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Edited Transcript of FSNN earnings conference call or presentation 15-May-18 2:30pm GMT

Thomson Reuters StreetEvents

Q1 2018 Fusion Connect Inc Earnings Call

NEW YORK May 21, 2018 (Thomson StreetEvents) -- Edited Transcript of Fusion Connect Inc earnings conference call or presentation Tuesday, May 15, 2018 at 2:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Michael Coyne

Fusion Telecommunications International, Inc. - Former VP - IR & Financial Planning

* Kevin Dotts

* Matthew D. Rosen

Fusion Telecommunications International, Inc. - Chairman & CEO

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Conference Call Participants

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* George Frederick Sutton

Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst

* Michael Joshua Nichols

B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group

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Presentation

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Operator [1]

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Good day, and welcome to the Fusion First Quarter 2018 Financial Results Conference Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Brian Coyne. Please go ahead.

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Brian Michael Coyne, Fusion Telecommunications International, Inc. - Former VP - IR & Financial Planning [2]

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Thank you, and good morning to everyone joining us on this call. Earlier today, Fusion issued a press release announcing its results for the first quarter of 2018, which is available on the Investor Relations section of Fusion's website at ir.fusionconnect.com. There will also be an audio replay of this call available for a limited time on our Investor Relations website.

Presenting on today's call are Matt Rosen, Fusion's Chairman and CEO; and Kevin Dotts, Fusion's CFO. Our format today will include prepared remarks followed by Q&A.

Now before we begin, let me remind all participants that, during this call, we will be making forward-looking statements that are subject to risks and uncertainties. Any forward-looking statements are made pursuant to the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Expressions of future goals, including, without limitation, expressions using the terminology may, will, believe, expect, plans, anticipates, predicts, and forecasts, along with other expressions which reflect something other than historical fact, are intended to identify forward-looking statements.

These forward-looking statements involve a number of risks and uncertainties, including factors discussed in the risk factor section of our Annual Report on Form 10-K, and our quarterly reports on Form 10-Q and in our other SEC filings and company releases. Our actual results may differ materially from any forward-looking statements due to such risks and uncertainties. The company undertakes no obligation to revise or update any forward-looking statements in order to reflect events or circumstances that may arise after this conference call, except as required by law.

Also, today's discussion will refer to adjusted EBITDA, which is a non-GAAP measure. The presentation of GAAP financial measures and a reconciliation of non-GAAP information to GAAP financial measures is included in the press release, which we issued this morning, which is also available on Fusion's website.

And with that, let me now turn the call over to Matt.

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Matthew D. Rosen, Fusion Telecommunications International, Inc. - Chairman & CEO [3]

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Thanks, Brian. And welcome to everyone joining us on today's call. I'd especially like to welcome Kevin Dotts to Fusion as our new CFO. Kevin brings to Fusion over 25 years of senior financial leadership experience, including 15 years at GE. He has served as CFO of several public and private businesses with over $1 billion in annual revenue and was most recently the CFO of Birch, EarthLink and Internap. We're excited to have him onboard and look forward to his contributions to executing on our growth and our capital market strategies.

Today's call comes at a time when Fusion's strategic momentum and its opportunity have never been greater. We entered the cloud services industry in 2012, and at year-end, we generated just under $7 million of cloud services revenue and had roughly 5,000 customers. Less than 6 years later, we're a cloud services company with more than $0.5 billion in annual revenue and over 150,000 customers. This remarkable accomplishment is a testament to the vision, the hard work, and the relentless determination of the entire Fusion team to generate value for our shareholders.

Our performance in the first quarter of 2018 was solid as we delivered another quarter of year-over-year revenue and adjusted EBITDA growth, excluding the impact of acquisitions. We also achieved several important milestones during the first quarter, which helped set the stage for the even more transformational accomplishments that followed.

In January, we acquired the software, intellectual property and customer base of IQMax, which includes a number of the top hospitals in the United States. IQMax' software provides secure messaging, collaboration, enterprise data integration and advanced cloud communication solutions. IQMax' technology tightly integrates with Fusion's existing unified communications platform and adds to our robust IP portfolio.

The transaction accelerates the expansion of Fusion's cloud ecosystem, facilitating integration with a wide range of CRM, external messaging and other business productivity software platforms.

We believe that having our own IP is a competitive advantage as it allows us to control our product development road map, rapidly customize our offerings to meet the rigorous demands of enterprise customers, and expand our profitability over time. On February 5, we closed a very successful follow-on offering of 8.6 million shares of our common stock, priced at $4.80 a share for net proceeds before expenses of approximately $39 million. The offering was upsized by more than 30% from the time of its launch till pricing and was significantly oversubscribed even after we exercised the overallotment option.

The momentum we gained from these events grew significantly through the many transformational achievements that took place on May 4. Many months of hard work and determination culminated on this day, headlined by the closing of our acquisition of the cloud and business services business of Birch. We now have a significantly larger and broader set of resources to market and sell our end-to-end cloud solutions to a much bigger group of existing and potential business customers and generate significant levels of cash flow.

We also completed the spinoff of Fusion's Carrier Services business as well as Birch's consumer and single-line business customer base. Fusion's sole focus is now on the cloud and Business Services market.

To finance the acquisition, we closed $680 million of new senior secured credit facilities, consisting of first and second lien term loans and including a $40 million revolver that's currently undrawn. Kevin will provide additional information about the facilities in his section of the call.

Fusion also raised $10 million of additional debt through the issuance of its subordinated notes of Holcombe Green, Fusion's Chairman -- Vice Chairman and largest shareholder. This note carries the same terms as Fusion's second-lien term loan.

We then closed a $15 million private placement of nonconvertible preferred shares in a transaction that was led by Holcombe Green. These shares are redeemable by Fusion at any time.

We retired all of Fusion's Series A and Series B preferred stock and paid the accrued and unpaid dividends on those preferred at the time of the close through the issuance of 1.3 million shares of Fusion's common stock. The total stated value of these preferreds plus the accrued and unpaid dividends was $18.9 million.

We also concluded an $8 million private placement of common stock priced at $5.25 a share led by a fund managed by Morgan Stanley. This fund, along with the other purchasers in a private placement, also participated in our new debt facilities. These institutions recognize the value that we likewise see in Fusion's equity. And we believe their investments demonstrate their strong confidence in our highly differentiated strategy.

In conjunction with the closing of the new facilities, we signed a definitive agreement to acquire MegaPath, a privately held integrated cloud services provider that delivers UCaaS, SD-WAN, cloud computing and security solutions with a strong West Coast presence. MegaPath will contribute additional financial scale to Fusion with approximately $70 million in annual revenue, 95% of which is contracted monthly recurring revenue and adjusted EBITDA of approximately $15 million, including anticipated cost synergies.

MegaPath represented a highly attractive acquisition, bringing more than 8,000 small- and medium-sized businesses and large enterprise customers to Fusion with an ARPU of $750 and 1% churn.

MegaPath has a team of approximately 250 highly skilled cloud service professionals, including approximately 45 solution sales professionals. In addition to sales talents, MegaPath will bring technical and engineering expertise that will help expedite the integration of the business into Fusion. MegaPath's approach to solution selling and customer support as well as its culture are quite similar to Fusion's, which will further facilitate the achievement of our strategic objective.

We also plan to leverage MegaPath's OSS, operational support system, and billing systems across the entire company to support our business and our customers while advancing our growth initiatives. Total consideration in the deal is $71.5 million, subject to working capital adjustments with up to $10 million payable at our discretion in Fusion’s common stock priced at $5.78 a share. We've escrowed $62 million of our new credit facility for this acquisition, and the agreement does not include a financing contingency. Given this, and with regulatory approval needed in only one state, we expect to complete the MegaPath acquisition within the next 90 days and achieve a postsynergy purchase price multiple below 5x adjusted EBITDA, including anticipated cost synergies. And finally, as planned, we changed our corporate name to Fusion Connect, which better reflects our exclusive focus on cloud and Business Services and on the way business is utilized and connected to the cloud to improve their efficiency, collaboration, and innovation.

We've already begun to make solid progress on integrating Birch. After spending the last several months working closely with the Birch team, we completed our integration plans prior to the closing of the transaction. This allowed us to hit the ground running the moment we made the announcement.

My senior management team and I spent last Monday, meeting with employees, communicating with our customers, our sales channel partners and our vendors. This is part of what we call our Day 1 process, in which we clearly convey Fusion's strategy and its benefits to all key stakeholders. And I'm extremely pleased to say that the internal and external feedback has been universally positive.

Much of that success is because our communication efforts, focusing on the benefits of the combination, have been taking place in earnest ever since we announced our intention to acquire Birch last August. The impact that our messaging is having was apparent at the recent channel partners trade show in Las Vegas. Nearly everyone I met spoke about the single-source trend, its effect on the direction of the industry. Fusion's positioning resonated loudly with our partners and agents as they are recognizing the tremendous value of our single source for the cloud approach as well as the significant benefits of the combination of Fusion and birch for their customers and themselves.

Over the coming months, we'll continue the integration process according to our well-established process, procedures and tracking. As in all our previous acquisitions, we've identified hundreds of integration and synergy items and are tracking them on a daily basis, which gives us confidence in achieving the vast majority of the integration items and the full amount of the anticipated cost savings within 12 months following the close. Our integration plans involve 3 main areas -- our organization, our network, and our systems -- all of which are governed by a very proactive communication strategy.

Already, we've largely implemented the new organizational structure for Fusion. Instead of maintaining separate divisions run by multiple general managers, as other companies in our space have done -- that has never been our philosophy -- we are operating as a single business unit, which increases efficiency and focus while ensuring that everyone is aligned with one mission and one set of objectives.

Throughout the process, we're focusing enormous resources on the combined customer base to ensure that we maintain the highest level of service quality. As with our prior acquisitions, we do not plan customer migrations, which can often result in disruption and customer losses. And in all the acquisitions that Fusion has done, we've never seen an uptick in churn following the close.

Instead, our strategy is to sell more products and services to our existing customers through cross-selling and up-selling. We've spent a lot of time over the past few months segmenting the customer base, creating product packages that are good fits with those customers and identifying the optimal distribution channels to reach them. We've also begun to train and incentivize the sales team for cross-selling and up-selling into the customer base and expect that, with the addition of MegaPath, we can be even more aggressive in our solutions-oriented sales approach.

In terms of our network, Fusion has always been a software and services company that believes control of the network is critical to providing value to customers, controlling service quality and improving customer loyalty. This has never been more true than it is now. On this front, we've identified a number of ways to improve our connectivity services by leveraging the best network components that each company has to offer while driving cost savings by eliminating redundancy and taking advantage of our scale to realize better pricing from vendors.

In terms of our systems, we again have the benefit of time to plan for back-office integration and we're highly confident in our ability to become even more effective in the way we sell to new and existing customers and support them. We are also implementing several enterprise-wide systems to ensure that we continue to lead the industry, not follow it.

Our success as a company isn't solely dependent on technology but more on the expertise, talent, creativity and determination of all of our employees. And that's why we're investing a new employee training and recognition program so that our team stays ahead of the curve and allows us to continue asserting ourselves as industry leaders. Meanwhile, we are also eliminating redundant billing, HR, and other systems, and expect to realize significant cost savings as a result even as we enhance our own ability to manage our business at a much larger scale.

The integration of all of these components coupled with our unique strategy position Fusion to become the cloud services industry leader. We believe we have all the right elements for success, including the right team of cloud service professionals with deep technology experience as well as the right products and services, sold as a fully integrated solutions with superior customer support. Our customers will continue to benefit from our ability to provide all of the cloud services they require over our own infrastructure with a superior end-to-end experience since we can control and manage the underlying service delivery technology.

Our significant customer scale gives us meaningful up-sell and cross-sell opportunities and we can leverage the combined company's infrastructure to do so, including our extensive 100% IP-based network in the U.S. and Canada with 31,000 route miles of fiber, located primarily in 11 metropolitan areas. By leveraging the full complement of these assets, we expect to improve our cost advantage in delivering our services.

We can also take advantage of our systems and a robust intellectual property far more broadly than before, which will lower our cost and increase our margins over time. And finally, our largest financial scale further empowers our growth strategy, including facilitating additional future acquisitions.

In summary, I'm very excited by our opportunity to be a disruptive force in the industry. We believe strongly that our unique strategy, the strength of our operating model and the power that comes from leveraging our platform to drive significant levels of free cash flow will greatly benefit our customers and partners, our employees and, particularly, our shareholders.

Generating increasing amounts of cash flow has been a priority for Fusion over the past several quarters thanks to a contribution from our acquisitions as well as modest organic growth. We now anticipate that the combination of Fusion with Birch and MegaPath will allow us to generate approximately 25% adjusted EBITDA margins across the entire business once the integration is completed. Additionally, as our cash flow increases, we expect to be able to delever our balance sheet. We believe this will be a significant driver of shareholder value in the coming years. We also expect to continue to acquire cloud services businesses at highly attractive postsynergy multiples and to quickly integrate them and expand their EBITDA to reach over 25% targeted margins. Given our robust pipeline of M&A opportunities, we believe we have a very high ceiling for additional accretive growth.

Back in August 2016, we set what we considered at the time to be an ambitious immediate-term objective of $200 million in annualized revenue and $30 million in adjusted EBITDA for a 15% margin. We expected to reach this objective within 3 years. While it's just a little over 20 months later, we're now a company that's generating more than $0.5 million in annualized revenue with a postsynergy-adjusted EBITDA margin of about 25%. Our execution over the last 2.5 years that allowed us to surpass those initial targets by multiples of the original figure, clearly demonstrates our determination to build something big and creates significant value.

And today, we're announcing Fusion's next set of immediate financial -- intermediate financial objectives, which are $750 million in annual revenue and $185 million in annualized adjusted EBITDA. We expect to achieve these objectives through the same formula of modest organic growth, complemented by step-function growth through accretive acquisitions.

Now I'd like to turn the call over to Kevin, who'll discuss our results in more detail. Kevin?

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Kevin Dotts, [4]

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Thanks, Matt. And let me say also how excited I am to be here.

I would also like to remind our listeners that in our financial results for the quarter, the Carrier Services segment is classified as a discontinued operation due to the fact that it was spun off from Fusion on May 4, 2018. Therefore, our discussion of revenue, gross margin, income and adjusted EBITDA for -- during the first quarter of 2018 and the year-ago period, does not include any contribution from Carrier Services. Beginning in the second quarter, we will be presenting the combined results of Fusion and Birch with comparable prior periods based on Birch's historical financials.

Turning to the numbers. For the first quarter of 2018, total revenue was $29 million, up 2% versus $28.5 million in the first quarter of 2017. Approximately 85% of total revenue in the first quarter was monthly recurring revenue, or MRR. Fusion ended March with approximately 13,300 business customers, an ARPU of $715 and a monthly churn rate of 1.2%, which is within our historical range of 1% to 1.2%.

Gross margin during the first quarter was 55.5% compared to 57.4% in the first quarter of 2017. The decrease in gross margin was driven by the addition of lower-margin revenue from certain new customers we began servicing during the first half of 2017. Net loss attributable to Fusion common shareholders from continuing operations was $4.2 million, or $0.20 per share compared to net loss in first quarter of 2017 of $4.4 million or $0.32 per share.

Adjusted EBITDA for the first quarter of 2018 was $3.7 million, up 2% year-over-year. Capital expenditures totaled $980,000 in the first quarter or 3.4% of consolidated revenue. Fusion's unlevered free cash flow defined as adjusted EBITDA less capital expenditures was $2.7 million in the first quarter of 2018.

Finally, our cash balance at March 31, 2018, was $31 million compared to $2.5 million at December 31, 2017. On February 5, Fusion completed a follow-on offering of 8.6 million shares of its common stock at a price of $4.80 per share for a net proceeds before offering expenses of $38.7 million. Additionally, during the quarter, Fusion made $6.6 million of debt paydowns of its then outstanding senior secured term loan.

Now I'd like to review the summary terms of our new $680 million senior-secured credit facilities. They consist of a $555 million first-link facility, which comprises a $45 million term loan A facility, a $510 million term loan B facility and a $40 million revolving credit facility, which is currently undrawn. The facilities also include an $85 million senior lien -- senior term loan facility.

These new facilities retired the indebtedness at both Fusion and Birch that the companies held prior to the close. Additionally, as Matt noted earlier, $62 million of a $510 million term loan B facility has been escrowed as consideration for the MegaPath acquisition. The maturities on those facilities are 4 years on the term loan A and revolver, 5 years on the term loan B and 5.5 years on the second-lien term loan from the effective date.

As Matt mentioned, Fusion completed 2 additional financing transactions on May 4. First, we raised $10 million of debt through the issuance of a subordinated note to Holcombe Green with an interest rate of LIBOR plus 10.5%. Second, Fusion closed a $15 million private placement of nonconvertible preferred shares in a transaction with an investment group led by Holcombe Green. These shares are redeemable by Fusion at any time.

On the same day, Fusion retired all of its series A-1, A-2, A-4, and series B-2 preferred stock and paid the accrued and unpaid dividends on those preferreds at the time of the close through the issuance of 1.3 million shares of Fusion common stock.

Including the revolver that is currently undrawn, Fusion's new facilities plus the $10 million subordinated note bear interest at a weighted average rate of LIBOR plus 7.6%. Excluding the revolver, the facilities and the subordinated note bear interest at a weighted average rate of LIBOR plus 7.8%, within range of our guidance. More information regarding the new facilities is included in our filing Form 8-K dated May 10, 2018.

At closing, the ratio of total net debt to adjusted EBITDA was approximately 3.7x, using the last 12 months pro forma combined adjusted EBITDA plus expected cost synergies. Over time, we expect to reduce our leverage through growth and adjusted EBITDA and the amortization of the principal on the facilities.

We are targeting approximately $20 million of cost synergies from the Birch combination and approximately $15 million of cost synergies from the MegaPath combination and expect both amounts to be achieved within 12 months of their respective closing of each transaction. We expect approximately $8 million in onetime cash expenses in order to complete the integration of both businesses and to achieve those synergies.

We expect postsynergy combined adjusted EBITDA margins to be around 25% with some potential upside in future periods. We also expect to remain CapEx-lite postclose, targeting CapEx below 10% of total revenue. This positions us to generate significant recurring unlevered free cash flow.

And with that, I'll turn the call back over to Matt.

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Matthew D. Rosen, Fusion Telecommunications International, Inc. - Chairman & CEO [5]

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Thanks, Kevin. Now I'd like to turn the call back to the operator to open up to your questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) And we'll go first to George Sutton with Craig-Hallum.

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George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst [2]

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I'd like to welcome Kevin back to the public markets. So I wanted to understand on a product-offering basis as we move forward, how are you giving the message into both your internal sales force and the channel relative to the different products from Birch and Fusion and then, of course, once you bring forward MegaPath?

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Matthew D. Rosen, Fusion Telecommunications International, Inc. - Chairman & CEO [3]

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So I would say that the single-word answer there is training. We as Fusion have obviously the broader set of products and services. And so we were already offering all of the services that Birch had. So the training really comes to the sales professionals at Birch as well as the distribution partners that we currently don't work with that Birch was using. And it's just we've got a very structured plan that includes quite a bit of training on the products and services themselves and the applications of those products and services as well as the pricing. We've already begun the training, actually, the first day that we closed the transaction. And this is, really, not just a onetime event. This is an ongoing effort to make sure that our existing staff internally as well as any entities, i.e., distribution partners that are working with us to make sure they're trained on all of the products and services because this is a continuingly developing product set for us, and so we always want to make sure that we're training people appropriately.

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George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst [4]

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I'm curious if you would kind of walk through the trends that Birch was seeing in Q1 and a sense of the pipeline as we enter the new ownership period.

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Matthew D. Rosen, Fusion Telecommunications International, Inc. - Chairman & CEO [5]

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Sure. So what I would say and I think everyone on the call recognizes the fact that Birch was not set up as a growth-oriented business. And so we've been spending a number of months getting the company positioned that when we actually did close the transaction, we could start to transform the business into a growth-oriented company. And so even during the integration process and planning, the company was making a number of moves to position it as such. It is not an overnight accomplishment. It is going to take us a little bit of time. As I just said, we have to train all of the different factions responsible for delivering -- selling, delivering and maintaining the services that we have. So I think I would say the first quarter was an improvement compared -- another improvement, I would say, compared to what they had been seeing historically. And I think we'll continue to see those improvements as the quarters evolve.

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George Frederick Sutton, Craig-Hallum Capital Group LLC, Research Division - Partner, Co-Director of Research & Senior Research Analyst [6]

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Great. Lastly from me, relative to your intermediate objectives, I wondered if you could define intermediate? And it looks fairly simplistic. You're looking for 25% EBITDA margins on the revenues. Is that how we should read this?

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Matthew D. Rosen, Fusion Telecommunications International, Inc. - Chairman & CEO [7]

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Yes. I would say that we're looking for 25%. There might be a little bit of upside there, but we are targeting the business because we want to continue to make sure that we're balancing the generation of significant amounts of cash flow and EBITDA margins with our ability to continue to grow the business and stay ahead of the curve and create value. And so that's where we're coming up with this 25% figure. And the immediate -- intermediate term for us is approximately 3 to 4 years.

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Operator [8]

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Well go next to Josh Nichols with B. Riley FBR.

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Michael Joshua Nichols, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [9]

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Yes. Just wanted to ask on a pro forma basis, could you talk a little bit about the gross margin profile you expect to see kind of out of the gate and how you expect that to kind of trend over the next 12 to 18 months as you continue to integrate and cross-sell a number of the Birch customer base?

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Matthew D. Rosen, Fusion Telecommunications International, Inc. - Chairman & CEO [10]

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Sure. So out of the gate, we're looking at about 50% gross margins. So obviously, the flow-through is quite considerable to the bottom line. As we continue to evolve, one of the things we'll be seeing is, through the sale of our proprietary services, the margin profiles are quite a bit higher, and so I would actually look to see the overall margins as we continue to penetrate our services throughout the existing Birch customer base as well as all of the new customers coming onboard, we'd actually expect that gross margin to tick up. I would argue that it'll tick up very slightly over time, but we would expect it to tick up.

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Michael Joshua Nichols, B. Riley FBR, Inc., Research Division - Senior Analyst of Discovery Group [11]

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And then regarding the company's dual-mandate gross strategy for organic growth and M&A here, I guess, do you plan on taking a little bit of time to integrate this acquisition over maybe like the next 12 months-or-so? Or do you think that you're well positioned enough and have done enough work on the integration side where you still have flexibility and feel comfortable pursuing some additional M&A at some point later this year?

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Matthew D. Rosen, Fusion Telecommunications International, Inc. - Chairman & CEO [12]

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Yes. I would say that the time that we had from announcement of the transaction till now really gave us a head start at integrating those businesses. And so when we actually announced the closing last Monday, we were literally able to kind of start -- push buttons and start in almost every area of the integration. So we would expect it to grow a bit faster than what we had initially anticipated because we had that extra time. I will tell you that, as I've done historically, I will look at the current situation where we are with the integration and evaluate any potential acquisitions and how that weighs in. But we do think that we will be in a position to acquire another business within 12 months. We think we'll be far enough along with the integration that we'll be in very, very good position to acquire another business, effectively integrate it and not disrupt the ongoing operation of the company.

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Operator [13]

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(Operator Instructions) And at this time, there are no further questions. I'll turn the call back to Matt.

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Matthew D. Rosen, Fusion Telecommunications International, Inc. - Chairman & CEO [14]

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Thank you, operator. And thanks to everyone who joined us today. We look forward to speaking with many of you at these 3 upcoming conferences that I'd like to highlight. First on May 23, we'll be attending the 19th annual B. Riley FBR Institutional Investor Conference in Santa Monica, California. On May 30, we'll be attending the 15th Annual Craig-Hallum Institutional Investor Conference in Minneapolis, Minnesota. And on June 6, we'll be attending the Morgan Stanley Leveraged Finance Conference in New Orleans. We hope to see many of you there, and we greatly appreciate your continued support of Fusion as we build the industry's leading integrated cloud services provider. After what has so far been a momentous 2018, I can assure you that we're just getting started. Have a great day, and thanks again.

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Operator [15]

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This does conclude today's conference. We thank you for your participation.