**UNITED
        STATES**
 **SECURITIES
        AND EXCHANGE COMMISSION**
 **Washington,
        D.C. 20549**
 
 **FORM
        10-Q**
 
 **|X|
        QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
        ACT
        OF 1934**
 
 **For
        the quarterly period ended June 30, 2005**
 
 **OR**
 
 **|_|
        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 518, 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 an accelerated filer (as defined
        in Rule
        12b-2 of the Exchange Act).
 
 Yes
        |_|       No |X|
 
 The
        number of shares outstanding of the Registrant's capital stock as of August
        12,
        2005 is as follows:
 
 
 **Title
                  of each Class**
              **Number
                  of Shares****Outstanding**Class
                  A Common Stock, $0.01 par value
              15,749,391Common
                  Stock, $0.01 par value
              11,104,962Redeemable
                  Common Stock Purchase Warrants
              7,281,838
 
  
 
  **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **INDEX**
 
 
 Part
                  I. Financial Information
              PageItem
                  l. Financial Statements
              3Item 2. Management’s Discussion and Analysis of Financial Condition and
                  Results of Operations
              17Item 3. Quantitative and Qualitative Disclosures About Market
                  Risk
              26Item 4. Controls and Procedures
              26Part
                  II. Other Information
              27Item 1. Legal Proceedings
              27Item 2. Unregistered Sales of Equity Securities and Use of
                  Proceeds
              27Item 3. Defaults Upon Senior Securities
              28Item 4. Submission of Matters to a Vote of Security
                  Holders
              28Item 5. Other Information
              28Item 6. Exhibits
              28
 
 
 2
  
 **Item
        1. FINANCIAL STATEMENTS**
 **PART
        1 - FINANCIAL INFORMATION**
 **ITEM
        1: FINANCIAL STATEMENTS**
 
 **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Consolidated
        Balance Sheets**
 **June
                      30,**
                  
                  
                  **December
                      31,****2005**
                  
                  
                  **2004****(unaudited)****ASSETS****Current
                      assets**Cash
                      and cash equivalents
                  
                  $
                  17,963,928
                  
                  $
                  4,368,726Accounts
                        receivable, net of allowance for doubtful accounts of approximately
                        $411,000 and  $414,000, in 2005 and 2004, respectively
                  
                  5,344,964
                  
                  
                  3,145,535Restricted
                      cash
                  
                  
                  75,000
                  
                  
                  145,000Prepaid
                      expenses and other current assets
                  
                  
                  414,930
                  
                  
                  889,761**Total
                      current assets**
                  
                  
                  23,798,822
                  
                  
                  8,549,022**Property
                      and equipment, net**
                  
                  
                  3,626,643
                  
                  
                  3,271,474**Other
                      assets**Security
                      deposits
                  
                  
                  726,517
                  
                  
                  902,028Restricted
                      cash
                  
                  
                  218,176
                  
                  
                  235,276Goodwill
                  
                  
                  761,143
                  
                  
                  —Intangible
                      assets, net
                  
                  
                  4,873,130
                  
                  
                  —Other
                  
                  
                  651,503
                  
                  
                  704,317**Total
                      other assets**
                  
                  
                  7,230,469
                  
                  
                  1,841,621$
                  34,655,934
                  
                  $
                  13,662,117**LIABILITIES
                      AND STOCKHOLDERS’ EQUITY (DEFICIT)****Current
                      liabilities**Long-term
                      debt, related parties, current portion
                  
                  $
                  —
                  
                  $
                  1,739,025Long-term
                      debt, current portion
                  
                  
                  150,000
                  
                  
                  2,660,281Capital
                      lease obligations, current portion
                  
                  
                  1,092,490
                  
                  
                  1,131,830Accounts
                      payable and accrued expenses
                  
                  
                  8,686,741
                  
                  
                  10,274,688Investment
                      in Estel
                  
                  
                  525,883
                  
                  
                  140,821Liabilities
                      of discontinued operations
                  
                  
                  786,303
                  
                  
                  1,116,090**Total
                      current liabilities**
                  
                  
                  11,241,417
                  
                  
                  17,062,735**Long-term
                      liabilities**Capital
                      lease obligations, net of current portion
                  
                  
                  40,837
                  
                  
                  156,495Preferred
                        stock, Series C, subject to mandatory redemption (liquidation
                        preference
                        in the aggregate of approximately $10,932,000 in 2004)
                  
                  —
                  
                  
                  9,716,026**Total
                      long-term liabilities**
                  
                  
                  40,837
                  
                  
                  9,872,521**Minority
                      interests**
                  
                  
                  194,963
                  
                  
                  16,890**Commitments
                      and contingencies****Stockholders’
                      equity (deficit)**Common
                        stock, $.01 par value, 105,000,000 shares authorized, 11,104,962
                        and 0
                        shares issued, and 10,429,381 and 0 shares outstanding in
                        2005 and 2004,
                        respectively
                  
                  
                  104,294
                  
                  
                  —Common
                        stock, Class A $.01 par value, 21,000,000 shares authorized,
                        15,749,391
                        and 17,479,993 shares issued and outstanding in 2005 and
                        2004,
                        respectively
                  
                  
                  157,494
                  
                  
                  174,800Capital
                      in excess of par value
                  
                  
                  105,875,521
                  
                  
                  65,127,291Accumulated
                      deficit
                  
                  
                  (82,958,592
                  )
                  
                  (78,592,120
                  )**Total
                      stockholders’ equity (deficit)**
                  
                  
                  23,178,717
                  
                  
                  (13,290,029
                  )$
                  34,655,934
                  
                  $
                  13,662,117
 
 See
        accompanying condensed notes to consolidated financial statements.
   3
    **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Consolidated
        Statements of Operations**
 **Three
                      months ended**June
                      30,
                
                
                
                **Six
                    months ended**June
                    30,**2005**
                
                
                **2004**
                
                
                
                **2005**
                
                
                **2004****(unaudited)**
                
                
                **(unaudited)**
                
                
                
                **(unaudited)**
                
                
                **(unaudited)****Revenues**
                
                
                $
                19,259,891
                
                **$**
                16,117,765
                
                
                **$**
                31,188,943
                
                **$**
                26,305,429**Operating
                    expenses:**Cost
                    of revenues, exclusive of depreciation and amortization shown
                    separately
                    below
                
                17,703,991
                
                
                14,001,283
                
                
                
                28,701,414
                
                
                22,710,304Depreciation
                    and amortization
                
                
                
                436,387
                
                
                441,828
                
                
                
                869,411
                
                
                879,396Selling,
                    general and administrative expenses
                
                
                
                3,029,680
                
                
                2,313,675
                
                
                
                5,735,087
                
                
                4,456,091Total
                    operating expenses
                
                
                
                21,170,058
                
                
                16,756,786
                
                
                
                35,305,912
                
                
                28,045,791**Operating
                    loss**
                
                
                
                (1,910,167
                )
                
                (639,021
                )
                
                
                (4,116,969
                )
                
                (1,740,362
                )**Other
                    income (expense)**Interest
                    income (expense), net
                
                
                
                91,380
                
                
                (538,388
                )
                
                
                (184,423
                )
                
                (823,519
                )Forgiveness
                    of debt
                
                
                
                5,340
                
                
                157,183
                
                
                
                5,340
                
                
                1,976,595Loss
                    from investment in Estel
                
                
                
                (142,545
                )
                
                (164,030
                )
                
                
                (299,460
                )
                
                (318,910
                )Other
                
                
                
                5,956
                
                
                8,500
                
                
                
                5,956
                
                
                17,750Minority
                    interests
                
                
                
                49,155
                
                
                53,264
                
                
                
                48,084
                
                
                31,381Total
                    other income (expense)
                
                
                
                9,286
                
                
                (483,471
                )
                
                
                (424,503
                )
                
                883,297**Loss
                    from continuing operations**
                
                
                
                (1,900,881
                )
                
                (1,122,492
                )
                
                
                (4,541,472
                )
                
                (857,065
                )**Discontinued
                    operations:**Income
                    from discontinued operations
                
                
                
                **-**
                
                
                -
                
                
                
                175,000
                
                
                -**Net
                    loss**
                
                
                $
                (1,900,881
                )
                **$**
                (1,122,492
                )
                
                **$**
                (4,366,472
                )
                **$**
                (857,065
                )**Losses
                    applicable to common stockholders:**Loss
                    from continuing operations
                
                
                $
                (1,900,881
                )
                **$**
                (1,122,492
                )
                
                **$**
                (4,541,472
                )
                **$**
                (857,065
                )Preferred
                    stock dividends
                
                
                
                -
                
                
                (365,961
                )
                
                
                -
                
                
                (385,918
                )**Net
                    loss applicable to common stockholders from continuing operations**
                
                (1,900,881
                )
                
                (1,488,453
                )
                
                
                (4,541,472
                )
                
                (1,242,983
                )Income
                    from discontinued operations
                
                
                
                -
                
                
                -
                
                
                
                175,000
                
                
                -**Net
                    loss applicable to common stockholders**
                
                
                $
                (1,900,881
                )
                **$**
                (1,488,453
                )
                
                **$**
                (4,366,472
                )
                **$**
                (1,242,983
                )**Basic
                    and diluted net loss per common share:**Loss
                    from continuing operations
                
                
                $
                (0.07
                )
                **$**
                (0.09
                )
                
                **$**
                (0.19
                )
                **$**
                (0.08
                )Income
                    from discontinued operations
                
                
                
                -
                
                
                -
                
                
                
                0.01
                
                
                -**Net
                    loss applicable to common stockholders**
                
                
                $
                (0.07
                )
                **$**
                (0.09
                )
                
                **$**
                (0.18
                )
                **$**
                (0.08
                )**Weighted
                    average shares outstanding**Basic
                    and diluted
                
                
                
                26,146,204
                
                
                16,542,010
                
                
                
                23,730,789
                
                
                15,967,983
 
 See
        accompanying condensed notes to consolidated financial statements.
 4
  **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Consolidated
        Statements of Cash Flows**
  **Six
                        months ended June 30,****2005**
                    
                    
                    
                    
                    **2004****(unaudited)**
                    
                    
                    
                    
                    **(unaudited)****Cash
                        flows from operating activities**Net
                        loss
                    
                    **$**
                    (4,366,472
                    )
                    
                    
                    $
                    (857,065
                    )Adjustments
                        to reconcile net loss to net cash used in operating activities:Gain
                        from sale of assets
                    
                    
                    -
                    
                    
                    
                    
                    (17,750
                    )Depreciation
                        and amortization
                    
                    
                    869,411
                    
                    
                    
                    
                    879,396Bad
                        debt expense
                    
                    
                    177,000
                    
                    
                    
                    
                    124,439Gain
                        on forgiveness of debt
                    
                    
                    (5,340
                    )
                    
                    
                    
                    (1,976,595
                    )Gain
                        on discontinued operations
                    
                    
                    (175,000
                    )
                    
                    
                    
                    -Accretion
                        of Series C Preferred Stock
                    
                    
                    287,115
                    
                    
                    
                    
                    687,389Loss
                        from investment in Estel
                    
                    
                    299,460
                    
                    
                    
                    
                    318,910Minority
                        interests
                    
                    
                    (48,084
                    )
                    
                    
                    
                    (31,381
                    )Increase
                        (decrease) in cash attributable to changes in operating assets
                        and
                        liabilities:Accounts
                        receivable
                    
                    
                    (2,180,712
                    )
                    
                    
                    
                    (2,565,160
                    )Prepaid
                        expenses and other current assets
                    
                    
                    655,197
                    
                    
                    
                    
                    (155,201
                    )Other
                        assets
                    
                    
                    (285,376
                    )
                    
                    
                    
                    11,514Accounts
                        payable and accrued expenses
                    
                    
                    (1,295,101
                    )
                    
                    
                    
                    (392,578
                    )Liabilities
                        of discontinued operations
                    
                    
                    (154,787
                    )
                    
                    
                    
                    (25,067
                    )**Net
                        cash used in operating activities**
                    
                    
                    (6,222,689
                    )
                    
                    
                    
                    (3,999,149
                    )**Cash
                        flows from investing activities:**Purchase
                        of property and equipment
                    
                    
                    (1,064,825
                    )
                    
                    
                    
                    (739,479
                    )Advances
                        to Estel
                    
                    
                    (127,784
                    )
                    
                    
                    
                    (123,833
                    )Payments
                        from Estel
                    
                    
                    82,378
                    
                    
                    
                    
                    -Purchase
                        of Jamaican joint venture, net of cash acquired
                    
                    
                    (146,486
                    )
                    
                    
                    
                    -Purchase
                        of minority interest in Efonica joint venture, net of cash
                        acquired
                    
                    
                    (480,555
                    )
                    
                    
                    
                    -Purchase
                        of Turkey joint venture, net of cash acquired
                    
                    
                    (76,528
                    )
                    
                    
                    
                    -Return
                        of security deposits
                    
                    
                    175,511
                    
                    
                    
                    
                    89,497Repayments
                        of (payments for) restricted cash
                    
                    
                    87,100
                    
                    
                    
                    
                    (120,000
                    )**Net
                        cash used in investing activities**
                    
                    
                    (1,551,189
                    )
                    
                    
                    
                    (893,815
                    )**Cash
                        flows from financing activities**Proceeds
                        from sale of common stock and warrants, net
                    
                    
                    23,888,097
                    
                    
                    
                    
                    1,277,070Proceeds
                        from sale of Series C preferred stock, net
                    
                    
                    -
                    
                    
                    
                    
                    4,628,962Proceeds
                        from exercise of stock options
                    
                    
                    50,250
                    
                    
                    
                    
                    -Proceeds
                        from exercise of warrants
                    
                    
                    85,144
                    
                    
                    
                    
                    -Repayments
                        of escrow advances
                    
                    
                    -
                    
                    
                    
                    
                    (73,330
                    )Proceeds
                        from long-term debt
                    
                    
                    -
                    
                    
                    
                    
                    600,000Payment
                        of dividends on Series C preferred stock
                    
                    
                    (664,634
                    )
                    
                    
                    
                    -Payments
                        of long-term debt and capital lease obligations
                    
                    
                    (1,971,816
                    )
                    
                    
                    
                    (788,071
                    )Contributions
                        from (to) minority stockholders of joint ventures
                    
                    
                    (17,961
                    )
                    
                    
                    
                    59,578**Net
                        cash provided by financing activities**
                    
                    
                    21,369,080
                    
                    
                    
                    
                    5,704,209**Net
                        increase in cash and cash equivalents**
                    
                    
                    13,595,202
                    
                    
                    
                    
                    811,245**Cash
                        and cash equivalents, beginning of period**
                    
                    
                    4,368,726
                    
                    
                    
                    
                    3,205,645**Cash
                        and cash equivalents, end of period**
                    
                    **$**
                    17,963,928
                    
                    
                    
                    $
                    4,016,890
 
 See
        accompanying condensed notes to consolidated financial statements.
 
 
 5
 
 **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 Consolidated
        Statements of Cash Flows (continued)
 **Six
                      months ended June 30,****2005**
                  
                  
                  **2004****(unaudited)**
                  
                  
                  **(unaudited)****Supplemental
                    disclosure of cash flow information:**Cash
                      paid during the period for interest
                  
                  $
                  602,717
                  
                  $
                  114,582**Supplemental
                    disclosure of noncash investing and financing activities:**Acquisition
                      of capital leases
                  
                  $
                  75,354
                  
                  $
                  —Conversion
                      of accounts payable to common stock
                  
                  $
                  —
                  
                  $
                  2,070Note
                      issued in settlement agreement
                  
                  $
                  —
                  
                  $
                  150,000Credits
                      received from sale of property and equipment
                  
                  $
                  —
                  
                  $
                  9,250Conversion
                      of convertible notes payable and related debt offering costs
                  
                  $
                  2,444,395
                  
                  $
                  —Conversion
                      of Series C preferred stock to common stock
                  
                  $
                  10,003,141
                  
                  $
                  —Conversion
                      of prepaid offering costs to additional paid in capital
                  
                  $
                  614,008
                  
                  $
                  —Conversion
                      of long-term debt to Series C preferred stock
                  
                  $
                  —
                  
                  $
                  585,360Issuance
                      of restricted stock for consulting services
                  
                  $
                  50,000
                  
                  $
                  —Conversion
                      of escrow advances to Series C preferred stock
                  
                  $
                  —
                  
                  $
                  176,620Stock
                      dividends issued
                  
                  $
                  —
                  
                  $
                  573,195Stock
                      dividends declared
                  
                  $
                  —
                  
                  $
                  385,918**Supplemental
                    disclosure of joint venture acquisition activities:**Fair
                      value of tangible assets, net of cash acquired
                  
                  $
                  614,284
                  
                  $
                  —Fair
                      value of indentifiable intangible assets
                  
                  
                  4,877,900
                  
                  
                  —Goodwill
                      acquired
                  
                  
                  761,143
                  
                  
                  —Liabilities
                      acquired
                  
                  
                  (377,440
                  )
                  
                  —Minority
                      interest acquired
                  
                  
                  (244,118
                  )
                  
                  —Common stock
                      issued excluding shares in escrow
                  
                  
                  (4,928,200
                  )
                  
                  —Cash
                      paid for acquisition of joint ventures, net of cash acquired
                  
                  $
                  703,569
                  
                  **$**
                  **—**
 
 See
        accompanying condensed notes to consolidated financial statements.
 
 
 6
  **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 
 **1.
        Basis of Presentation**
 
 The
        accompanying consolidated financial statements should be read in conjunction
        with the 2004 Form 10-K for Fusion Telecommunications International, Inc.
        (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.
 
 ***Goodwill
        and Other Intangible Assets***
 
 Goodwill
        represents the excess of the purchase price of an acquired business over
        the
        amounts assigned to assets acquired and liabilities assumed. In accordance
        with
        Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and
        Other Intangible Assets,” goodwill is not being amortized but is reviewed for
        impairment on an annual basis. Other intangible assets consist primarily
        of the
        trade name and trademarks associated with the Company’s wholly-owned subsidiary,
        Efonica FZ, LLC (“Efonica”). These long-lived assets are not amortized because
        they have indefinite lives. The remaining intangible asset acquired in the
        Efonica transaction is a customer list, which is being amortized using the
        straight-line method over the 10 year estimated useful life.
 
 ***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 loss available to common stockholders
        by
        the weighted-average number of common shares outstanding during the period.
        Diluted loss 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 loss of the Company.
 
 Basic
        and
        diluted loss per share and weighted average shares are the same for the three
        and six months ended June 30, 2005 and 2004, as all securities are
        anti-dilutive.
 
 Unexercised
        stock options to purchase 1,581,290 and 631,486 shares of the Company’s
        common stock as of June 30, 2005 and 2004, 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 7,539,845 and 286,578 shares of the Company’s common stock
        as of June 30, 2005 and 2004, respectively, were not included in the
        computation of diluted earnings per share because the exercise of the warrants
        would be anti-dilutive to earnings per share.
 
 Non-converted
        debt to purchase 10,714 shares of the Company’s common stock as of June 30,
        2004, was not included in the computation of diluted earnings per share because
        the conversion of the debt would be anti-dilutive to earnings per share.
        Had the
        debt been converted, interest expense would have been reduced by approximately
        $10,000 during the six months ended June 30, 2004. As of June 30, 2005, the
        Company did not have any outstanding convertible debt.
 
 ***Stock-Based
        Compensation***
 
 The
        Company follows SFAS No. 123, “Accounting for Stock-Based Compensation”. The
        provisions of SFAS No. 123 allow companies to either expense the estimated
        fair
        value of stock options or to continue to follow the intrinsic value method
        set
        forth in Accounting Principles Board Opinion No. 25, “Accounting for Stock
        Issued to Employees” (“APB 25”) but disclose the pro forma effect on net income
        (loss) had the fair value of the options been expensed. The Company has elected
        to continue to apply APB 25 in accounting for its stock option incentive
        plans.
 
 7
  **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 
 If
        compensation expense for the Company’s stock option incentive plan had been
        determined based on the fair value at the grant dates as calculated in
        accordance with SFAS No. 123, the Company’s net loss attributable to common
        stockholders and net loss per common share would approximate the pro forma
        amounts below:
 
 **For
                  the Three Months****Ended
                  June 30,**
              
              
              **For
                  the Six Months****Ended
                  June 30,****2005**
              
              
              **2004**
              
              
              **2005**
              
              
              **2004**Net
                  loss applicable to common stockholders, as reported
              
              $
              (1,900,881
              )
              $
              (1,488,453
              )
              $
              (4,366,472
              )
              $
              (1,242,983
              )Deduct:
                  total stock-based compensation expense under fair value method
                  for awards,
                  net of related tax effect
              
              
              (152,218
              )
              
              (204,367
              )
              
              (284,064
              )
              
              (369,165
              )Net
                  loss applicable to common stockholders, pro forma
              
              $
              (2,053,099
              )
              $
              (1,692,820
              )
              $
              (4,650,536
              )
              $
              (1,612,148
              )Loss
                  per share:Basic
                  and diluted loss applicable to common stockholders, as reported
              
              $
              (0.07
              )
              $
              (0.09
              )
              $
              (0.18
              )
              $
              (0.08
              )Basic
                  and diluted loss applicable to common stockholders, pro forma
              
              $
              (0.08
              )
              $
              (0.10
              )
              $
              (0.20
              )
              $
              (0.10
              )
 
 When
        the
        Company adopts SFAS 123(R), currently scheduled for the beginning of 2006,
        the
        Company will include the expense associated with share-based payments issued
        to
        employees in its Consolidated Statements of Operations. The Company has not
        yet
        completed its assessment of which valuation model or transition option to
        select. See further discussion of SFAS 123 (R) in Note 9.
 
 **2.
        Acquisitions**
 
 ***Jamaica***
 
 On
        December 16, 2004, the Company entered into an agreement to acquire 51% of
        the
        common stock of a Jamaican company for $150,000. This acquisition was completed
        to establish the Company as a licensed carrier operation in Jamaica providing
        the Company an entrance into this emerging market. The Jamaican joint venture
        did not have any results of operations until the second quarter of 2005.
        The
        closing of this acquisition took place on January 11, 2005. The following
        table
        summarizes the estimated fair values of the assets acquired and the minority
        interest on January 11, 2005:
 
 Cash
              
              $
              3,514Prepaid
                  expenses and other current assets
              
              
              17,385Property
                  and equipment, net
              
              
              25,800Other
                  assets
              
              
              100,000Goodwill
              
              
              147,419Minority
                  interest
              
              
              (144,118
              )Total
                  cash paid
              
              $
              150,000
 
  
 8
  **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 
 The
        initial purchase price allocations may be adjusted within one year of the
        purchase date for changes in estimates of the fair value of the assets acquired.
        The excess of the purchase price over the fair values of the assets acquired
        was
        allocated to goodwill.
 
 ***Efonica***
 
 During
        February 2005, the Company closed on its agreement to acquire the 49.8% minority
        interest in one of its joint ventures, Efonica from Karamco, Inc. This
        acquisition was completed to better enable Efonica to serve as the retail
        VoIP
        services division of Fusion, offering a full suite of VoIP solutions to
        customers in Asia, the Middle East, Africa, Latin America and the Caribbean.
        With 100% control, the Company can better leverage the significant experience
        and relationships of Efonica. The operating results for the 49.8%
        minority
        interest acquired are included in the consolidated statement of operations
        from
        the date of acquisition. The proforma effect of this acquisition on the
        statements of operations for the six months ended June 30, 2005, is not
        material. The proforma effect for the six months ended June 30, 2004, results
        in
        a reduction to minority interest of $56,845 and consequently, an increase
        in net
        loss of $56,845. The purchase price will be a minimum of $5,500,000 and a
        maximum of $14,300,000, as adjusted for the approximate $196,000 representing
        Karamco’s portion of Efonica’s debt owed to the Company as of the closing date
        and the $500,000 which was paid in cash during February 2005, based upon
        a
        multiple of earnings achieved by Efonica during the 12-month period ending
        February 28, 2006 (4.5 x Efonica’s net income as adjusted for certain
        intracompany and other expenses). Karamco received cash of $500,000, with
        the
        balance paid in shares of common stock. The number of shares issued to Karamco
        was determined by the $6.45 per share initial price of the common stock at
        the
        date of the Company’s IPO. On the date of the transaction, approximately
        $4,400,000 worth of such shares of common stock (675,581 shares) were issued
        to
        Karamco and are being held in escrow until the final valuation of the joint
        venture is determined after the year ending February 28, 2006. In the event
        that
        the purchase price would be lower (based upon Efonica’s net income for that one
        year period) than $10,000,000, the excess of the common shares in escrow
        will be
        returned to the Company for cancellation. In the event that the purchase
        price
        would be higher than the $10,000,000 (based upon Efonica’s net income), the
        Company will issue Karamco additional shares of our common stock (based on
        the
        IPO price of $6.45 per share), subject to the $14,300,000 maximum.
 
 Out
        of
        the shares issued to Karamco in June 2005, the Company registered for resale
        150,000 shares of common stock. The Company was obligated to repurchase the
        shares from Karamco at the higher of the IPO price or the average five (5)
        day
        bid price prior to the sixtieth day after February 11, 2005 (“IPO Prospectus
        Date”). Karamco may not sell more than $967,500 of stock during the one-year
        period following the IPO Prospectus Date. If the sale of the 150,000 shares
        that
        are to be registered results in less than $967,500 of gross proceeds the
        Company
        must pay Karamco the difference between the aggregate gross proceeds of
        Karamco’s sale of the registered shares and $967,500 (the “Difference Payment”).
        The Company has paid Karamco $325,000 towards the Difference Payment, which
        is
        included in other assets in the June 30, 2005, Consolidated Balance Sheet.
        In
        the event the Difference Payment owed is less than $325,000, Karamco shall
        immediately reimburse the Company for such excess. Karamco’s obligation to
        reimburse the Company for any excess is secured by an escrow of 50,387 shares
        of
        the Company’s common stock owned by Karamco. Karamco is owned by Roger Karam,
        who became the CEO of Efonica and the Company’s President of VoIP Services upon
        the effective date.
 
 The
        following table summarizes the estimated fair values of the assets acquired
        and
        liabilities assumed, including $20,316 of related acquisition costs:
  Cash
                
                $
                39,581Accounts
                    receivable
                
                
                64,709Prepaid
                    expenses and other current assets
                
                
                175,040Property
                    and equipment, net
                
                
                50,651Intangible
                    assets
                
                
                4,877,900Goodwill
                
                
                613,724Accounts
                    payable, accrued expenses and other
                
                
                (373,269
                )Common
                    stock issued
                
                
                (4,928,200
                )Total
                    cash paid
                
                $
                520,136
 
 The
        initial purchase price allocations were based upon an independent appraisal.
        The
        intangible assets acquired were allocated $4,579,100 to the Efonica trade
        name
        and trademarks and $298,800 was allocated to the customer list. In determining
        the purchase price allocation, the trademark was determined based upon the
        income approach through the application of the relief from royalties method
        and
        the customer list was determined based upon the income approach through the
        application of the excess earnings method. The rate used to discount the
        net
        cash flows to present values was based upon a weighted average cost of capital
        of approximately 28%. The excess of the purchase price over the fair values
        of
        the assets acquired and liabilities assumed was allocated to
        goodwill.
 
 
 9
 
 
 **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 
 ***Turkey***
 
 On
        March
        8, 2005, a new wholly owned subsidiary of the Company, Fusion Turkey, LLC
        entered into a Stock Purchase Agreement to acquire 75% of the shares of LDTS
        Uzak Mesafe Telekomikasyon ve Iletism Hizmetleri San. Tic. A.S. (“LDTS”), from
        the existing shareholders. LDTS possesses a telecommunications license approved
        by the Turkish Telecom Authority. This license will permit the Company to
        offer VoIP services under its Efonica brand and other Internet services
        to
        corporations and consumers in Turkey.
 
 The
        closing of the acquisition took place on May 6, 2005. The following table
        summarized the estimated fair value of the assets and liabilities acquired
        and
        the minority interest on May 6, 2005:
 
 Cash
              
              $
              997Prepaid
                  expense and other current assets
              
              
              1,880Other
                  assets
              
              
              178,919Accounts
                  payable and accrued liabilities
              
              
              (4,171
              )Minority
                  interest
              
              
              (100,000
              )$
              77,625
  The
        primary net asset acquired was the license (included in other assets), which
        was
        issued on March 17, 2004, and is valid for 15 years. Consequently, the license
        is being amortized over the remaining term. As the transaction closed on
        May 6,
        2005, the Consolidated Statements of Operations for the three and six months
        ended June 30, 2005, include activity related to this subsidiary. The proforma
        effect of this acquisition is not materially different than its presentation
        in
        the Consolidated Statements of Operations.
 
 **3.
        Discontinued operations**
 
 During
        2001, management of the Company decided to cease the operations of its domestic
        retail telecommunication services business lines. In connection with this
        decision, a liability at December 31, 2004, of approximately $984,000 remained
        which related to trade payables and accrued expenses. During the six months
        ended June 30, 2005, the Company determined that one of the accrued liabilities
        would be settled for $175,000 less than the amount that was accrued at December
        31, 2004, which resulted in a gain on discontinued operations of
        $175,000.
 
 **4.
        Goodwill and identifiable intangible assets**
 
 The
        changes in the amount of goodwill for the six months ended June 30,
        2005,
        by reporting segment are as follows:
 
 VoIP
                  to Consumers andCorporations
              
              
              Internet,
                  Managed Private Networksand
                  Other
              
              
              TotalBalance
                  as of December 31, 2004
              
              $
              —
              
              $
              —
              
              $
              —Goodwill
                  for Jamaican acquisition
              
              
              —
              
              
              147,419
              
              
              147,419Goodwill
                  for purchase of Efonica minority interest
              
              
              613,724
              
              
              —
              
              
              613,724Balance
                  as of June 30, 2005
              
              $
              613,724
              
              $
              147,419
              
              $
              761,143
 
 Identifiable
        intangible assets, net, as of June 30, 2005, are composed of:
 
 Trademarks
              
              $
              4,581,810Customer
                  list
              
              
              291,320$
              4,873,130
 
 
 10
  **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 
 These
        identifiable intangible assets were acquired in connection with the Company's
        purchase of the 49.8% minority interest in its Efonica joint venture. The
        trademarks are not subject to amortization as they have an indefinite life.
        Amortization on the customer list during the three and six months ended June
        30,
        2005, was $7,480. There was no customer list amortization during 2004. The
        following table presents estimated amortization expense for the remaining
        six
        months of 2005, and each of the succeeding calendar years.
 
 2005
              
              $
              14,9302006
              
              
              29,8802007
              
              
              29,8802008
              
              
              29,8802009
              
              
              29,880Thereafter
              
              
              156,870$
              291,320
 
 **5.
        Accounts payable and accrued expenses**
 
 Accounts
        payable and accrued expenses consist of the following at June 30, 2005, and
        December 31, 2004:
 
 **June
                  30,****2005**
              
              
              **December
                  31,****2004**Trade
                  accounts payable
              
              $
              5,619,031
              
              $
              5,662,058Accrued
                  expenses
              
              
              1,654,497
              
              
              2,050,175Interest
                  payable
              
              
              291,723
              
              
              814,262Dividends
                  payable on Series C Preferred Stock
              
              
              —
              
              
              664,635Deferred
                  revenue
              
              
              847,905
              
              
              971,456Other
              
              
              273,585
              
              
              112,102$
              8,686,741
              
              $
              10,274,688
 
 **6.
        Long-term debt and capital lease obligations**
 
 At
        June
        30, 2005, and December 31, 2004, components of long-term debt and capital
        lease
        obligations of the Company are comprised of the following:
 
 **June
                  30,****2005**
              
              
              **December
                  31,****2004**Convertible
                  notes payable
              
              
              (a
              )
              $
              —
              
              $
              250,000Demand
                  notes payable
              
              
              (b
              )
              
              —
              
              
              898,931Promissory
                  notes payable
              
              
              (c
              )
              
              150,000
              
              
              150,000Demand
                  notes payable
              
              
              (d
              )
              
              —
              
              
              81,790Promissory
                  notes payable
              
              
              (e
              )
              
              —
              
              
              150,000Promissory
                  notes payable
              
              
              (f
              )
              
              —
              
              
              25,000Promissory
                  notes payable
              
              
              (g
              )
              
              —
              
              
              102,000Promissory
                  notes payable
              
              
              (h
              )
              
              —
              
              
              233,252Convertible
                  notes payable
              
              
              (i
              )
              
              —
              
              
              2,508,333Capital
                  lease obligation
              
              
              (j
              )
              
              1,133,327
              
              
              1,288,325Total
                  long-term debt and capital lease obligations
              
              
              
              
              
              1,283,327
              
              
              5,687,631Less
                  current portion
              
              
              
              
              
              1,242,490
              
              
              5,531,136$
              40,837
              
              $
              156,495
 
 (a)  Balance
        at December 31, 2004, represented two convertible subordinated note agreements.
        Interest rate was 9.25% at December 31, 2004, payable semi-annually on January
        31 and July 31. During February 2005, these notes were paid in full upon
        completion of the Company’s IPO.
 
 (b)  Two
        officers of the Company entered into various loan agreements with the Company
        in
        exchange for demand notes payable. The interest rates ranged from 4.0%-4.75%
        per
        annum and were due on demand. During February 2005, these notes were paid
        in
        full upon completion of the Company’s IPO.
 
 11
  **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 
 (c)  During
        February 2004, the Company entered into a settlement agreement for $600,000.
        In
        the same month, the Company paid $450,000 and agreed to make 12 monthly payments
        for the remaining $150,000. The debt has not been repaid as of June 30, 2005,
        as
        the debtor has not complied with the terms of the settlement
        agreement.
 
 (d)  Balance
        at December 31, 2004, represented promissory notes to three stockholders.
        The
        interest rates ranged from 4.75%-12.00% per annum and were due on demand.
        During
        February 2005, these notes were paid in full upon completion of the Company’s
        IPO.
 
 (e)  Balance
        at December 31, 2004, related to various promissory notes. Interest rate
        was
        4.75% per annum. During February 2005, these notes were paid in full upon
        completion of the Company’s IPO.
 
 (f)  Balance
        at December 31, 2004, represented promissory note which bore interest
        at
        4.5% per annum. Principal and interest were payable in one lump sum on the
        earlier of 15 days from the completion of an IPO or September 1, 2005. During
        February 2005, this note was repaid in full upon completion of the Company’s
        IPO.
 
 (g)  Balance
        at December 31, 2004, represented a loan agreement which bore interest at
        15%.
        During February 2005, the note was repaid in full upon completion of the
        Company’s IPO.
 
 (h)  The
        balance at December 31, 2004, relates to promissory notes to various
        stockholders for the purpose of resolving the Company’s capital lease debt
        service contract with the lessor of the equipment under lease. The notes
        accrued
        interest at 8% per annum. The balance also related to an equipment lease
        with a
        non-related party. These notes were all repaid during the six months ended
        June
        30, 2005.
 
 (i)  Balance
        at December 31, 2004, represented two convertible notes, which bore interest
        at
        6.5% per annum. In February 2005, these notes were automatically converted
        into
        651,515 common shares (based upon a conversion price of $3.85 per share)
        upon
        the completion of the Company’s IPO.
 
 (j)  At
        June
        30, 2005 and December 31, 2004, approximately $720,000 of the capital lease
        obligations were in default and accordingly has been classified as currently
        due.
 
 **7.
        Series C Preferred Stock**
 
 At
        December 31, 2004, there were 109,962 shares of the $90 Series C Convertible
        Redeemable Preferred Stock (“Series C Preferred Stock”) outstanding. The holders
        of the Series C Preferred Stock were entitled to receive cumulative dividends
        of
        8% per share per annum which were payable annually beginning on December
        18,
        2004, and were payable in cash, unless the Company completed its IPO before
        December 18, 2004. Since the IPO was not completed until February 2005, the
        dividends on the Series C Preferred Stock of approximately $665,000 were
        paid on
        January 18, 2005. Upon the closing of the Company’s initial public offering
        during February 2005, the 109,962 outstanding shares of the Series C Preferred
        Stock were automatically converted into 3,141,838 shares of the Company’s common
        stock and 3,141,838 Redeemable Common Stock Purchase Warrants. There was
        no
        beneficial conversion feature associated with this conversion.
 
 **8.
        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 has two classes of outstanding common stock. The
        holders
        of the Class A Common Stock have identical rights and privileges as the regular
        common stock, except that they will not be able to transfer shares of Class
        A
        Common Stock until the first anniversary of the date of the prospectus, which
        was February 11, 2005. After the date of the IPO, the Class A Common Stock
        may
        be converted at the option of the holder, without the consent of the
        underwriters, if the holder executes and delivers a lock up agreement preventing
        the public sale of the common stock until the first anniversary of the date
        of
        the IPO. The Class A common stock will automatically convert into the regular
        common stock on the first anniversary of the date of the IPO.
 
 Upon
        completion of the IPO, $2.5 million of convertible debt was converted into
        651,515 shares of common stock. In addition, 1,439,643 shares of common stock
        were issued (of which 675,581 shares are held in escrow) in connection with
        the
        Company’s acquisition of the 49.8% minority interest in Efonica (see Note 2 for
        further discussion). In accordance with SFAS No. 141, since 675,581 of these
        shares are held in escrow and this consideration is contingent on specified
        events in the future, these shares are not reflected as outstanding as of
        June
        30, 2005. In addition, as discussed in Note 7, all outstanding Series C
        preferred stock was converted into common stock.
  12
  **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 
 During the
        six months ended June 30, 2005, a director exercised stock options which
        resulted in the issuance of 21,429 shares of common stock and two individuals
        exercised warrants, which resulted in the issuance of 28,572 shares of Class
        A
        common stock.
 
 On
        April
        19, 2005, the Company entered into a consulting service agreement. In connection
        with this agreement, the Company issued 11,363 shares of restricted common
        stock
        based upon a price of $4.40 per share. Subsequent to June 30, 2005, the
        restricted shares have been released in accordance with the agreement. The
        $50,000 expense associated with these shares is being amortized over the
        one-year term of the agreement.
 
 **9.
        Current Accounting Pronouncements**
 
 In
        May
        2005, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 154,
“Accounting Changes and Error Corrections.” SFAS No. 154 is a replacement of APB
        No. 20 and FASB Statement No. 3 SFAS No. 154 provides guidance on the accounting
        for and reporting of accounting changes and error corrections. It establishes
        retrospective application as the required method for reporting a change in
        accounting principle. SFAS No. 154 provides guidance for determining whether
        retrospective application is impractical. The reporting of a correction of
        an
        error, by restating previously issued financial statements, is also addressed
        by
        SFAS No. 154. SFAS No. 154 is effective for accounting changes and corrections
        of errors made in fiscal years beginning after December 15, 2005. The Company
        will adopt this pronouncement at the beginning of fiscal year 2006.
 
 In
        December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based
        Payment” (“SFAS 123(R)”). This Statement requires companies to expense the
        estimated fair value of stock options and similar equity instruments issued
        to
        employees. Currently, companies are required to calculate the estimated fair
        value of these share-based payments and can elect to either include the
        estimated cost in earnings or disclose the pro forma effect in the footnotes
        to
        their financial statements. The Company has chosen to disclose the pro forma
        effect. The fair value concepts were not changed significantly in SFAS 123(R);
        however, in adopting this Standard, companies must choose among alternative
        valuation models and amortization assumptions. The valuation model the Company
        has used continues to be available, but the Company has not yet completed
        its
        assessment of the alternatives. In April 2005, the SEC announced a deferral
        of
        the effective date of SFAS 123(R) for calendar year companies until the
        beginning of 2006.
 
 **10.
        Contingencies**
 
 ***Legal
        Matters***
 
 On
        April
        15, 2003, World Access, Inc., a former customer, brought an action against
        the
        Company for recovery of preferential transfers and other claims under the
        Bankruptcy Code in the United States Bankruptcy Court, Northern District
        of
        Illinois Eastern Division ( *In
        Re: World Access, Inc., et al vs. Fusion Telecommunications International,
        Inc.,* Adv.
        Pro.
        No. 03 A 00851). The suit seeks damages in the amount of approximately $335,000
        for alleged avoidance of preferential transfers, recovery of transfers, setoff,
        recovery setoff, payment of improperly setoff debt, turnover of property,
        and
        damages for overdue debt and turnover of property. The Company filed a proof
        of
        claim with the court in the amount of approximately $85,000 for amounts that
        were due at the time this customer filed bankruptcy. In March 2005, the Company
        settled this matter for $5,500, and agreed to waive the Company’s proof of claim
        in the amount of approximately $85,000. The Company expects to execute the
        formal settlement agreement on or before September 1, 2005.
  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: 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 plaintiffs have filed an appeal of the motion, which is
        pending.
  Due
        to
        the regulatory nature of the industry, the Company is periodically involved
        in
        various correspondence and inquiries from state and federal regulatory agencies.
        Management does not expect the outcome of these inquiries to have a material
        impact on the operations or the financial condition of the Company.
  13
 
 **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 **11.
        Segment Information**
 
 The
        Company has four 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.
 
 The
        Company’s segments and their principal activities consist of the following:
 
 Traditional
        Voice — This segment includes the termination of voice telephony minutes from or
        to the countries served by the Company, utilizing traditional Time Division
        Multiplexing (TDM) and “circuit-switched” technology. Typically, this will
        include interconnection with traditional telecommunications carriers either
        located internationally or those carriers that interconnect with the Company
        at
        its US Points of Presence (POP) and provide service to other
        destinations.
 
 VoIP
        (Voice over Internet Protocol) to Carriers — VoIP includes the termination of
        voice telephony minutes by the Internet rather than older circuit-switched
        technology. This permits far less costly and more rapid interconnection between
        the Company and international telecommunications carriers.
 
 VoIP
        (Voice over Internet Protocol) to Consumers and Corporations — Primarily through
        the Company’s Efonica subsidiary and Estel joint venture, the Company provides
        VoIP services targeted to end-users and corporations. 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 US,
        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. Lastly, the Company offers the
        Interview desktop-to-desktop video conferencing service to customers anywhere
        in
        the world.
  Operating
        segment information for the three months ended June 30, 2005 and 2004, is
        summarized as follows:
 
 **June
                  30, 2005**
              
              
              **Traditional
                  Voice**
              
              
              **VoIP
                  to Carriers**
              
              
              **VoIP
                  to Consumers and Corporations**
              
              
              **Internet,
                  Managed Private Networks & Other**
              
              
              **Corporate
                  & Unallocated**
              
              
              **Consolidated**Net
                  revenues
              
              $
              2,628,360
              
              $
              15,166,072
              
              $
              995,856
              
              $
              469,603
              
              $
              -
              
              $
              19,259,891Cost
                  of revenues (exclusive of depreciation and amortization)
              $
              (2,464,576
              )
              $
              (14,245,323
              )
              $
              (734,518
              )
              $
              (259,574
              )
              $
              -
              
              $
              (17,703,991
              )Depreciation
                  and amortization
              
              $
              (35,402
              )
              $
              (340,694
              )
              $
              (16,567
              )
              $
              (4,589
              )
              $
              (39,135
              )
              $
              (436,387
              )Selling,
                  general and administrative
              
              $
              (80,720
              )
              $
              (1,132,000
              )
              $
              (653,179
              )
              $
              (177,548
              )
              $
              (986,233
              )
              $
              (3,029,680
              )Other
                  income (expense)
              
              $
              67,931
              
              $
              (123,376
              )
              $
              24,554
              
              $
              16,521
              
              $
              23,656
              
              $
              9,286Net
                  income (loss)
              
              $
              115,593
              
              $
              (675,321
              )
              $
              (383,854
              )
              $
              44,413
              
              $
              (1,001,712
              )
              $
              (1,900,881
              )Capital
                  Expenditures
              
              $
              83,395
              
              $
              472,733
              
              $
              31,697
              
              $
              14,995
              
              $
              66,981
              
              $
              669,801
 
 14
 
 **FUSION
        TELECOMMUNICATIONS INTERNATIONAL, INC.**
 **AND
        SUBSIDIARIES**
 
 **Condensed
        Notes to Consolidated Financial Statements**
 
 **June
                  30, 2004**
              
              
              **Traditional
                  Voice**
              
              
              **VoIP
                  to Carriers**
              
              
              **VoIP
                  to Consumers and Corporations**
              
              
              **Internet,
                  Managed Private Networks & Other**
              
              
              **Corporate
                  & Unallocated**
              
              
              **Consolidated**Net
                  revenues
              
              $
              4,308,334
              
              $
              10,751,327
              
              $
              495,621
              
              $
              562,483
              
              $
              -
              
              $
              16,117,765Cost
                  of revenues (exclusive of depreciation and amortization)
              $
              (3,758,378
              )
              $
              (9,477,701
              )
              $
              (365,865
              )
              $
              (399,339
              )
              $
              -
              
              $
              (14,001,283
              )Depreciation
                  and amortization
              
              $
              (123,270
              )
              $
              (258,590
              )
              $
              (7,536
              )
              $
              (11,757
              )
              $
              (40,675
              )
              $
              (441,828
              )Selling,
                  general and administrative
              
              $
              (455,608
              )
              $
              (955,950
              )
              $
              (166,612
              )
              $
              (33,292
              )
              $
              (702,213
              )
              $
              (2,313,675
              )Other
                  income (expense)
              
              $
              (198,366
              )
              $
              (683,843
              )
              $
              (3,283
              )
              $
              (64,574
              )
              $
              466,595
              
              $
              (483,471
              )Net
                  income (loss)
              
              $
              (227,288
              )
              $
              (624,757
              )
              $
              (47,675
              )
              $
              53,521
              
              $
              (276,293
              )
              $
              (1,122,492
              )Capital
                  Expenditures
              
              $
              130,417
              
              $
              334,536
              
              $
              15,617
              
              $
              19,322
              
              $
              55,544
              
              $
              555,436
 
 Operating
        segment information for the six months ended June 30, 2005 and 2004, is
        summarized as follows:
 
 **June
                  30, 2005**
              
              
              **Traditional
                  Voice**
              
              
              **VoIP
                  to Carriers**
              
              
              **VoIP
                  to Consumers and Corporations**
              
              
              **Internet,
                  Managed Private Networks & Other**
              
              
              **Corporate
                  & Unallocated**
              
              
              **Consolidated**Net
                  revenues
              
              $
              5,478,519
              
              $
              22,445,110
              
              $
              2,183,261
              
              $
              1,082,053
              
              $
              -
              
              $
              31,188,943Cost
                  of revenues (exclusive of depreciation and amortization)
              $
              (5,267,874
              )
              $
              (21,148,210
              )
              $
              (1,652,585
              )
              $
              (632,745
              )
              $
              -
              
              $
              (28,701,414
              )Depreciation
                  and amortization
              
              $
              (137,794
              )
              $
              (601,434
              )
              $
              (24,226
              )
              $
              (27,182
              )
              $
              (78,775
              )
              $
              (869,411
              )Selling,
                  general and administrative
              
              $
              (507,097
              )
              $
              (2,119,690
              )
              $
              (860,066
              )
              $
              (284,194
              )
              $
              (1,964,040
              )
              $
              (5,735,087
              )Other
                  income (expense)
              
              $
              (87,690
              )
              $
              (328,234
              )
              $
              (14,936
              )
              $
              (17,298
              )
              $
              23,655
              
              $
              (424,503
              )Income
                  (loss) from continuing operations
              
              $
              (521,936
              )
              $
              (1,752,458
              )
              $
              (368,552
              )
              $
              120,634
              
              $
              (2,019,160
              )
              $
              (4,541,472
              )Income
                  from discontinued operations
              
              $
              175,000
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              175,000Net
                  income (loss)
              
              $
              (346,936
              )
              $
              (1,752,458
              )
              $
              (368,552
              )
              $
              120,634
              
              $
              (2,019,160
              )
              $
              (4,366,472
              )Capital
                  Expenditures
              
              $
              168,338
              
              $
              689,671
              
              $
              67,085
              
              $
              33,248
              
              $
              106,483
              
              $
              1,064,825
 
 **June
                  30, 2004**
              
              
              **Traditional
                  Voice**
              
              
              **VoIP
                  to Carriers**
              
              
              **VoIP
                  to Consumers and Corporations**
              
              
              **Internet,
                  Managed Private Networks & Other**
              
              
              **Corporate
                  & Unallocated**
              
              
              **Consolidated**Net
                  revenues
              
              $
              6,676,994
              
              $
              17,666,897
              
              $
              836,003
              
              $
              1,125,535
              
              $
              -
              
              $
              26,305,429Cost
                  of revenues (exclusive of depreciation and amortization)
              $
              (5,821,462
              )
              $
              (15,533,514
              )
              $
              (588,632
              )
              $
              (766,696
              )
              $
              -
              
              $
              (22,710,304
              )Depreciation
                  and amortization
              
              $
              (240,542
              )
              $
              (505,012
              )
              $
              (12,278
              )
              $
              (40,548
              )
              $
              (81,016
              )
              $
              (879,396
              )Selling,
                  general and administrative
              
              $
              (860,928
              )
              $
              (1,764,348
              )
              $
              (242,338
              )
              $
              (145,126
              )
              $
              (1,443,351
              )
              $
              (4,456,091
              )Other
                  income (expense)
              
              $
              1,100,396
              
              $
              (334,966
              )
              $
              (2,435
              )
              $
              (57,391
              )
              $
              177,693
              
              $
              883,297Net
                  income (loss)
              
              $
              854,458
              
              $
              (470,943
              )
              $
              (9,680
              )
              $
              115,774
              
              $
              (1,346,674
              )
              $
              (857,065
              )Capital
                  Expenditures
              
              $
              168,929
              
              $
              446,975
              
              $
              21,151
              
              $
              28,476
              
              $
              73,948
              
              $
              739,479
  15
  **Traditional
                  Voice**
              
              
              **VoIP
                  to Carriers**
              
              
              **VoIP
                  to Consumers and Corporations**
              
              
              **Internet,
                  Managed Private Networks & Other**
              
              
              **Corporate
                  & Unallocated**
              
              
              **Consolidated****Assets**June
                  30, 2005
              
              $
              1,728,304
              
              $
              6,929,922
              
              $
              6,452,743
              
              $
              340,847
              
              $
              19,204,118
              
              $
              34,655,934December
                  31, 2004
              
              $
              2,074,700
              
              $
              4,563,839
              
              $
              547,588
              
              $
              433,707
              
              $
              6,042,283
              
              $
              13,662,117
 
 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
        condensed notes thereto included in another part of this quarterly report.
        This
        discussion contains certain forward-looking statements that involve substantial
        risks and uncertainties. When used in this report the words
“anticipate,”“believe,”“estimate,”“expect” and similar expressions as they
        relate to our management or us are intended to identify such forward-looking
        statements. Our actual results, performance or achievements could differ
        materially from those expressed in, or implied by, these forward-looking
        statements. Historical operating  results
        are not necessarily indicative of the trends in operating results for any
        future
        period.
 
 **Overview**
 
 We
        are an
        international communications carrier delivering VoIP, private networks, Internet
        access, Internet protocol video conferencing and other advanced services
        to,
        from, in and between emerging markets in Asia, the Middle East, Africa, the
        Caribbean and Latin America.
 Our
        corporate strategy focuses our resources on VoIP and the emerging international
        markets. 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. Our network
        utilizes the most currently available Softswitch technology, relieving us
        of the
        burden of costly, inefficient legacy systems and allowing more rapid and
        cost-effective deployment and expansion of services worldwide. Additionally,
        we
        are currently in the process of expanding our infrastructure 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
              
              
              Six
                  MonthsEnded
                  June 30,
              
              
              Ended
                  June 30,2005
              
              
              2004
              
              
              2005
              
              
              2004Revenues
              
              $
              19,259,891
              
              $
              16,117,765
              
              $
              31,188,943
              
              $
              26,305,429Operating
                  expenses:Cost
                  of revenues
              
              
              17,703,991
              
              
              14,001,283
              
              
              28,701,414
              
              
              22,710,304Depreciation
                  and amortization
              
              
              436,387
              
              
              441,828
              
              
              869,411
              
              
              879,396Selling,
                  general and administrative
              
              
              3,029,680
              
              
              2,313,675
              
              
              5,735,087
              
              
              4,456,091Total
                  operating expenses
              
              
              21,170,058
              
              
              16,756,786
              
              
              35,305,912
              
              
              28,045,791Operating
                  Loss
              
              
              (1,910,167
              )
              
              (639,021
              )
              
              (4,116,969
              )
              
              (1,740,362
              )Other
                  income (expense):Interest
                  income (expense), net
              
              
              91,380
              
              
              (538,388
              )
              
              (184,423
              )
              
              (823,519
              )Forgiveness
                  of debt
              
              
              5,340
              
              
              157,183
              
              
              5,340
              
              
              1,976,595Loss
                  from investment in Estel
              
              
              (142,545
              )
              
              (164,030
              )
              
              (299,460
              )
              
              (318,910
              )Other
              
              
              5,956
              
              
              8,500
              
              
              5,956
              
              
              17,750Minority
                  interests
              
              
              49,155
              
              
              53,264
              
              
              48,084
              
              
              31,381Total
                  other income (expense)
              
              
              9,286
              
              
              (483,471
              )
              
              (424,503
              )
              
              883,297Loss
                  from continuing operations
              
              
              (1,900,881
              )
              
              (1,122,492
              )
              
              (4,541,472
              )
              
              (857,065
              )Income
                  from discontinued operations
              
              
              -
              
              
              -
              
              
              175,000
              
              
              -Net
                  loss
              
              $
              (1,900,881
              )
              $
              (1,122,492
              )
              $
              (4,366,472
              )
              $
              (857,065
              )
 
  17
 The
        following table presents our historical operating results as a percentage
        of
        revenues for the periods indicated:
 
 Three
                  Months
                Ended
                  June 30,
              
              
              Six
                  Months
                Ended
                  June 30,2005
              
              
              2004
              
              
              2005
              
              
              2004Revenues
              
              
              100.0%
              
              
              100.0%
              
              
              100.0%
              
              
              100.0%Operating
                  expenses:Cost
                  of revenues
              
              
              91.9%
              
              
              86.9%
              
              
              92.0%
              
              
              86.3%Depreciation
                  and amortization
              
              
              2.3%
              
              
              2.7%
              
              
              2.8%
              
              
              3.4%Selling,
                  general and administrative
              
              
              15.7%
              
              
              14.4%
              
              
              18.4%
              
              
              17.0%Total
                  operating expenses
              
              
              109.9%
              
              
              104.0%
              
              
              113.2%
              
              
              106.7%Operating
                  loss
              
              
              -9.9%
              
              
              -4.0%
              
              
              -13.2%
              
              
              -6.7%Other
                  income (expense)Interest
                  income (expense), net
              
              
              0.5%
              
              
              -3.3%
              
              
              -0.6%
              
              
              -3.1%Forgiveness
                  of debt
              
              
              0.0%
              
              
              1.0%
              
              
              0.0%
              
              
              7.5%Loss
                  from investment in Estel
              
              
              -0.7%
              
              
              -1.0%
              
              
              -1.0%
              
              
              -1.2%Other
              
              
              0.0%
              
              
              0.1%
              
              
              0.0%
              
              
              0.1%Minority
                  interests
              
              
              0.2%
              
              
              0.2%
              
              
              0.2%
              
              
              0.1%Total
                  other income (expense)
              
              
              0.0%
              
              
              -3.0%
              
              
              -1.4%
              
              
              3.4%Loss
                  from continuing operations
              
              
              -9.9%
              
              
              -7.0%
              
              
              -14.6%
              
              
              -3.3%Income
                  from discontinued operations
              
              
              0.0%
              
              
              0.0%
              
              
              0.6%
              
              
              0.0%Net
                  loss
              
              
              -9.9%
              
              
              -7.0%
              
              
              -14.0%
              
              
              -3.3%
  **Revenues**
 
 Historically,
        we have generated the majority of our revenue from voice traffic sold to
        other
        carriers, with a primary focus on VoIP terminations to the emerging markets.
        We
        have increased our business in this area through an internal focus on the
        growth
        of our existing customer base, which is primarily U.S. based, as well as
        the
        addition of new customers, and the establishment of in-country partnerships
        that
        help us to more quickly deploy direct VoIP terminating arrangements with
        postal
        telephone and telegraph companies and other licensed carriers in emerging
        markets. Although we believe that this business continues to be strong, ongoing
        competitive and pricing pressures have caused us to increase our focus on
        higher
        margin, value-added services (VoIP to consumers and businesses, Internet
        access,
        Internet protocol videoconferencing and private networks) and market them
        to, or
        in conjunction with, international carriers, Internet service providers,
        cable
        companies and wireless operators on a direct, co-branded or private label
        basis.
 
 In
        an
        effort to further increase margins, expand our customer base, and develop
        more
        stable revenue streams, we have begun to selectively target enterprise customers
        (large corporations, government entities and other businesses). Revenues
        generated from sales to these customers are primarily derived from the sale
        of
        the value-added services mentioned above. With a primary focus on marketing
        VoIP
        services to these enterprise customers, we believe we will recognize higher
        margin and stronger growth opportunities. 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 enhance this value-added offering.
        We expect to add these features by the end of the year. In February
        2005,
        we closed on the purchase of the 49.8% minority interest in
        Efonica.
 
 Our
        increased focus on VoIP services to enterprise customers resulted in a growing
        upward trend for this product segment. During the first six months of 2005,
        VoIP
        services to consumers and corporations accounted for 7.0% of our total
        consolidated revenue compared to 3.2% in the first six months of
        2004.
 
 18
  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.
 
 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, 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.
 
 We
        manage
        our cost of revenues by managing the margins that we realize from individual
        providers. We also monitor the cost of revenue terminated over our own networks
        (On-net) versus cost of revenue terminated by third party providers (Off-net).
        Our On-net cost of revenues are managed through our relationships with strategic
        partners and our joint ventures, routing traffic to those networks where
        we can
        effectively do so. Our Off-net cost of revenues are managed by routing to
        our
        third party providers based on a least cost approach, and focusing on maximizing
        margins by providers. Most providers offer multiple destinations for
        termination, and give better rates for higher volumes.
 
 Off-net
        revenue does not typically mirror On-net revenue in regional geographic
        termination percentages, because Off-net revenues are terminated by those
        other
        third party providers, and may terminate anywhere in the world. On-net revenues
        only terminate to areas supported by our own network of strategic partners
        that
        we have agreements with and also typically have made investments with. If
        we
        have traffic to On-net destinations that exceeds our capacity, we overflow
        such
        traffic to other providers (Off-net).
 
 Total
        Consolidated Revenue includes VoIP to carriers, Traditional Voice to carriers,
        VoIP to Consumers, and Internet, Private Network & Other. Revenues are
        further broken down between On-net and Off-net as mentioned above. All
        categories of revenue are recorded and tracked at the product and customer
        level.
  **Fusion
        Telecommunications International**
 
 **Terminating
        Revenue by Geographic Region**
 
 **On-Net
        Versus Off-Net**
 
 **Period**
              
              
              **Caribbean**
              
              
              **Latin
                  America**
              
              
              **Asia**
              
              
              **Middle
                  East**
              
              
              **Africa**
              
              
              **Consolidated
                  Terminating On-Net Revenue**
              
              
              **Consolidated
                  Off-Net Revenue**
              
              
              **Total
                  Consolidated Revenue**Three
                  Months Ended
                June
                  30, 2005
              
              $
              534,536
              
              $
              -
              
              $
              450,325
              
              $
              365,943
              
              $
              38,879
              
              $
              1,389,683
              
              $
              17,870,208
              
              $
              19,259,8912.8
              %
              
              0.0
              %
              
              2.3
              %
              
              1.9
              %
              
              0.2
              %
              
              7.2
              %
              
              92.8
              %Three
                  Months Ended
                June
                  30, 2004
              
              $
              578,707
              
              $
              38,083
              
              $
              2,755,589
              
              $
              942,421
              
              $
              161,318
              
              $
              4,476,118
              
              $
              11,641,647
              
              $
              16,117,7653.6
              %
              
              0.2
              %
              
              17.1
              %
              
              5.8
              %
              
              1.0
              %
              
              27.7
              %
              
              72.3
              %
 
 **Period**
              
              
              **Caribbean**
              
              
              **Latin
                  America**
              
              
              **Asia**
              
              
              **Middle
                  East**
              
              
              **Africa**
              
              
              **Consolidated
                  Terminating On-Net Revenue**
              
              
              **Consolidated
                  Off-Net Revenue**
              
              
              **Total
                  Consolidated Revenue**Six
                  Months Ended
                June
                  30, 2005
              
              $
              982,325
              
              $
              -
              
              $
              1,641,212
              
              $
              879,680
              
              $
              52,221
              
              $
              3,555,438
              
              $
              27,633,505
              
              $
              31,188,9433.1
              %
              
              0.0
              %
              
              5.3
              %
              
              2.8
              %
              
              0.2
              %
              
              11.4
              %
              
              88.6
              %Six
                  Months Ended
                June
                  30, 2004
              
              $
              605,176
              
              $
              38,083
              
              $
              5,278,159
              
              $
              2,453,660
              
              $
              238,308
              
              $
              8,613,386
              
              $
              17,692,043
              
              $
              26,305,4292.3
              %
              
              0.1
              %
              
              20.1
              %
              
              9.3
              %
              
              0.9
              %
              
              32.7
              %
              
              67.3
              %
 
 
 Regional
        percentages are calculated based on Total Consolidated Revenue.
  
 19
 
 **OPERATING
        EXPENSES**
 
 Our
        operating expenses during the six months ended June 30, 2005 and 2004, are
        categorized as cost of revenues, depreciation and amortization, loss on
        impairment, and selling, general and administrative expenses.
 
 Cost
        of
        revenues includes costs incurred with the operation of our leased network
        facilities, and the purchase of voice termination and Internet protocol services
        from other telecommunications carriers and Internet service providers. We
        continue to work to lower the variable component of the cost of revenue through
        the use of least cost routing, and continual negotiation of usage-based and
        fixed costs with domestic and international service providers.
 
 Depreciation
        and amortization includes depreciation of our communications network equipment,
        amortization of leasehold improvements of our switch locations and
        administrative facilities, and the depreciation of our office equipment and
        fixtures.
 
 Selling,
        general and administrative expenses include salaries and benefits, commissions,
        occupancy costs, sales, marketing and advertising, professional fees and
        other
        administrative expenses.
 
 **COMPANY
        HIGHLIGHTS**
 
 The
        following summary of significant events during the six months
        ended June 30, 2005, highlights the accomplishments and events that
        have
        influenced our performance during that time period.
 
 •
              
              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).•
              
              Revenue
                  Growth — Revenue grew 18.6% in the first six months of 2005, over the
                  first six months of 2004, and revenue in our VoIP to consumers
                  and
                  corporations segment grew 161.2% in the first six months of 2005
                  over the
                  first six months of 2004.•
              
              Purchase
                  of a Jamaica Entity — In January 2005, we concluded the purchase of a
                  51.0% interest in Convergent Technologies, which has international
                  and
                  domestic license agreements with the Jamaican government.•
              
              Purchase
                  of Efonica —In February 2005, we acquired the remaining 49.8% interest in
                  our Efonica joint venture.•
              
              Turkey
                  Purchase Agreement — In May 2005, we closed on the stock purchase
                  agreement with an entity in Turkey to acquire 75% of the shares
                  from the
                  existing Shareholders. This subsidiary will enable us to provide
                  VoIP
                  services under our Efonica brand and other Internet Services to
                  corporation and consumers in Turkey.
 
 The
        information in our period-to-period comparisons below represents only our
        results from continuing operations.
 
 **Three
        Months Ended June 30, 2005, Compared with Three Months Ended June 30,
        2004.**
 
 **Revenues**
 
 Consolidated
        revenues increased $3.1 million or 19.5% to approximately $19.3 million in
        the
        three months ended June 30, 2005, compared to $16.1 million in the three
        months
        ended June 30, 2004. Revenues for VoIP services to consumers and corporations
        represented $0.5 million or 15.9% of the consolidated revenue growth, increasing
        from $0.5 million in the second quarter 2004, to $1.0 million in the second
        quarter 2005, mainly due to the growth of Efonica.
 
 VoIP
        services sold to carriers increased $4.4 million or 41.1% in the second quarter
        of 2005, versus the second quarter of 2004. This increase represented 140.5%
        of
        the consolidated revenue growth for the quarter. The majority of the technical
        difficulties associated with the migration to the new Softswitch were addressed
        in the second quarter of 2005. This is evidenced by the significant growth
        of
        the VoIP services sold to carriers product segment to 78.7% of total
        consolidated revenue for the three months ended June 2005 versus 66.7% of
        total
        consolidated revenue for the three months ended June 2004.
        Traditional Voice services sold to carriers decreased $1.7 million
        or 39.0%
        in the second quarter of 2005, versus the second quarter of 2004, as we continue
        to execute our corporate strategy to focus our resources on the VoIP product
        segments.
 
 Revenues
        from our Internet, Private Network & Other Services decreased $0.1 million
        or 16.5% from $0.6 million in the second quarter 2004, to $0.5 million in
        the
        second quarter 2005 due to the cancellation of a government
        contract.
 
 20
 
 **Cost
        of Revenues**
 
 Consolidated
        cost of revenues increased $3.7 million or 26.4% to $17.7 million in the
        second
        quarter of 2005 from $14.0 million in the second quarter of 2004. Approximately
        $3.5 million of this increase was attributable to an increase in voice services
        to carriers, of which $4.8 million was an increase in VoIP services cost
        of
        revenues to carriers, offset by a decrease of $1.3 million in cost of revenues
        for Traditional Voice services to carriers.
 
 The
        cost
        of revenues for VoIP services to consumers and corporations grew $0.3 million
        in
        the second quarter 2005, from $0.4 million to $0.7 million in the second
        quarter
        2004, due primarily to the rapid growth in that revenue base. Cost of revenues
        for Internet, Private Network & Other decreased $0.1 million from $0.4
        million with the second quarter of 2004 to $0.3 million in the second quarter
        of
        2005.
 
 Consolidated
        gross margin decreased $0.6 million or 26.5% for the second quarter 2005
        over
        the second quarter 2004. Gross margin for total Voice services to carriers
        decreased by $0.7 million, but was partially offset by an improvement in
        the
        gross margin for VoIP services to consumers and corporations of $0.1 million.
        Gross margin for Internet, Private Networks and Other remained flat for the
        second quarter of 2005 over the second quarter of 2004. The decline in gross
        margin for voice services to carriers was caused primarily by price pressure
        sensitivity associated with several of our key routes, both on-net and
        off-net.
 
 **Operating
        Expenses**
 
 ***Depreciation
        and Amortization.*** Depreciation
        and amortization remained consistent at $0.4 million during the three months
        ended June 30, 2005 and 2004. Although depreciation increased as a result
        of
        assets added during 2004 and the first six months of 2005, including the
        new
        Softswitch, this increase was offset by a decrease resulting from certain
        assets
        becoming fully depreciated during 2004 and the first quarter of
        2005.
 
 ***Selling,
        General and Administrative.*** Selling,
        general and administrative expenses increased $0.7 million or 30.9% to $3.0
        million during the three months ended June 30, 2005, from $2.3 million during
        the three months ended June 30, 2004. This increase is primarily attributed
        to
        increased salaries and benefits, as more personnel have been required
        to
        support our revenue growth and expansion of our infrastructure. In addition,
        also increasing as a result of growth and our becoming a public company in
        February 2005, have been our legal and professional fees, advertising/marketing
        expenses and bad debt expense. As a percentage of revenues, selling, general
        and
        administrative expenses increased from 14.4% during 2004 to 15.7% during
        2005.
        We believe that as we execute our business strategies, selling, general and
        administrative expenses as a percentage of revenue will begin to
        decline.
 
 ***Operating
        Loss.*** Our
        operating loss increased $1.3 million or 198.9% to a loss of $1.9 million
        during
        the three months ended June 30, 2005, from a loss of $0.6 million during
        the
        three months ended June 30, 2004. The increase in operating loss was primarily
        attributable to both the decrease in gross margin and the increase in selling,
        general and administrative expenses associated with infrastructure growth
        and
        public company compliance requirements.
 
 ***Other
        Income (Expense).*** Total
        other income (expense) changed from other expense of approximately $0.5 million
        during the three months ended June 30, 2004, to other income of $9,286 during
        the three months ended June 30, 2005. During the three months ended June
        30,
        2005, we had interest expense of $0.1 million in contrast to interest income
        of
        $0.5 million during the three months ended June 30, 2004. The 2004 period
        included accretion of $0.5 million (in accordance with SFAS 150) related
        to our
        then outstanding Series C preferred stock. There was no accretion during
        the
        three months ended June 30, 2005, due to this preferred stock converting
        to
        common stock in connection with our IPO. In addition, interest expense was
        higher during the three months ended June 30, 2004, as the Company had
        significant outstanding debt during this quarter (balance at June 30, 2004,
        was
        approximately $3.9 million) of which a significant portion was repaid during
        February 2005, in connection with our IPO (balance at June 30, 2005, was
        approximately $1.1 million). We also had an increase in interest income during
        the three months ended June 2005 versus the three months ended June 2004,
        as a
        result of our investment of the IPO proceeds. Gain on debt forgiveness decreased
        by $0.2 million to $5,340 in 2005 from $0.2 million in 2004. Both the 2004
        and
        2005 gains on debt forgiveness were attributed to settlement of network
        obligations. The loss from investment in Estel remained consistent during
        the
        three months ended June 30, 2005 and 2004, decreasing $21,000 in 2005. Minority
        interest changed from $53,264 during 2004 to a $49,155 during 2005.
  ***Net
        Loss.*** The
        primary factors impacting our net loss for the three months ended June 30,
        2005,
        were a decrease in gross margin, an increase in selling, general and
        administrative, the reduction in forgiveness of debt, net with an improvement
        in
        interest income (expense) net.
  **Six
        Months Ended June 30, 2005, Compared with Six Months Ended June 30,
        2004.**
 
 **Revenues**
 
 Consolidated
        revenues increased $4.9 million or 18.6% to approximately $31.2 million in
        the
        six months ended June 30, 2005, compared to $26.3 million in the six months
        ended June 30, 2004. Revenues for VoIP services to consumers and corporations
        represented $1.4 million or 27.6% of the consolidated revenue growth, increasing
        from $0.8 million in the six months ended June 30, 2004, to $2.2 million
        in the
        six months ended June 30, 2005, mainly due to the growth of
        Efonica.
  21
 
 Revenues
        for VoIP services sold to carriers increased $4.8 million or 27.0% in the
        six
        months ended June 30, 2005, versus the six months ended June 30, 2004. This
        increase represented 97.8% of the consolidated revenue growth for the quarter.
        During the six months ended June 30, 2005 growth in revenues for VoIP services
        sold to carriers was impacted, primarily during the first quarter of 2005,
        by
        technical difficulties associated with the migration to the new Softswitch.
        However a significant portion of these issues were addressed in the second
        quarter 2005 and revenues are again trending upward. Additionally, Traditional
        Voice services sold to carriers decreased $1.2 million or 17.9% in the six
        months ended June 30, 2005, versus the six months ended June 30, 2004 as
        we
        continue our to focus our resources on VoIP services.
  Revenues
        from our Internet, Private Network & Other Services remained fairly
        consistent at $1.1 million in both the six months ended June 30, 2005, and
        the
        six months ended June 30, 2004. .
 
 **Cost
        of Revenues**
 
 Consolidated
        cost of revenues increased $6.0 million or 26.4% to $28.7 million in the
        six
        months ended June 30, **** 2005,
        from $22.7 million in the six months ended June 30 **,** 2004.
        Approximately $5.1 million of this increase was attributable to an increase
        in
        voice services to carriers, of which $5.6 million was an increase in VoIP
        services to carriers, offset by a decrease of $0.5 million in Traditional
        Voice
        services to carriers.
 
 The
        cost
        of revenues for VoIP services to consumers and corporations grew $1.1 million
        in
        the six months ended June 30, 2005, from $0.6 million to $1.7 million, due
        primarily to the rapid growth in that revenue base. Cost of revenues for
        Internet, Private Network & Other decreased $0.1 million or 17.5% to $0.6
        million for the six months ended June 30, 2005 from $0.7 million for the
        six
        months ended June 30, 2004, due to negotiated cost reductions for government
        contracts.
 
 Consolidated
        gross margin decreased $1.1 million for the six months ended June 2005 over
        2004. Gross margin for total Voice services to carriers decreased by $1.5
        million, which was partially offset by an improvement in the gross margin
        for
        VoIP services to consumers and corporations of $0.3 million. In addition,
        we had
        a decrease in gross margin for Internet, Private Networks and Other of $0.1
        million.
 
 The
        decline in gross margin for Voice services to carriers was primarily related
        to
        the technical difficulties associated with the migration to the Softswitch
        technology, which adversely impacted our ability to route traffic to the
        least
        cost provider, specifically for the first quarter of 2005. In addition,
        increased competition for some of our on-net routes caused price pressure
        sensitivity, which negatively impacted the margin.
 
 **Operating
        Expenses**
 
 ***Depreciation
        and Amortization.*** Depreciation
        and amortization remained consistent at $0.9 million during the six months
        ended
        June 30, 2005 and 2004. Although our depreciation increased as a result of
        assets added during 2004 and the first six months of 2005, including the
        new
        Softswitch, this increase was offset by a decrease in depreciation resulting
        from certain assets becoming fully depreciated during 2004 and the first
        six
        months of 2005.
 
 ***Selling,
        General and Administrative.*** Selling,
        general and administrative expenses increased $1.3 million or 28.7% to $5.7
        million during the six months ended June 30, 2005, from $4.5 million during
        the
        six months ended June 30, 2004. This increase is primarily attributed to
        increased salaries and benefits, as more personnel have been required
        to
        support the revenue growth and expansion of our infrastructure. In addition,
        also increasing as a result of growth and our becoming a public company in
        February 2005, have been our legal and professional fees, advertising/marketing
        expenses and bad debt expense. As a percentage of revenues, selling, general
        and
        administrative expenses increased from 17.0% during 2004, to 18.4% during
        2005.
        We believe that as we execute our business strategies, selling, general and
        administrative expenses as a percentage of revenue will begin to
        decline.
 
 ***Operating
        Loss.*** Our
        operating loss increased $2.4 million or 136.6% to a loss of $4.1 million
        during
        the six months ended June 30, 2005, from a loss of $1.7 million during the
        six
        months ended June 30, 2004. The increase in operating loss was primarily
        attributable to both the decrease in gross margin and the increase in selling,
        general and administrative expenses associated with infrastructure growth
        and
        public company compliance requirements.
 
 ***Other
        Income (Expense).*** Total
        other income (expense) changed from other income of approximately $0.9 million
        during the six months ended June 30, 2004, to other expense of $0.4 million
        during the six months ended June 30, 2005. During the six months ended June
        30,
        2005, we had interest expense of $0.2 million in contrast to interest expense
        of
        $0.8 million during the six months ended June 30, 2004. The $0.8 million
        interest expense net, for the six months ended June 30, 2004, included accretion
        of $0.7 million (in accordance with SFAS 150) related to the then outstanding
        Series C preferred stock. The $0.2 million interest expense, net for the
        six
        months ended June 30, 2005, included only $0.3 million of accretion since
        all
        Series C preferred stock was converted to common stock in connection with
        our
        February 2005 IPO. Consequently, accretion ceased and only includes accretion
        for the period between January 1, 2005 and February 17, 2005. In addition,
        interest expense was higher during the six months ended June 30, 2004, as
        the
        Company had a significantly higher debt balance during 2004 in comparison
        to
        2005 since a significant portion of debt was repaid in connection with the
        IPO.
        We also had increased interest income during the six months ended June 30,
        2005
        versus 2004, as a result of our investment of the IPO proceeds. Gain on debt
        forgiveness decreased in 2005 by $2.0 million to $5,340 from $2.0 million
        during
        2004. The 2004 gain on debt forgiveness was attributed to $0.2 million of
        settlements of capital lease obligations, $0.2 million of settlement of general
        obligations and $1.6 million of settlements of network obligations. The loss
        from investment in Estel remained consistent at approximately $0.3 million
        during the two periods. Minority interest changed from $31,381 during 2004
        to
        $48,084 during 2005.
 
 22
  ***Net
        Loss.*** The
        primary factors impacting our net loss for the six months ended June 30,
        2005,
        were a decrease in gross margin, an increase in selling, general and
        administrative, and the reduction in forgiveness of debt net with a decrease
        in
        interest expense and an increase in interest income.
 
 **Liquidity
        and Capital Resources**
 
 Since
        our
        inception, we have incurred significant operating and net losses. In addition,
        we have not generated positive cash flows from operations. As of June 30,
        2005,
        we had an accumulated deficit of approximately $83.0 million. During 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 $0.05 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. As a result of an
        IPO
        offering, we have total stockholders’ equity at June 30, 2005, of approximately
        $23.2 million. In addition, as a result of our offering, we converted $2.5
        million of convertible debt into 651,515 shares of common stock and we repaid
        approximately $1.5 million in outstanding debt and $0.6 million of accrued
        interest. In addition, 109,962 shares of outstanding Series C preferred stock
        were converted into 3,141,838 shares of common stock.
 
 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:
  **Six
                    months ended June 30,****2005**
                
                
                **2004**Cash
                    used in operating activities
                
                $
                (6,222,689
                )
                $
                (3,999,149
                )Cash
                    used in investing activities
                
                
                (1,551,189
                )
                
                (893,815
                )Cash
                    provided by financing activities
                
                
                21,369,080
                
                
                5,704,209Increase
                    in cash and cash equivalents
                
                
                13,595,202
                
                
                811,245Cash
                    and cash equivalents, beginning of period
                
                
                4,368,726
                
                
                3,205,645Cash
                    and cash equivalents, end of period
                
                $
                17,963,928
                
                $
                4,016,890
 
 Our
        cash
        flow results have historically been and continue to be impacted by the costs
        associated with implementing the new 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 us. During the first quarter of 2005, we largely completed
        the
        transition and integration to the Softswitch. Therefore, we have only recently
        completed the deployment of our packet-based network infrastructure. Because
        certain of our costs are fixed, we would expect that as our revenues increase,
        total expenses would represent a smaller percentage of our revenues.
 
 **Source
        of Liquidity**
 
 As
        of
        June 30, 2005, as a result of our first quarter IPO, we had cash and cash
        equivalents of approximately $18.0 million. In addition, as of June 30, 2005,
        we
        had approximately $0.3 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 June 30, 2005, we financed our operations from cash provided
        from financing activities. These activities were primarily through net proceeds
        of approximately $23.3 million from our February 2005 IPO and prior to 2005,
        the
        private placement of approximately $52.2 million of equity securities and
        $21.6
        million from the issuance of notes. In addition, since inception we have
        financed the acquisition of $6.8 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 and revenues from operations will be
        sufficient to meet our working capital and capital expenditure needs for
        the
        next 12 months, our long-term liquidity is dependent on our ability to attain
        future profitable operations. We cannot predict if and when we will be able
        to
        attain future profitability.
 
 **Uses
        of Liquidity**
 
 Our
        short-term and long-term liquidity needs arise primarily from interest and
        principal payments relating to our capital lease obligations, capital
        expenditures, working capital requirements as may be needed to support the
        growth of our business, and any additional funds that may be required for
        business expansion opportunities.
 
 Our
        cash
        capital expenditures were approximately $1.1 million and $0.7 million during
        the
        six months ended June 30, 2005 and 2004, respectively. We expect our cash
        capital expenditures to be approximately $3.7 million for the six months
        ending
        December 31, 2005. The 2005 estimated capital expenditures include network
        expansion, purchase of additional software for expanded product offerings,
        new
        international deployments and customer premise equipment.
  23
 We
        also
        spent approximately $1.0 million during the six months ended June 30, 2005
        on
        our international acquisitions (includes the $325,000 Difference Payment
        discussed in Note 2 to the consolidated financial statements). Cash used
        in
        operations was approximately $6.2 million and $4.0 million during the six
        months
        ended June 30, 2005 and 2004, respectively. 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. The increase in cash used in operations during the six months
        ended June 30, 2005 is primarily attributed to the increase in net loss.
        The
        transition to the Softswitch has contributed to the net loss during the six
        months ended June 30, 2005. We believe the transition issues are largely
        behind
        us and expect improved financial results in the future.
 
 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.
 
 We
        intend
        to fund corporate overhead, including management salaries from the working
        capital that we have raised from our IPO.
 
 **Debt
        Service Requirements**
 
 As
        a
        result of our IPO, we repaid a majority of our outstanding debt and converted
        $2.5 million in convertible notes payable to common stock. In addition,
        approximately $10.0 million of our Series C preferred stock was converted
        into
        common stock. As a result, at June 30, 2005, our debt balance decreased
        significantly to approximately $1.3 million comprised primarily of $1.1 million
        in capital leases. All of this debt, other than approximately $41,000 is
        due
        during the 12 months ending June 30, 2006. Our interest expense has decreased
        significantly and will continue to be less than prior years due to the following
        factors:
 
 1.
              
              During
                  the year ended December 31, 2004, we recorded $1.7 million of accretion
                  to
                  interest expense related to our Series C Preferred Stock. This
                  Series C
                  Preferred Stock was converted to common stock during February 2005
                  and
                  consequently, accretion ceased on this date. Accretion expense
                  in 2005
                  through the date of conversion was only $0.3 million. Although
                  the
                  accretion represented a non-cash charge to interest expense during
                  2004
                  and the first quarter of 2005, approximately $0.7 million in cash
                  dividends were paid during January 2005 in connection with the
                  Series C
                  Preferred Stock.2.
              
              As
                  discussed above, subsequent to the IPO, we repaid approximately
                  $1.5
                  million of debt and $2.5 million in debt was converted into equity.
                  This
                  reduction in our debt balances during February 2005 has resulted
                  in a
                  significant reduction in our cash interest expense, which will
                  continue in
                  the future.
 
 **Capital
        Instruments**
 
 As
        of
        June 30, 2005, the only outstanding stock we had is our two classes of Common
        Stock.
 
 **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, 2004, 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, and from monthly recurring charges associated with Internet
        and
        Private Line services.
 
 Variable
        revenue is earned based on the number of minutes during a call and is recognized
        upon completion of a call, adjusted for allowance for doubtful accounts
        receivable and billing adjustments. Revenue for each customer is calculated
        from
        information received through our network switches. Customized software has
        been
        designed to track the information from the switch and analyze the call detail
        records against stored detailed information about revenue rates. This software
        provides us the ability to do a timely and accurate analysis of revenue earned
        in a period. Consequently, the recorded amounts are generally accurate and
        the
        recorded amounts are unlikely to be revised in the future.
 
 Fixed
        revenue is earned from monthly recurring services provided to the customer
        that
        are fixed and recurring in nature, and are contracted for over a specified
        period of time. The initial start of revenue recognition is after the
        provisioning, testing and acceptance of the service by the customer. The
        charges
        continue to bill until the expiration of the contract, or until cancellation
        of
        the service by the customer. Additionally, the majority of our VoIP services
        to
        consumers 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 are booked to deferred
        revenue, until usage occurs.
  24
 **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 telecommunications carriers to originate, transport and terminate
        calls. The majority of our cost of revenue is variable, based upon the number
        of
        minutes of use, with transmission and termination costs being the most
        significant expense. Call activity is tracked and analyzed with customized
        software that analyzes the traffic flowing through our network switches.
        Each
        period the activity is analyzed and an accrual is recorded for minutes not
        invoiced. This cost accrual is calculated using minutes from the system and
        the
        variable cost of revenue based upon predetermined contractual
        rates.
 
 In
        addition to the variable cost of revenue, there are also fixed expenses.
        One
        category of fixed expenses are 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 our 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).
 
 **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
        May
        2005, the FASB issued SFAS No. 154, “Accounting Changes and error Corrections.”
        SFAS No. 154 is a replacement of APB No. 20 and FASB Statement No. 3 SFAS
        No.
        154 provides guidance on the accounting for and reporting of accounting changes
        and error corrections. It establishes retrospective application as the required
        method for reporting a change in accounting principle. SFAS No. 154 provided
        guidance for determining whether retrospective application is impractical.
        The
        reporting of a correction of an error by restating previously issued financial
        statements is also addressed by SFAS No. 154. SFAS No. 154 is effective for
        accounting changes and corrections of errors made in fiscal years beginning
        after December 15, 2005. We will adopt this pronouncement at the beginning
        of
        fiscal year 2006.
 
 In
        December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based
        Payment” (“SFAS 123(R)”). This Statement requires companies to expense the
        estimated fair value of stock options and similar equity instruments issued
        to
        employees. Currently, companies are required to calculate the estimated fair
        value of these share-based payments and can elect to either include the
        estimated cost in earnings or disclose the pro forma effect in the footnotes
        to
        their financial statements. We have chosen to disclose the pro forma effect.
        The
        fair value concepts were not changed significantly in FAS 123(R); however,
        in
        adopting this Standard, companies must choose among alternative valuation
        models
        and amortization assumptions. The valuation model we have used continues
        to be
        available, but we have not yet completed our assessment of the alternatives.
        In
        April 2005, the SEC announced a deferral of the effective date of FAS 123(R)
        for
        calendar year companies until the beginning of 2006.
 
 **Inflation**
 
 We
        do not
        believe inflation has a significant effect on our operations at this
        time.
 
 **FORWARD-LOOKING
        STATEMENTS**
 
 Certain
        statements discussed in this Report under the heading "Management's Discussion
        and Analysis of Financial Condition and Results of Operation - Liquidity
        and
        Capital Resources" may constitute forward-looking statements within the meaning
        of the Private Securities Litigation Reform Act of 1995. The words or phrases
        "would be," "will allow," "intends to," "will likely result," "are expected
        to,"
        "will continue," "is anticipated," "estimate," "project," or similar expressions
        are intended to identify "forward-looking statements". 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,
        the
        competitive environment for Internet telephony, our limited operating history,
        changes of rates of all related telecommunications services, the level and
        rate
        of customer acceptance of new products and services, legislation that may
        affect
        the Internet telephony industry, rapid technological changes, risks associated
        with the integration of businesses following an acquisition, competitors
        with
        broader product lines and greater resources, emergence into new markets,
        the
        termination of any of the Company's significant contracts, 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, as well as other risks referenced from time
        to
        time in our filings with the Securities and Exchange Commission. Statements
        made
        herein are as of the date of the filing of this Form 10-Q with the Securities
        and Exchange Commission and should not be relied upon as of any subsequent
        date.
        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 hereof, and we
        assume no obligation to update any forward-looking statement to reflect
        occurrences, developments, unanticipated events or circumstances after the
        date
        of such statement.
  25
 **ITEM
        3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK**
 
 We
        are
        exposed to certain market risks that are inherent in our financial instruments.
        These instruments arise from transactions in the normal course of
        business.
 
 At
        June
        30, 2005, the majority of our cash balances were held primarily in the form
        of
        short-term highly liquid investment grade money market funds in major financial
        institutions. Due to the short-term nature of our investments, we believe
        that
        we are not subject to any material interest or market rate risks.
 
 At
        June
        30, 2005, we were not subject to interest rate risk as all of our current
        debt
        at June 30, 2005 is at fixed interest rates. During the six months ended
        June
        30, 2005, we conducted substantially all of our business in the United States
        dollar. The reporting currency for our financial statements has been the
        United
        States dollar and the functional currency for our subsidiaries has been the
        U.S.
        dollar. However, in connection with our Joint Ventures in Jamaica and Turkey,
        we
        likely will be conducting a percentage of our business in other foreign
        currencies in the future that could have an adverse impact on our future
        results
        of operations. In addition, we might enter into other foreign joint ventures
        in
        the future, which might conduct business in other foreign currencies that
        could
        have an adverse impact on our future results of operations.
 
 **ITEM
        4. CONTROLS AND PROCEDURES**
 
 **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.
 
 **Changes
        in Internal Controls over Financial Reporting**
 
 There
        was
        no change in our internal control over financial reporting that occurred
        during
        the quarter ended June 30, 2005, that has materially affected, or is reasonably
        likely to materially affect, our internal control over financial
        reporting.
 
 26
  **Fusion
        Telecommunications International, Inc. and Subsidiaries**
 
 **Part
        II: Other Information**
 
 **Item
        1. Legal Proceedings**
 
 On
        April
        15, 2003, World Access, Inc., a former customer, brought an action against
        the
        Company for recovery of preferential transfers and other claims under the
        Bankruptcy Code in the United States Bankruptcy Court, Northern District
        of
        Illinois Eastern Division (In *Re:
        World Access, Inc., et al vs. Fusion Telecommunications International, Inc.,* Adv.
        Pro.
        No. 03 A 00851). The suit seeks damages in the amount of approximately $335,000
        for alleged Avoidance of Preferential Transfers, Recovery of Transfers, Setoff,
        Recovery Setoff, Payment of Improperly Setoff Debt, Turnover of Property,
        and
        Damages for Overdue Debt & Turnover of Property. The Company filed a Proof
        of Claim with the court in the amount of approximately $85,000 for amounts
        that
        were due at the time this customer filed bankruptcy. In March 2005, the Company
        settled this matter for $5,500, and agreed to waive the Company’s proof of claim
        in the amount of approximately $85,000. The Company expects to execute the
        formal settlement agreement on or before September 1, 2005.
  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: 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 plaintiffs have filed an appeal of the motion, which is
        pending.
  Due
        to
        the regulatory nature of the industry, the Company is periodically involved
        in
        various correspondence and inquiries from state and federal regulatory agencies.
        Management does not expect the outcome of these inquiries to have a material
        impact on the operations or the financial condition of the company.
  **Item
        2. Unregistered Sales of Securities and Use of Proceeds**
 
 (a)  Unregistered
        Sales of Securities
 
 On
        February 16, 2005, the Company issued 21,429 shares of common stock to a
        director for $50,250 in respect of the exercise of options. These securities
        were issued without registration under the Securities Act in reliance on
        Section
        4(2) of the Securities Act.
 
 On
        February 17, 2005, the Company issued 651,515 shares of Common Stock to a
        director, upon the conversion of $2,508,333 in indebtedness. These securities
        were issued without registration under the Securities Act in reliance on
        Section
        4(2) of the Securities Act.
 
 On
        February 18, 2005, the Company issued 1,439,643 shares of Common Stock to
        Karamco, Inc. valued at $9,285,710 in connection with the sale of Karamco
        Inc.’s
        49.8% interest in Efonica FZ-LLC to the Company. Of these shares, 675,581
        valued
        at approximately $4.4 million, are being held in escrow pending the final
        determination of the purchase price of Efonica FZ-LLC after the year ending
        February 28, 2006. The Company subsequently registered 150,000 of Karamco
        Inc.’s
        shares. These securities were issued without registration under the Securities
        Act in reliance on Section 4(2) of the Securities Act.
 
 On
        May 2,
        2005, the Company issued 11,363 shares of Common Stock to a consultant or
        consulting services valued at $50,000. These securities were issued without
        registration under the Securities Act in reliance on Section 4(2) of the
        Securities Act.
 
 On June
        30, 2005, the Company issued 28,572 shares of Class A Common Stock to two
        individuals for $85,144 in respect of the exercise of warrants. These securities
        were issued without registration under the Securities Act in reliance on
        Section
        4(2) of the Securities Act.
 
 (b)  Use
        of
        Proceeds
 
 The
        Company’s Registration Statement filed with the Securities and Exchange
        Commission (333-120412) on Form S-1 to register 3,600,000 shares of common
        stock
        and 3,600,000 redeemable common stock purchase warrants convertible into
        shares
        of common stock was declared effective on February 8, 2005. The offering
        commenced on January 18, 2005, and terminated on February 12, 2005. Upon
        completion, the underwriters managed by Kirlin Securities, Inc., successfully
        sold 3,600,000 shares of common stock and 3,600,000 redeemable common stock
        purchase warrants at $6.45 and $0.05, respectively, for an aggregate offering
        price of $6.50. On March 30, 2005, the underwriters exercised their
        over-allotment and purchased an additional 480,000 shares of common stock
        and
        540,000 purchase warrants. The net proceeds of the offering, including the
        over-allotment, totaled $23,300,000 and is being utilized by the Company
        for the
        purchase of additional equipment for expanded capacity and service offerings,
        international deployment, marketing and advertising and working
        capital.
 
 27
 
 The
        Registration Statement also registered 3,141,838 redeemable common stock
        purchase warrants to be offered for sale by certain selling security holders.
        The Company will not receive any proceeds from the sales of such
        warrants.
 
 As
        of
        June 30, 2005, approximately $2.0 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 $1.1 million was used to
        purchase property and equipment and $0.9 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.
 
 Of
        these
        payments, principal and accrued interest in respect of indebtedness to the
        Company was repaid as follows: approximately $1.1 million to Marvin S. Rosen,
        Chairman of the Board and Chief Executive Officer, $0.8 million to Philip
        Turits, Secretary, Treasurer and Director, $0.2 million to Evelyn Langlieb
        Greer, Director
 
 Karamco,
        Inc., a corporation of which Roger Karam, our President of VoIP Division,
        is the
        sole shareholder, received $825,000 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, as adopted pursuant to Section
                  302 of the
                  Sarbanes-Oxley Act of 2002.31.2
              
              Certification
                  of the Principal Accounting Officer, as adopted pursuant to Section
                  302 of
                  the Sarbanes-Oxley Act of 2002.32
              
              Certification
                  of the Chief Executive Officer and Principal Accounting Officer
                  pursuant
                  to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
                  the
                  Sarbanes-Oxley Act of 2002.
 
 28
  **SIGNATURES**
 
 Pursuant
        to the requirements of the Securities Exchange Act of 1934, the registrant
        has
        duly caused this report to be signed on its behalf by the undersigned thereunto
        duly authorized.
 
 **FUSION
        TELECOMMUNICATION INTERNATIONAL, INC.**
 
 Dated:
        August 15, 2005     By:  /s/
        Marvin S. Rosen
 Marvin
        S.
        Rosen
 Chairman
        of the Board and Chief Executive Officer
 
 Dated:
        August 15, 2005     By: /s/
        Barbara Hughes
 Barbara
        Hughes
 Vice
        President of Finance and
        Principal Accounting and Financial Officer
   
 
 29