**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-Q**





**x
      QUARTERLY REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**





**For
      the quarterly period ended June 30, 2006**





**OR**





**o
      TRANSITION REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934**





**For
      the transition period from _________ to _________**





**Commission
      file number 000 -32421**





**Fusion
                Telecommunications International, Inc.****—————————————————————****(Exact
                name of registrant as specified in its charter)**




******Delaware**
            **58-2342021****—————————————**
            **————————****(State
                or other jurisdiction of**
              **incorporation
                or organization)**
            **(I.R.S.
                Employer**
              **Identification
                No.)********420
                Lexington Avenue, Suite 1718, New York New York**
            **10170****————————————————————**
            **—————****(Address
                of principal executive offices)**
            **(Zip
                Code)********(212)
                201-2400****——————————————————————****Registrant’s
                telephone number, including area code**








Indicate
      by 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 check mark whether the registrant is a large accelerated filer, accelerated
      filer, or non-accelerated filer. See definition of “accelerated filer and large
      accelerated filer” as defined in Rule 12b-2 of the Exchange Act.





Large
      Accelerated Filer o      Accelerated
      Filer oNon-Accelerated Filer 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
      number of shares outstanding of the Registrant's capital stock as of August
      7,
      2006 is as follows:








**Title
                of each Class**
            **Number
                of Shares****Outstanding**Common
                Stock, $0.01 par value
            26,919,211Redeemable
                Common Stock Purchase Warrants
            7,281,838











**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC.**


**AND
      SUBSIDIARIES**





**INDEX**








**Part
                I. Financial Information**
            PageItem
                l. Financial Statements
            3Item 2. Management’s Discussion and Analysis of Financial Condition and
                Results of Operations
            15Item 3. Quantitative and Qualitative Disclosures About Market
                Risk
            24Item 4. Controls and Procedures
            24**Part
                II. Other Information**Item 1. Legal Proceedings
            25Item 1A. Risk Factors
            25Item 2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            27Item 3. Defaults Upon Senior Securities
            27Item 4. Submission of Matters to a Vote of Security
                Holders
            27Item 5. Other Information
            28Item 6. Exhibits
            28








2


**Item
      1. FINANCIAL STATEMENTS**


**PART
      1 - FINANCIAL INFORMATION**


**ITEM
      1: FINANCIAL STATEMENTS**





**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**Consolidated
      Balance Sheets**









**June
                30, 2006**
            
            **December
                31, 2005**(unaudited)**ASSETS****Current
                assets**Cash
                and cash equivalents
            
            $
            5,912,003
            
            $
            14,790,504Accounts
                receivable, net of allowance for doubtful accounts of
                approximately
              $516,000
                and $414,000, at June 30, 2006 and December 31, 2005,
                respectively
            
            
            3,863,513
            
            
            2,952,760Restricted
                cash
            
            
            40,000
            
            
            —Prepaid
                expenses and other current assets
            
            
            1,433,898
            
            
            1,242,266**Total
                current assets**
            
            
            11,249,414
            
            
            18,985,530**Property
                and equipment, net**
            
            
            7,034,928
            
            
            4,516,271**Other
                assets**Security
                deposits
            
            
            185,293
            
            
            331,891Restricted
                cash
            
            
            416,566
            
            
            218,176Goodwill
            
            
            5,118,640
            
            
            5,118,640Intangible
                assets, net
            
            
            4,879,784
            
            
            4,861,012Other
                assets
            
            
            347,553
            
            
            354,259Total
                other assets
            
            
            10,947,836
            
            
            10,883,978**TOTAL
                ASSETS**
            
            $
            29,232,178
            
            $
            34,385,779**LIABILITIES
                AND STOCKHOLDERS’ EQUITY****Current
                liabilities**Long-term
                debt, current portion
            
            $
            150,000
            
            $
            150,000Capital
                lease/equipment financing obligations, current portion
            
            
            1,094,165
            
            
            1,419,965Accounts
                payable and accrued expenses
            
            
            10,124,583
            
            
            9,269,341Investment
                in Estel
            
            
            651,069
            
            
            771,182Liabilities
                of discontinued operations
            
            
            235,085
            
            
            620,809**Total
                current liabilities**
            
            
            12,254,902
            
            
            12,231,297**Long-term
                liabilities**Capital
                lease/equipment financing obligations, net of current
                portion
            
            
            78,100
            
            
            7,650Other
                long-term liabilities
            
            
            —
            
            
            4,357,497Total
                long-term liabilities
            
            
            78,100
            
            
            4,365,147**Commitments
                and contingencies****Minority
                interests**
            
            
            59,167
            
            
            67,694**Stockholders’
                equity**Common
                stock, $.01 par value, 105,000,000 shares authorized, 26,919,211
                and
              11,114,962
                shares issued and 26,894,211 and 10,439,381 shares
                outstanding
              at
                June 30, 2006 and December 31, 2005, respectively
            
            
            268,943
            
            
            104,394Common
                stock, Class A $.01 par value, authorized 21,000,000 shares, 0 and
              15,739,963
                shares issued and outstanding at June 30, 2006 and December 31,
                2005,
              respectively
            
            
            —
            
            
            157,400Capital
                in excess of par value
            
            
            110,314,011
            
            
            105,447,041Accumulated
                deficit
            
            
            (93,742,945
            )
            
            (87,987,194
            )Total
                stockholders’ equity
            
            
            16,840,009
            
            
            17,721,641**TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY**
            
            $
            29,232,178
            
            $
            34,385,779











See
      accompanying condensed notes to consolidated financial
      statements.


3





**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**Consolidated
      Statements of Operations**









**Three
                months ended**
            
            
            **Six
                months ended****June
                30,**
            
            
            **June
                30,****2006**
            
            
            **2005**
            
            
            **2006**
            
            
            **2005****(unaudited)**
            
            
            **(unaudited)**
            
            
            **(unaudited)**
            
            
            **(unaudited)****Revenues**
            
            $
            10,543,112
            
            **$**
            19,259,891
            
            **$**
            20,065,270
            
            **$**
            31,188,943**Operating
                expenses:**Cost
                of revenues, exclusive of depreciation and amortization shown
              separately
                below
            
            
            9,382,411
            
            
            17,703,991
            
            
            17,987,714
            
            
            28,701,414Depreciation
                and amortization
            
            
            247,651
            
            
            436,387
            
            
            478,541
            
            
            869,411Selling,
                general and administrative expenses (includes $245,639 and
              $449,871
                of non-cashcompensation
                for the three and six months
              ended
                June 30, 2006, respectively)
            
            
            3,969,352
            
            
            2,950,198
            
            
            7,648,133
            
            
            5,618,654Advertising
                and marketing
            
            
            301,759
            
            
            79,482
            
            
            324,751
            
            
            116,433Total
                operating expenses
            
            
            13,901,173
            
            
            21,170,058
            
            
            26,439,139
            
            
            35,305,912**Operating
                loss**
            
            
            (3,358,061
            )
            
            (1,910,167
            )
            
            (6,373,869
            )
            
            (4,116,969
            )**Other
                income (expense)**Interest
                income
            
            
            102,117
            
            
            126,543
            
            
            235,578
            
            
            182,870Interest
                expense
            
            
            (29,514
            )
            
            (35,163
            )
            
            (59,514
            )
            
            (367,293
            )Gain
                on settlements of debt
            
            
            465,854
            
            
            5,340
            
            
            465,854
            
            
            5,340Loss
                from investment in Estel
            
            
            (33,080
            )
            
            (142,545
            )
            
            (70,638
            )
            
            (299,460
            )Other
            
            
            48,758
            
            
            5,956
            
            
            38,311
            
            
            5,956Minority
                interests
            
            
            2,235
            
            
            49,155
            
            
            8,527
            
            
            48,084Total
                other income (expense)
            
            
            556,370
            
            
            9,286
            
            
            618,118
            
            
            (424,503
            )**Loss
                from continuing operations**
            
            
            (2,801,691
            )
            
            (1,900,881
            )
            
            (5,755,751
            )
            
            (4,541,472
            )**Discontinued
                operations:**Income
                from discontinued operations
            
            
            —
            
            
            —
            
            
            —
            
            
            175,000**Net
                loss**
            
            $
            (2,801,691
            )
            **$**
            (1,900,881
            )
            **$**
            (5,755,751
            )
            **$**
            (4,366,472
            )**Basic
                and diluted net loss per common share:**Loss
                from continuing operations
            
            $
            (0.10
            )
            **$**
            (0.07
            )
            **$**
            (0.22
            )
            **$**
            (0.19
            )Income
                from discontinued operations
            
            
            —
            
            
            —
            
            
            —
            
            
            0.01Net
                loss per common share
            
            $
            (0.10
            )
            **$**
            (0.07
            )
            **$**
            (0.22
            )
            **$**
            (0.18
            )**Weighted
                average shares outstanding**Basic
                and diluted
            
            
            26,894,211
            
            
            26,146,204
            
            
            26,546,842
            
            
            23,730,789














See
      accompanying condensed notes to consolidated financial
      statements.


4


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**Consolidated
      Statements of Cash Flows**

















**Six
                months ended June 30,****2006**
            
            
            **2005****(unaudited)**
            
            
            **(unaudited)****Cash
              flows from operating activities**Net
                loss
            
            $
            (5,755,751
            )
            **$**
            (4,366,472
            )Adjustments
                to reconcile net loss to net cash used in operating activities:Gain
                from sale of assets
            
            
            (40,683
            )
            
            —Depreciation
                and amortization
            
            
            478,541
            
            
            869,411Bad
                debt expense (recovery)
            
            
            (68,250
            )
            
            177,000Stock
                based compensation
            
            
            499,665
            
            
            —Gain
                on forgiveness of debt
            
            
            (465,854
            )
            
            (5,340
            )Gain
                on discontinued operations
            
            
            —
            
            
            (175,000
            )Accretion
                of Series C Preferred Stock
            
            
            —
            
            
            287,115Loss
                from investment in Estel
            
            
            70,638
            
            
            299,460Minority
                interests
            
            
            (8,527
            )
            
            (48,084
            )Increase
                (decrease) in cash attributable to changes in operating assets and
                liabilities:Accounts
                receivable
            
            
            (1,052,503
            )
            
            (2,180,712
            )Prepaid
                expenses and other current assets
            
            
            (175,175
            )
            
            655,197Other
                assets
            
            
            6,706
            
            
            (285,376
            )Accounts
                payable and accrued expenses
            
            
            708,296
            
            
            (1,295,101
            )Liabilities
                of discontinued operations
            
            
            (385,724
            )
            
            (154,787
            )**Net
                cash used in operating activities**
            
            
            (6,188,621
            )
            
            (6,222,689
            )**Cash
                flows from investing activities:**Purchase
                of property and equipment
            
            
            (2,099,675
            )
            
            (1,064,825
            )Advances
                to Estel
            
            
            (47,853
            )
            
            (127,784
            )Payments
                from Estel
            
            
            67,102
            
            
            82,378Purchase
                of Jamaican joint venture, net of cash acquired
            
            
            —
            
            
            (146,486
            )Purchase
                of minority interest in Efonica joint venture, net of cash acquired
            
            
            —
            
            
            (480,555
            )Purchase
                of Turkey joint venture, net of cash acquired
            
            
            —
            
            
            (76,528
            )Return
                of security deposits
            
            
            146,598
            
            
            175,511Repayments
                of (payments for) restricted cash
            
            
            (238,390
            )
            
            87,100Payments
                of legal fees for intellectual property
            
            
            (34,012
            )
            
            —**Net
                cash used in investing activities**
            
            
            (2,206,230
            )
            
            (1,551,189
            )**Cash
                flows from financing activities**Proceeds
                from sale of common stock and redeemable common stock purchase warrants,
                net
            
            
            —
            
            
            23,888,097Proceeds
                from exercise of stock options
            
            
            —
            
            
            50,250Proceeds
                from exercise of warrants
            
            
            500
            
            
            85,144Payment
                of dividends on Series C preferred stock
            
            
            —
            
            
            (664,634
            )Payments
                of long-term debt and capital lease /equipment financing obligations
            
            
            (484,150
            )
            
            (1,971,816
            )Contributions
                from (to) minority stockholders of joint ventures
            
            
            —
            
            
            (17,961
            )**Net
                cash provided by (used in) financing activities**
            
            
            (483,650
            )
            
            21,369,080**Net
                increase in cash and cash equivalents**
            
            
            (8,878,501
            )
            
            13,595,202**Cash
                and cash equivalents, beginning of period**
            
            
            14,790,504
            
            
            4,368,726**Cash
                and cash equivalents, end of period**
            
            $
            5,912,003
            
            **$**
            17,963,928











See
      accompanying condensed notes to consolidated financial
      statements.


5








**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**Consolidated
      Statements of Cash Flows (continued)**





**Six
                    months ended June 30,****2006**
                
                **2006****(unaudited)**
                
                **(unaudited)**Supplemental
                    disclosure of cash flow information:Cash
                    paid during the period for interest
                
                $
                31,669
                
                $
                602,717Supplemental
                    disclosure of non-cash investing and financing activities:
                
                
                
                
                $
                —Acquisition
                    of capital lease/equipment financing obligations
                
                $
                228,800
                
                $
                75,354Acquisition
                    of short term financing agreement
                
                $
                492,964
                
                
                —Conversion
                    of convertible notes payable and related debt offering costs
                
                $
                —
                
                $
                2,444,395Conversion
                    of Series C preferred stock to common stock
                
                $
                —
                
                $
                10,003,141Conversion
                    of prepaid offering costs to additional paid in capital
                
                $
                —
                
                $
                614,008Release
                    of Efonica shares from escrow
                
                $
                4,357,497
                
                $
                —Issuance
                    of restricted stock for consulting services
                
                $
                66,250
                
                $
                50,000Liability
                    for acquisition of Intellectual Property Transfer
                    Agreement
                
                $
                120,000
                
                $
                —Supplemental
                    disclosure of joint venture acquisition activities:Fair
                    value of tangible assets, net of cash acquired
                
                $
                —
                
                $
                614,284Fair
                    value of identifiable intangible assets
                
                
                —
                
                
                4,877,900Goodwill
                    acquired
                
                
                —
                
                
                761,143Liabilities
                    acquired
                
                
                —
                
                
                (377,440
                )Minority
                    interest acquired
                
                
                —
                
                
                (244,118
                )Common stock
                    issued or to be issued
                
                
                —
                
                
                (4,928,200
                )Cash
                    paid for acquisition of joint ventures, net of cash
                    acquired
                
                $
                —
                
                $
                703,569





See
      accompanying condensed notes to consolidated financial
      statements.


6


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**1.
      Basis of Presentation**





The
      accompanying condensed notes to consolidated financial statements should be
      read
      in conjunction with the 2005 Form 10-K for Fusion Telecommunications
      International, Inc. and its Subsidiaries (the “Company”). These financial
      statements have been prepared in accordance with instructions to Form 10-Q
      and
      Article 10 of Regulation S-X and, therefore, omit or condense certain footnotes
      and other information normally included in the financial statements prepared
      in
      accordance with accounting principles generally accepted in the United States.
      In the opinion of the Company’s management, all adjustments (consisting of
      normal recurring accruals) considered necessary for fair financial statement
      presentation have been made. The results of operations for an interim period
      may
      not give a true indication of the results for the year.





During
      the six months ended June 30, 2006 and 2005, 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 earnings available to common stockholders
      by the weighted-average number of common shares outstanding during the period.
      Diluted earnings 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 earnings of the Company.





Unexercised
      stock options to purchase 2,852,033 and 1,581,290 shares of the Company’s common
      stock as of June 30, 2006 and 2005, 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 7,442,791 and 7,539,845 shares of the Company’s common
      stock as of June 30, 2006 and 2005, 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.





***Stock-based
      Compensation***





On
      January 1, 2006, the Company adopted Statement of Financial Accounting Standards
      (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (SFAS No. 123R”), that
      addresses the accounting for share-based payment transactions in which an
      enterprise receives employee services in exchange for either equity instruments
      of the enterprise or liabilities that are based on the fair value of the
      enterprise’s equity instruments or that may be settled by the issuance of such
      equity instruments. SFAS No. 123R eliminates the ability to account for
      share-based compensation transactions, as the Company formerly did, using the
      intrinsic value method as prescribed by Accounting Principles Board (APB”),
      Opinion No. 25, “Accounting for Stock Issued to Employees,” and generally
      requires that such transactions be accounted for using a fair-value-based method
      and recognized as an expense in the Company’s Consolidated Statements of
      Operations.





The
      Company adopted SFAS No. 123R using the modified prospective method, which
      required the application of the accounting standard as of January 1, 2006.
      The
      Company’s consolidated financial statements as of June 30, 2006, and for the
      three and six months ended June 30, 2006, reflect the impact of adopting SFAS
      No. 123R. In accordance with the modified prospective method, the consolidated
      financial statements for prior periods have not been restated to reflect, and
      do
      not include, the impact of SFAS No. 123R.





Stock-Based
      compensation expense recognized during the period is based on the value of
      the
      portion of stock-based payment awards that is ultimately expected to vest.
      Stock-based compensation expense recognized in the Consolidated Statements
      of
      Operations during the three and six months ended June 30, 2006, includes
      compensation expense for stock-based payment awards granted prior to, but not
      yet vested, as of December 31, 2005, based on the grant date fair value
      estimated in accordance with SFAS No. 123R. As stock-based compensation expense
      recognized in the Consolidated Statement of Operations for the three and six
      months ended June 30, 2006, is based on awards ultimately expected to vest,
      it
      has been reduced for estimated forfeitures. SFAS No. 123R requires forfeitures
      to be estimated at the time of grant and revised, if necessary, in subsequent
      periods if actual forfeitures differ from those estimates. When estimating
      forfeitures, the Company considered termination behaviors as well as trends
      for
      actual option forfeiture. In the pro forma information required under SFAS
      No.
      148 (“Accounting for Stock-Based Compensation - Transition and Disclosure - an
      amendment of FASB Statement No. 123”) for the periods prior to 2006, the Company
      accounted for forfeitures as they occurred.





7


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**1.
      Basis of Presentation (continued)**





The
      Company has recognized compensation expense based on the estimated grant date
      fair value method using the Black-Scholes valuation model. For these awards,
      the
      Company has recognized compensation expense using a straight-line amortization
      method. The impact on the Company’s results of operations of recording
      stock-based compensation for the three and six months ended June 30, 2006,
      was
      an expense of $245,639 and $449,871, respectively, which is included in selling,
      general and administrative expenses in the Consolidated Statements of
      Operations.





The
      following table illustrates the effect on the net loss and loss per share as
      if
      the Company had applied the fair value recognition provisions of SFAS No. 123R
      for the three and six months ended June 30, 2005.





**For
                the Three Months Ended**
              **June
                30, 2005**
            
            **For
                the Six Months Ended**
              **June
                30, 2005**Net
                loss applicable to common stockholders, as reported
            
            $
            (1,900,881
            )
            $
            (4,366,472
            )Deduct:
                total stock-based compensation expense under fair value method
              for
                awards, net of related tax effect
            
            
            (152,218
            )
            
            (284,064
            )Net
                loss applicable to common stockholders, pro forma
            
            $
            (2,053,099
            )
            $
            (4,650,536
            )Loss
                per share:Basic
                and diluted loss, as reported
            
            $
            (0.07
            )
            $
            (0.18
            )Basic
                and diluted loss, pro forma
            
            $
            (0.08
            )
            $
            (0.20
            )





***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 period. Actual results
      could differ from those estimates.





***Reclassifications***





Certain
      reclassifications have been made to the 2005 amounts to conform to the 2006
      presentation.




**2.
      Liquidity**




At
      June
      30, 2006, the Company had a working capital deficit of $1,005,488 and an
      accumulated deficit of $93,742,945. The Company has continued to sustain losses
      from operations, and for the six months ended June 30, 2006 and 2005 has
      incurred a net loss of $5,755,751 and $4,366,472, respectively. In addition,
      the
      Company has not generated positive cash flow from operations since inception.
      The Company is reviewing options to raise additional capital through debt and/or
      equity financing. While management believes that its current cash resources
      should be adequate to fund its operations for the year ending December 31,
      2006,
      the Company’s long-term liquidity is dependent on its ability to successfully
      complete the rollout of its full suite of retail VoIP paid services, in order
      to
      attain profitable operations in the future. The Company cannot make any
      guarantees if and when it will be able to attain profitability.




**3.
      Acquisitions and Joint Ventures**





***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 by the Pakistan Telecommunications Company Limited
      (“PTCL”). Turner Hill subsequently assigned its interest to Braddon Corporate
      Holdings Limited (“Braddon”).


8


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**3.
      Acquisitions and Joint Ventures - (continued)**





As
      of
      December 31, 2005, a rolling advance of $415,500 was owed to the Company by
      PTCL. During February 2006, PTCL returned $389,000 of the rolling advance,
      which was reflected in prepaid expenses and other current assets in the
      December 31, 2005 Consolidated Balance Sheet. The remaining rolling advance
      balance of $26,500 is currently being disputed (reflected in security deposits
      in the June 30, 2006 Balance Sheet) along with a $58,960 receivable balance
      from
      PTCL (reflected in prepaids and other current assets in the June 30, 2006
      Balance Sheet).





***iFreedom***





On
      November 14, 2005, the Company entered into an agreement to acquire the
      assets of iFreedom Communications International Holdings Limited and a number
      of
      its subsidiaries, (“iFreedom”), an entity that markets monthly recurring
      international VoIP service plans geared to meet the needs of consumers and
      businesses in emerging markets. The agreement provided for a purchase price
      of
      $500,000 in cash, and 1,100,000 shares of restricted common 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 were not met by iFreedom, the parties tried to work in good faith
      to
      renegotiate the terms and conditions of the transaction, but were not
      successful. The Company no longer intends to pursue this
      transaction.





The
      Company has been providing termination services to iFreedom, which services
      have
      aggregated outstanding charges of approximately $582,000 as of June 30, 2006.
      iFreedom has entered into a non interest-bearing Note with respect to these
      charges. IFreedom has executed a secured promissory note evidencing and securing
      their indebtedness to the Company. The Company and iFreedom are presently
      negotiating a repayment schedule for the termination services the Company has
      provided to iFreedom.





**4.
      Prepaid expenses and other current assets**





Prepaid
      expenses and other current assets consist of the following at June 30, 2006
      and
      December 31, 2005.





**June
                30,**
              **2006**
            
            **December
                31,**
              **2005**Prepaid
                expenses
            
            $
            661,384
            
            $
            425,832Prepaid
                insurance
            
            
            97,883
            
            
            105,884Prepaid
                advertising/marketing
            
            
            360,301
            
            
            —Due
                from PTCL
            
            
            58,960
            
            
            447,505Other
                current assets
            
            
            255,370
            
            
            263,045$
            1,433,898
            
            $
            1,242,266





**5.
      Discontinued Operations**





The
      Company’s discontinued operations relate to Management’s decision in 2001 to
      cease the operations of its domestic retail telecommunication services business
      lines. The Company continues its efforts to settle certain of these remaining
      liabilities. As a result of these efforts, the Company recognized a gain of
      $175,000 during the six months ended June 30, 2005. The remaining liability
      at
      December 31, 2005, of approximately $621,000, are related to trade payables
      and
      accrued expenses is associated with the discontinued retail telecommunications
      services. During the six months ended June 30, 2006, the Company paid
      approximately $386,000 of these outstanding liabilities.





**6.
      Accounts payable and accrued expenses**





Accounts
      payable and accrued expenses consist of the following at June 30, 2006 and
      December 31, 2005:





**June
                30,**
              **2006**
            
            **December
                31,**
              **2005**Trade
                accounts payable
            
            $
            5,664,146
            
            $
            6,134,373Accrued
                expenses
            
            
            2,837,066
            
            
            1,892,216Interest
                payable
            
            
            363,060
            
            
            334,869Deferred
                revenue
            
            
            535,596
            
            
            810,837Short-term
                financing agreement
            
            
            492,964
            
            
            —Other
            
            
            231,751
            
            
            97,046$
            10,124,583
            
            $
            9,269,341


9


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**6.
      Accounts payable and accrued expenses (continued)**





During
      the three months ended June 30, 2006, the Company entered into an agreement
      to
      purchase certain hardware, software and software support from an equipment
      vendor. The payments are due on a monthly basis over a 9-month period. The
      vendor is charging a 7% finance charge for the $241,000 hardware portion of
      the
      purchase.





**7.
      Long-term debt and capital lease/equipment financing obligations**





At
      June
      30, 2006, and December 31, 2005, components of long-term debt and capital
      lease/equipment financing obligations of the Company are comprised of the
      following:





**June
                30,**
              ******2006**
            
            **December
                31,**
              **2005**Promissory
                notes payable
            
            $
            150,000
            
            $
            150,000Capital
                lease/equipment financing obligations
            
            
            1,172,265
            
            
            1,427,615Total
                long-term debt and capital lease/equipment financing
                obligations
            
            
            1,322,265
            
            
            1,577,615Less
                current portion
            
            
            (1,244,165
            )
            
            1,569,965
            )$
            78,100
            
            $
            7,650





**** ***Promissory
      note payable***





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 promissory note has not been repaid as of June
      30, 2006, as the other party to the settlement agreement has not complied with
      the terms of the agreement.





***Capital
      lease/equipment financing obligations***





The
      Company entered into several financing agreements for equipment purchases during
      2005 and prior. The Company has imputed an interest rate of 10.0% related to
      these agreements, which are payable every 90 days over a 12-18 month
      period.





During
      the quarter ended June 30, 2006, the Company entered into a capital lease
      agreement for $228,800. The interest rate is 7.3% and payments are due every
      90
      days over a 16-month period.





At
      June
      30, 2006 and December 31, 2005, approximately $720,000 of the capital lease
      obligations was in default and accordingly has been classified as currently
      due.
      See Legal Matters section of Note 11 for further discussion.





Future
      aggregate principal payments for the Company’s debt and capital lease/equipment
      financing obligations as of June 30, 2006 are as follows:





Total
                minimum payments due during the period ending June 30,
                2007
            
            $
            1,692,075Less
                amount representing interest
            
            
            (369,810
            )Present
                value of minimum payments
            
            
            1,322,265Less
                current portion
            
            
            (1,244,165
            )$
            78,100





**8.
      Equity Transactions**





On
      February 17, 2005, the Company closed its initial public offering 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 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 has two classes of outstanding common stock. The holders
      of the Class A Common Stock have identical rights and privileges to the regular
      common stock, except that they were able to transfer shares of Class A Common
      Stock until February 11, 2006. On that date, the 15,737,963 shares of
      outstanding Class A Common Stock were automatically converted into shares of
      common stock.


10











**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**8.
      Equity Transactions (continued)**





Upon
      completion of the IPO, convertible debt with a balance of $2,508,333 was
      converted into 651,515 shares of common stock. In addition, 1,439,643 shares
      of
      common stock were issued in connection with the Company’s acquisition of the
      49.8% minority interest in Efonica (see Note 3 for further discussion). In
      addition, all outstanding Series C preferred stock was converted into common
      stock.





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
      28, 2006, the Company entered into a consulting service agreement. In connection
      with the agreement, the Company issued 50,000 shares of restricted common stock.
      Of these shares, 25,000 shares were given to the consultant upon the signing
      of
      the agreement. The other 25,000 shares are being held in escrow until the sixth
      (6 th )
      month
      anniversary, at which time 12,500 shares will be released. The remaining 12,500
      shares will be released upon the ninth (9 th )
      month
      anniversary, unless the agreement has been terminated, pursuant to the Company’s
      right to terminate. The $66,250 expense associated with the 25,000 shares given
      to the consultant is being amortized over the six-month term.





**9.
      Gain on settlements of debt**





During
      December 2003, the Company entered into 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
      received a reduced rate for certain minutes of traffic that passed through
      the
      Company’s network through December 2005. The Company and the carrier continued
      to comply with the terms of this agreement until it was settled as discussed
      below. Since the settlement agreement was entered into, approximately $89,000
      of
      deferred revenue was recognized in connection with this service
      agreement.





During
      June 2006, the service agreement was cancelled and the carrier released the
      Company of all remaining indebtedness under the December 2003 settlement
      agreement. Consequently, the remaining deferred revenue balance of approximately
      $466,000 was recorded as a gain on settlement of debt.





**10.** **New
      Accounting Pronouncements**





In
      February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
      Financial Instruments - an amendment of FASB Statements No. 133 and 140,” which
      simplifies accounting for certain hybrid financial instruments by permitting
      fair value re-measurement for any hybrid instrument that contains an embedded
      derivative that otherwise would require bifurcation and eliminates a restriction
      on the passive derivative instruments that a qualifying special-purpose entity
      may hold. SFAS No. 155 is effective for all financial instruments acquired,
      issued or subject to a re-measurement (new basis) event occurring after the
      beginning of an entity’s first fiscal year that begins after September 15, 2006.
      The adoption of SFAS No. 155 is not expected to have an impact on the Company’s
      results of operations or financial position.





In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets - an amendment of FASB Statement No. 140,” which establishes, among other
      things, the accounting for all separately recognized servicing assets and
      servicing liabilities by requiring that all separately recognized servicing
      assets and servicing liabilities be initially measured at fair value, if
      practicable. SFAS No. 156 is effective as of the beginning of an entity’s first
      fiscal year that begins after September 15, 2006. The adoption of SFAS No.
      156
      is not expected to have an impact on the Company’s results of operations or
      financial position.





**11.
      Commitments and contingencies**





***Legal
      Matters*** ****





On
      May 28, 2003, Jack Grynberg, et al., an investor in one of the Company’s
      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, the Company filed with the Court a
      Motion to Dismiss, which was granted. The Company was awarded attorneys’ fees by
      the court. The plaintiffs have filed an appeal of the motion, which is
      pending.





11


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**







**11.
      Commitments and contingencies**  **-
      (continued)**




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 asserted a counterclaim
      against the vendor and an affiliated company and is vigorously prosecuting
      the
      counterclaim. 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 Company’s accompanying financial
      statements.





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 Company’s operations or financial condition.





***Letters
      of Credit***





In
      connection with the Company’s relocation of its New York executive office during
      April 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.





Subsequent
      to June 30, 2006, in connection with the Company’s 75% owned subsidiary in
      Turkey, the Company provided a Letter of Credit for 250,000 Euros (approximately
      $0.3 million) to the Telekomunikasyon Kurumu Telecommunication Administrator.
      This Letter of Credit is to secure a license to do business as a long distance
      telecommunication services company in Turkey. The guarantee is effective until
      January 1, 2007.





***Intellectual
      Property Transfer Agreement***





On
      February 15, 2006, the Company entered into an Intellectual Property Transfer
      Agreement with Xtreme VoIP Corp. (“Xtreme”) pursuant to which the Company
      purchased a software application and other intellectual property rights (the
      “Intellectual Property”) 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 is $600,000, of which $60,000 was paid in cash as of June 30,
      2006, and $120,000, which is payable in cash or stock on or before the third
      anniversary of the agreement, depending upon the attainment of subscriber
      milestones. On the second anniversary of this agreement, the Company has the
      option of (i) 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, or (ii) keeping the
      Intellectual Property and complying with the terms of the agreement, which
      provides for final payment of the balance due by the fourth anniversary. In
      the
      event that the Company does not revert the assets, and 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 software sales sold by the Company. 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 the assets revert back to Xtreme
      and in the event that the Company sub-licenses the Intellectual Property as
      a
      product to third parties, Xtreme will be entitled to a royalty equal to 50%
      of
      the software sales.





During
      April 2006, the Company filed a patent application with the United States Patent
      and Trademark Office for this technology.





**12.
      Segment Information**





The
      Company operates and manages three reportable segments, 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.





During
      the three and six months ended June 30, 2005, 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 three and six months ended
      June
      30, 2005, have been presented in a consistent manner as one.


12





**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**12.
      Segment Information (continued)**





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 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.





VoIP
      to
      Consumers and Corporations — The Company selectively 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.




Operating
      segment information for the three months ended June 30, 2006 and 2005 is
      summarized as follows:





**Three
                months ended June 30, 2006**
            
            **Voice
                to Carriers**
            
            **VoIP
                to Consumers and Corporations**
            
            **Internet,
                Managed Private Networks & Other**
            
            **Corporate
                &**
              **Unallocated**
            
            **Consolidated**Net
                revenues
            
            $
            9,567,095
            
            $
            571,541
            
            $
            404,476
            
            $
            —
            
            $
            10,543,112Cost
                of revenues (exclusive of depreciation and amortization)
            
            $
            (8,755,497
            )
            $
            (442,294
            )
            $
            (184,620
            )
            $
            —
            
            $
            (9,382,411
            )Depreciation
                and amortization
            
            $
            (200,912
            )
            $
            (13,689
            )
            $
            (9,276
            )
            $
            (23,774
            )
            $
            (247,651
            )Selling,
                general and administrative
            
            $
            (1,464,322
            )
            $
            (545,600
            )
            $
            (30,387
            )
            $
            (1,929,043
            )
            $
            (3,969,352
            )Advertising
                and marketing
            
            $
            (13,500
            )
            $
            (288,259
            )
            $
            —
            
            $
            —
            
            $
            (301,759
            )Other
                income (expense)
            
            $
            528,411
            
            $
            1,652
            
            $
            24,397
            
            $
            1,910
            
            $
            556,370Net
                income (loss)
            
            $
            (338,725
            )
            $
            (716,649
            )
            $
            204,590
            
            $
            (1,950,907
            )
            $
            (2,801,691
            )Capital
                Expenditures
            
            $
            70,301
            
            $
            839,565
            
            $
            —
            
            $
            861,900
            
            $
            1,771,766**Three
                months ended June 30, 2005**
            
            
            **Voice
                to Carriers**
            
            
            **VoIP
                to Consumers and Corporations**
            
            
            **Internet,
                Managed Private Networks & Other**
            
            
            **Corporate
                & Unallocated**
            
            
            **Consolidated**Net
                revenues
            
            $
            17,794,432
            
            $
            995,856
            
            $
            469,603
            
            $
            —
            
            $
            19,259,891Cost
                of revenues (exclusive of depreciation and amortization)
            
            $
            (16,709,899
            )
            $
            (734,518
            )
            $
            (259,574
            )
            $
            —
            
            $
            (17,703,991
            )Depreciation
                and amortization
            
            $
            (376,096
            )
            $
            (16,567
            )
            $
            (4,589
            )
            $
            (39,135
            )
            $
            (436,387
            )Selling,
                general and administrative
            
            $
            (1,165,252
            )
            $
            (621,165
            )
            $
            (177,548
            )
            $
            (986,233
            )
            $
            (2,950,198
            )Advertising
                and marketing
            
            $
            (47,468
            )
            $
            (32,014
            )
            $
            —
            
            $
            —
            
            $
            (79,482
            )Other
                income (expense)
            
            $
            (55,445
            )
            $
            24,554
            
            $
            16,521
            
            $
            23,656
            
            $
            9,286Net
                income (loss)
            
            $
            (559,728
            )
            $
            (383,854
            )
            $
            44,413
            
            $
            (1,001,712
            )
            $
            (1,900,881
            )Capital
                Expenditures
            
            $
            556,128
            
            $
            31,697
            
            $
            14,995
            
            $
            66,981
            
            $
            669,801





13


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**12.
      Segment Information (continued)**





Operating
      segment information for the six months ended June 30, 2006 and 2005, is
      summarized as follows:





**Six
                months ended June 30, 2006**
            
            **Voice
                to Carriers**
            
            **VoIP
                to Consumers and Corporations**
            
            **Internet,
                Managed Private Networks & Other**
            
            **Corporate
                & Unallocated**
            
            **Consolidated**Net
                revenues
            
            $
            17,893,747
            
            $
            1,331,042
            
            $
            840,481
            
            $
            —
            
            $
            20,065,270Cost
                of revenues (exclusive of depreciation and amortization)
            
            $
            (16,540,773
            )
            $
            (1,021,457
            )
            $
            (425,484
            )
            $
            —
            
            $
            (17,987,714
            )Depreciation
                and amortization
            
            $
            (385,262
            )
            $
            (29,875
            )
            $
            (17,787
            )
            $
            (45,617
            )
            $
            (478,541
            )Selling,
                general and administrative
            
            $
            (2,881,417
            )
            $
            (1,087,877
            )
            $
            (163,084
            )
            $
            (3,515,755
            )
            $
            (7,648,133
            )Advertising
                and marketing
            
            $
            (13,500
            )
            $
            (311,251
            )
            $
            —
            
            $
            —
            
            $
            (324,751
            )Other
                income
            
            $
            581,694
            
            $
            1,824
            
            $
            26,857
            
            $
            7,743
            
            $
            618,118Net
                income(loss)
            
            $
            (1,345,511
            )
            $
            (
                1,117,594
            )
            $
            260,983
            
            $
            (3,553,629
            )
            $
            (5,755,751
            )Capital
                Expenditures
            
            $
            140,602
            
            $
            984,088
            
            $
            —
            
            $
            974,985
            
            $
            2,099,675





**Six
                months ended June 30, 2005**
            
            **Voice
                to Carriers**
            
            **VoIP
                to Consumers and Corporations**
            
            **Internet,
                Managed Private Networks & Other**
            
            **Corporate
                & Unallocated**
            
            **Consolidated**Net
                revenues
            
            $
            27,923,629
            
            $
            2,183,261
            
            $
            1,082,053
            
            $
            —
            
            $
            31,188,943Cost
                of revenues (exclusive of depreciation and amortization)
            
            $
            (26,416,084
            )
            $
            (1,652,585
            )
            $
            (632,745
            )
            $
            —
            
            $
            (28,701,414
            )Depreciation
                and amortization
            
            $
            (739,228
            )
            $
            (24,226
            )
            $
            (27,182
            )
            $
            (78,775
            )
            $
            (869,411
            )Selling,
                general and administrative
            
            $
            (2,553,133
            )
            $
            (819,220
            )
            $
            (282,261
            )
            $
            (1,964,040
            )
            $
            (5,618,654
            )Advertising
                and marketing
            
            $
            (73,654
            )
            $
            (40,846
            )
            $
            (1,933
            )
            $
            —
            
            $
            (116,433
            )Other
                income (expense)
            
            $
            (415,924
            )
            $
            (14,936
            )
            $
            (17,298
            )
            $
            23,655
            
            $
            (424,503
            )Income
                (loss) from continuing operations
            
            $
            (2,274,394
            )
            $
            (368,552
            )
            $
            120,634
            
            $
            (2,019,160
            )
            $
            (4,541,472
            )Income
                from discontinued operations
            
            $
            175,000
            
            $
            —
            
            $
            —
            
            $
            —
            
            $
            175,000Net
                income (loss)
            
            $
            (2,099,394
            )
            $
            (368,552
            )
            $
            120,634
            
            $
            (2,019,160
            )
            $
            (4,366,472
            )Capital
                Expenditures
            
            $
            858,009
            
            $
            67,085
            
            $
            33,248
            
            $
            106,483
            
            $
            1,064,825





**Voice
                to Carriers**
            
            **VoIP
                to Consumers and Corporations**
            
            **Internet,
                Managed Private Networks & Other**
            
            **Corporate
                & Unallocated**
            
            **Consolidated****Assets**June
                30, 2006
            
            $
            9,096,879
            
            $
            11,795,648
            
            $
            404,069
            
            $
            7,935,582
            
            $
            29,232,178December
                31, 2005
            
            $
            7,516,881
            
            $
            10,453,247
            
            $
            322,176
            
            $
            16,093,475
            
            $
            34,385,779





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.




14


**ITEM
      2. 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 Quarterly 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. The forward looking statements are made as of the date of this Quarterly
      Report on Form 10-Q and we do not undertake to update the forward looking
      statements or to update the reasons that actual results could differ from those
      projected in the forward looking statements.*





**Overview**





We
      are an
      international communications carrier delivering VoIP to, from, in and between
      emerging markets in Asia, the Middle East, Africa, Latin America, and the
      Caribbean. We also offer on a limited basis, private networks, Internet access,
      and other advanced services. Our corporate strategy focuses our resources on
      customizing VoIP services to meet the demands of international communities
      of
      interest in emerging markets 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, and market
      intelligence. Additionally, we have worked over the last 18 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. We recently put into production the first phase of our retail
      infrastructure.





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





**Three
                Months**
            
            **Six
                Months****Ended
                June 30,**
            
            **Ended
                June 30,**2006
            
            2005
            
            2006
            
            2005Revenues
            
            $
            10,543,112
            
            $
            19,259,891
            
            $
            20,065,270
            
            $
            31,188,943Operating
                expenses:Cost
                of revenues
            
            
            9,382,411
            
            
            17,703,991
            
            
            17,987,714
            
            
            28,701,414Depreciation
                and amortization
            
            
            247,651
            
            
            436,387
            
            
            478,541
            
            
            869,411Selling,
                general and administrative
            
            
            3,969,352
            
            
            2,950,198
            
            
            7,648,133
            
            
            5,618,654Advertising
                and marketing
            
            
            301,759
            
            
            79,482
            
            
            324,751
            
            
            116,433Total
                operating expenses
            
            
            13,901,173
            
            
            21,170,058
            
            
            26,439,139
            
            
            35,305,912Operating
                Loss
            
            
            (3,358,061
            )
            
            (1,910,167
            )
            
            (6,373,869
            )
            
            (4,116,969
            )Other
                income (expense):Interest
                income
            
            
            102,117
            
            
            126,543
            
            
            235,578
            
            
            182,870Interest
                expense
            
            
            (29,514
            )
            
            (35,163
            )
            
            (59,514
            )
            
            (367,293
            )Gain
                on settlement of debt
            
            
            465,854
            
            
            5,340
            
            
            465,854
            
            
            5,340Loss
                from investment in Estel
            
            
            (33,080
            )
            
            (142,545
            )
            
            (70,638
            )
            
            (299,460
            )Other
            
            
            48,758
            
            
            5,956
            
            
            38,311
            
            
            5,956Minority
                interests
            
            
            2,235
            
            
            49,155
            
            
            8,527
            
            
            48,084Total
                other income (expense)
            
            
            556,370
            
            
            9,286
            
            
            618,118
            
            
            (424,503
            )Loss
                from continuing operations
            
            
            (2,801,691
            )
            
            (1,900,881
            )
            
            (5,755,751
            )
            
            (4,541,472
            )Income
                from discontinued operations
            
            
            —
            
            
            —
            
            
            —
            
            
            175,000Net
                loss
            
            $
            (2,801,691
            )
            $
            (1,900,881
            )
            $
            (5,755,751
            )
            $
            (4,366,472
            )





15


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





**Three
                Months**
              **Ended
                June 30,**
            
            **Six
                Months**
              **Ended
                June 30,**2006
            
            2005
            
            2006
            
            2005Revenues
            
            
            100
            %
            
            100.0
            %
            
            100
            %
            
            100.0
            %Operating
                expenses:Cost
                of revenues
            
            
            89.0
            %
            
            91.9
            %
            
            89.7
            %
            
            92.0
            %Depreciation
                and amortization
            
            
            2.4
            %
            
            2.3
            %
            
            2.4
            %
            
            2.8
            %Selling,
                general and administrative
            
            
            37.6
            %
            
            15.3
            %
            
            38.1
            %
            
            18.0
            %Advertising
                and marketing
            
            
            2.9
            %
            
            0.4
            %
            
            1.6
            %
            
            0.4
            %Total
                operating expenses
            
            
            131.9
            %
            
            109.9
            %
            
            131.8
            %
            
            113.2
            %Operating
                loss
            
            
            (31.9
            %)
            
            (9.9
            %)
            
            (31.8
            %)
            
            (13.2
            %)Other
                income (expense)Interest
                income
            
            
            1.0
            %
            
            0.7
            %
            
            1.2
            %
            
            0.6
            %Interest
                expense
            
            
            (0.3
            %)
            
            (0.2
            %)
            
            (0.3
            %)
            
            (0.12
            %)Gain
                on settlement of debt
            
            
            4.4
            %
            
            0.0
            %
            
            2.3
            %
            
            0.0
            %Loss
                from investment in Estel
            
            
            (0.3
            %)
            
            (0.7
            %)
            
            (0.3
            %)
            
            (1.0
            %)Other
            
            
            0.5
            %
            
            0.0
            %
            
            0.2
            %
            
            0.0
            %Minority
                interests
            
            
            0.0
            %
            
            0.2
            %
            
            0.0
            %
            
            0.2
            %Total
                other income (expense)
            
            
            5.3
            %
            
            0.0
            %
            
            3.1
            %
            
            (1.4
            %)Loss
                from continuing operations
            
            
            (26.6
            %)
            
            (9.9
            %)
            
            (28.7
            %)
            
            (14.6
            %)Income
                from discontinued operations
            
            
            0.0
            %
            
            0.0
            %
            
            0.0
            %
            
            0.6
            %Net
                loss
            
            
            (26.6
            %)
            
            (9.9
            %)
            
            (28.7
            %)
            
            (14.0
            %)





**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 focused 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 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 have
      increased 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 acquired a 50.2% equity interest in a joint venture with Karamco, Inc.,
      and
      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. In February 2005, we closed on the purchase of the 49.8% minority
      interest in Efonica.




On
      June
      19, 2006, we launched our Efonica VoIP service. This new service, coupled with
      the simultaneous introduction of our patent-pending Worldwide Internet Area
      Code, gives us the potential to change the way people throughout the world
      communicate. Since our launch, we have added over 250,000 subscribers, from
      over
      50 countries. We have and will continue to develop and launch a wide variety
      of
      paid services. We will market our paid features to our free subscribers and
      sell
      paid packages through physical and online distribution partners. In addition
      to
      all of the basic features of our free service, our paid packages include a
      number of value added features and services. We believe that there is value
      to
      creating a worldwide Internet calling community.


16





We
      manage
      our carrier revenues by product and customer. We manage our carrier costs by
      provider (vendor). We track carrier 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 certain Selling, General and Administrative
      resources. For example, the majority of our operations personnel support all
      product lines and are not separately hired to support individual product
      segments. For segment reporting purposes, all expenses below cost of revenues
      are allocated based on percentage of revenues unless the items can be
      specifically identified to one of the product segments.





**OPERATING
      EXPENSES**





Our
      operating expenses during the six months ended June 30, 2006 and 2005, are
      categorized as cost of revenues; depreciation and amortization; selling, general
      and administrative; and advertising and marketing.





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. It also includes amortization of our Efonica customer
      list.





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





Advertising
      and marketing expense includes online and newspaper ads for our Efonica retail
      services, as well as product press releases. It also includes costs associated
      with exhibitions we attend to promote these retail services.





**COMPANY
      HIGHLIGHTS**





The
      following summary of significant events during the six months
      ended June 30, 2006, highlights the accomplishments and events that have
      influenced our performance during that time period. This six month period
      includes many significant accomplishments including the launch of our VoIP
      services under our global Efonica brand and the introduction of our
      patent-pending Worldwide Internet Area Code.





·
              Acquired
                  Proprietary Technology - Acquired Proprietary Directed SIP Peer-to-Peer
                  Technology That Avoids Routing Internet Phone Calls Through Network
                  Of
                  Users’ Computers;·
              New
                  Partnership - Announced Partnership With AnchorFree To Market VoIP
                  Services To Users Of Large WI-FI Network;·
              Licensed
                  Market-Leading Technology - Licensed Global IP Sound’s Market-Leading
                  Technology to Power its VoIP Softphone;·
              Filed
                  Patent Application - Filed Patent Application for our Proprietary
                  VoIP
                  Technology for SIP Peer-To-Peer VoIP Communication;·
              Completion
                  of Softphone Development - Completed Development of Our Proprietary
                  PC-based VoIP Softphone, Which Allows Us to Differentiate Our Efonica®
                  VoIP Offering;·
              Launched
                  Free Internet Service - Launched New Free Internet Phone Service,
                  Which
                  Allows Efonica® Subscribers Worldwide to Make Free Calls Without
                  Computers. We Also Created the Internet Area CodeTM which allows
                  subscribers to use their existing telephone numbers preceded by
                  a
                  “10”;·
              Worldwide
                  Internet Area Code Patent - Filed Patent Application For Worldwide
                  Internet Area CodeTM; and·
              Introduction
                  of EFO Out - We Introduced One of Our New Paid Services, EFO Out,
                  Which
                  Allows Users to Call Any Landline or Mobile Telephone Number In
                  The World
                  At Extremely Competitive
                  Prices.





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





**Three
      Months Ended June 30, 2006, Compared with Three Months Ended June 30,
      2005.**





**Revenues**





Consolidated
      revenues were $10.5 million during the three months ended June 30, 2006,
      compared to $19.3 million during the three months ended June 30, 2005, a
      decrease of $8.7 million or 45.3%. Although our consolidated revenues for the
      three months ended June 30, 2006 declined from the three months ended June
      30,
      2005 (the quarter ended June 30, 2005 was an unusually large peak period),
      they
      increased approximately $1.0 million or 10.7% from the three months ended March
      31, 2006. This increase in revenue was from our voice services sold to carriers
      segment. We expect our revenue from our voice services sold to carriers to
      continue to increase in future quarters.


17








Revenues
      for VoIP services to consumers and corporations represented $0.4 million or
      4.9%
      of the consolidated revenue reduction, decreasing to $0.6 million during the
      three months ended June 30, 2006, from $1.0 million during the three months
      ended June 30, 2005. As we have focused on our new suite of retail VoIP
      services, we have scaled back some existing customers and made a strategic
      decision to service a broader spectrum of customers once our new products are
      deployed. Although it will be later in the year when we complete the full
      deployment of our free and paid retail services and fully recover on the retail
      services segment, once the recovery is complete, we expect to resume ramping
      up
      the retail VoIP service revenue.





The
      decrease in voice services sold to carriers represented 94.4% of the
      consolidated revenue reduction. Voice services sold to carriers decreased $8.2
      million or 46.2%, to $9.6 million during the three months ended June 30, 2006
      from $17.8 million during the three months ended June 30, 2005. These revenues
      were impacted by a combination of the peaks and valleys that are inherent in
      the
      carrier services business and downward pricing pressure on average rate per
      minute. The three months ended June 30, 2005 was an unusually large peak
      period.





Revenues
      from our Internet, private network & other services decreased $65,000 or
      13.9% to $0.4 million during the three months ended June 30, 2006, from $0.5
      million during the three months ended June 30, 2005 primarily due to the loss
      of
      one customer (accounted for $21,000 of the decrease) and a reduction in revenue
      from a customer (accounted for an additional $21,000 of the
      decrease).





***Cost
      of Revenues***





Consolidated
      cost of revenues decreased $8.3 million or 47.0% to $9.4 million during the
      three months ended June 30, 2006 from $17.7 million during the three months
      ended June 30, 2005. Approximately $8.0 million or 95.6% of this decrease was
      attributable to a decrease in voice services to carriers.





The
      cost
      of revenues for VoIP services to consumers and corporations decreased $0.3
      million or 39.8%, to $0.4 million during the three months ended June 30, 2006
      from $0.7 million during the three months ended June 30, 2005, due to the
      reduction in volume mentioned above.





Cost
      of
      revenues for Internet, private network & other decreased $0.1 million or
      28.9% to $0.2 million during the three months ended June 30, 2006 from $0.3
      million during the three months ended June 30, 2005. This decrease is a result
      of the revenue decreases previously discussed. When the revenues ceased, the
      corresponding cost of revenues decreased as well.





The
      consolidated gross margin percentage improved to 11.0% during the three months
      ended June 30, 2006 from 8.1% during the three months ended June 30, 2005 due
      to
      an improvement in margins in the carrier segment. The gross margin percentage
      improved in the carrier segment (from 6.1% to 8.5%) primarily due to improved
      route management. The gross margin percentage declined in the VoIP services
      to
      consumers and corporation segment (from 26.2% to 22.6%) due to pricing
      pressures. Absolute gross margin dollars for Voice services decreased by $0.3
      million and gross margin dollars for VoIP services to consumers and corporation
      decreased by $0.1 million.





**Operating
      Expenses**





***Depreciation
      and Amortization*** .
      Depreciation and amortization decreased by $0.2 million or 43.2% to
      $0.2 million during the three months ended June 30, 2006, from
      $0.4 million during the three months ended June 30, 2005. Our depreciation
      expense decreased primarily as a result of many of our assets being fully
      depreciated during the three months ended June 30, 2006, which were not fully
      depreciated during the three months ended June 30, 2005. We expect our
      depreciation expense to increase during future quarters as a result of the
      amortization of fixed assets associated with our retail VoIP infrastructure
      as
      well as our relocated New York headquarters.





***Selling,
      General and Administrative*** *.* Selling,
      general and administrative expenses increased $1.0 million or 34.5% to
      $4.0 million during the three months ended June 30, 2006, from $3.0 million
      during the three months ended June 30, 2005. This increase is primarily
      attributed to increased salaries and benefits of approximately $0.5 million,
      as
      more personnel have been required to support our growth and our retail VoIP
      infrastructure. In addition, contributing to the 2006 increase is approximately
      $0.2 million of compensation expense recorded in connection with our adoption
      of
      SFAS 123(R) on January 1, 2006. Also, increasing as a result of our growth,
      our
      VoIP retail services infrastructure and our becoming a public company in
      February 2005, have been our legal and professional fees (including
      expenses associated with Sarbanes Oxley), occupancy, and travel expenses. We
      believe that as we execute our business strategies and complete our VoIP retail
      rollout, selling, general and administrative expenses as a percentage of
      revenues will begin to decline.





***Advertising
      and Marketing**.* Advertising
      and marketing expenses increased $0.2 million or 279.7% to $0.3
      million during the three months ended June 30, 2006, from $0.1 million during
      the three months ended June 30, 2005. This increase is a result of our more
      aggressive marketing plan for our retail VoIP services.





***Operating
      Loss*** *.* Our
      operating loss increased $1.4 million or 75.8% to a loss of $3.4 million during
      the three months ended June 30, 2006, from a loss of $1.9 million during the
      three months ended June 30, 2005. The increase in operating loss was primarily
      attributable to the reduction in our gross profit of $0.4 million and the
      increase in our selling, general and administrative expenses and sales/marketing
      expenses associated with our retail VoIP infrastructure, as well as public
      company compliance requirements.








18





***Other
      Income (Expense)*** *.* Total
      other income (expense) increased $0.5 million to other income of $556,000 during
      the three months ended June 30, 2006 from other income of $9,000 during the
      three months ended June 30, 2005. The increase in other income is primarily
      attributed to $0.5 million of forgiveness of debt. During December 2003, we
      entered into 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 received a reduced rate for certain
      minutes of traffic that passed through our network until December 2005. Both
      we
      and the carrier continued to comply with the terms of this past December 2005.
      Since the settlement agreement was entered into, approximately $89,000 of
      deferred revenue was recognized in connection with this service agreement.
      During June 2006, the service agreement was cancelled and the carrier released
      us of all remaining indebtedness under the December 2003 settlement agreement.
      Consequently, the remaining deferred revenue balance of approximately $466,000
      was recorded as a gain on settlement of debt. Also contributing to the increase
      in other income is a reduction in the loss from our investment in Estel of
      approximately $0.1 million. Interest income and interest expense both remaining
      relatively consistent during the two quarters.





***Net
      Loss*** *.* The
      primary factors causing our increased net loss of $0.9 million, is the $0.4
      million reduction in gross margin and the $1.0 million increase in selling,
      general and administrative expenses, net with a $0.5 million forgiveness of
      debt.





**Six
      Months Ended June 30, 2006, Compared with Six Months Ended June 30,
      2005.**





***Revenues***





Consolidated
      revenues were $20.1 million during the six months ended June 30, 2006, compared
      to $31.2 million during the six months ended June 30, 2005, a decrease of $11.1
      million or 35.7%. This decrease can be attributed to the fact that the three
      months ended June 30, 2005 was an unusually large peak period for the voice
      to
      carrier segment. %. Although our consolidated revenues for the six months ended
      June 30, 2006 declined from the six months ended June 30, 2005, they increased
      approximately $1.9 million or 10.4% from the six months ended December 31,
      2005.
      This increase in revenue was primarily from our voice services sold to carriers
      segment.





Revenues
      for VoIP services to consumers and corporations represented $0.9 million or
      7.7%
      of the consolidated revenue reduction, decreasing to $1.3 million during the
      six
      months ended June 30, 2006, from $2.2 million during the six months ended June
      30, 2005. As we have focused on our new suite of retail VoIP services, we have
      scaled back some existing customers and made a strategic decision to service
      a
      broader spectrum of customers once our new products are deployed. Although
      it
      will be later in the year when we complete the full deployment of our free
      and
      paid retail services and fully recover on the retail services segment, once
      the
      recovery is complete, we expect to resume ramping up the retail VoIP service
      revenue.





The
      decrease in voice services sold to carriers represented 90.2% of the
      consolidated revenue reduction Voice services sold to carriers decreased $10.0
      million or 35.9%, to $17.9 million during the six months ended June 30, 2006
      from $27.9 million during the six months ended June 30, 2005. These revenues
      were impacted by a combination of the peaks and valleys that are inherent in
      the
      carrier services business and downward pricing pressure on average rate per
      minute. The three months ended June 30, 2005 was an unusually large peak period
      contributing to the decrease during the six months ended June 30, 2006.





Revenues
      from our Internet, private network & other services decreased $0.3 million
      or 22.3% to $0.8 million during the six months ended June 30, 2006, from $1.1
      million during the six months ended June 30, 2005 due to the loss of two
      customers.





***Cost
      of Revenues***





Consolidated
      cost of revenues decreased $10.7 million or 37.3% to $ 18.0 million during
      the
      six months ended June 30, 2006 from $28.7 million during the six months ended
      June 30, 2005. The decrease in consolidated cost of revenues is primarily a
      result of the volume decrease in voice to carrier revenues which decreased
      $10.0
      million or 35.9% to $17.9 million during the six months ended June 30, 2006
      from
      $27.9 million during the six months ended June 30, 2005.





The
      cost
      of revenues for VoIP services to consumers and corporations decreased $0.6
      million or 38.2%, to $1.0 million during the six months ended June 30, 2006
      from
      $1.7 million during the six months ended June 30, 2005, due to the reduction
      in
      volume mentioned above.





Cost
      of
      revenues for Internet, private network & other decreased 32.8% to $0.4
      million during the six months ended June 30, 2006 from $0.6 million during
      the
      six months ended June 30, 2005, due to the loss of two customers and other
      revenue reductions.





Consolidated
      gross margin decreased $0.4 million or 16.5% from $2.5 million during the six
      months ended June 30, 2006 to $2.1 million during the six months ended June
      30,
      2005. Gross margin for Voice services to carriers decreased by $0.2 million
      and
      gross margin for VoIP services to consumers and corporation decreased by $0.2
      million.





The
      consolidated gross margin percentage increased to 10.4% during the six months
      ended June 30, 2006 from 8.0% during the six months ended June 30, 2005. This
      increase relates primarily to the Voice services to carriers segment due to
      improved routing management.











19





***Operating
      Expenses***





***Depreciation
      and Amortization*** .
      Depreciation and amortization decreased by $0.4 million or 45.0% to
      $0.5 million during the six months ended June 30, 2006, from
      $0.9 million during the six months ended June 30, 2005. Our depreciation
      expense decreased primarily as a result of many our assets being fully
      depreciated during 2006, which incurred depreciation expense during all or
      a
      portion of the first six months of 2005.





***Selling,
      General and Administrative*** *.* Selling,
      general and administrative expenses increased $2.0 million or 36.1% to
      $7.6 million during the six months ended June 30, 2006, from
      $5.6 million during the six months ended June 30, 2005. This increase is
      primarily attributed to increased salaries and benefits of approximately $1.0
      million, as more personnel have been required to support our growth and our
      retail VoIP infrastructure. In addition, contributing to the 2006 increase
      is
      approximately $0.4 million of compensation expense recorded in connection with
      our adoption of SFAS123(R) on January 1, 2006. Also, increasing as a result
      of
      our growth, our VoIP retail service infrastructure and our becoming a public
      company in February 2005, have been our legal and professional fees
      (including expenses associated with Sarbanes Oxley), occupancy, and travel
      expenses. We believe that as we execute our business strategies and complete
      our
      VoIP retail rollout, selling, general and administrative expenses as a
      percentage of revenues will begin to decline.





***Advertising
      and Marketing**.*Advertising
      and marketing expenses
      increased $0.2 million or 178.9% to $0.3 million during the six months ended
      June 30, 2006, from $0.1 million during the six months ended June 30, 2005.
      This
      increase is a result of our more aggressive marketing plan for our retail VoIP
      services.





***Operating
      Loss*** *.* Our
      operating loss increased $2.3 million or 54.8% to a loss of $6.4 million during
      the six months ended June 30, 2006, from a loss of $4.1 million during the
      six
      months ended June 30, 2005. The increase in operating loss was primarily
      attributable to the reduction in our gross profit of $0.4 million and the
      increase in our selling, general and administrative expenses and
      advertising/marketing expenses associated with our retail VoIP infrastructure,
      and public company compliance requirements.





***Other
      Income (Expense)*** *.* Total
      other income (expense) changed to other income of approximately $0.6 million
      during the six months ended June 30, 2006 from other expense of $0.4 million
      during the six months ended June 30, 2005.




Interest
      income remained fairly consistent at $0.2 million during the six months ended
      June 30, 2006 and 2005. Interest expense decreased $0.3 million or 83.8% to
      $0.1
      million during the six months ended June 30, 2006 from $0.4 million during
      the
      six months ended June 30, 2005. The $0.4 million of interest expense during
      the
      six months ended June 30, 2005, consisted primarily of accretion on the Series
      C
      Preferred Stock which was converted to common stock in connection with our
      February 2005 IPO, at which point the accretion ceased. In addition, during
      2005, interest expense included interest for debt outstanding between January
      1,
      2005 and February 17, 2005, at which point we used our IPO proceeds to repay
      a
      significant portion of our interest-bearing debt. Interest expense during the
      six months ended June 30, 2006 and 2005 includes interest on our capital
      lease/equipment financing leases.





Gain
      on
      settlements of debt increased to $0.5 million during the six months ended June
      30, 2006 from approximately $5,000 during the six months ended June 30, 2005.
      The 2006 gain on settlement relates to a debt settlement agreement we entered
      into during 2003 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 received a reduced rate for certain minutes of
      traffic that passed through our network through December 2005. Both parties
      continued to comply with the terms of the agreement past December 2005. During
      June 2006, the service agreement was cancelled and the carrier released us
      of
      all remaining indebtedness under the settlement agreement. Consequently, we
      recorded the remaining deferred revenue balance of approximately $466,000 as
      a
      gain on settlement of debt.





The
      loss
      from investment in Estel decreased $0.2 million to $0.1 million during the
      six
      months ended June 30, 2006 from $0.3 million during the six months ended June
      30, 2005. This reduction is primarily due to improved operating results at
      Estel.





***Net
      Loss*** *.* The
      primary factors impacting our net loss for the six months ended June 30, 2006,
      were the decrease in gross margin dollars, decrease in depreciation and
      amortization expense, increase in selling, general and administrative and
      marketing/advertising expenses, decrease in interest expense, gain on debt
      settlement during 2006, and the income from discontinued operations during
      the
      six months ended June 30, 2005 which was nonrecurring during 2006.





**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 June 30, 2006,
      we had stockholders’ equity of approximately $16.8 million and a working capital
      deficit of approximately $1.0 million. Our positive stockholders’ equity is a
      result of the February 2005 closing of our initial public offering. Our IPO
      included 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 the 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; to fund the purchase of equipment for
      expanded capacity, international deployment, expanded service offerings and
      consumer hardware; the payment of debt, capital leases and related interest;
      international expansion; and marketing and advertising.


20







We
      are
      currently reviewing options to raise additional capital through debt and/or
      equity financing. While management believes that our current cash resources
      should be adequate to fund our operations for the year ending December 31,
      2006,
      our long-term liquidity is dependent on our ability to successfully complete
      the
      rollout of our full suite of retail VoIP free and paid services, in order to
      attain future profitable operations. We cannot make any guarantees if and when
      we will be able to attain future profitability.





Below
      is
      a summary of our cash flows for the periods indicated. These cash flow results
      are consistent with prior years in that we continue to use significant cash
      in
      connection with our operating and investing activities. In addition, during
      2006, we used cash in financing activities, in contrast to having cash being
      provided by financing activities, which has been the case in previous years.





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






**Six
                months ended June 30,********2006**
            
            
            ******2005**Cash
                used in operating activities
            
            $
            (6,188,621
            )
            $
            (6,222,689
            )Cash
                used in investing activities
            
            
            (2,206,230
            )
            
            (1,551,189
            )Cash
                provided by (used in) financing activities
            
            
            (483,650
            )
            
            21,369,080Increase
                (decrease) in cash and cash equivalents
            
            
            (8,878,501
            )
            
            13,595,202Cash
                and cash equivalents, beginning of period
            
            
            14,790,504
            
            
            4,368,726Cash
                and cash equivalents, end of period
            
            $
            5,912,003
            
            $
            17,963,928





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. On June 19, 2006, we launched our new free Internet service which
      allows Efonica® subscribers worldwide to make free calls without computers. We
      have and plan to continue to develop and launch a wide variety of paid services
      such as voicemail and out of network calling. We will sell these paid services
      to existing free subscribers and through online and physical distribution
      channels. Because certain of our costs are fixed and because the VoIP to
      consumers and corporations segment of our business has a higher profit margin,
      we expect that as our revenues increase (especially in the VoIP to consumers
      and
      corporations segment), total expenses would represent a smaller percentage
      of
      our revenues.





**Source
      of Liquidity**





As
      of
      June 30, 2006, we had cash and cash equivalents of approximately $5.9 million.
      In addition, as of June 30, 2006, we had approximately $0.5 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).
      This amount increased to $0.8 million during July 2006.





From
      our
      inception through June 30, 2006, 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, including exercise
      of
      the over-allotment option, and the private placement of approximately $52.3
      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 $7.9 million of fixed assets
      through capital lease/equipment financing obligations.





As
      noted
      above, we are currently reviewing options to raise additional capital through
      debt and/or equity financing. We can make no assurances that we will be able
      to
      obtain such financing nor that such financing will be obtained on reasonable
      terms.





**Uses
      of Liquidity**





Our
      short-term and long-term liquidity needs arise primarily from principal and
      interest payments related to our capital lease/equipment financing 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 $2.1 million and $1.1 million during
      the
      six months ended June 30, 2006 and 2005, respectively. The spending during
      2006
      relates primarily to our retail VoIP infrastructure as well as our relocated
      New
      York office. We expect our cash capital expenditures to be approximately $1.0
      million for the six months ending December 31, 2006. The 2006 estimated capital
      expenditures include network expansion, purchase of additional software for
      expanded product offerings and new international deployments.


21





Cash
      used
      in operations was approximately $6.2 million during the six months ended June
      30, 2006 and 2005, respectively. The cash used in our operations is primarily
      a
      function of our net losses and changes in working capital as a result of the
      timing of receipts and disbursements. Cash used in operations will be impacted
      by the over $1.5 million we plan to spend for advertising and marketing during
      the remainder of 2006. Now that we have paid and settled a significant amount
      of
      our older liabilities and our retail infrastructure has become operational
      and
      will have expanded paid service features in the future, we expect our net cash
      used in operating activities to improve in future periods. We intend to continue
      to use the remaining capital raised from the IPO for general corporate overhead
      purposes, including salaries, marketing, capital expenditures, international
      expansion, capital lease/equipment financing obligation payments, and other
      expenses associated with 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. In connection with the relocation of our New York executive
      office, 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 lease terms. Subsequent to June 30, 2006, in connection
      with our 75% owned subsidiary in Turkey, we provided a Letter of Credit for
      250,000 Euros (approximately $0.3 million) to the Telekomunikasyon Kurumu
      Telecommunication Administrator. This Letter of Credit is to secure a license
      for us to do business as a long distance telecommunication services company
      in
      Turkey. The guarantee is effective until January 1, 2007.





**Debt
      Service Requirements**





As
      of
      June 30, 2006, we had approximately $1.3 million of debt comprised primarily
      of
      approximately $1.2 million in capital lease/equipment financing obligations.
      All
      of this debt, other than approximately $78,000 is due during the 12 months
      ending June 30, 2006. Subsequent to our IPO, at which point we repaid a
      significant portion of our then outstanding debt, we have not incurred any
      additional debt other than some new capital lease/equipment financing
      obligations.





Our
      interest expense has decreased significantly during the six months ended June
      30, 2006 compared to the six months ended June 30, 2005 due to the following
      factors:





1.
            
            During
                the six months ended June 30, 2005, we recorded $0.3 million of accretion
                to interest expense related to our Series C Preferred Stock. This
                Series C
                Preferred Stock was converted to common stock during February 2005
                and
                consequently, accretion ceased on this date.2.
            
            As
                discussed above, subsequent to the IPO, the reduction in our debt
                balances
                during February 2005, resulted in a significant reduction in our
                subsequent interest expense.





**Capital
      Instruments**





At
      June
      30, 2006, we did not have any outstanding preferred stock. We had Series C
      Preferred Stock outstanding until the closing of our IPO in February 2005,
      at which point 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.





**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 our 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.


22








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 is that 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**





In
      February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid
      Financial Instruments - an amendment of FASB Statements No. 133 and 140,” which
      simplifies accounting for certain hybrid financial instruments by permitting
      fair value re-measurement for any hybrid instrument that contains an embedded
      derivative that otherwise would require bifurcation and eliminates a restriction
      on the passive derivative instruments that a qualifying special-purpose entity
      may hold. SFAS No. 155 is effective for all financial instruments acquired,
      issued or subject to a re-measurement (new basis) event occurring after the
      beginning of an entity’s first fiscal year that begins after September 15, 2006.
      The adoption of SFAS No. 155 is not expected to have an impact on our results
      of
      operations or financial position.





In
      March
      2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial
      Assets - an amendment of FASB Statement No. 140,” which establishes, among other
      things, the accounting for all separately recognized servicing assets and
      servicing liabilities by requiring that all separately recognized servicing
      assets and servicing liabilities be initially measured at fair value, if
      practicable. SFAS No. 156 is effective as of the beginning of an entity’s first
      fiscal year that begins after September 15, 2006. The adoption of SFAS No.
      156
      is not expected to have an impact on our results of operations or financial
      position.





**Inflation**





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




23





**ITEM
      3. 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
      June
      30, 2006, the majority of our cash balances were held primarily in the form
      of
      short-term highly liquid investment grade money market funds held in major
      financial institutions. 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
      June
      30, 2006, all of our outstanding debt has fixed interest rates. As such, we
      are
      not subject to interest rate risk on any of our debt. Consequently, 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 foreign currencies that could have an
      adverse impact on our future results of operations.





**ITEM
      4. CONTROLS AND PROCEDURES**





(a)  ***Evaluation
      of Disclosure Controls and Procedures*** .
      As of
      the end of the period covered by this report, our management, under the
      supervision and with the participation of our Chief Executive Officer and Chief
      Financial Officer, evaluated the effectiveness of the design and operation
      of
      our disclosure controls and procedures pursuant to Rule 13a-15(e) of the
      Securities Exchange Act of 1934, as amended (the “Exchange Act”). Based on that
      evaluation, the Chief Executive Officer and the Chief Financial Officer
      concluded that our disclosure controls and procedures as of the end of the
      period covered by this report have been designed and are functioning effectively
      to provide reasonable assurance that the information we (including our
      consolidated subsidiaries) are required to disclose in reports filed under
      the
      Exchange Act is recorded, processed, summarized and reported within the time
      periods specified in the Securities and Exchange Commission’s rules and
      forms.





(b)  ***Changes
      in Internal Controls*** .
      There
      were no changes in our internal control over financial reporting, that occurred
      during the quarter ended June 30, 2006, that has materially affected, or is
      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.




24








**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC. AND SUBSIDIARIES**





**Part
      II: Other Information**





**Item
      1. Legal Proceedings**





On
      May 28, 2003, Jack Grynberg, et al., an investor in one of the Company’s
      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, the Company filed with the Court a
      Motion to Dismiss, which was granted. The Company was 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. We asserted a counterclaim against the
      vendor and an affiliated company and are vigorously prosecuting the
      counterclaim. Our 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 us under the capital lease arrangement, no
      adjustment that may result from resolution of these uncertainties has been
      made
      in the accompanying financial statements.




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 Company’s operations or financial condition.





**Item
      1A. Risk Factors**





**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
      our
      significant contracts or partnerships, our inability to maintain working capital
      requirements to fund future operations or our inability to attract and retain
      highly qualified management, technical and sales personnel . **** All
      forward-looking statements included in this document are made as of the date
      hereof, based on information available to us as of the date thereof, and we
      assume no obligation to update any forward-looking statements.





Factors
      and risks, including certain of those described in greater detail herein, that
      could cause actual results or circumstances to differ materially from those
      set
      forth or contemplated in forward-looking statements include, without
      limitation:




·
            We
                have a history of operating and net losses. There can be no assurance
                that
                we will ever achieve profitability or have sufficient funds to execute
                our
                business strategies.




·
            We
                have recently launched a new retail VoIP service that has experienced
                significant growth in subscribers. There can be no assurances that
                our
                infrastructure can effectively support our growing subscriber
                base.·
            Part
                of our business plan is to market our paid features to our free
                subscribers and sell paid packages through physical and online
                distribution partners. There can be no assurance that we will be
                able to
                successfully sell our paid suite of services and that our revenues
                will be
                significantly increased.·
            The
                success of our planned expansion is dependent upon market developments
                and
                traffic patterns, which may lead us to make expenditures that may
                not
                result in increased revenues.




·
            We
                experienced certain technical difficulties during the recent launch
                of the
                Beta version of our retail services. Although these difficulties
                have been
                addressed, there can be no assurance as to what future technical
                difficulties we might encounter, including possible service outages,
                which
                could result in a loss of revenue and harm our
                reputation.





25





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




·
            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
                new services are dependent upon multiple, complex 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.
                In addition**,**although
                we believe we can fully support these complex systems, if we have
                too many
                subscribers, there is a possibility we can have trouble effectively
                supporting them.




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




·
            If
                our information and processing systems for billing and client service
                are
                not properly implemented, it could have a negative affect on our
                ability
                to collect revenues.




·
            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 protecting our intellectual property
                rights.




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




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




·
            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
                communications services industry is highly competitive and many of
                our
                competitors have more resources available to them, accordingly we
                may be
                unable to compete effectively.




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




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




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




·
            We
                are dependent on third-party equipment providers who may not be able
                to
                provide us the equipment necessary to deliver the services that we
                seek to
                provide.




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





·
            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.




·
            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.




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


.


·
            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. It is possible that changes in the regulatory environment
                in
                countries where we do business can adversely affect us, including
                the
                potential for blockage of our
                services.


26


**Item
      2. Unregistered Sales of Securities and Use of Proceeds**





(a) Unregistered
      Sales of Securities -
      None





(b) Use
      of
      Proceeds





The
      Company’s Registration Statement filed with the Securities and Exchange
      Commission (333-120412) on Form S-1 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 and is being utilized by the Company for
      the
      purchase of additional equipment for expanded capacity and service offerings,
      international deployment, 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
      June 30, 2006, approximately $3.0 million of the net proceeds received by the
      Company was used to repay outstanding debt and capital lease/equipment financing
      obligations, and $0.6 million was used to repay accrued interest. Approximately
      $4.5 million was used to purchase property and equipment, $0.9 million was
      used
      in connection with the Company’s purchase of the minority interest in its
      Efonica joint venture, $0.1 million for the Company’s investment in a Turkey
      joint venture, and $7.5 million was used 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, $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 $930,000 with respect to the Company’s purchase of
      the minority interest in Efonica.





**Item
      3. Defaults Upon Senior Securities**





None.





**Item
      4. Submission Of Matters to a Vote of Security Holders**





We
      held
      our Annual Meeting of Stockholders on June 15, 2006. At this meeting, the
      stockholders voted in favor of the following items listed in the Proxy Statement
      dated May 15, 2006.





(1)
            Increase
                in the number of shares available for the 1998 option plan to
                4,000,000:





**For**
            
            **Against**
            
            **Abstain**14,297,576
            
            218,755
            
            50,950





(2)  Election
      of Directors:





**Nominee**
            
            **For**
            
            **Withheld**Marvin
                S. Rosen
            
            
            21,731,162
            
            
            35,530Matthew
                D. Rosen
            
            
            21,738,162
            
            
            28,508Philip
                D. Turits
            
            
            21,738,384
            
            
            28,308E.
                Alan Brumberger
            
            
            21,738,184
            
            
            28,508Michael
                J. Del Giudice
            
            
            21,709,362
            
            
            30,330Julius
                Erving
            
            
            21,612,063
            
            
            154,629Evelyn
                Langlieb Greer
            
            
            21,668,037
            
            
            98,655Fred
                Hochberg
            
            
            21,707,812
            
            
            58,880Raymond
                E. Mabus
            
            
            21,736,384
            
            
            30,308Dennis
                Mehiel
            
            
            21,682,801
            
            
            83,891Paul
                C. O’Brien
            
            
            21,738,184
            
            
            28,508





(3)
            The
                ratification of the appointment of Rothstein, Kass & Company, P.C., as
                independent public accountants for the year ending December 31,
                2006:





**For**
            
            **Against**
            
            **Abstain**21,725,621
            
            26,785
            
            14,286


27





**Item
      5. Other Information**





Following
      the successful launch of the first phase of
      its new Efonica products, the Company has initiated a plan to divert additional
      resources toward the development, marketing and support of its new retail VoIP
      products and services. This plan includes expanding the Company’s development
      team, sales force and customer support infrastructure. As part of this plan,
      effective August 11, 2006, the Company has eliminated several executive
      management positions. The following executive officers have left the Company:
      Joel Maloff, Chief Technical Officer, Jonathan Rand, Chief Marketing Officer
      and
      Eric Ram, Executive Vice President - Business Development.





**Item
      6. Exhibits**





**Exhibit
                No.**
            
            **Description**31.1
            
            Certification
                of the Chief Executive Officer, as adopted pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002.31.2
            
            Certification
                of the Chief Financial Officer, as adopted pursuant to Section 302
                of the
                Sarbanes-Oxley Act of 2002.32
            
            Certification
                of the Chief Executive Officer and Chief Financial Officer pursuant
                to 18
                U.S.C. Section 1350, as adopted pursuant to Section 906 of the
                Sarbanes-Oxley Act of 2002.





28





**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
              TELECOMMUNICATION INTERNATIONAL, INC.**Dated:
                August 14, 2006
            By:
            /s/
                Matthew D. RosenMatthew
                D. RosenPresident
                and Chief Executive OfficerDated:
                August 14, 2006
            By:
            /s/
                Barbara HughesBarbara
                HughesChief
                Financial Officer











29