (c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
         (d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
   5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
         (a)   All significant deficiencies and material weaknesses in the design or operation of internal controls and procedures for financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
         (b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
 
 
Date:  March 31, 2006
 
 
/s/ Barbara Hughes
Barbara Hughes
Vice President of Finance and
Principal Accounting and Financial Officer
 
 
 

 
 
 
 


EXHIBIT 32  
 
CERTIFICATION
PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
(SUBSECTIONS (A) AND (B) OF SECTION 1350,  
CHAPTER 63 OF TITLE 18, UNITED STATES CODE)
 
Pursuant to section 906 of the Sarbanes-Oxley Act of 2002 (subsections (a) and (b) of section 1350, chapter 63 of title 18, United States Code), each of the undersigned officers of Fusion Telecommunications International, Inc., a Delaware corporation (the “Company”), does hereby certify, to such officer’s knowledge, that:
 
The Annual Report on Form 10-K for the year ended December 31, 2005 (the “Form 10-K”) of the Company fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934, and the information contained in the Form 10-K fairly presents, in all material respects, the financial condition and results of operations of the Company for the periods presented therein.
 
 
/s/ Matthew D. Rosen
 
Matthew D. Rosen
 
President and Chief Executive Officer
 
 
 
Date: March 31, 2006
 
 
 
 
 
/s/ Barbara Hughes
 
Barbara Hughes
 
Vice President of Finance and Principal Accounting and
 
Financial Officer
 
 
 
Date: March 31, 2006