**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 March 31, 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)
                972-2000**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  ̈




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  ̈  Accelerated
      Filer  ̈   Non-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  ̈  No x




Indicate
      the number of shares outstanding of each of the issuer’s classes of capital
      stock as of May 8, 2006, is as follows:




Title
                of each Class
            
            Number
                of Shares OutstandingCommon
                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**
            **Page**Item
                l. Financial Statements
            3Item
                2. Management’s Discussion and Analysis of Financial  Condition
                and Results of Operations
            17Item
                3. Quantitative and Qualitative Disclosures About Market
                Risk
            27Item
                4. Controls and Procedures
            27**Part
                II: Other Information**Item
                1. Legal Proceedings
            28Item
                2. Unregistered Sales of Equity Securities and Use of
                Proceeds
            28Item
                3. Defaults Upon Senior Securities
            29Item
                4. Submission of Matters to a Vote of Security Holders
            29Item
                5. Other Information
            29Item
                6. Exhibits
            29







2


**Item
      1. FINANCIAL STATEMENTS**




**PART
      1 - FINANCIAL INFORMATION**




**ITEM
      1: FINANCIAL STATEMENTS**




**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC.**


**AND
      SUBSIDIARIES**





**Consolidated
      Balance Sheets**


**March
                31, 2006**
            
            **December
                31, 2005**(unaudited)**ASSETS****Current
                assets**Cash
                and cash equivalents
            
            $
            10,835,732
            
            $
            14,790,504Accounts
                receivable, net of allowance for doubtful accounts of
                approximately
              $441,000
                and $414,000, in 2006 and 2005, respectively
            
            
            3,067,707
            
            
            2,952,760Prepaid
                expenses and other current assets
            
            
            1,243,080
            
            
            1,242,266**Total
                current assets**
            
            
            15,146,519
            
            
            18,985,530**Property
                and equipment, net**
            
            
            4,778,455
            
            
            4,516,271**Other
                assets**Security
                deposits
            
            
            334,891
            
            
            331,891Restricted
                cash
            
            
            456,566
            
            
            218,176Goodwill
            
            
            5,118,640
            
            
            5,118,640Intangible
                assets, net
            
            
            4,853,392
            
            
            4,861,012Other
                assets
            
            
            349,277
            
            
            354,259Total
                other assets
            
            
            11,112,766
            
            
            10,883,978**TOTAL
                ASSETS**
            
            $
            31,037,740
            
            $
            34,385,779**LIABILITIES
                AND STOCKHOLDERS’ EQUITY****Current
                liabilities**Long-term
                debt, current portion
            
            $
            150,000
            
            $
            150,000Capital
                lease/equipment financing obligations, current portion
            
            
            1,122,221
            
            
            1,419,965Accounts
                payable and accrued expenses
            
            
            9,379,943
            
            
            9,269,341Investment
                in Estel
            
            
            691,576
            
            
            771,182Liabilities
                of discontinued operations
            
            
            236,538
            
            
            620,809**Total
                current liabilities**
            
            
            11,580,278
            
            
            12,231,297**Long-term
                liabilities**Capital
                lease/equipment financing obligations, net of current
                portion
            
            
            —
            
            
            7,650Other
                long-term liabilities
            
            
            —
            
            
            4,357,497Total
                long-term liabilities
            
            
            —
            
            
            4,365,147**Commitments
                and contingencies****Minority
                interests**
            
            
            61,402
            
            
            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
              in
                2006 and 2005, respectively
            
            
            268,942
            
            
            104,394Common
                stock, Class A $.01 par value, authorized 21,000,000 shares, 0 and
              15,739,963
                shares issued and outstanding in 2006 and 2005,
                respectively
            
            
            —
            
            
            157,400Capital
                in excess of par value
            
            
            110,068,372
            
            
            105,447,041Accumulated
                deficit
            
            
            (90,941,254
            )
            
            (87,987,194
            )Total
                stockholders’ equity
            
            
            19,396,060
            
            
            17,721,641**TOTAL
                LIABILITIES AND STOCKHOLDERS’ EQUITY**
            
            $
            31,037,740
            
            $
            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**
              **March
                31,****2006**
            
            **2005****(unaudited)**
            
            **(unaudited)****Revenues**
            
            $
            9,522,158
            
            $
            11,929,052**Operating
                expenses:**Cost
                of revenues, exclusive of depreciation
              and
                amortization shown separately below
            
            
            8,605,303
            
            
            10,997,423Depreciation
                and amortization
            
            
            230,890
            
            
            433,024Selling,
                general and administrative expenses
            
            
            3,701,773
            
            
            2,705,407Total
                operating expenses
            
            
            12,537,966
            
            
            14,135,854**Operating
                loss**
            
            
            (3,015,808
            )
            
            (2,206,802
            )**Other
                income (expense):**Interest
                income
            
            
            133,461
            
            
            56,327Interest
                expense
            
            
            (30,000
            )
            
            (332,130
            )Loss
                from investment in Estel
            
            
            (37,558
            )
            
            (156,915
            )Other
            
            
            (10,447
            )
            
            —Minority
                interests
            
            
            6,292
            
            
            (1,071
            )Total other income (expense)
            
            
            61,748
            
            
            (433,789
            )**Loss
                from continuing operations**
            
            
            (2,954,060
            )
            
            (2,640,591
            )**Discontinued
                operations:**Income
                from discontinued operations
            
            
            —
            
            
            175,000**Net
                loss**
            
            $
            (2,954,060
            )
            $
            (2,465,591
            )**Basic
                and diluted net loss per common share:**Loss
                from continuing operations
            
            $
            (0.11
            )
            $
            (0.12
            )Income
                from discontinued operations
            
            
            —
            
            
            0.01Net
                loss per common share
            
            $
            (0.11
            )
            $
            (0.11
            )**Weighted
                average shares outstanding**Basic and
                diluted weighted average shares outstanding
            
            
            26,195,614
            
            
            21,288,610








**See
      accompanying condensed notes to consolidated financial
      statements.**




4


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC.**


**AND
      SUBSIDIARIES**





**Consolidated
      Statements of Cash Flows**




**Three
                months ended March 31****2006**
            
            **2005****(unaudited)**
            
            **(unaudited)****Cash
                flows from operating activities:**Net
                loss
            
            $
            (2,954,060
            )
            $
            (2,465,591
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Loss
                from disposal of fixed assets
            
            
            7,455
            
            
            —Depreciation
                and amortization
            
            
            230,890
            
            
            433,024Bad
                debt expense, net
            
            
            (38,250
            )
            
            81,000Stock
                based compensation
            
            
            216,732
            
            
            —Gain
                on discontinued operations
            
            
            —
            
            
            (175,000
            )Accretion
                of Series C Preferred Stock
            
            
            —
            
            
            287,115Loss
                from investment in Estel
            
            
            37,558
            
            
            156,915Minority
                interests
            
            
            (6,292
            )
            
            1,071**Increase
                (decrease) in cash attributable to changes in operating assets and
                liabilities:**Accounts
                receivable
            
            
            (181,698
            )
            
            (1,355,535
            )Prepaid
                expenses and other current assets
            
            
            52,938
            
            
            377,885Other
                assets
            
            
            4,982
            
            
            670,391Accounts
                payable and accrued expenses
            
            
            (54,398
            )
            
            (943,672
            )Liabilities
                of discontinued operations
            
            
            (384,271
            )
            
            (154,572
            )**Net
                cash used in operating activities**
            
            
            (3,068,414
            )
            
            (3,086,969
            )**Cash
                flows from investing activities**Purchase
                of property and equipment
            
            
            (327,909
            )
            
            (395,024
            )Advances
                to Estel
            
            
            (32,302
            )
            
            (76,546
            )Payments
                from Estel
            
            
            20,137
            
            
            4,611Returns
                of (payments for) security deposits
            
            
            (3,000
            )
            
            182,936Repayments
                of (payments for) restricted cash
            
            
            (238,390
            )
            
            70,000Purchase
                of Jamaican joint venture, net of cash acquired
            
            
            —
            
            
            (146,486
            )Purchase
                of minority interest in Efonica joint venture, net of cashacquired
            
            
            —
            
            
            (460,419
            )**Net
                cash used in investing activities**
            
            
            (581,464
            )
            
            (820,928
            )**Cash
                flows from financing activities**Proceeds
                from sale of common stock and redeemable common stock purchasewarrants,
                net
            
            
            —
            
            
            23,286,008Proceeds
                from exercise of stock options
            
            
            —
            
            
            50,250Proceeds
                from exercise of warrants
            
            
            500
            
            
            —Payment
                of dividends on Preferred C Stock
            
            
            —
            
            
            (664,634
            )Payments
                of long-term debt and capital lease/equipment financingobligations
            
            
            (305,394
            )
            
            (1,626,691
            )Contributions
                to minority stockholders of joint ventures
            
            
            —
            
            
            (17,960
            )**Net
                cash provided by (used in) financing activities**
            
            
            (304,894
            )
            
            21,026,973**Net
                increase (decrease) in cash and cash equivalents**
            
            
            (3,954,772
            )
            
            17,119,076**Cash
                and cash equivalents, beginning of period**
            
            
            14,790,504
            
            
            4,368,726**Cash
                and cash equivalents, end of period**
            
            $
            10,835,732
            
            $
            21,487,802








**See
      accompanying condensed notes to consolidated financial
      statements.**


5


**FUSION
      TELECOMMUNICATIONS INTERNATIONAL, INC.**


**AND
      SUBSIDIARIES**





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


**Three
                months ended March 31,****2006**
            
            **2005****(unaudited)**
            
            **(unaudited)****Supplemental
                disclosure of cash flow information:**Cash
                paid during the period for interest
            
            $
            22,980
            
            $
            541,106**Supplemental
                disclosure of noncash investing and financing
                activities:**Acquisition
                of capital leases/equipment financing obligations
            
            $
            —
            
            $
            21,140Conversion
                of convertible notes payable and related debt offering
                costs
            
            $
            —
            
            $
            2,444,395Conversion
                of Series C Preferred Stock to common stock
            
            $
            —
            
            
            10,003,141Release
                of Efonica shares from escrow
            
            $
            4,357,497
            
            $
            —Issuance
                of restricted stock for consulting services
            
            $
            66,250
            
            $
            —Liability
                for acquisition of Intellectual Property Transfer
                Agreement
            
            $
            165,000
            
            $
            —**Supplemental
                disclosure of joint venture acquisition
                activities:**Fair
                value of tangible assets, net of cash acquired
            
            $
            —
            
            $
            433,585Fair
                value of identifiable intangible assets
            
            
            —
            
            
            4,690,235Goodwill
                acquired
            
            
            —
            
            
            928,671Liabilities acquired
            
            
            —
            
            
            (373,268
            )Minority
                interest acquired
            
            
            —
            
            
            (144,118
            )Common stock
                issued or to be issued
            
            
            —
            
            
            (4,928,200
            )Cash
                paid for acquisition of joint ventures, net of cash
                acquired
            
            $
            —
            
            $
            (606,905
            )


****


**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 true indication of the results for the year.




During
      the three months ended March 31, 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 income available to common stockholders
      by
      the weighted-average number of common shares outstanding during the period.
      Diluted income per share reflects the potential dilution that could occur if
      securities or other contracts to issue common stock were exercised or converted
      into common stock or resulted in the issuance of common stock that then shared
      in the income of the Company.




Unexercised
      stock options to purchase 2,673,046 and 1,577,860 shares of the Company’s common
      stock as of March 31, 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 7,448,149 and 7,568,416 shares of the Company’s common
      stock as of March 31, 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 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 expense in the Company’s
      Consolidated Statement of Operations.




The
      Company adopted SFAS No. 123R using the modified prospective method, which
      requires the application of the accounting standard as of January 1, 2006.
      The
      Company’s consolidated financial statements as of and for the quarter ended
      March 31, 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.


7


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





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**







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




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 Statement of
      Operations during the first quarter of 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 statement of
      operations for the first quarter of 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. 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.




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. As SFAS No. 123R requires that stock-based compensation expense be
      based
      on awards that are ultimately expected to vest, stock-based compensation for
      the
      three-months ended March 31, 2006, has been reduced for estimated forfeitures.
      When estimating forfeitures, the Company considered termination behaviors as
      well as trends of actual option forfeitures. The impact on the Company’s results
      of operations of recording stock-based compensation for the three-months ended
      March 31, 2006, was an expense of $204,232, which is included in selling,
      general and administrative expenses in the March 31, 2006 Consolidated Statement
      of Operations.




The
      following table illustrates the effect of the net loss and loss per share as
      if
      the Company had applied the fair value recognition provisions of SFAS No. 123R
      for the quarter ended March 31, 2005.





**Quarter
                ended March 31, 2005**Net
                loss, as reported
            
            $
            (2,465,591
            )Deduct:
                total stock-based compensation expense under fair value method for
                awards,
                net of related tax effect
            
            
            (131,846
            )Net
                loss, pro forma
            
            $
            (2,597,437
            )Loss
                per share:Basic
                and diluted loss, as reported
            
            $
            (0.11
            )Basic
                and diluted loss, pro forma
            
            $
            (0.12
            )




***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.


8





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




**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**




2. **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. Turner Hill subsequently assigned its interest
      to
      Braddon Corporate Holdings Limited (“Braddon”). The investment by Braddon was
      fully absorbed by its pro-rata share of losses during January 2005. The
      Company has continued to fund 100% of the operations and as a result, the
      Company had recorded 100% of the losses since January 2005.




In
      connection with this joint venture, the Company entered into a Service Agreement
      (the “Agreement”) with Pakistan Telecommunications Company Limited (“PTCL”),
      under which PTCL provided for the termination of incoming international traffic
      into Pakistan focusing on VoIP services from the United States and Europe.
      The
      Agreement provided for an initial term of one year, with additional one-year
      extensions terms. The Company had exercised its option to extend the Agreement,
      which was in effect through August 31, 2004. The Company was also required
      to keep on deposit with PTCL, a one month rolling advance equal to the number
      of
      minutes terminated during the preceding month, times the prevailing termination
      rate charged by PTCL to the Company.




Due
      to a
      change in market conditions during 2005, the termination of incoming VoIP
      traffic into Pakistan was no longer advantageous to the Company and thus, the
      Company decided to cease operations with Braddon. The Company terminated the
      service Agreement on November 30, 2005.




As
      of
      December 31, 2005, $415,500 of the rolling advance was owed to the Company
      by
      PTCL. During February 2006, PTCL returned $389,000 of the rolling advance,
      which was reflected in prepaids and other current assets in the
      December 31, 2005 Consolidated Balance Sheet. The remaining balance is
      currently being disputed.




***Efonica***




In
      December 2002, the Company acquired a 50.2% equity interest in a joint
      venture with Karamco, Inc. (“Karamco”) to provide various VoIP services
      throughout the emerging markets. Operations of the joint venture began during
      2003.




During
      February 2005, the Company closed on its agreement to acquire the remaining
      49.8% minority interest in Efonica from Karamco. This acquisition was completed
      to better enable Efonica to serve as the retail VoIP services division of the
      Company, offering a full suite of VoIP solutions to customers in Asia, the
      Middle East, Africa, Latin America and the Caribbean. With 100% control, the
      Company can better leverage the significant experience and relationships of
      Efonica. The operating results for the 49.8% minority interest acquired are
      included in the Consolidated Statement of Operations from the date of
      acquisition.




Under
      its
      original terms, the purchase price ranged between a minimum of $5.4 million
      and a maximum of $14.3 million. At closing, Karamco received cash of
      $500,000 and shares equal to the Base Purchase Price determined by the initial
      price of common stock at the date of the Company’s IPO. The Base Purchase Price
      was equal to 49.8% of the initial estimated valuation of Karamco or
      approximately $9.8 million. At the date of the IPO, approximately 1.44
      million of shares were issued under this agreement of which Karamco received
      approximately 765,000 shares and approximately 676,000 shares were held in
      escrow. During 2005, approval was given to release the shares then being held
      in
      escrow. Consequently, the value of these shares of approximately
      $4.4 million was reflected as goodwill and as a long-term liability in the
      December 31, 2005 Consolidated Balance Sheet. In March 2006, under an
      amendment to the Efonica Purchase Agreement, the escrowed shares were released,
      subject to a lock-up period until February 15, 2007. The release of the 675,581
      shares in escrow resulted in an increase to stockholders’ equity of
      approximately $4.4 million and a reduction to the recorded long-term
      liability.


9


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





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**




**2.
      Acquisitions and Joint Ventures - (continued)**




Out
      of
      the shares issued to Karamco, the Company agreed to register for resale 150,000
      shares of common stock in a registration statement. Karamco was restricted
      from
      selling in excess of $1 million worth of common stock during the one-year
      period following the IPO Prospectus Date. If the sale of the 150,000 shares
      registered resulted in less than $1 million of gross proceeds, the Company
      is required to pay Karamco the difference between the aggregate gross proceeds
      of Karamco’s sale of the registered shares and $1 million (the “Difference
      Payment”). As of March 31, 2006, the Company had paid Karamco $430,000 towards
      the Difference Payment which is reflected as capital in excess of par value
      in
      the accompanying Consolidated Balance Sheets as of March 31, 2006 and December
      31, 2005. In the event the Difference Payment is less than $430,000, Karamco
      is
      obligated to reimburse the Company for such excess. This obligation is secured
      by 50,387 shares held in escrow. The time period for the Difference Payment,
      under the amendment to the purchase agreement was extended to March
      2007.




During
      the three months ended March 31, 2005, the proforma impact of the acquisition
      on
      the Consolidated Statement of Operations would be a reduction in the net loss
      of
      approximately $18,000.




***iFreedom***




On
      November 14, 2005, the Company entered into an agreement to acquire the
      assets of iFreedom Communications International Holdings Limited (“iFreedom”),
      and a number of its subsidiaries, an entity that markets monthly recurring
      international VoIP service plans geared to meet the needs of consumers and
      businesses in the emerging markets. The agreement provided for a purchase price
      of $500,000 in cash, and 1,100,000 shares of 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 have not yet been met by iFreedom, the parties have been working
      in
      good faith to renegotiate the terms and conditions of the transaction and have
      reached a proposed resolution.




The
      Company now plans to acquire iFreedom’s operations in Malaysia and the
      Philippines. In addition, the Company would hire certain of iFreedom’s employees
      and potentially acquire certain other assets. The purchase price is expected
      to
      be $500,000 in cash, which may go towards satisfying certain liabilities
      iFreedom owes to the Company as described below, and 750,000 shares of
      restricted common stock, which would be held in escrow subject to a performance
      based earn out. The Company anticipates executing a formal agreement documenting
      this new understanding, although there can be no assurance that such an
      agreement will be signed, what parties will be included, or that the above
      stated terms will be included.




The
      Company has been providing termination services to iFreedom, which services
      have
      aggregated charges of approximately $479,000 as of March 31, 2006. iFreedom
      has entered into a non interest-bearing Note with respect to these charges.
      The
      Note is secured by a Security Agreement. It is expected that up to $500,000
      in
      principal amount of this Note will be offset at closing in lieu of cash due.
      The
      Company expects to resolve this outstanding receivable at closing, but can
      make
      no assurance all or any of the receivable will be paid.




**3.
      Prepaid expenses and other current assets**




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







**March
                31, 2006**
            
            **December
                31, 2005**Prepaid
                expenses
            
            $
            614,078
            
            $
            425,832Prepaid
                insurance
            
            
            92,587
            
            
            105,884Pakistan
                rolling advance
            
            
            26,500
            
            
            415,500Reimbursement
                from landlord for construction allowance
            
            
            355,880
            
            
            —Other
                current assets
            
            
            154,035
            
            
            295,050$
            1,243,080
            
            $
            1,242,266







10







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





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**




**4.
      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 quarter ended March 31, 2005. The remaining liability at
      December 31, 2005, of approximately $621,000 related to trade payables and
      accrued expenses associated with the discontinued retail telecommunications
      services. During the three months ended March 31, 2006, the Company paid
      approximately $385,000 of these outstanding liabilities.





**5.
      Accounts payable and accrued expenses**





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





**March
                31, 2006**
            
            **December
                31, 2005**Trade
                accounts payable
            
            $
            5,929,748
            
            $
            6,134,373Accrued
                expenses
            
            
            2,084,047
            
            
            1,892,216Interest
                payable
            
            
            348,332
            
            
            334,869Deferred
                revenue
            
            
            857,503
            
            
            810,837Other
            
            
            160,313
            
            
            97,046$
            9,379,943
            
            $
            9,269,341





**6.
      Long-term debt and capital lease/equipment financing
      obligations**




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




**March
                31, 2006**
            
            **December
                31, 2005**Promissory
                notes payable
            
            $
            150,000
            
            $
            150,000Capital
                lease/equipment financing obligations
            
            
            1,122,221
            
            
            1,427,615Total
                long-term debt and capital lease/equipment obligations
            
            
            1,272,221
            
            
            1,577,615Less
                current portion
            
            
            (1,272,221
            )
            
            (1,569,965
            )$
            —
            
            $
            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 March
      31, 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 has 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.





11


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





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**6.
      Long-term debt and capital lease obligations - (continued)**





At
      March
      31, 2006 and December 31, 2005, approximately $720,000 of the capital lease
      obligations were in default and accordingly have been classified as currently
      due. See Legal Matters section of Note 9 for further discussion.





Future
      aggregate principal payments as of for the Company’s debt and capital
      lease/equipment financing obligations as of March 31, 2006 are as
      follows:





Total
                minimum payments due during the period ended March 31,
                2007
            
            $
            1,621,373Less
                amount representing interest
            
            
            (349,152
            )Present
                value of minimum payments
            
            
            1,272,221Less
                current portion
            
            
            (1,272,221
            )$
            —





**7.
      Equity Transactions**





On
      February 17, 2005, the Company closed its initial public offering of securities
      of 3,600,000 shares of common stock at a price of $6.45 per share and 3,600,000
      redeemable common stock purchase warrants at $0.05 per warrant. Gross proceeds
      of the offering were approximately $23,400,000. 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 had two classes of outstanding common stock.  The
      holders of the Class A Common Stock had identical rights and privileges as
      the
      regular common stock, except that they were not able to transfer shares of
      class
      A common stock until the first anniversary of the IPO date. On February 11,
      2006, the 15,739,963 shares of outstanding Class A Common Stock were
      automatically converted into shares of common stock.




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 2 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 and 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 agreement. The $66,250 expense associated with the 25,000
      shares given to the consultant is being amortized over the six-month
      term.





12


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





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**8.
      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 remeasurement 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 remeasurement (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.





**9.
      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.




On
      March 30, 2006, an equipment vendor, filed a complaint with the Circuit
      Court in Broward County, State of Florida seeking damages in the amount of
      $1,379,502 allegedly due on two promissory notes plus accrued interest through
      March 1, 2006 and attorney costs. Management will assert a counterclaim
      against the vendor and intends to vigorously defend the action. 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.





***Letter
      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.







13


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





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**9.
      Commitments and contingencies**  **-
      (continued)**




***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
      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 is payable in cash ($15,000 was
      paid as of March 31, 2006), $120,000 is payable in cash or stock on or before
      the third anniversary of the Agreement, depending upon the attainment of
      subscriber milestones. On the second anniversary of the 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 (6th) 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
      Office for this technology.




**10.
      Segment Information**




The
      Company has three reportable segments that it operates and manages which are
      organized by products and services. The Company measures and evaluates its
      reportable segments based on revenues and cost of revenues. This segment income
      excludes unallocated corporate expenses and other adjustments arising during
      each period. The other adjustments include transactions that the chief operating
      decision makers exclude in assessing business unit performance due primarily
      to
      their non-operational and/or non-recurring nature. Although such transactions
      are excluded from the business segment results, they are included in reported
      consolidated earnings. Each segment is managed according to the products, which
      are provided to the respective customers, and information is reported on the
      basis of reporting to the Company’s Chief Operating Decision Maker. In previous
      years, the Company had four reportable segments with Voice To Carriers being
      broken out into two separate segments. Since the Company’s Chief Operating
      Decision Maker currently reviews these two segments as one, the segment
      disclosures for the quarter ended March 31, 2005 have been presented in a
      consistent manner.




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




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


14


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





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**10.
      Segment Information - (continued)**




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




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





Operating
      segment information for the three months ended March 31, 2006 and 2005 is
      summarized as follows:


**Three
                    months ended March 31, 2006****Voice
                    to**
                  **Carriers**
                
                **VoIP
                    to**
                  **Consumers**
                  **and
                    Corporations**
                
                **Internet,
                    Managed**
                  **Private**
                  **Networks
                    & Other**
                
                **Corporate
                    &**
                  **Unallocated**
                
                **Consolidated**Net
                    revenues
                
                $
                8,326,652
                
                $
                759,501
                
                $
                436,005
                
                $
                —
                
                $
                9,522,158Cost
                    of revenues (exclusive of depreciation and
                    amortization)
                
                $
                (7,785,276
                )
                $
                (579,163
                )
                $
                (240,864
                )
                $
                —
                
                $
                (8,605,303
                )Depreciation
                    and amortization
                
                $
                (184,350
                )
                $
                (16,186
                )
                $
                (8,511
                )
                $
                (21,843
                )
                $
                (230,890
                )Selling,
                    general and administrative
                
                $
                (1,417,095
                )
                $
                (565,269
                )
                $
                (132,697
                )
                $
                (1,586,712
                )
                $
                (3,701,773
                )Other
                    income (expense)
                
                $
                53,283
                
                $
                172
                
                $
                2,460
                
                $
                5,833
                
                $
                61,748Net
                    income (loss)
                
                $
                (1,006,786
                )
                $
                (400,945
                )
                $
                56,393
                
                $
                (1,602,722
                )
                $
                (2,954,060
                )Capital
                    Expenditures
                
                $
                70,301
                
                $
                144,523
                
                $
                —
                
                $
                113,085
                
                $
                327,909
 
 
 **Three
                  months ended****March
                  31, 2005**Voice
                  to
                Carriers
              
              VoIP
                  to
                Consumers
                and
                  Corporations
              
              Internet,
                  Managed
                Private
                Networks
                  & Other
              
              Corporate
                  &
                Unallocated
              
              ConsolidatedNet
                  revenues
              
              $
              10,129,198
              
              $
              1,187,405
              
              $
              612,449
              
              $
              —
              
              $
              11,929,052Cost
                  of revenues (exclusive of depreciation and
                  amortization)
              
              $
              (9,706,185
              )
              $
              (918,067
              )
              $
              (373,171
              )
              $
              —
              
              $
              (10,997,423
              )Depreciation
                  and amortization
              
              $
              (363,132
              )
              $
              (7,659
              )
              $
              (22,593
              )
              $
              (39,640
              )
              $
              (433,024
              )Selling,
                  general and administrative
              
              $
              (1,414,067
              )
              $
              (206,887
              )
              $
              (106,646
              )
              $
              (977,807
              )
              $
              (2,705,407
              )Other
                  income (expense)
              
              $
              (360,480
              )
              $
              (39,490
              )
              $
              (33,819
              )
              $
              —
              
              $
              (433,789
              )Income
                  (loss) from continuing operations
              
              $
              (1,714,666
              )
              $
              15,302
              
              $
              76,220
              
              $
              (1,017,447
              )
              $
              (2,640,591
              )Income
                  from discontinued operations
              
              $
              175,000
              
              $
              —
              
              $
              —
              
              $
              —
              
              $
              175,000Net
                  income (loss)
              
              $
              (1,539,666
              )
              $
              15,302
              
              $
              76,220
              
              $
              (1,017,447
              )
              $
              (2,465,591
              )Capital
                  Expenditures
              
              $
              301,881
              
              $
              35,388
              
              $
              18,253
              
              $
              39,502
              
              $
              395,024**Assets**March
                  31, 2006
              
              $
              7,739,027
              
              $
              10,684,610
              
              $
              354,839
              
              $
              12,259,264
              
              $
              31,037,740December
                  31, 2005
              
              $
              7,516,881
              
              $
              10,453,247
              
              $
              322,176
              
              $
              16,093,475
              
              $
              34,385,779






15





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





**CONDENSED
      NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





**10.
      Segment Information - (continued)**





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


16


**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.*




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 the emerging markets and around the world. We seek to gain early
      entry in high growth emerging markets, often in partnership with local
      organizations that have strong distribution channels, regulatory experience,
      market intelligence, the ability to deliver local loops and the capability
      of
      providing customer service support. This approach enables us to introduce our
      Internet protocol communications services in these markets, thereby benefiting
      from the time-to-market advantages, expanded geographic reach and reduced
      capital requirements that local partnerships afford. Additionally, we have
      worked over the last 15 months to build a carrier grade retail infrastructure
      to
      expand our VoIP service and feature options and to better support the growth
      of
      our VoIP services to consumers and corporations.





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




**Three
                Months ended**
              **Ended
                March 31,********2006**
            
            **2005**Revenues
            
            $
            9,522,158
            
            $
            11,929,052Operating
                Expenses:Cost
                of Revenues
            
            
            8,605,303
            
            
            10,997,423Depreciation
                and amortization
            
            
            230,890
            
            
            433,024Selling,
                general and administrative expenses
            
            
            3,701,773
            
            
            2,705,407Total
                other operating expenses
            
            
            12,537,966
            
            
            14,135,854Operating
                loss
            
            
            (3,015,808
            )
            
            (2,206,802
            )Other
                income (expense):Interest
                income
            
            
            133,461
            
            
            56,327Interest
                expense
            
            
            (30,000
            )
            
            (332,130
            )Loss
                from investment in Estel
            
            
            (37,558
            )
            
            (156,915
            )Other
                from investment in Estel
            
            
            (10,447
            )
            
            —Minority
                interests
            
            
            6,292
            
            
            (1,071
            )Total
                other income (expense)
            
            
            61,748
            
            
            (433,789
            )Loss
                from continuing operations
            
            
            (2,954,060
            )
            
            (2,640,591
            )Income
                from discontinued operations
            
            
            —
            
            
            175,000Net
                loss
            
            $
            (2,954,060
            )
            $
            (2,465,591
            )




17


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




**Three
                Months**
              **Ended
                March 31,****2006**
            
            **2005**Revenues
            
            
            100.0
            %
            
            100.0
            %Operating
                expenses:Cost
                of revenues
            
            
            90.4
            %
            
            92.2
            %Depreciation
                and amortization
            
            
            2.4
            %
            
            3.6
            %Selling,
                general and administrative
            
            
            38.9
            %
            
            22.7
            %Total
                other operating expenses
            
            
            (131.7
            )%
            
            (118.5
            )%Operating
                loss
            
            
            (31.7
            )%
            
            (18.5
            )%Other
                income (expense):Interest
                income
            
            
            1.4
            %
            
            0.5
            %Interest
                expense
            
            
            (0.3
            )%
            
            (2.8
            )%Loss
                on equity investment
            
            
            (0.4
            )%
            
            (1.3
            )%Other
                income
            
            
            (0.1
            )%
            
            0.0
            %Minority
                interests
            
            
            0.1
            %
            
            0.0
            %Total other income (expense)
            
            
            0.7
            %
            
            (3.6
            )%Loss
                from continuing operations
            
            
            (31.0
            )%
            
            (22.1
            )%Income
                from discontinued operations
            
            
            0.0
            %
            
            1.4
            %Net
                loss
            
            
            (31.0
            )%
            
            (20.7
            )%





**Revenues**




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




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




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




We
      manage
      our revenues by product and customer. We manage our costs by provider (vendor).
      We track total revenue at the customer level because our sales force has to
      manage the revenue generation at the customer level, and invoices are billed
      to
      and collected at the customer level. We also have to track the same revenues
      by
      product, because different products have different billing and payment terms,
      and individual customers may have multiple billing and payment terms if they
      purchase multiple products from us.




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


18




**Operating
      Expenses**




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




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




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




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




**Company
      Highlights**




The
      following summary of significant events during the three months ended March
      31,
      2006 and 2005, highlight the accomplishments and events that have influenced
      our
      performance during the respective periods.




***Three
      Months Ended March 31, 2006***




·
            *Acquired
                Proprietary Technology*-**Acquired
                Proprietary Directed SIP Peer-to-Peer Technology that will enable
                us to
                enter the free service VoIP market
                segment.




·
            *Completed
                Initial Buildout*-**Completed
                initial infrastructure buildout of the major network elements of
                our new
                retail infrastructure and have Beta customers using VoIP
                service.




·
            *New
                Partnership*-**Announced
                partnership with AnchorFree to market VoIP services to users of large
                wireless Internet access network.




***Three
      Months Ended March 31, 2005***




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




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




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




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




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


19




**Three
      Months Ended March 31, 2006 Compared with Three Months Ended March 31,
      2005.**





***Revenues***





Consolidated
      revenues were $9.5 million during the three months ended March 31, 2006,
      compared to $11.9 million during the three months ended March 31, 2005, a
      decrease of $2.4 million or 20.2%.





Revenues
      for VoIP services to consumers and corporations represented $0.4 million or
      17.8% of the consolidated revenue reduction, decreasing to $0.8 million during
      the three months ended March 31, 2006, from $1.2 million during the three months
      ended March 31, 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 take us through the second quarter to complete the
      deployment and fully recover on the retail services segment, once the recovery
      is complete, we expect to quickly ramp up the retail VoIP service revenue.





Voice
      services sold to carriers decreased $1.8 million or 17.8%, to $8.3 million
      during the three months ended March 31, 2006 from $10.1 million during the
      three
      months ended March 31, 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.





Revenues
      from our Internet, Private Network & Other Services decreased $0.2 million
      or 28.8% to $0.4 million during the three months ended March 31, 2006, from
      $0.6
      million during the three months ended March 31, 2005 due to the cancellation
      of
      a government contract.





***Cost
      of Revenues***





Consolidated
      cost of revenues decreased $2.4 million or 21.8% to $8.6 million during the
      three months ended March 31, 2006 from $11.0 million during the three months
      ended March 31, 2005. Approximately $1.9 million of this decrease or 80.3%
      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 36.9%, to $0.6 million during the three months ended March 31, 2006
      from $0.9 million during the first three months ended March 31, 2005, due to
      the
      reduction in volume mentioned above. Cost of revenues for Internet, Private
      Network & Other decreased 35.5% to $0.2 million during the three months
      ended March 31, 2006 from $0.4 million during the three months ended March
      31,
      2005.





Consolidated
      gross margin remained relatively consistent at $0.9 million during the three
      months ended March 31, 2006 and 2005. Gross margin for Voice services to
      carriers increased by $0.1 million, which was offset by a decrease in the gross
      margin for VoIP services to consumers and corporation of $0.1
      million.





The
      consolidated gross margin percentage increased to 9.6% during the three months
      ended March 31, 2006 from 7.8% during the three months ended March 31, 2005.
      This increase relates primarily to the Voice services to carriers segment due
      to
      the absence of technical difficulties associated with the migration to the
      Softswitch technology, which adversely impacted our ability to route traffic
      to
      the least cost provider during the three months ended March 31,
      2005.





20


***Operating
      Expenses***





***Depreciation
      and Amortization*** .
      Depreciation and amortization decreased by $0.2 million or 46.7% to
      $0.2 million during the three months ended March 31, 2006, from
      $0.4 million during the three months ended March 31, 2005. Our depreciation
      expense decreased primarily as a result of many our assets being fully
      depreciated during the first quarter of 2006, which were not fully depreciated
      during the first quarter of 2005.





***Selling,
      General and Administrative*** *.* Selling,
      general and administrative expenses increased $1.0 million or 36.8% to
      $3.7 million during the three months ended March 31, 2006, from
      $2.7 million during the three months ended March 31, 2005. This increase is
      primarily attributed to increased salaries and benefits, as more personnel
      have
      been required to support the growth and expansion of our infrastructure. In
      addition, contributing to the 2006 increase is $0.2 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 and our becoming a public
      company in February 2005, have been our legal and professional fees
      (including expenses associated with Sarbanes Oxley), occupancy,
      advertising/marketing expenses, travel related expenses, and insurance expense.
      As a percentage of revenues, selling, general and administrative expenses
      increased to 38.9% during the three months ended March 31, 2006, from 22.7%
      during the three months ended March 31, 2005. We believe that as we execute
      our
      business strategies, selling, general and administrative expenses as a
      percentage of revenues will begin to decline.





***Operating
      Loss*** *.* Our
      operating loss increased $0.8 million or 36.7% to a loss of $3.0 million during
      the three months ended March 31, 2006, from a loss of $2.2 million during the
      three months ended March 31, 2005. The increase in operating loss was primarily
      attributable to the increase in selling, general and administrative expenses
      associated with infrastructure growth and public company compliance
      requirements.





***Other
      Income (Expense)*** *.* Total
      other income (expense) changed from other expense of approximately $0.4 million
      during the three months ended March 31, 2005 to other income of $0.1 million
      during the three months ended March 31, 2006. During the first quarter of 2006,
      we had interest expense of $30,000 in contrast to interest expense of $0.3
      million during the first quarter of 2005. The $0.3 million of interest expense
      during the three month ended March 31, 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,
      interest expense was lower during the quarter ended March 31, 2006, as we used
      the IPO proceeds to repay a significant portion of our interest-bearing debt
      which was outstanding at the time of the IPO. We also had increased interest
      income during the first quarter of 2006 of $133,000 versus $56,000 during the
      first quarter of 2005, as a result of the investment of the IPO proceeds for
      the
      entire first quarter during 2006 compared to only a portion of the quarter
      during 2005. The loss from investment in Estel changed from $0.2 million during
      the three months ended March 31, 2005 to $38,000 during the three months ended
      March 31, 2006 primarily due to a reduction of the Estel allowance for bad
      debt.





***Net
      Loss*** *.* The
      primary factors impacting our net loss for the three months ended March 31,
      2006, were the increase in selling, general and administrative expenses, the
      decrease in interest expense, and the income from discontinued operations during
      the three months ended March 31, 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 March 31,
      2006, we had stockholders’ equity of approximately $19.4 million and working
      capital of approximately $3.6 million. Our positive working capital and
      stockholders’ equity are a result of the February 2005 closing of our
      initial public offering. Prior to our IPO, we had a stockholders’ deficit and a
      working capital deficit. 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 this offering were immediately used to repay
      a
      significant portion of our debt that was outstanding. The proceeds have been
      and
      will continue to be used for working capital and general corporate purposes;
      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. We may seek additional financing through the sale of debt or equity
      securities, although we have no commitments to do so.


21









Below
      is
      a summary of our cash flows for the periods indicated. These cash flow results
      are consistent with prior years in that we continued to use significant cash
      in
      connection with our operating and investing activities and had significant
      cash
      provided by financing activities.







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




**Three
                months Ended March 31,****2006**
            
            **2005**Cash
                used in operating activities
            
            $
            (3,068,414
            )
            $
            (3,086,969
            )Cash
                used in investing activities
            
            
            (581,464
            )
            
            (820,928
            )Cash
                provided by (used in) financing activities
            
            
            (304,894
            )
            
            21,026,973Increase
                (decrease) in cash and cash equivalents
            
            
            (3,954,772
            )
            
            17,119,076Cash
                and cash equivalents, beginning of period
            
            
            14,790,504
            
            
            4,368,726Cash
                and cash equivalents, end of period
            
            $
            10,835,732
            
            $
            21,487,802




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. Because certain of our costs are fixed, we expect that as our revenues
      increase, total expenses will represent a smaller percentage of our revenues.
      In
      addition, our cash flows have been impacted during 2005 and the first quarter
      of
      2006, by costs associated with the development of our new retail infrastructure
      which is expected to be completed during the second quarter of
      2006.




**Source
      of Liquidity**




As
      of
      March 31, 2006, we had cash and cash equivalents of approximately
      $10.8 million. In addition, as of March 31, 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).




From
      our
      inception through March 31, 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,
      and the private placement of approximately $50.8 million of equity
      securities, $1.6 million from the exercise of stock options and warrants,
      and $21.6 million from the issuance of notes. In addition, since inception
      we have financed the acquisition of $7.7 million of fixed assets through
      capital leases.




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




**Uses
      of Liquidity**




Our
      short-term and long-term liquidity needs arise primarily from 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 $0.3 million and $0.4 million during
      the
      three months ended March 31, 2006 and 2005, respectively. We expect our cash
      capital expenditures to be approximately $2.7 million for the nine months ending
      December 31, 2006. The 2006 estimated capital expenditures primarily
      consist of the completion of our retail infrastructure buildout, purchase of
      additional software for expanded product offerings, and international
      deployment.




Cash
      used
      in operations was approximately $3.1 million during the three months ended
      March 31, 2006 and 2005. The cash used in our operations has historically been
      a
      function of our net losses, gains on forgiveness of debt, and changes in working
      capital as a result of the timing of receipts and disbursements. Our net cash
      used in operating activities was fairly consistent between the two periods.
      Now
      that we have paid and settled a significant amount of our older liabilities
      and
      our retail infrastructure is expected to be operational during the second
      quarter of 2006, we expect our net cash used in operating activities to improve
      during future periods. We intend to continue to use our working capital raised
      from the IPO proceeds for general corporate overhead purposes, including
      salaries, marketing, capital expenditure requirements, international expansion,
      capital lease payments, and other expenses associated with the business
      needs.


22









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 the lease terms.




**Debt
      Service Requirements**




At
      March 31, 2006, we had approximately $1.3 million of current debt,
      which relates primarily to our capital lease/equipment financing obligations.
      Subsequent to our IPO in February 2005, we repaid $1.5 million of debt
      as well as $0.6 million of interest and converted $2.5 million of debt
      into common stock. Since then, we have not incurred any additional debt other
      than some new capital leases.




Our
      interest expense decreased significantly during the three months ended March
      31,
      2006 compared to March 31, 2005 due to the following factors:




1.
            We
                recorded $0.3 million of accretion to interest expense related to our
                Series C Preferred Stock during the three months ended March 31,
                2005.
                This Series C Preferred Stock was converted to common stock during
                February 2005, and consequently, accretion ceased on this date.
                Although the accretion represented a non-cash charge to interest
                expense,
                approximately $0.7 million in cash dividends were paid during
                January 2005, in connection with the Series C Preferred
                Stock.




2.
            As
                discussed above, subsequent to the IPO, the reduction in our debt
                balances
                during February 2005, resulted in a significant reduction in our
                subsequent interest expense.




**Capital
      Instruments**




At
      March 31, 2006, we did not have any outstanding preferred stock. The
      Company 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.


23









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




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




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




**Recently
      Issued Accounting Pronouncements**




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 remeasurement 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 remeasurement (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 our 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 our financial
      position.





24


**FORWARD-LOOKING
      STATEMENTS**







Certain
      statements contained herein may constitute forward-looking statements within
      the
      meaning of the Private Securities Litigation Reform Act of 1995. Because such
      statements include risks and uncertainties, actual results may differ materially
      from those expressed or implied by such forward-looking statements. Factors
      that
      could cause actual results to differ materially include, but are not limited
      to,
      risks associated with the integration of businesses following an acquisition,
      concentration of revenue from one source, competitors with broader product
      lines
      and greater resources, emergence into new markets, the termination of any of
      the
      Company’s significant contracts or partnerships, the Company’s inability to
      maintain working capital requirements to fund future operations or the Company’s
      inability to attract and retain highly qualified management, technical and
      sales
      personnel **.** 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 losses and, prior to our IPO, a working
                capital deficit and stockholders’ deficit. There can be no assurance that
                we will ever achieve profitability or have sufficient funds to execute
                our
                business strategy**.**




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




·
            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
                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 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**.**




·
            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.




25











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




·
            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.






26





**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
      March
      31, 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
      March
      31, 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 Vice
      President of Finance, 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 Vice President of Finance
      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 March 31, 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.





27


**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. Management will assert a counterclaim
      against the vendor and intends to vigorously defend the action. The Company’s
      legal counsel has advised that, at this stage, they cannot accurately predict
      the likelihood of an unfavorable outcome or quantify the amount or range of
      potential loss, if any. Accordingly, with the exception of amounts previously
      accrued by the Company under the capital lease arrangement, no adjustment that
      may result from resolution of these uncertainties has been made in the 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.




**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 approximately $23,300,000 and has been and continues
      to
      be utilized by the Company for the payment of debt, capital leases and related
      interest; the purchase of additional equipment for expanded capacity
      international deployment, expanded service offerings and consumer hardware;
      marketing and advertising; international expansion 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
      March 31, 2006, approximately $2.8 million of the net proceeds received by
      the
      Company was used to repay outstanding debt and capital leases, and $0.6 million
      was used to repay accrued interest. Approximately $2.2 million was used to
      purchase property and equipment, $7.0 million was used in connection with the
      Company’s purchase of the minority interest in its Efonica joint venture and the
      Company’s investment in a Turkey joint venture and $4.9 million was used to fund
      operations..





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


28








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**





Previously
      reported in the Company’s quarterly report on form 10-Q for the quarter ended
      March 31, 2005.




**Item
      5** . **Other
      Information**





None.




**Item
      6.**  **Exhibits**





**Exhibit
                No.**
            
            
            **Description**31.1
            
            
            Certification
                of the Chief Executive Officer, pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.31.2
            
            
            Certification
                of the Chief Financial Officer, pursuant to Section 302 of the
                Sarbanes-Oxley Act of 2002.32
            
            
            Certification
                of the Chief Executive Officer and Chief Financial Officer pursuant
                to Section 906 of the Sarbanes-Oxley Act of 2002.







29




**SIGNATURES**






Pursuant
      to the requirements of the Securities Exchange Act of 1934, the registrant
      has
      duly caused this report to be signed on its behalf by the undersigned thereunto
      duly authorized.




**FUSION
                TELECOMMUNICATIONS INTERNATIONAL, INC.**Date:
                May 15, 2006
            By:
            /s/
                Matthew D. RosenMatthew
                D. RosenPresident
                and Chief Executive Officer(Principal
                Executive Officer)


****


Date: May
                15, 2006
            By:
            /s/
                Barbara HughesBarbara
                HughesChief
                Financial Officer(Principal Financial
                Officer)






30