UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


WASHINGTON,
D.C. 20549




FORM
10-KSB/A


(Amendment
No. 1)




x
            ANNUAL
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE OF
      1934




For the
fiscal year ended December 31, 2007




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




For the
transition period from ____________ to ____________




Commission
file number: 000-52862





MSTI Holdings,
Inc.


(Name of
Small Business Issuer in Its Charter)




Delaware
                      
                      26-0240347(State
      or Other Jurisdiction of Incorporation
                      
                      (I.R.S.
      Employer Identification No.)or
      Organization)259-263
      Goffle RoadHawthorne,
      New Jersey
                      
                      07506(Address
      of Principal Executive Offices)
                      
                      (Zip
      Code)




(973)
      304-6080(Issuer’s
      Telephone
Number)




Securities
registered under Section 12(b) of the Exchange Act:





Title of Each Class
                      
                      Name of Each Exchange on Which RegisteredNone
                      
                      None





Securities registered under Section 12(g) of the Exchange Act:





Common Stock, par
value $0.001 per share


(Title of
Class)





Check
whether the issuer is not required to file reports pursuant to Section 13 or
15(d) of the Exchange Act.   o




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




Check if
there is no disclosure of delinquent filers in response to Item 405 of
Regulation S-B contained in this form, and no disclosure will be contained, to
the best of registrant’s knowledge, in definitive proxy or information
statements incorporated by referenced in Part III of this Form 10-KSB or any
amendment to this Form 10-KSB.  x





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





The
issuer’s revenues for the fiscal year ended December 31, 2007, were
$2,675,750.





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the closing price of $0.40 on April 9,
2008 was $3,766,369.





As of
April 1, 2008, there were 29,816,552 shares of the issuer’s common equity
outstanding.




Transitional
Small Business Disclosure Format (Check one): Yes  o   No 
x








MSTI
HOLDINGS, INC.


FORM
10-KSB/A





Table
of Contents





PageExplanatory
      Note
                1Part
      IItem
      1.
                Description
      of Business
                2Item
      2.
                Description
      of Property
                19Item
      3.
                Legal
      Proceedings
                19Item
      4.
                Submission
      of Matters to a Vote of Security Holders
                19Part
      IIItem
      5.
                Market
      for Registrant’s Common Equity, Related Stockholder Matters and Small
      Business Issuer Purchases of Securities
                19Item
      6.
                Management’s
      Discussion and Analysis or Plan of Operations
                20Item
      7.
                Financial
      Statements
                25Item
      8.
                Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                25Item
      8A(T).
                Controls
      and Procedures
                25Item
      8B.
                Other
      Information
                26Part
      IIIItem
      9.
                Directors,
      Executive Officers, Promoters, Control Persons and Corporate Governance;
      Compliance With Section 16(a) of the Exchange Act
                26Item
      10.
                Executive
      Compensation
                29Item
      11.
                Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                31Item
      12.
                Certain
      Relationships and Related Transactions and Director
      Independence
                33Item
      13.
                Principal
      Accounting Fees and Services
                33Item
      14.
                Exhibits
                35








EXPLANATORY
NOTE




MSTI
Holdings, Inc. is filing this Amendment No. 1 on Form 10-KSB/A for the year
ended December 31, 2007 (“Form 10-KSB/A”) to amend our Form 10-KSB for the year
ended December 31, 2007, filed with the Securities and Exchange Commission (the
“SEC”) on April 15, 2008 (the “Original 10-KSB”). The Company is filing this
Form 10-KSB/A in response to comments received from the SEC. The Company is
hereby amending the Form 10-KSB as follows:





The
Company has revised the disclosure in the risk factor on page 14, to delete the
statement that the Company has not performed an in depth analysis to determine
if past failures of internal control exist.





The
Company has revised its financial statements to delete the successor columns for
the year ended December 31, 2006, in the Consolidated Statement of Losses and
the Consolidated Statement of Cash Flows.





The
Company has changed the unrecognized stock based compensation disclosed in Note
J.





The
Company has revised the disclosure in Note L – Income Taxes, page
F-26.





The
Company has revised paragraph 4 of its certifications Exhibits 31.1 and
31.2.





The
amendment did not have any material impact on the Company financial results; the
annual report is filed in its entirety with the applicable changes. Except for
the amendments and updates described above, this Amendment No. 1 on Form
10-KSB/A does not modify or update in any other way the Original 10-KSB. This
Form 10-KSB/A does not reflect events that occurred after the filing of the
Original 10-KSB.


1





PART
I





Forward-Looking
Statements




This
Annual Report on Form 10-KSB contains “forward-looking statements” within the
meaning of Section 27A of the Securities Act of 1933, as amended (the
“Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as
amended (the “Exchange Act”). All statements in this Annual Report other than
statements of historical fact are “forward-looking statements” for purposes of
these provisions, including any statements of the plan and objectives for future
operations and any statement of assumptions underlying any of the foregoing.
Forward-looking statements can be identified by the use of words such as
“expects,” “plans,” “will,” “may,” “anticipates,” believes,” “should,”
“intends,” “estimates,” and other words of similar meaning. These statements are
subject to risks and uncertainties that cannot be predicted or quantified and,
consequently, actual results may differ materially from those expressed or
implied by such forward-looking statements. Such risks and uncertainties are
outlined in “Risk Factors” below.




Item 1.   DESCRIPTION OF
BUSINESS





Corporate
History





Prior to
May 24, 2007, we were a public shell company, as defined by the Securities
and Exchange Commission, without material assets or activities. We were
incorporated in the State of Nevada on February 10, 2006 as Fitness Xpress
Software, Inc. On May 18, 2007, we merged with and into our wholly-owned
Delaware subsidiary, for the sole purpose of changing our state of incorporation
to Delaware. On May 24, 2007, Microwave Acquisition Corp., a newly formed
wholly-owned subsidiary of ours, merged with and into a private company,
Microwave Satellite Technologies, Inc. (“MST”), which was incorporated in the
State of New Jersey in 1982. In January 2006, Frank T. Matarazzo, our Chief
Executive Officer and then sole stockholder of MST, sold a 90% interest in MST
to Telkonet, Inc.





Upon
closing of the merger, MST became a wholly-owned subsidiary of ours and we
succeeded to MST’s line of business as our sole line of business. Following the
merger, we changed our name from Fitness Xpress Software, Inc. to MSTI Holdings,
Inc.





In May
2007, we consummated a private placement of units, consisting of 5,597,664
shares of our common stock and warrants to purchase an additional 2,798,836
shares of our common stock, and a private placement of 8% secured convertible
debentures due April 30, 2010 (the “Debentures”), for aggregate gross proceeds
of approximately $9.1 million.





On July
18, 2007, we acquired substantially all of the assets of Newport
Telecommunications Co., including approximately 1,900 new
subscribers.





Overview





We are a
carrier class communications technology company that specializes in providing
true quadruple play (“Quad-Play”) services to multi-tenant unit (“MTU”) and
multi-dwelling unit (“MDU”) residential, hospitality and commercial properties.
These Quad-Play services include video, voice, high-speed internet and wireless
fidelity (“Wi-Fi”) access. We are also a national internet service provider
(“ISP”) and offer a suite of ancillary services including the design,
installation and service of satellite and Internet Protocol (“IP”) based video
conferencing and surveillance systems.





Our
principal executive offices are located at 259-263 Goffle Road, Hawthorne, New
Jersey 07506 and our telephone number is (973) 304-6080. Our reports filed with
the SEC can be found at our website at www.mst-online.com .
Information on or accessed through our website is not incorporated into, and is
not a part of, this Annual Report.





NuVisionsTM




We
currently offer digital television service through DISH Network, a national
satellite television provider, under our private label NuVisionsTM brand of
services. The NuVisions TV offering includes over 500 channels of video and
audio programming, with a large high definition (more than 40 channels) and
ethnic (over 100 channels from 17 countries) offering. We also offer NuVisions
Broadband high speed internet service and NuVisions Digital Voice telephone
service to multi-family residences and commercial properties. We deliver
broadband based services using terrestrial fiber optic links and in February
2005 began deployment in New York City of a proprietary wireless gigabit network
that connects properties served in a redundant gigabit ring - a virtual fiber
optic network in the air.


2





Wi-Fi
Network





We have
constructed a large NuVisions Wi-Fi footprint in New York City intended to
create a ubiquitous citywide Wi-Fi network. NuVisions Wi-Fi offers Internet
access in the southern-half of Central Park, Riverside Park from 60th to 79th
Streets, Dag Hammarskjold Plaza, and the United Nations Plaza. In addition, we
provide NuVisions Wi-Fi service in and around Trump Tower on Fifth Avenue, Trump
World Tower on First Avenue, the Trump Place properties located on Riverside
Boulevard, Trump Palace, Trump Parc, Trump Parc East as well as portions of
Roosevelt Island surrounding the Octagon residential community. We currently
have plans to deploy additional Wi-Fi “Hot Zones” throughout New York City and
plan to continue to enlarge our Wi-Fi footprint as new properties are
served.





Internet
Protocol Television (“IPTV”)





In fourth
quarter of 2006, we invested in an IPTV platform to be deployed in May 2008.
IPTV is a method of distributing television content over IP that enables a more
user-defined, on-demand and interactive experience than traditional cable or
satellite television. The IPTV service delivers traditional cable TV programming
and enables subscribers to surf the Internet, receive on-demand content, and
perform a host of Internet-based functions via their TV sets.





PLC
Technology




With a
combined set of technology and services solutions, we have created and deliver a
platform of bundled IP services utilizing power line communications technology,
or PLC. Current services that utilize PLC include high speed Internet and VoIP
telephone. Our current plans include the further development and deployment of
energy management services and building control solutions, building
surveillance/security, and eConcierge using PLC technology.





Customers/Strategy





Our
customer base and strategy is to target and cultivate a subscriber base that
will demand high margin products, including, video, IPTV, VoIP, high-speed
Internet and Wi-Fi services.




We
currently maintain service agreements with approximately 22 MDU and MTU
properties. Generally, under the terms of a service agreement, we provide either
(i) “bulk services,” which may include one or all of a bundle of products and
services, at a fixed price per month to the owner of the MDU or MTU property,
and contract with individual residents for enhanced services, such as premium
cable channels, for a monthly fee or (ii) contract with individual
residents of the MDU property for one or more basic or enhanced services for a
monthly fee. These agreements typically include a revenue sharing arrangement
with property owners, whereby the property owner is entitled to a share of the
revenues derived from subscribers who reside at the MDU/MTU property . These  revenue sharing
arrangements are either based upon a fixed amount per subscriber or based on a
percentage, typically between 7-10%, of the monthly revenue we receive from
subscribers for our services. We believe that our complementary products and
services allow for future growth and as such are designed and integrated with
scalability in mind.





Services




Video




Our video
service currently offers over 500 channels in a variety of packages which are
tailored to suit specific individual needs. We transmit signals through the air
using microwave/satellite technology, or through a fiber optic network, designed
to provide superior reception to that of traditional cable TV companies that
relay signals through coaxial cable. Some important features of our video
services include:




·
              one
      of the largest selections of HDTV
programming
 
 ·
              large
      ethnic TV offering with over 17 different countries
      represented
 
 ·
              custom
      designed channel line-ups
 
 ·
              flexible
      pricing plans for basic and premium
packages
 
 ·
              community
      bulletin board channels
 
 ·
              building
      closed circuit TV (“CCTV”) surveillance/security
  channels
 
 ·
              multiple pay-per-view
      channels


3




·
              24
      hour a day-365 days a year customer
service
 
 ·
              interactive
      TV guide
 
 ·
              fully addressable system
      eliminating the need for technicians to gain access to apartments for
      service changes




Internet
Protocol Television




In
addition to traditional video, we currently intend to offer our IPTV platform.
IPTV is an emerging TV delivery technology that provides an interactive
experience. We believe that IPTV will offer a virtually unlimited selection of
programming and on-demand content, including HD video. In addition, we believe
that we will have the ability to offer new value-added and bundled services,
enabling subscribers to surf the Internet, receive on-demand content, and
perform a host of Internet-based functions via their TV sets, as these services
become available without having to re-engineer the network.




IPTV
covers both live TV (multicasting) as well as stored video (video on
demand-VOD). The playback of IPTV requires either a personal computer or a
“set-top box” connected to a TV.




An
IP-based platform provides the opportunity for an interactive and personalized
TV viewing experience. We may, for example, include an interactive program guide
that allows viewers to search for content by title or actor’s name, or a
picture-in-picture functionality that allows them to “channel surf” without
leaving the program they are watching. Viewers may be able to look up a player’s
stats while watching a sports game, or control the camera angle. They also may
be able to access photos or music from their PC on their television, use a
wireless phone to schedule a recording of their favorite show, or even adjust
parental controls so their child can watch a documentary for a school report,
while they’re away from home.




Our
roll-out, currently planned for second quarter of 2008, of an IP-based network
also provides us the opportunity for integration and convergence. Converged
services imply interaction of existing services in a seamless manner to create
new value added services. An example of such integration and conversion is
On-Screen Caller ID, getting Caller ID on TV and the ability to process (send to
voice mail, etc.). IP-based services will help us provide consumers
anytime-anywhere access to content over their televisions, PCs and cell phones,
and to integrate services and content. Within businesses and institutions, IPTV
may eliminate the need to run a parallel infrastructure to deliver live and
stored video services.




We
presently purchase all of our video programming from EchoStar Satellite, LLC
(“EchoStar”). We pay EchoStar a monthly license fee based on the number of our
customers, subject to volume discounts and monthly programming costs. We may
enter into agreements with other program suppliers in the future in connection
with the deployment of IPTV.





In
connection with the roll out of IPTV, we currently expect to enter into an
agreement with a leading content aggregator and IPTV transport company to
aggregate video and audio channel programming from cable television satellite
transmissions and re-transmit them to our facilities for a monthly fee based
upon the number of our IPTV customers.





Digital
Voice/VoIP




Our
digital voice service offering utilizes the underlying VoIP protocol but does
not traverse the Internet in the same manner as traditional VoIP providers. No
special equipment or Internet connection is required to use our digital voice
service. A customer’s ordinary analog phone and existing copper wires in the
building are utilized with the conversion of analog to IP taking place in a
building’s main telephone room. The traffic is carried “on network” to NuVisions
voice partners. Customers are provided with utmost functionality typically found
in traditional regional Bell operating company (RBOC) architecture. Unlike many
other VoIP providers, since our service does not rely on the public Internet,
NuVisions Digital Voice can fully control quality of service in the
network.




We
currently offer one consumer voice service and have plans to offer in the future
a business VoIP service. Special features of NuVisions Digital
Voice include:




·
              ability
      to retain existing phone number;
 
 ·
              many
      free features including Voicemail, Call Waiting, 3-Way Calling, Caller ID
      with Name, and call forwarding;
 
 ·
              web-portal
      with unified messaging, voicemail to email, custom call
      handling;
 
 ·
              24/7 online account
      management;


4




·
              new
      VIDEO phone service that uses broadband Internet
    connection;
 
 ·
              unlimited
      calls to anywhere in the United States for a low monthly
    fee;
 
 ·
              competitive
      international rates;
 
 ·
              sound quality indistinguishable
      from a traditional phone
service.




Wi-Fi,
Wireless Hot Zones and Metropolitan Wide Area Wireless Network




Through a
joint venture with Global Transport Logistics, Inc. (“GTLI”), we formed
Interactivewifi.com to build and operate a large Wi-Fi network in New York City
in 2006 and have deployed several new wide-areas “Hot Zones” in 2007. We
currently plan to continue to expand “Hot Zone” coverage around the City.
Consumers pay an hourly or monthly fee for internet access in these
Interactivewifi.com wireless “Hot Zones,” or have free access to selected New
York City government websites.




Under
this joint venture arrangement, we contributed capital for purchase and
deployment of network control equipment and wireless access points, as well as
for development and deployment of the software system by which users access the
Wi-Fi network, pay for service via credit card, and by which we control
bandwidth utilization and hours of usage by individual subscribers. Under the
joint venture, Interactivewifi.com pays us a fee for the bandwidth utilized by
users of the Wi-Fi network, which we deliver to Interactivewifi.com over our
Metropolitan Wide Area Network. In addition, our NuVisions high speed internet
subscribers are given free access to the Interactivewifi.com “Hot
Zones.”




The
Interactivewifi.com Wi-Fi network currently offers Internet access in the
southern-half of Central Park, Riverside Park from 60 th to 79
th
Streets, Dag Hammarskjold Plaza, and the United Nations Plaza. In addition,
Wi-Fi service is available in and around Trump Tower on Fifth Avenue, Trump
World Tower on First Avenue, the Trump Place properties owned by Equity
Residential and Extell Corporation located on Riverside Boulevard, Trump Palace,
Trump Parc, Trump Parc East as well as portions of Roosevelt Island surrounding
the Octagon residential community.




Our
Metropolitan Wide Area Network, a gigabit network that connects the MTU/MDU
properties that we serve in a redundant gigabit ring within New York City,
delivers our NuVisions internet, telephone and, in the near future, IPTV
services, to these properties. This Network is built with carrier grade Gigabit
Ethernet microwave equipment and is the foundation of a resilient network which
delivers broadband signals from building-to-building, and connects to broadband
networks, including Telkonet PLC technology, installed within the building. From
each property that we connect in our Metropolitan Wide Area Network,
Interactivewifi.com deploys wireless access points, offering Wi-Fi access in the
common areas and geographic areas surrounding these properties, which expands
the Wi-Fi network’s coverage.




Expansion
of the Metropolitan Wide Area Network and the Interactivewifi.com network within
New York City allows us to offer consumers paid-for access and value-added
features, bringing us one step closer to our goal of digital convergence. We
offer our customer freedom from the traditional wired connections offered by
many of our competitors. Not only does our NuVisions high-speed Internet
subscription give mobility within a home or property by allowing connection to
any electrical outlet in the property for Internet service, it also gives
subscribers free access to the Internet in the expanding Wi-Fi network
throughout New York City. We currently plan to deploy additional “Hot-Zones” in
and around New York City, which will allow Wi-Fi Internet access to the network
within the parks, common areas and properties served by our NuVisions brand.
High speed wireless “Hot Zones” will provide  Internet connections at
speeds 100 times greater than 56k modem, without busy signals and disconnects
during peak usage times.




In
addition, Interactivewifi.com has agreements with premier wireless network
aggregators including iPass and Boingo. Pursuant to these agreements, customers
of the wireless network aggregators can gain access to the Interactivewifi.com
network using their account with the wireless network aggregator. Each time one
of their customers connects to our network Interactivewifi.com charges the
wireless aggregator a fixed fee per connection and Interactivewifi.com pays us a
fee for the bandwidth utilized by the customer of the wireless
aggregator.




Power
Line Communications (PLC)




Using PLC
technology products allows us to provide connectivity over a property’s existing
electrical wiring and infrastructure without costly installation of additional
wiring or major disruption of business activity.




The
benefits of PCL include:




·
              secure
      data transmission;
 
 ·
              Secure
      Telkonet iBridgeTM- to-Gateway architecture ensures no user can see other
      users on the network;
 
 ·
              data is secure from outside
      intrusion;


5




·
              data
      is encrypted with 56-bit Data Encryption
  Standard;
 
 ·
              no
      wireless connectivity or RF interference issues;
  and
 
 ·
              the convenience of wireless with
      the security of a wired
solution




Through a
co-marketing agreement, we leverage PLC technology from Telkonet in our
properties to deliver our diverse range of services through the properties’
existing electrical infrastructure. We currently expect to enter into a new
agreement with Telkonet that will give us the right to offer its PLC
technology in the New York metropolitan area on terms favorable to
us.




eConcierge




Our
eConcierge service was launched in January 2008, and will be marketed under our
eConcierge brand name. The eConcierge solution will enable seamless
communication between residents and building management, provide information
about neighborhood services and offer access to amenities through a computer or
simple touch-screen tablet interface. The system can also be utilized for
internal control of individual apartment systems and functions such as lighting,
temperature, and other IP enabled devices and systems. Advertising space  on
the portal will be offered to local merchants and residents that register on the
portal will be given a card that can be used to receive discounts from merchant
advertisers.




Other
eConcierge service features may include:




·
              messaging
      system and chat among residents and
staff
 
 ·
              exclusive
      local and online discounts for building
  residents
 
 ·
              calendar
      of local events and building news
 
 ·
              lists
      and reviews of service providers such as tutors, babysitters and
      housekeepers
 
 ·
              building
      marketplace
 
 ·
              butler
      service for instant requests to
staff
 
 ·
              online
      building services sign-up
 
 ·
              community
      based/ building specific
 
 ·
              advertising
      revenue w/real time back-end
 
 ·
              unique
      to our service/tied to building
management
 
 ·
              discount cards/ ID
      cards




Energy
Management




Energy
management services are also implemented as part of a suite of bundled managed
services giving building owners, managers, and residents the capabilities to
monitor, control and adjust energy usage throughout a building using the same
PLC technology that is currently being used to deliver the other services
offered in residential, commercial, and hotel properties. We have installed one
energy management system at the Octagon, a 500-unit luxury apartment complex on
New York City’s Roosevelt Island. This service is still in its early stages and
requires further development.




Competition




The home
entertainment and video programming industry is competitive, and we expect
competition to intensify in the future. We face our most significant competition
from the franchised cable operators. In addition, our competition includes other
satellite providers, telecom providers and off-air
broadcasters.


6





Hardwired
Franchised Cable System





Cable
companies currently dominate the market in terms of subscriber penetration, the
number of programming services available, audience ratings and expenditures on
programming. However, satellite services are gaining market share which we
believe will provide us with the opportunity to acquire and consolidate a
subscriber base by providing a high quality signal at a comparable or reduced
price to many cable operators' current service.





Other
Operators





Our next
largest competitors are other operators who build and operate communications
systems such as satellite master antenna television systems, commonly known as
SMATV, or private cable headend systems, which generally serve condominiums,
apartment and office complexes and residential developments. We also compete
with national direct broadcast satellite (DBS) operators such as
EchoStar.





Off-Air
Broadcasters





A
majority of U.S. households that are not serviced by cable operators are
serviced only by broadcast networks and local television stations (“off-air
broadcasters”). Off-air broadcasters send signals through the air, which are
received by traditional television antennas. Signals are accessible to anyone
with an antenna and programming is funded by advertisers. Audio and video
quality is limited and service can be adversely affected by weather or by
buildings blocking a signal.





Traditional
Telephone Companies




Traditional
telephone companies such as Verizon and AT&T have recently diversified their
service offerings to compete with traditional franchised cable companies in a
triple-play market. Although their subscriber growth is currently smaller than
franchise cable companies, these traditional phone companies are developing
video offerings such as Verizon's FIOS product. These phone companies have in
the past also been resellers of DIRECTV and EchoStar video programming, however,
rarely in the multi-dwelling unit market. In the future, video offerings from
traditional phone companies may become a significant competitor in the MDU
market.





Market




Cable
television began in 1948 as an alternate television service to households where
reception of over-the-air TV signals was poor and has since expanded into a
multi-billion dollar industry. Once simply considered a conveyer of video
programming, cable’s broadband infrastructure may provide a pipeline for
delivery of new advanced services, including digital networks, video-on-demand,
interactive television, high-speed Internet access and telephony.





Video
Marketplace




The
American television consumer can choose from a variety of multichannel video
providers, from the local cable operator to national direct broadcast satellite
providers and, in many markets, newer facilities-based broadband companies that
offer a full range of telecommunications services. In addition, we believe that
a number of the nation’s largest RBOCs are currently planning to offer video
services in the future.





High-Speed
Internet Marketplace




As the
cost of high-speed Internet service declined and connection speeds became more
important, high-speed service overtook dial-up in market share for the first
time, according to the J.D. Power and Associates 2006 ISP Residential Customer
Satisfaction Study. The study found that 56% of residential ISP customers
subscribe to high-speed Internet service, an increase of 11% from 2005.
Correspondingly, market share of dial-up service has dropped from 55% in 2005 to
44% in 2006. We believe this trend is expected to continue, as according to J.D.
Power, the intent to switch service providers among dial-up customers has
increased by 3% from 2005 to 21% in 2006, while switching intent among
high-speed customers has essentially remained flat since 2003 at
11%.




The
average amount subscribers report spending per month for high-speed Internet
service has steadily decreased since 2004, down by $1.99 to $42.13 in 2006.
During the same time period, the average amount dial-up service subscribers
report spending has also declined, however, less significantly from $0.69 in
2004 to $18.45 per month in 2006, according to J.D. Power.




Although
high-speed Internet service is still generally considerably more expensive than
dial-up, we believe bundling high-speed with other products, such as telephone
and video service, has made it an increasingly attractive option for many
customers. However, dial-up still holds a significant portion of the market. We
believe customers may be willing to pay more for faster Internet speeds,
provided they receive other services for less.


7





We
believe that the future will bring even more choice for consumers, including new
broadband over power line (BPL) service that allows the delivery of IP-based
broadband using the communications capabilities of the national utilities
companies via the power grid. According to the United Telecom Council, there are
a number of trials underway nationwide, and a small number of commercial
deployments have been launched. Many cable operators have responded to this
competitive marketplace by offering consumers a bundled package of their
services, which has enabled them to attract new customers and retain existing
subscribers.





Cable
Industry Capital Expenditures




We
believe that the cable industry is facing a fundamental change in industry
dynamics due to accelerating capital expenditures, service saturation and
slowing subscriber growth to increased competition and out-of-home media
explosion, though such change may not be evident for several years.




We
believe cable operators must add bandwidth capacity and speed to stay
competitive since bundled high-speed data, digital video and VoIP services are
attractively priced by telephone, satellite and other rival providers. We
believe there is significant consumer demand for peer-to-peer communications,
file-sharing and other tools for producing and delivering broadband video, and
that if high-definition channel availability doubles over the next year, cable
operators will need to create more room through advanced video compression,
switched broadcast and node splitting.




After
passage of the 1996 Telecommunications Act, cable operators aggressively tapped
into capital markets to accelerate a nationwide broadband infrastructure
upgrade. The cable industry’s new interactive digital service is the result of a
substantial investment in state-of-the-art fiber optic networks.





Governmental
Regulation





Federal
Regulation




Our
systems do not use or traverse public rights-of-way and thus are exempt
from the comprehensive regulation of cable systems under the Federal
Communications Act of 1934, as amended (the “Communications Act”). Because our
systems are subject to minimal federal regulation, we have greater pricing
freedom and are not required to serve any customer whom we do not choose to
serve, and we believe that we have significantly more competitive
flexibility than do the franchised cable systems. We believe that these
regulatory advantages help to make our private systems competitive with larger
franchised cable systems.





On
October 5, 1992, Congress enacted the Cable Consumer Protection and Competition
Act of 1992 (the “1992 Cable Act”), which imposed additional regulation on
traditional franchised cable operators and permits regulation of rates in
markets in which there is no “effective competition”, as defined in the 1992
Cable Act, and directed the FCC to adopt comprehensive new federal standards for
local regulation of certain rates charged by traditional franchised cable
operators. Conversely, the legislation also provides for deregulation of
traditional hardwire cable in a given market where effective competition is
shown to exist. Rates charged by private cable operators, typically already
lower than traditional franchise cable rates, are not subject to regulation
under the 1992 Cable Act.





In
February 1996, Congress passed the Telecommunications Act of 1996 (the “1996
Act”), which substantially amended the Communications Act. The 1996 Act contains
provisions intended to increase competition in the telephone, radio, broadcast
television, and hardwire and wireless cable television businesses. This
legislation has altered, and we believe it will continue to alter, federal,
state, and local laws and regulations affecting the communications industry,
including certain of the services we provide.





Under the
federal copyright laws, permission from the copyright holder generally must be
secured before a video program may be retransmitted. Section 111 of the
Copyright Act establishes the cable compulsory license pursuant to which certain
“cable systems” are entitled to engage in the secondary transmission of
broadcast programming without the prior permission of the holders of copyrights
in the programming. In order to do so, a cable system must secure a compulsory
copyright license. Such a license may be obtained upon the filing of certain
reports with and the payment of certain licensing fees to the U.S. Copyright
Office. Private cable operators, such as MSTI, may rely on the cable compulsory
license with respect to the secondary transmission of broadcast programming. We
do not expect the licensing fees to have a material adverse effect on our
business.





Under the
retransmission consent provisions of the 1992 Cable Act, multichannel video
programming distributors, including, but not limited to, franchised and private
cable operators, seeking to retransmit certain commercial television broadcast
signals, notwithstanding the cable compulsory license, must first obtain the
permission of the broadcast station in order to retransmit the station’s signal.
However, private cable systems, unlike franchised cable systems, are not
required under the FCC’s “must carry” rules to retransmit local television
signals. Although there can be no assurances that we will be able to obtain
requisite broadcaster consents, we believe, in most cases, we will be able to do
so for little or no additional cost.


8





On
November 29, 1999, Congress enacted the Satellite Home Viewer Improvement Act of
1999 (“SHVIA”), which amended the Satellite Home Viewer Act. SHVIA permits DBS
operators to transmit local television signals into local markets. SHVIA
generally seeks to place satellite operators on an equal footing with cable
television operators in regards to the availability of television broadcast
programming. SHVIA amends the Copyright Act and other applicable laws and
regulations in order to clarify the terms and conditions under which a DBS
operator may retransmit local and distant broadcast television stations to
subscribers. The law was intended to promote the ability of satellite services
to compete with cable television systems and to resolve disputes that had arisen
between broadcasters and satellite carriers regarding the delivery of broadcast
television station programming to satellite service subscribers. As a result of
SHVIA, television stations are generally entitled to seek carriage on any DBS
operator's system providing local service in their respective markets. SHVIA
creates a statutory copyright license applicable to the retransmission of
broadcast television stations to DBS subscribers located in their markets.
Although there is no royalty payment obligation associated with this license,
eligibility for the license is conditioned on the satellite carrier's compliance
with applicable laws, regulations and FCC rules governing the retransmission of
such “local” broadcast television stations to satellite service subscribers.
Noncompliance with such laws, regulations and/or FCC requirements could subject
a satellite carrier to liability for copyright infringement. SHVIA was extended
and re-enacted by the Satellite Home Viewer Extension and Reauthorization Act
(“SHVERA”) in December of 2004.





We are
not directly subject to rate regulation or certification requirements by the FCC
or state public utility commissions because our equipment installation and sales
agent activities do not constitute the provision of common carrier or cable
television services. As a private cable operator, we are not subject to
regulation as a DBS provider, but primarily rely upon our third-party
programming aggregators to procure all necessary re-transmission consents and
other programming rights under the Communications Act and the Copyright
Act.





State
and Local Cable System Regulation




We do not
anticipate that our deployment of video programming services will be subject to
state or local franchise laws primarily due to the fact that our facilities do
not use or traverse public rights-of-way. Although we may be required to comply
with state and local property tax, environmental laws and local zoning laws, we
do not anticipate that compliance with these laws will have any material adverse
impact on our business.





State
Mandatory Access Laws




A number
of states have enacted mandatory access laws that generally require, in exchange
for just compensation, the owners of rental apartments (and, in some instances,
the owners of condominiums) to allow the local franchise cable television
operator to have access to the property to install its equipment and provide
cable service to residents of the MDU. Such state mandatory access laws
effectively eliminate the ability of the property owner to enter into an
exclusive right of entry with a provider of cable or other broadcast services.
In addition, some states have anti-compensation statutes forbidding an owner of
an MDU from accepting compensation from whomever the owner permits to provide
cable or other broadcast services to the property. These statutes have been and
are being challenged on constitutional grounds in various states. These state
access laws may provide both benefits and detriments to our business plan should
we expand significantly in any of these states.





Preferential
Access Right




We
generally negotiate exclusive rights to provide satellite services singularly or
in competition with competing cable providers, and also negotiate, where
possible, “rights-of-first-refusal” to match price and terms of third-party
offers to provide other communication services in buildings where we have
negotiated broadcast access rights. We believe that these preferential rights of
entry are generally enforceable under applicable law. However, current trends at
the state and federal level suggest that the future enforceability of these
provisions may be uncertain. In 2001, the FCC issued an order prohibiting
telecommunications service providers from negotiating exclusive contracts with
owners of commercial MDU properties. The FCC recently extended this prior action
to prohibit carriers from entering into contracts with residential MDU owners
that grant carriers exclusive access for the provision of telecommunications
services to residents in those MDUs. The ban applies retroactively to existing
contracts as well as to any future agreements. The FCC has also banned
agreements that provide exclusive access for video services to MDUs. This ban
applies retroactively to existing contracts as well as to any future agreements.
The ban on exclusive video agreements does not currently apply to non-franchised
entities such as ours; however, the FCC is currently considering extending the
ban to such entities. While limitations on exclusivity may undermine the
exclusivity provisions of our rights of entry on the one hand, they may also
open up many other properties to which we could provide a competing service.
There can be no assurance that future state or federal laws or regulations will
not restrict our ability to offer access payments, limit MDU owners' ability to
receive access payments or enter into exclusive agreements, any of which could
have a material adverse effect on our business.





Regulation
of the High-Speed lnternet and Wi-Fi Business




ISPs,
including Internet access providers, are largely unregulated by the FCC or state
public utility commissions at this time (apart from federal, state and local
laws and regulations applicable to business in general). However, there can be
no assurance that this business will not become subject to regulatory
restraints. Also, although the FCC has rejected proposals to impose additional
costs and regulations on ISPs to the extent they use local exchange telephone
network facilities, such change may affect demand for Internet related services.
No assurance can be given that changes in current or future regulations adopted
by the FCC or state regulators or other legislative or judicial initiatives
relating to Internet services would not have a material adverse effect on our
business.


9





Regulation
of the VoIP Business




IP-based
voice services are currently exempt from the reporting and pricing restrictions
placed on common carriers by the FCC. However, there are several state and
federal regulatory proceedings further defining what specific service offerings
qualify for this exemption. Due to the growing acceptance and deployment of VoIP
services, the FCC and a number of state public service commissions are
conducting regulatory proceedings that could affect the regulatory duties and
rights of entities that provide IP-based voice applications. There is regulatory
uncertainty as to the imposition of traditional retail, common carrier
regulation on VoIP products and services.





Backlog





Our
subscriber portfolio includes approximately 22 MDU properties with bulk service
agreements and/or access licenses to service the individual subscribers in
metropolitan New York. The remaining terms of the access agreements provide us
access rights from 7 to 15 years with the final agreement expiring in 2016 and
the revenues to be recognized under non-cancelable bulk agreements provide a
minimum of $2,100,000 in revenue through 2013.





Employees





As of
March 31, 2008, the Company had a total of 36 full time employees. The Company
anticipates that in 2008 it may need to hire additional staff in the areas of
customer support, engineering, sales and marketing, and
administration.





Risk
Factors





The
Company’s results of operations, financial condition and cash flows can be
adversely affected by various risks. These risks include, but are not limited
to, the principal factors listed below and the other matters set forth in this
annual report on Form 10-KSB. You should carefully consider all of these
risks before making an investment decision.





Risks
Relating to Our Business




We
have a history of operating losses and expect to incur losses for the
foreseeable future.




We have
had a loss from operations of $8,442,412 and $3,630,495 for the fiscal years
ended December 31, 2007 and 2006, respectively, and expect to incur
additional losses in the foreseeable future. Our losses to date have resulted
principally from:




·
              costs and expenses associated
      with building out our network and the expansion of the services that we
      offer;
 ·
              costs and expenses associated
      with distribution and marketing of our
  products;
 ·
              general and administrative costs
      relating to our operations;
and
 ·
              interest expense related to our
      outstanding
indebtedness.




Our
ability to achieve profitability will depend primarily on our ability to expand
the number of our commercial multi-tenant unit and residential multi-dwelling
unit customers. However, we may never generate enough funds through operations
to support our business.





Our
independent auditors have expressed substantial doubt about our ability to
continue as a going concern, which may hinder our ability to obtain future
financing.





In their
report dated April 14, 2008, our independent auditors stated that our financial
statements for the year ended December 31, 2007 were prepared assuming that we
would continue as a going concern, and that they have substantial doubt about
our ability to continue as a going concern.  Our auditors’ doubts are
based on our incurring net losses and deficits in cash flows from
operations.  We continue to experience net operating
losses.  Our ability to continue as a going concern is subject to our
ability to generate a profit and/or obtain necessary funding from outside
sources, including by the sale of our securities, or obtaining loans from
financial institutions, where possible.  Our continued net operating
losses and our auditors’ doubts increase the difficulty of our meeting such
goals and our efforts to continue as a going concern may not prove
successful.





We
will need additional financing to execute our business plan and fund operations,
which additional financing may not be available. Without additional funding, we
may not be able to continue to operate our business.


10




Even with
the proceeds of the May 2007 private placement and issuance of debentures, we
may not be able to execute our current business plan and fund business
operations long enough to achieve profitability. The funds raised in the private
placement may not be adequate to complete our current business plan. Our
ultimate success will depend upon our ability to raise additional capital. There
can be no assurance that additional funds will be available when needed from any
source or, if available, will be available on terms that are favorable to or
acceptable to us.





Hiring
qualified management and key employees, maintaining compliance with applicable
laws, marketing activities, administrative requirements, such as salaries,
insurance expenses and general overhead expenses, legal compliance costs and
accounting expenses, will all require a substantial amount of additional capital
and our cash flow from operations may not be adequate for such purposes. We will
need to obtain significant additional financing in the event that our plans
require significant expenditures not presently contemplated, such as for capital
expenditures, or to cover operating expenses from expanded services, to service
future indebtedness or to be competitive or expand into new markets or
services.




We may be
required to pursue sources of additional capital through various means,
including joint venture projects, debt financing, equity financing or other
means. There is no assurance that we will be successful in locating a suitable
financing transaction in a timely fashion or at all. In addition, there is no
assurance that we will be successful in obtaining the capital we require by any
other means.




To
execute our business strategy, we may issue additional equity securities in
public or private offerings, potentially at a price lower than the initial
public offering price or the market price at the time of such issuance. Future
financings through equity investments are likely to be dilutive to the existing
stockholders. We may seek debt financing, and may be forced to incur significant
interest expense. Also, the terms of securities we may issue in future capital
transactions may be more favorable for our new investors and less favorable to
existing investors. Newly issued securities may include preferences, superior
voting rights, the issuance of warrants or other derivative securities, and the
issuances of incentive awards under equity employee incentive plans, which may
have additional dilutive effects. Further, we may incur substantial costs in
pursuing future capital and/or financing, including investment banking fees,
legal fees, accounting fees, printing and distribution expenses and other costs.
We may also be required to recognize non-cash expenses in connection with
certain securities we may issue, such as convertible notes and warrants, which
will adversely impact our financial condition.




Our
ability to obtain needed financing may be impaired by such factors as the
capital markets, both generally and specifically in the telecommunications
industry, the fact that we are not profitable, which could impact the
availability or cost of future financings. If we cannot secure sufficient
funding we may be forced to forego strategic opportunities or delay, scale back
or eliminate network deployments, operations, acquisitions and investments. If
the amount of capital we are able to raise from financing activities, together
with our revenues from operations, is not sufficient to satisfy our capital
needs, even to the extent that we reduce our operations accordingly, we may be
required to cease operations.




Our
obligations to the holders of our debentures are secured by all of our assets,
so if we default on those obligations, the debenture holders could foreclose on
our assets.




The
holders of our debentures have a security interest in all of our assets and
those of our subsidiary. As a result, if we default under our obligations to the
debenture holders, the debenture holders could foreclose their security
interests and liquidate some or all of these assets, which may cause us to cease
operations.




The
success of our business depends on the continuing contributions of our key
personnel, the loss of which could have a material adverse effect on our
operations.




We rely
heavily on the services of Frank T. Matarazzo, our Chief Executive Officer, and
Keith Scarzafava, our Chief Technology Officer. Loss of the services of either
individual could adversely impact our operations. In addition, we rely on our
technical personnel for reliability of our networks and systems. We believe our
future success will depend upon our ability or retain these key employees and
our ability to attract and retain other skilled engineering, technical,
managerial, and sales personnel, including outsourced personnel. Employees may
not remain employed by us for any definite period of time. The loss of key
personnel could have a material adverse effect on our business and results of
operations.




Our
outstanding debentures state that if our current chief executive officer ceases
to hold that office, we would be in default under the debentures and may
need to cease operations.





On
February 11, 2008, our debentures were amended to state that if Frank T.
Matarazzo ceases to be our Chief Executive Officer during the term of the
debenture, we would be in default and the debenture holders could foreclose
their security interest and liquidate our assets, which may cause us to cease
operations.




The
communication industry is intensely competitive and rapidly evolving. Our
failure to compete effectively could lead to less demand for our products, loss
of market share and damage our operating results.


11





We
operate in a highly competitive, quickly changing environment, and our future
success will depend on our ability to develop and introduce new services and
service enhancements that achieve broad market acceptance in the commercial
multi-tenant unit sector and the residential multi-dwelling unit sector. We will
also need to respond effectively to new product announcements by our competitors
by quickly introducing competitive products.




Delays in
product development and introduction could result in:




·
              loss of or delay in revenue and
      loss of market share;
 ·
              negative publicity and damage to
      our reputation and brand;
and
 
 ·
              decline in the selling price of
      our products and
services.





Our
competitors consist of other satellite companies, direct broadcast satellite
system operators, cable companies, traditional phone companies and off-air
broadcasters. Some of these competitors have been engaged in our industry for
substantially longer periods of time and may have access to greater resources
than we do. Large companies, including Direct TV, DISH Network, Time Warner,
Cablevision and Verizon, are active in our market of providing and distributing
broadband and video services. These companies may have greater success in the
recruitment and retention of qualified employees, as well as in conducting their
operations, which may give them a competitive advantage.




Competing
cable television operators have large, established subscriber bases, and many
cable operators have significant investments in, and access to, programming. One
of the competitive advantages of direct broadcast satellite system providers
such as us has been the ability to provide subscribers with more channels and a
better quality digital signal than traditional analog cable television systems.
Many cable television operators have made significant investments to upgrade
their systems from analog to digital, significantly increasing the number and
variety of channels and the quality of the transmission they can provide to
their subscribers. As a result of these upgrades, cable television operators
have become better able to compete with direct broadcast satellite system
providers. Increased competition could result in price reductions, reduced
margins or loss of market share and greater competition for qualified technical
personnel. There can be no assurance that we will be able to compete
successfully against current and future competitors. If we are unable to compete
effectively, or if competition results in a deterioration of market conditions,
our business and results of operations would be adversely affected.




The
market for our products and services are subject to technological change. Our
failure to keep pace with technological changes could lead to less demand for
our products and services, loss of market share and reduced
revenues.




The
market for digital satellite television and high-speed Internet products and
services is characterized by rapid change, evolving industry standards and
frequent introductions of new technologies. These new standards and technologies
could make our existing or future products or services obsolete. Keeping pace
with the introduction of new standards and technologies could result in
additional costs or prove difficult or impossible. The failure to keep pace with
these changes and to continue to enhance and improve the responsiveness,
functionality and features of our services could harm our ability to attract and
retain users.




We
rely on a limited number of third party suppliers, including Telkonet,
Bridgewater and EchoStar. If these companies fail to perform or experience
delays, shortages, or increased demand for their products or services, we may
face shortages, increased costs, and may be required to suspend deployment of
certain products and services.




We depend
on a limited number of third party suppliers to provide the equipment required
to deliver our cable and broadband services and cable television programming and
other services. If these providers fail to perform their obligations under our
agreements with them or we are unable to renew these agreements on favorable
terms or at all, we may be forced to suspend the deployment of our broadband and
cable services and enrollment of new subscribers, which would have an adverse
effect on our business, prospects, financial condition and operating
results.




We
are not large enough to negotiate cable television programming contracts as
favorable as some of our larger competitors, which may put us at a competitive
disadvantage or negatively impact our results of operations.




Programming
costs are generally directly related to the number of subscribers to which the
programming is provided, with discounts available to large traditional cable
operators and direct broadcast satellite providers based on their high
subscriber levels. As a result, larger cable and direct broadcast satellite
systems generally pay lower per subscriber programming costs. We have attempted
to obtain volume discounts from our suppliers. Despite these efforts, we believe
that our per subscriber programming costs are significantly higher than large
cable operators and direct broadcast satellite system providers with which we
compete in some of our markets. This may make it difficult for us to remain
competitive with prices offered by these providers while maintaining our
operating results.




In
addition, as programming agreements come up for renewal, we may not be able to
renew these agreements on comparable or favorable terms. If we are unable to
reach agreement with a programmer on terms that we believe are reasonable, we
may be forced to remove that programming from our offerings, which could result
in a loss of customers.


12





Programming
costs have risen in past years and are expected to continue to rise, which may
adversely affect our financial results.




The cost
of acquiring programming is a significant portion of the operating costs for our
cable television business. These costs have increased each year and we expect
them to continue to increase, especially the costs associated with sports
programming. Many of our programming contracts cover multiple years and provide
for future increases in the fees we must pay. Historically, we have absorbed
increased programming costs in large part through increased prices to our
customers. However, competitive and other marketplace factors may not permit us
to continue to pass these costs through to customers. In order to minimize the
negative impact that increased programming costs may have on our margins, we may
pursue a variety of strategies, including offering some programming at premium
prices or moving some programming from our analog service to our premium digital
services. Despite our efforts to manage programming expenses and pricing, the
rising cost of programming may adversely affect our results of
operations.





Any
acquisitions we make could result in difficulties in successfully managing our
combined business and consequently harm our financial condition.




We may
seek to expand by acquiring competing businesses in our current or other
geographic markets. We cannot accurately predict the timing, size and success of
our acquisition efforts and the associated capital commitments that might be
required. We expect to face competition for acquisition candidates, which may
limit the number of acquisition opportunities available to us and may lead to
higher acquisition prices. We may not be able to identify, acquire or profitably
manage additional businesses or successfully integrate acquired businesses, if
any, into our company, without substantial costs, delays or other operational or
financial difficulties. In addition, acquisitions involve numerous other risks,
including:




·
              failure of the acquired
      businesses to achieve expected
results;
 ·
              diversion of management’s
      attention and resources to
acquisitions;
 ·
              failure to retain key customers
      or personnel of the acquired
businesses;
 ·
              disappointing quality or
      functionality of acquired equipment and people;
  and
 ·
              risks associated with
      unanticipated events, liabilities or
      contingencies.


Customer
dissatisfaction or performance problems at an acquired business could negatively
affect our reputation. The inability to acquire businesses on reasonable terms
or successfully integrate and manage acquired companies, or the occurrence of
performance problems at acquired companies, could result in dilution,
unfavorable accounting treatment or one-time charges and difficulties in
successfully managing our business.




Our inability to
obtain capital, use internally generated cash or debt, or use shares of our
common stock to finance future acquisitions could impair the growth and
expansion of our business .




Reliance
on internally generated cash or debt to finance our operations or complete
acquisitions could substantially limit our operational and financial
flexibility. The extent to which we will be able or willing to use shares of our
common stock to consummate acquisitions will depend on our market value which
will vary, and liquidity, which may be limited, and the willingness of potential
sellers to accept our common stock as full or partial payment. Using shares of
our common stock for this purpose also may result in significant dilution to our
stockholders. We may not be able to obtain the necessary capital to finance any
acquisitions or our other cash needs. If we are unable to obtain additional
capital on acceptable terms, we may be required to reduce the scope of any
expansion or redirect resources committed to internal purposes. In addition to
requiring funding for acquisitions, we may need additional funds to implement
our internal growth and operating strategies or to finance other aspects of our
operations. Our failure to: (i) obtain additional capital on acceptable terms;
(ii) use internally generated cash or debt to complete acquisitions because it
significantly limits our operational or financial flexibility; or (iii) use
shares of our common stock to make future acquisitions, may hinder our ability
to actively pursue any acquisition program.




Our
indebtedness and restrictive debt covenants could limit our financing options
and liquidity position, which would limit our ability to grow our
business.




The terms
of our outstanding debentures could have negative consequences to us, such
as:




·
              we may be unable to obtain
      additional financing to fund working capital, operating losses, capital
      expenditures or acquisitions on terms acceptable to us, or at
      all;
 ·
              we may be unable to refinance our
      indebtedness on terms acceptable to us, or at all;
    and
 ·
              we may be more vulnerable to
      economic downturns and limit our ability to withstand competitive
      pressures.


Additionally,
covenants in the securities purchase agreement governing the debentures impose
operating and financial restrictions on us. These restrictions prohibit or limit
our ability, and the ability of our subsidiaries, to, among other
things:




·
              pay cash dividends to our
      stockholders;
 ·
              incur additional
      indebtedness;


13





·
              permit liens on assets or conduct
      sales of assets; and
 ·
              engage in transactions with
      affiliates.




These
restrictions may limit our ability to obtain additional financing, withstand
downturns in our business or take advantage of business opportunities. Moreover,
additional debt financing we may seek may contain terms that include more
restrictive covenants, may require repayment on an accelerated schedule or may
impose other obligations that limit our ability to grow our business, acquire
needed assets, or take other actions we might otherwise consider appropriate or
desirable.




Our
management and operational systems might be inadequate to handle our potential
growth.




We may
experience growth that could place a significant strain upon our management and
operational systems and resources. Failure to manage our growth effectively
could have a material adverse effect upon our business, results of operations
and financial condition. Our ability to compete effectively as a service
provider and to manage future growth will require us to continue to improve our
operational systems, organization and financial and management controls,
reporting systems and procedures. We may fail to make these improvements
effectively. Additionally, our efforts to make these improvements may divert the
focus of our personnel.





We must
integrate our key executives into a cohesive management team to expand our
business. If new hires perform poorly, or if we are unsuccessful in hiring,
training and integrating these new employees, or if we are not successful in
retaining our existing employees, our business may be harmed. To manage the
growth we will need to increase our operational and financial systems,
procedures and controls. Our current and planned personnel, systems, procedures
and controls may not be adequate to support our future operations. We may not be
able to effectively manage such growth, and failure to do so could have a
material adverse effect on our business, financial condition and results of
operations.




If
we fail to maintain an effective system of internal control in the future, we
may not be able to report our financial results accurately or to prevent fraud.
Any inability to report and file our financial results accurately and timely
could harm our business and adversely impact the trading price of our common
stock.




Effective
internal control is necessary for us to provide reliable financial reports and
prevent fraud. If we cannot provide reliable financial reports or prevent fraud,
we may not be able to manage our business as effectively as we would if an
effective control environment existed, and our business and reputation with
investors may be harmed. We may in the future discover areas of our internal
control that need improvement, internal control deficiencies may adversely
affect our financial condition, results of operation and access to
capital.




We
may be unable to protect our intellectual property, which could reduce the value
of our services and our brand.




Our
ability to compete effectively depends on our ability to protect our proprietary
technologies, network designs, and processes. We may not be able to safeguard
and maintain our proprietary rights. We rely on trademarks and policies and
procedures related to confidentiality to protect our intellectual property. Some
of our intellectual property, however, is not covered by any of these
protections. Any infringement by third parties on our intellectual property
could have a negative impact on our business. In addition, in order to protect
our intellectual property, we may be required to initiate legal proceedings
against persons we deem are violating our rights. Any such proceedings would be
expensive, and we may not have the funds available to pay for the costs and
expenses of such proceedings, and therefore we may be limited in our ability to
protect our rights.




We
could be subject to claims that we have infringed on the proprietary rights of
others, which claims would likely be costly to defend, could require us to pay
damages and could limit our ability to use necessary technologies in the
future.




Patent
technologies or processes that are substantially equivalent or superior to our
processes or products and services, or products or services of our vendors used
in our business, could result in claims that our services and products infringe
on these patents or proprietary rights of others. Defending against infringement
claims, even meritless claims, is time consuming, distracting, and costly. If we
are found to be infringing proprietary rights of a third party, we could be
enjoined from using such third party’s rights and be required to pay substantial
royalties and damages, and may no longer be able to use the intellectual
property on acceptable terms or at all. Failure to obtain licenses to
intellectual property could delay or prevent the development, manufacture, or
sale of our products or services and could cause us to establish reserves that
would impact our profitability, and expend significant resources to develop or
acquire non-infringing intellectual property.




If our data
security measures are breached, subscribers may perceive our network and
services as not secure, which may expose us to liability or harm our reputation
and our results of operations .




Network
security and the authentication of the subscriber’s credentials are designed to
protect unauthorized access to data on our broadband and wireless networks.
Because techniques used to obtain unauthorized access to or to sabotage networks
change frequently and may not be recognized until launched against a target, we
may be unable to anticipate or implement adequate preventive measures against
unauthorized access or sabotage. Consequently, unauthorized parties may overcome
our encryption and security systems and obtain access to data on our network,
including on a device connected to our network. In addition, because we operate
and control our network and our subscribers’ Internet connectivity, unauthorized
access or sabotage of our network could result in damage to our network and to
the computers or other devices used by our subscribers. An actual or perceived
breach of network security, regardless of whether the breach is our fault, could
harm public perception of the effectiveness of our security measures, adversely
affect our ability to attract and retain subscribers, expose us to significant
liability and adversely affect our business prospects.


14




Interruption
or failure of our information technology and communications systems could impair
our ability to provide our services, which could damage our reputation and harm
our operating results.




Our
services depend on the continuing operation of our information technology and
communications systems. Any damage to or failure of our systems could result in
interruptions in our service. Our systems are vulnerable to damage or
interruption from earthquakes, terrorist attacks, floods, fires, power loss,
telecommunications failures, computer viruses, computer denial of service
attacks, and other attempts to harm our systems, and similar causes. Some of our
systems are not fully redundant, and our disaster recovery planning may not be
adequate. The occurrence of a natural disaster or unanticipated problems at our
network centers or equipment could  result in lengthy
interruptions in our service and adversely affect our business, prospects,
financial condition and results of operations.




We have
experienced unscheduled service interruptions in the past, caused by temporary
problems in our systems or in the systems of third parties that we rely on, in
the past and may experience such service interruptions or system failures in the
future. Any unscheduled service interruption adversely affects our ability to
operate our business and could result in an immediate loss of revenues. If we
experience frequent or persistent system or network failures, our reputation
could be permanently harmed. We may make significant capital expenditures to
increase the reliability of our systems, but these capital expenditures may not
achieve the results we expect.





If
we are unable to attract, train and retain highly qualified personnel, the
quality of our services may decline and we may not successfully execute our
growth strategies.




Our
success depends in large part upon our ability to continue to attract, train,
motivate and retain highly skilled and experienced technical employees.
Qualified technical employees periodically are in great demand and may be
unavailable in the time frame required to satisfy our customers’ requirements.
While we currently have available technical expertise sufficient for the
requirements of our business, expansion of our business could require us to
employ additional highly skilled technical personnel. We expect competition for
such personnel to increase as the markets for cable, broadband Voice over
Internet Protocol (VoIP) and wireless services expand. We may not be able to
attract and retain sufficient numbers of highly skilled technical employees in
the future. The loss of technical personnel or our inability to hire or retain
sufficient technical personnel at competitive rates of compensation could impair
our ability to attract and retain customers and could harm our
business.




Potential
fluctuations in operating results could have a negative effect on the value of
our common stock.




Our
operating results may fluctuate significantly in the future as a result of a
variety of factors, most of which are outside of our control,
including:





·
              the level of use of the
      Internet;
 ·
              the demand for “bundled” video,
      voice, Internet and Wi-Fi
services;
 ·
              the amount and timing of capital
      expenditures and other costs relating to the expansion of our
      operations;
 ·
              price competition or pricing
      changes in the industry;
 ·
              technical difficulties or system
      downtime;
 ·
              economic conditions specific to
      the Internet and communications industry;
  and
 ·
              general economic
      conditions.




Our
quarterly results may also be significantly impacted by certain accounting
treatment of acquisitions, financing transactions or other matters. Such
accounting treatment could have a material impact on our results of operations
and have a negative impact on the price of our common stock.




We
may be affected if the United States participates in wars or military or other
action or by international terrorism.




Involvement
in a war or other military action or acts of terrorism may cause significant
disruption to commerce throughout the world. To the extent that such disruptions
result in (i) delays or cancellations of customer orders, (ii) a general
decrease in consumer spending on video broadcast and information technology,
(iii) our inability to effectively market and distribute our services or
products or (iv) our inability to access capital markets, our business, results
of operations or financial condition could be materially and adversely affected.
We are unable to predict whether the involvement in a war or other military
action will result in any long-term commercial disruptions or if such
involvement or responses will have any long-term material adverse effect on our
business, results of operations, or financial condition.


15





Risks
Relating to Our Industry




The
industry in which we operate is continually evolving, which makes it difficult
to evaluate our future prospects and increases the risk of an investment in our
company. Our services may become obsolete, and we may not be able to develop
competitive products or services on a timely basis or at all.




The
broadband and video services industries are characterized by rapid technological
change, competitive pricing, frequent new service introductions, and evolving
industry standards and regulatory requirements. We believe that our success
depends on our ability to anticipate and adapt to these challenges and to offer
competitive services on a timely basis. We face a number of difficulties and
uncertainties associated with our reliance on technological development, such
as:




·
              competition from service
      providers using more traditional and commercially proven means to deliver
      similar or alternative
services;
 ·
              competition from new service
      providers using more efficient, less expensive technologies, including
      products not yet invented or
developed;
 ·
              uncertain consumer
      acceptance;
 ·
              realizing economies of
      scale;
 ·
              responding successfully to
      advances in competing technologies in a timely and cost-effective
      manner;
 ·
              requirements for capital
      expenditures to deploy new technologies;
  and
 ·
              existing, proposed or undeveloped
      technologies that may render wireless broadband and VoIP telephone
      services less profitable or
obsolete.


As the
services offered by us and our competitors develop businesses and consumers may
not accept our services as a commercially viable alternative to other means of
delivering broadband and video services. This could negatively impact our
financial condition and results of operations.




We
are subject to government regulation, which may adversely impact our
business.




Our
business is regulated by federal, state and local governmental entities. A
number of other federal, state and local privacy, security, and consumer laws
also apply to our business. These laws and regulations and their application are
subject to continual change as new legislation, regulations or amendments to
existing laws and regulations are adopted from time to time by governmental or
regulatory authorities, including as a result of judicial interpretations of
such laws and regulations. Regulations or interpretations of those regulations
that are favorable to our competitors could adversely affect our competitive
position. Our ability to compete successfully will depend on the nature and
timing of these legislative changes, regulations and interpretations, and
whether they are favorable to us or our competitors.




To
maintain the quality of our network and user experience, we may manage the
bandwidth used by our subscribers’ applications, in part by restricting the
types of applications that may be used over our network. If the Federal
Communications Commission (FCC) or other regulatory authorities were to adopt
regulations that constrain our ability to employ bandwidth management practices,
excessive use of bandwidth-intensive applications would likely reduce the
quality of our services for all subscribers. Such decline in the quality of our
services could harm our business.




The scope
of the regulations that may apply to VoIP telephone services providers and the
impact of such regulations on providers’ competitive position are presently
unknown and could be detrimental to our business and prospects.




The
failure of the Internet to continue as an accepted medium for business commerce
could have a negative impact on our results of operations.




Our
long-term viability is substantially dependent upon the continued widespread
acceptance and use of the Internet as a medium for business commerce. The
Internet has experienced, and is expected to continue to experience, significant
growth in the number of users. However, the Internet infrastructure may not
continue to be able to support the demands placed on it by this continued
growth. In addition, delays in the development or adoption of new standards and
protocols to handle increased levels of Internet activity or increased
government regulation could slow or stop the growth of the Internet as a viable
medium for business commerce. Moreover, critical issues concerning the
commercial use of the Internet (including security, reliability, accessibility
and quality of service) remain unresolved and may adversely affect the growth of
Internet use or the attractiveness of its use for business commerce. The failure
of the necessary infrastructure to further develop in a timely manner or the
failure of the Internet to continue to develop rapidly as a valid medium for
business would have a negative impact on our results of
operations.


16





Risks
Relating to Our Organization




We
are a holding company that depends on cash flow from our wholly-owned subsidiary
to meet our obligations.




After the
reverse merger with MST, we became a holding company with no material assets
other than the stock of MST. Accordingly, all our operations will be conducted
by MST. We currently expect that we will be required to retain the earnings and
cash flow of our subsidiary for use by us in our operations, including servicing
any debt obligations we may have now or in the future.




Our
largest stockholder can exert significant control over our business and affairs
and may have actual or potential interests that depart from our other
stockholders.




Our
largest stockholder, Telkonet, owns or controls approximately 62% of the issued
and outstanding shares of our common stock, which percentage may increase in the
event that any of the outstanding warrants that are held by Telkonet are
exercised, any warrants in the future are granted to them, or the exercise of
any convertible securities or the acquisition of additional shares of our common
stock by them. Their interests may differ from the interests of other
stockholders. Such stockholder will have significant control over all corporate
actions requiring stockholder approval, irrespective of how our other
stockholders may vote, including the following actions:





·
              election
      of our directors;
 ·
              amendment
      of our Certificate of Incorporation or By-laws;
  and
 ·
              mergers,
      sale of assets or other corporate
transactions.




Also,
concentrations of stock ownership in one stockholder may discourage a potential
acquirer from making a tender offer or otherwise attempting to obtain control of
our company, which in turn could reduce our stock price or prevent our
shareholders from realizing a premium over our stock price.




Public
company compliance may make it more difficult to attract and retain officers and
directors.




Sarbanes-Oxley
and new rules subsequently implemented by the Securities and Exchange Commission
have required changes in corporate governance practices of public companies. We
expect these new rules and regulations to increase our compliance costs and to
make certain activities more time consuming and costly. We also expect that
these new rules and regulations may make it more difficult for us to attract and
retain qualified persons to serve on our board of directors or as executive
officers.





Because
we are not yet required to comply with rules requiring the adoption of certain
corporate governance measures, our stockholders have limited protections against
interested director transactions, conflicts of interest and similar
matters.




The
Sarbanes-Oxley Act, as well as rule changes proposed and enacted by the
Securities and Exchange Commission, the New York and American Stock Exchanges
and the Nasdaq Stock Market as a result of Sarbanes-Oxley, require the
implementation of various measures relating to corporate governance. These
measures are designed to enhance the integrity of corporate management and the
securities markets and apply to securities that are listed on those exchanges.
Because we are not presently required to comply with many of the corporate
governance provisions, we have not yet adopted these measures.




Risks
Relating to Our Common Stock





Our stock price
may be volatile in response to various factors, some of which are out of our
control .




The
market price of our common stock is likely to be highly volatile and could
fluctuate widely in price in response to various factors, many of which are
beyond our control, including the following:




·
              changes
      in the communications technology industry and
  markets;
 ·
              volume
      and timing of subscriptions from major
  customers;
 ·
              competitive
      pricing pressures;
 ·
              our
      ability to obtain working capital
financing;
 ·
              technological
      innovations or new competitors in our
market;
 ·
              additions
      or departures of key personnel;
 ·
              our
      ability to execute our business
plan;
 ·
              operating
      results that fall below
expectations;
 ·
              loss
      of any strategic relationship;
 ·
              industry
      or regulatory developments;
 ·
              economic
      and other external factors; and
 ·
              period-to-period
      fluctuations in our financial
results.




17





In
addition, the securities markets have from time to time experienced significant
price and volume fluctuations that are unrelated to the operating performance of
particular companies. These market fluctuations may also materially and
adversely affect the market price of our common stock.





Our
common stock may be deemed a “penny stock”, which would make it more difficult
for our investors to sell their shares.




Our
common stock may be subject to the “penny stock” rules adopted under Section
15(g) of the Securities Exchange Act of 1934, as amended. The penny stock rules
apply to non-Nasdaq listed companies whose common stock trades at less than
$5.00 per share or that have tangible net worth of less than $5,000,000
($2,000,000 if the company has been operating for three or more years). These
rules require, among other things, that brokers who trade penny stock to persons
other than “established customers” complete specified documentation, make
suitability inquiries of investors and provide investors with specified
information concerning trading in the security, including a risk disclosure
document and quote information under some circumstances. Many brokers have
decided not to trade penny stocks because of the requirements of the penny stock
rules and, as a result, the number of broker-dealers willing to act as market
makers in these securities is limited. If we remain subject to the penny stock
rules for any significant period, that could have an adverse effect on the
market, if any, for our securities. If our securities are subject to the penny
stock rules, investors will find it more difficult to dispose of our
securities.




Offers
or availability for sale of a substantial number of shares of our common stock
may cause the price of our common stock to decline.




Since our
stockholders could sell substantial amounts of our common stock in the public
market, upon the expiration of statutory holding periods, under Rule 144, or
upon expiration of lock-up periods applicable to outstanding shares, or issued
upon conversion of debentures or the exercise of outstanding options or
warrants, this could create a circumstance commonly referred to as an “overhang”
and in anticipation of which the market price of our common stock could fall.
The existence of an overhang, whether or not sales have occurred or are
occurring, also could make more difficult our ability to raise additional
financing through the sale of equity or equity-related securities in the future
at a time and price that we deem reasonable or appropriate.




We
have not paid dividends in the past and do not expect to pay dividends in the
future. Any return on investment may be limited to the value of our common
stock.




We have
never paid cash dividends on our common stock and do not anticipate doing so in
the foreseeable future. The payment of dividends on our common stock will depend
on earnings, financial condition and other business and economic factors
affecting it at such time as the board of directors may consider relevant. In
addition, restrictive covenants contained in our debentures prevent us from
paying dividends to our stockholders. If we do not pay dividends, our common
stock may be less valuable because a return on your investment will only occur
if our stock price appreciates.


18





ITEM
2.     DESCRIPTION OF PROPERTY.





We lease
approximately 12,600 square feet of office and warehouse space in Hawthorne, New
Jersey for approximately $6,897 per month. The current lease term expires on
April 30, 2010, at which time we have the option to extend the lease for an
additional five-year period. The Company also rents office space from 25 River
Drive South Urban Renewal Co. for approximately $2,500 per month. This lease
will expire in December 2009.





We lease
approximately 64 square feet at a collocation facility located in New York City
for our telecommunications and video equipment, at a monthly rent of
$1,664.




We have a
license to maintain a major point-of-presence at the Trump International Hotel
and Tower Condominium located at Columbus Circle in New York City. Pursuant to
the license agreement, we have the right to install antennas and other equipment
on the building’s rooftop and in certain equipment storage areas for a license
fee of $3,800 per month. The term of the agreement expires on June 30,
2012.





We
believe our current facilities are adequately covered by insurance, and are
adequate for our immediate and near-term needs. Additional space may be required
as we expand our activities. We do not currently foresee any significant
difficulties in obtaining any required additional facilities.





ITEM
3.     LEGAL PROCEEDINGS.





There are
no legal proceedings pending, and we are not aware of any proceeding that a
governmental authority is contemplating, against us.





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





No matter
was submitted during the fourth quarter of the fiscal year ended December 31,
2007, to a vote of security holders through the solicitation of proxies or
otherwise .




PART
II





ITEM
5.     MARKET FOR COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND SMALL
 BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES.





Market
Information





Since
June 1, 2007, our common stock has been listed for trading on the OTC Bulletin
Board under the ticker symbol “MSHI.OB.” As of April 1, 2008, we had 101
stockholders of record and 29,816,552 shares of common stock issued and
outstanding. Prior to that date, there was no active market for our common
stock.




The
following table documents the high and low bid prices for our common stock on
the OTC Bulletin Board for the period beginning June 1, 2007 through December
31, 2007. The quotations reflect inter-dealer prices, without retail mark-up,
mark-down or commission and may not represent actual transactions.





High
                  
                  
                  LowYear
      Ended December 31, 2007Second
      Quarter, beginning June 1, 2007
                  
                  $
                  1.95
                  
                  
                  $
                  1.10Third
      Quarter
                  
                  $
                  1.45
                  
                  
                  $
                  0.45Fourth
      Quarter
                  
                  $
                  1.35
                  
                  
                  $
                  0.40





Dividend
Policy





In the
past, we have not declared or paid cash dividends on our common stock, and we do
not intend to pay any cash dividends on our common stock. Rather, we intend to
retain future earnings (if any) to fund the operation and expansion of our
business and for general corporate purposes. In addition, our debentures
prohibit us from paying any cash dividends so long as any portion of the
debentures remains outstanding.


19





Securities
Authorized for Issuance Under Equity Compensation Plans





As of
December 31, 2007, we have made the following grants under our 2007 Incentive
Stock Plan.





Equity
Compensation Plan Information





Number of securities
                                      to be issued upon
                                      exercise of
                                      outstanding options,
                                      warrants and rights
                                    
                                    
                                    Weighted-average
                                      exercise price of
                                      outstanding
                                      options, warrants
                                      and rights
                                    
                                    
                                    Number of securities
                                      remaining available for
                                      future issuance under
                                      equity compensation
                                      plansEquity compensation
      plans approved by security holders
                                    
                                    
                                    13,235,626
                                    
                                    
                                    $
                                    0.89
                                    
                                    
                                    
                                    222,000Equity
      compensation plans not approved by security holders
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0
                                    
                                    
                                    
                                    0Total
                                    
                                    
                                    13,235,626
                                    
                                    
                                    $
                                    0.89
                                    
                                    
                                    
                                    222,000





Recent
Sales of Unregistered Securities





None.




ITEM
6.     MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF
OPERATIONS.





Prior to
May 24, 2007, we were a public shell company without material assets or
liabilities. On May 24, 2007, MST completed a reverse merger with our
subsidiary, pursuant to which MST became our wholly-owned subsidiary, we
succeeded to the business of MST as our sole line of business, and the former
security holders of MST became our controlling stockholders. For financial
reporting purposes, MST, and not us, is considered the accounting acquirer in
the reverse merger. Accordingly, the historical financial statements presented
and the discussion and analysis or plan of operations below are those of MST and
do not include our historical financial results. All costs associated with the
reverse merger were expensed as incurred.





Overview





We are a
communications service provider offering Quad-Play services to MTU and MDU
residential, hospitality and commercial properties. These Quad-Play services
include video, voice, high-speed internet and Wi-Fi access. In addition, we
currently offer or plan to offer a variety of next-generation telecommunications
solutions and services, including satellite installation, video conferencing,
surveillance/security and energy management, and other complementary
professional services. Our net sales in 2007 were $2,675,750.





Critical
Accounting Policies and Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires us to make estimates
and assumptions that affect the amounts reported in the consolidated financial
statements and accompanying notes. On an ongoing basis, we evaluate significant
estimates used in preparing our financial statements, including those related to
revenue recognition, guarantees and product warranties and stock based
compensation. We base our estimates on historical experience, underlying run
rates and various other assumptions that we believe to be reasonable, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities. Actual results could differ from these estimates. The
following are critical judgments, assumptions, and estimates used in the
preparation of the consolidated financial statements.





Revenue
Recognition





For
revenue from product sales, the Company recognizes revenue in accordance with
Staff Accounting Bulletin No. 104, Revenue Recognition
(“SAB104”), which superceded Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements (“SAB101”). SAB 101 requires that four basic criteria must be
met before revenue can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the selling price is fixed and
determinable; and (4) collectibility is reasonably assured. Determination of
criteria (3) and (4) are based on management's judgments regarding the fixed
nature of the selling prices of the products delivered and the collectibility of
those amounts. Provisions for discounts and rebates to customers, estimated
returns and allowances, and other adjustments are provided for in the same
period the related sales are recorded. The Company defers any revenue for which
the product has not been delivered or is subject to refund until such time that
the Company and the customer jointly determine that the product has been
delivered or no refund will be required. SAB 104 incorporates Emerging Issues
Task Force 00-21 (“EITF 00-21”), Multiple-Deliverable Revenue
Arrangements. EITF 00-21 addresses accounting for arrangements that may
involve the delivery or performance of multiple products, services and/or rights
to use assets.


20





The
Company accounts for the revenue, costs and expense related to residential cable
services as the related services are performed in accordance with SFAS
No. 51, Financial Reporting by Cable Television Companies. Installation
revenue for residential cable services is recognized to the extent of direct
selling costs incurred. Direct selling costs have exceeded installation revenue
in all reported periods. Generally, credit risk is managed by disconnecting
services to customers who are delinquent. The capitalized cost of this equipment
is depreciated from three to ten years, on a straight-line basis down to the
Company's original estimate of the projected value of the equipment at the end
of the scheduled lease term.





Stock
Based Compensation





On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors including employee
stock options based on estimated fair values. SFAS 123(R) supersedes the
Company’s previous accounting under Accounting Principles Board Opinion
No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods
beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS
123(R). The Company has applied the provisions of SAB 107 in its adoption of
SFAS 123(R).




The
Company adopted SFAS 123(R) using the modified prospective transition method,
which requires the application of the accounting standard as of January 1, 2006,
the first day of the Company’s fiscal year 2006. The Company’s Consolidated
Financial Statements as of and for the year ended December 31, 2007 and 2006
reflect the impact of SFAS 123(R). In accordance with the modified prospective
transition method, the Company’s Consolidated Financial Statements for prior
periods have not been restated to reflect, and do not include, the impact of
SFAS 123(R). Stock-based compensation expense recognized under SFAS 123(R) for
the year ended December 31, 2007 and 2006, was $308,634 and $0, respectively,
net of tax effect.




Long-Lived
Assets





The
Company has adopted Statement of Financial Accounting Standards No. 144 (“SFAS
144”). The Statement requires that long-lived assets and certain identifiable
intangibles held and used by the Company be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Events relating to recoverability may include
significant unfavorable changes in business conditions, recurring losses, or a
forecasted inability to achieve break-even operating results over an extended
period. The Company evaluates the recoverability of long-lived assets based upon
forecasted discounted cash flows. Should impairment in value be indicated, the
carrying value of intangible assets will be adjusted, based on estimates of
future discounted cash flows resulting from the use and ultimate disposition of
the asset. SFAS No. 144 also requires assets to be disposed of be reported at
the lower of the carrying amount or the fair value less costs to sell. The
Company determined that the value of our capitalized cable and related equipment
has been impaired based upon our assessment of forecasted discounted cash flow
from subscribers revenue and has written off $493,512 of its value, based on the
lower of the carrying amount or the fair value less costs to sell, for the year
ended December 31, 2007.





Goodwill
and Other Intangibles





Goodwill
represents the excess of the cost of businesses acquired over fair value or net
identifiable assets at the date of acquisition. Goodwill is subject to a
periodic impairment assessment by applying a fair value test based upon a
two-step method. The first step of the process compares the fair value of the
reporting unit with the carrying value of the reporting unit, including any
goodwill. The Company utilizes a discounted cash flow valuation methodology to
determine the fair value of the reporting unit. If the fair value of the
reporting unit exceeds the carrying amount of the reporting unit, goodwill is
deemed not to be impaired in which case the second step in the process is
unnecessary. If the carrying amount exceeds fair value, the Company performs the
second step to measure the amount of impairment loss. Any impairment loss is
measured by comparing the implied fair value of goodwill, calculated per SFAS
No. 142, with the carrying amount of goodwill at the reporting unit, with
the excess of the carrying amount over the fair value recognized as an
impairment loss. The Company determined that the value of goodwill has been
impaired based upon managements assessment operating results and forecasted
discounted cash flow and has written off the entire $1,958,198 of its value
during the year ended December 31, 2007.





Results
of Operations





Year
Ended December 31, 2007 Compared to Year Ended December 31,
2006





Revenue . Our revenue consists
of providing subscriber (recurring) services and the delivery of product and
services in the MTU/MDU markets. The subscriber revenue consists of Quad-Play
services provided to a subscriber portfolio of properties with bulk service
agreements and/or access licenses to service the individual subscribers in
metropolitan New York. The product and services revenue consists of equipment,
installations and ancillary services provided to customers independent of
the subscriber portfolio. The total revenue for the year ended December 31,
2007, increased by $779,304 compared to 2006.


21





The
recurring revenue for the subscriber base increased by approximately $757,148
for the year ended December 31, 2007 compared to 2006. Our subscriber portfolio
includes approximately 22 MDU properties with bulk service agreements and/or
access licenses to service the individual subscribers in metropolitan New York.
Additionally, we added approximately 1,900 internet and telephone subscribers
through the acquisition of Newport Telecommunications Co. in July 2007. We
anticipate an increasing trend in subscriber revenue through the installation of
new buildings under contract and the subsequent subscriptions sold, as well as
through acquisitions similar to Newport.





The table
below outlines product and services versus subscriber (recurring) revenues for
comparable periods:




Year ended December 31,2007
                    
                    
                    2006
                    
                    
                    VarianceRevenue:Product and services
                    
                    $
                    393,208
                    
                    
                    
                    15
                    %
                    
                    $
                    371,052
                    
                    
                    
                    20
                    %
                    
                    $
                    22,156
                    
                    
                    
                    6
                    %Subscriber
                    
                    
                    2,282,542
                    
                    
                    
                    85
                    %
                    
                    
                    1,525,394
                    
                    
                    
                    80
                    %
                    
                    
                    757,148
                    
                    
                    
                    50
                    %Total
                    
                    
                    2,675,750
                    
                    
                    
                    100
                    %
                    
                    $
                    1,896,446
                    
                    
                    
                    100
                    %
                    
                    
                    779,304
                    
                    
                    
                    41
                    %





Cost of Sales. The product
costs primarily consist of equipment and installation labor for installation and
ancillary services provided to customers.





The
subscriber costs increased by $1,152,802 for the year ended December 31, 2007
compared to 2006.  These costs consist of customer support,
programming and amortization of the capitalized costs to support the subscriber
revenue.  Although our programming fees are a significant portion of
the cost, we continue to pursue competitive agreements and volume discounts in
conjunction with the anticipated growth of the subscriber base. The customer
support costs include build-out of the support services necessary to develop and
support the build-out of the Quad-Play subscriber base in metropolitan New York.
The capitalized costs are amortized over the lease term and include equipment
and installation labor.  Additionally, the recurring costs increased
due to the addition of the Newport subscribers in July 2007.





Year ended December 31,2007
                  
                  
                  2006
                  
                  
                  VarianceCost
      of Sales:Product and Services
                  
                  $
                  298,690
                  
                  
                  
                  76
                  %
                  
                  $
                  392,341
                  
                  
                  
                  106
                  %
                  
                  $
                  (93,651
                  )
                  
                  
                  (24
                  )%Subscriber
                  
                  
                  3,106,909
                  
                  
                  
                  136
                  %
                  
                  
                  1,954,107
                  
                  
                  
                  128
                  %
                  
                  
                  1,152,802
                  
                  
                  
                  59
                  %Total
                  
                  
                  3,405,599
                  
                  
                  
                  127
                  %
                  
                  $
                  2,346,448
                  
                  
                  
                  124
                  %
                  
                  
                  1,059,151
                  
                  
                  
                  45
                  %





Gross Profit. The gross profit
decreased by $279,847 for the year ended December 31, 2007 compared to 2006,
primarily due to increased programming costs and expenses related to the
addition of the existing infrastructure. We anticipate that we will increase our
gross profit through expanding our subscriber base and reducing programming
costs through the IPTV platform. The subscriber (recurring) revenue contributed
approximately 36% of a negative gross profit margin for the year ended December
31, 2007.




Year ended December 31,2007
                  
                  
                  2006
                  
                  
                  VarianceGross
      Profit:Product and services
                  
                  $
                  94,518
                  
                  
                  
                  24
                  %
                  
                  $
                  (21,289
                  )
                  
                  
                  (6
                  )%
                  
                  $
                  115,807
                  
                  
                  
                  544
                  %Subscriber
                  
                  
                  (824,367
                  )
                  
                  
                  (36
                  )%
                  
                  
                  (428,713
                  )
                  
                  
                  (28
                  )%
                  
                  
                  (395,654
                  )
                  
                  
                  (92
                  )%Total
                  
                  
                  (729,849
                  )
                  
                  
                  (27
                  )%
                  
                  
                  (450,002
                  )
                  
                  
                  (24
                  )%
                  
                  
                  (279,847
                  )
                  
                  
                  (62
                  )%





Operating Expenses. Operating
expenses, which consists of sales and marketing expenses, depreciation and
general and administrative costs, totaled $7,712,563 during the year ended
December 31, 2007 as compared to $3,180,493 for 2006. The Company recorded a
non-cash impairment write down of its goodwill and long lived assets to the
amount of $1,958,198 and $493,512, respectively, against its operating
income for the year ended December 31, 2007. Additionally, there were increased
costs associated with investor relations and professional services as well as
non-cash stock compensation expense of $308,634 associated with stock options
and $378,000 for common share issuances to employees and
consultants.


22




Selling, General and Administrative
Expenses. Selling, general, and administrative expenses which consist of
commissions, salaries, advertising, professional service fees, investor
relations services and overhead expenses, totaled $4,108,077 during the year
ended December 31, 2007 as compared to $2,856,631 for 2006. This increase is
primarily attributable to professional fees and investor relations services of
approximately $434,000 and $423,000, respectively, in connection with the merger
of MST was a public shell corporation. In addition, administrative costs
increased approximately $395,000 mainly due to the acquisition of Newport
Telecommunications Co. Our management believes that our expenses will continue
to increase as sales continue to grow and additional staff is added to support
our growth initiatives.





Depreciation and Amortization
.. Depreciation expenses for the year ended December 31, 2007 increased by
$142,280 compared to 2006.  This  was primarily due to
the addition of Newport Telecommunications and the addition of infrastructure
costs. The amortization expenses increased by $139,115 for the year ended
December 31, 2007 compared to 2006 and this was a result of the addition of the
Newport Telecommunications subscriber list.





Off
Balance Sheet Arrangements





None.





Liquidity
and Capital Resources





Our
working capital increased by $3,927,109 during the year ended December 31, 2007
from a working capital deficit of $(6,481,388) at December 31, 2006 to a working
capital deficit of $(2,554,279) at December 31, 2007. The increase in working
capital for the year ended December 31, 2007, resulted in a net increase in cash
of $908,497. The primary reason for the increase was the private placement and
sale of debentures for net proceeds of approximately $2,694,000 and $5,303,000,
respectively. The most significant uses and proceeds of cash were as
follows:




·
              Approximately
      $3,446,000 of cash consumed directly in operating
    activities;
  ·
              Approximately
      $1,655,000 was expended on net purchases of cost of cable equipment and
      installations and other fixed
assets;
 
 ·
              Approximately
      $863,000 was a repayment, net of any advances, of inter-company loans from
      Telkonet, Inc., our parent company and majority owner;
  and
  ·
              Approximately $1,118,000 was
      expended for the acquisition of Newport Telecommunications
      assets.




As of
December 31, 2007 and December 31, 2006, we had cash and cash equivalents of
$1,022,965 and $114,468, respectively. As of March 31, 2008, we had
approximately $263,930 of cash available to use as working capital.




As of
December 31, 2007 and 2006, we had a balance due to Telkonet, Inc., in the
amount of $1,270,287 and $5,603,310, respectively. The loans between the
companies relate to acquisition related consideration, professional fees, shared
administrative and other operating matters. In connection with the Merger,
$5,000,000 of such indebtedness was converted into 5,000,000 shares of our
common stock at a conversion price of $1.00 per share. The loan balance as of
December 31, 2007, includes the $1,530,000 consideration of Telkonet, Inc.
common stock transferred to us in conjunction with the acquisition of Newport
Telecommunications Co. on July 18, 2007. The loans are unsecured and bear
interest at the prime rate calculated monthly.





Private
Placement of Common Stock





On
May 24, 2007, we completed a private placement of units, pursuant to which
5,597,664 shares of common stock and five-year warrants to purchase 2,798,836
shares of common stock at an exercise price of $1.00 per share were issued, for
total net proceeds of $2,694,020.





Convertible
Senior Debentures





We also
sold senior convertible debentures for total gross proceeds of
$6,050,000.  The debentures bear interest at a rate of 8% per annum,
commencing on the first anniversary of the original issue date of the
debentures, payable quarterly in cash or common stock, at our option, and mature
on April 30, 2010. The debentures are not callable and are convertible at a
price of $0.65 per share into 10,117,462 shares of common stock.  In
addition, holders of the debentures received five-year warrants to purchase an
aggregate of 5,058,730 shares of our common stock at an exercise price of $1.00
per share.


23





Registration
Rights Liquidated Damages





We agreed
to file a “resale” registration statement with the SEC within 60 days after the
final closing of the private placement and the issuance of the debentures
covering all shares of common stock sold in the private placement and underlying
the debentures, as well as the warrants issued in connection therewith. We
agreed to use our best efforts to have such “resale” registration statement
declared effective by the SEC as soon as possible and, in any event, within 120
days after the initial closing of the private placement and the issuance of the
debentures.





In
addition, with respect to the shares of common stock sold in the private
placement and underlying the warrants, the Company agreed to maintain the
effectiveness of the “resale” registration statement from the effective date
until the earlier of (i) 18 months after the date of the closing of the private
placement or (ii) the date on which all securities registered under the
registration statement (a) have been sold, or (b) are otherwise able to be sold
pursuant to Rule 144, at which time exempt sales may be permitted for purchasers
of the units, subject to the Company’s right to suspend or defer the use of the
registration statement in certain events.





On
September 21, 2007, we received approval from the requisite number of purchasers
of the units and the convertible debentures to extend the deadline for causing
the “resale” registration statement to be declared effective by the SEC to
November 21, 2007.





In the
event that such registration statement was not declared effective by the SEC on
or before November 21, 2007, we were obligated to pay liquidated damages to the
purchasers of the units and the convertible debentures equal 1% of their
$9,128,717 purchase price for each month of delinquency, commencing from
the original effectiveness date of September 21, 2007, with respect to the units
and September 22, 2007, with respect to the convertible debentures.





We
received waivers from the debenture holders, as of January 31, 2008, and from
the unit holders, as of March 31, 2008, whereby they waived all rights to
liquidated damages due to the registration statement not being declared
effective by the SEC in a timely manner.




In
accordance with EITF 00-19-2, the Company evaluated the likelihood of achieving
registration statement effectiveness.  Accordingly, the Company has
accrued $500,000 as of December 31, 2007, to account for potential liquidated
damages until the expected effectiveness of the registration statement is
achieved or the damages are waived. Such damages have since been
waived.





We will
need to raise additional capital in the future to fund our operating needs. We
expect that the funds from the Private Placement and the issuance of the
Debentures will fund our operations through the first half of the year, assuming
the Company is not required to pay the liquidated damages. Our operating needs
include the planned costs to operate our business, including amounts required to
fund working capital and capital expenditures. Our future capital requirements
and the adequacy of our available funds will depend on many factors, including,
our ability to successfully commercialize our services, competing technological
and market developments and the need to enter into collaborations with other
companies or acquire other companies or technologies to enhance or complement
our product and service offerings.





Cash
flow analysis





Cash
utilized in operating activities was $3,445,698 during the year ended December
31, 2007 compared to $2,306,687 during the year ended December 31,
2006.




We
utilized cash for investing activities of $2,773,485 and $2,835,363 during the
year ended December 31, 2007 and 2006, respectively. The cash portion for the
acquisition of Newport Telecommunications in July 2007 was $1,118,294 including
acquisition costs.  Additionally, cost of cable equipment and
installation amounted to $1,541,491 and $2,800,446 for the year ended December
31, 2007 and 2006. Also, purchases of property and equipment amounted to
$113,700 and $34,917 for the year ended December 31, 2007 and 2006,
respectively.





We raised
$5,303,238 through the sale of debentures, and $2,694,020 through the sale of
common stock, during the year ended December 31, 2007. In 2006, we received
$5,603,310 from Telkonet, our parent company and payments of $363,092 and $6,555
were made towards our notes payable.





Our
registered independent certified public accountants have stated in their report
dated April 14, 2008, that we have incurred operating losses in the past years,
and that we are dependent upon management's ability to develop profitable
operations. These factors among others may raise substantial doubt about our
ability to continue as a going concern.




Additional
financing is required in order to meet our current and projected cashflow
requirements from operations. Additional investments are being sought, but we
cannot guarantee that we will be able to obtain such investments. Financing
transactions may include the issuance of equity or debt securities, obtaining
credit facilities, or other financing mechanisms. However, the trading price of
our common stock and the downturn in the U.S. stock and debt markets could make
it more difficult to obtain financing through the issuance of equity or debt
securities. Even if we are able to raise the funds required, it is possible that
we could incur unexpected costs and expenses, fail to collect significant
amounts owed to us, or experience unexpected cash requirements that would force
us to seek alternative financing. Further, if we issue additional equity or debt
securities, stockholders may experience additional dilution or the new equity
securities may have rights, preferences or privileges senior to those of
existing holders of our common stock. If additional financing is not available
or is not available on acceptable terms, we will have to curtail our
operations.


24





Acquisition
or Disposition of Plant and Equipment





During
the year ended December 31, 2007, fixed assets increased approximately
$2,773,000, which included the addition of the Newport assets acquired in July
2007 and equipment purchased for our cable build-out. The remainder is related
to computer equipment and peripherals used in day-to-day operations. We
anticipate significant expenditures as we continue to build-out the head-end
equipment, IPTV infrastructure and other related infrastructure.





We lease
approximately 12,600 square feet of office and warehouse space in Hawthorne, New
Jersey for approximately $6,897 per month. The current lease term expires on
April 30, 2010 at which time we have the option to extend the lease for an
additional five-year period. We also rent office space from 25 River Drive South
Urban Renewal Co. for approximately $2,500 per month. This lease will expire in
December 2009.





We lease
approximately 64 square feet at a collocation facility located in New York City
for our telecommunications and video equipment, at a monthly rent of
$1,664.




We have a
license to maintain a major point-of-presence at the Trump International Hotel
and Tower Condominium located at Columbus Circle in New York City. Pursuant to
the license agreement, we have the right to install antennas and other equipment
on the building’s rooftop and in certain equipment storage areas for a license
fee of $3,800 per month. The term of the agreement expires on June 30,
2012.





New
Accounting Pronouncements





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose
to measure many financial instruments, and certain other items, at fair value.
SFAS 159 applies to reporting periods beginning after November 15, 2007. The
adoption of SFAS 159 is not expected to have a material impact on the Company’s
financial position, results of operations or cash flows.





In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141(R), “Business Combinations” (“Statement 141(R)”) and Financial Accounting
Standards No. 160, “Noncontrolling Interests in Consolidated Financial
Statements” (“Statement 160”). Statements 141(R) and 160 require most
identifiable assets, liabilities, noncontrolling interests and goodwill acquired
in a business combination to be recorded at “full fair value” and require
noncontrolling interests (previously referred to as minority interests) to be
reported as a component of equity. Both statements are effective for fiscal
years beginning after December 15, 2008. Statement 141(R) will be applied to
business combinations occurring after the effective date. Statement 160 will be
applied prospectively to all noncontrolling interests, including any that arose
before the effective date. The Company has not determined the effect, if any,
the adoption of Statements 141(R) and 160 will have on the Company’s financial
position, results of operations or cash flows.





ITEM
7. FINANCIAL STATEMENTS.





See the
Financial Statements and Notes thereto commencing on Page F-1.





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





None.





ITEM
8A(T). CONTROLS AND PROCEDURES.




Evaluation of
Disclosure Controls and Procedures .





Under the
supervision and with the participation of our management, including our chief
executive officer and principal financial officer, we evaluated the
effectiveness of the design and operation of our disclosure controls and
procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934 (the “Exchange Act”)). Disclosure controls and
procedures include, without limitation, controls and procedures designed to
ensure that information required to be disclosed by an issuer in the reports
that it files or submits under the Exchange Act is accumulated and communicated
to the issuer’s management, including its principal executive and principal
financial officers, or persons performing similar functions, as appropriate to
allow timely decisions regarding required disclosure. Our Chief Executive
Officer and Vice President of Finance concluded that our disclosure controls and
procedures are effective, as of the year ended December 31, 2007, in ensuring
that material information that we are required to disclose in reports that we
file or submit under the Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission rules and forms.


25





Our
conclusion on the effectiveness of internal control over financial reporting did
not include the internal controls of Newport Telecommunications Co., which was
acquired in 2007 and which is included in our 2007 consolidated financial
statements.





Changes in
Internal Control over Financial Reporting .





During
the fourth quarter of 2007, there was no change in our internal control over
financial reporting (as such term is defined in Rule 13a-15(f) under the
Exchange Act) that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.




Management Annual
Report on Internal Control over Financial Reporting.





Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting. Internal control over financial reporting is
defined in Rule 13a-15(f) and 15d-15(f) under the Exchange Act as a process
designed by, or under the supervision of, a company’s principal executive and
principal financial officers and effected by a company’s board of directors,
management and other personnel, to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
for external purposes in accordance with accounting principles generally
accepted in the United States of America. Our internal control over financial
reporting includes those policies and procedures that:





·
              pertain
      to the maintenance of records that, in reasonable detail, accurately and
      fairly reflect the transactions and dispositions of our
      assets;
 
 ·
              provide
      reasonable assurance that transactions are recorded as necessary to permit
      preparation of financial statements in accordance with accounting
      principles generally accepted in the United States of America, and that
      our receipts and expenditures are being made only in accordance with
      authorization of management and directors;
and
 
 ·
              provide
      reasonable assurance regarding prevention or timely detection of
      unauthorized acquisition, use or disposition of our assets that could have
      a material effect on the financial
statements.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with policies or procedures may deteriorate.




We have
excluded from this assessment the operations of Newport Telecommunications Co.,
which constituted $2,598,148 and $2,471,926 of total and net assets,
respectively, as of December 31, 2007, and $668,942 of net sales for the year
then ended.





Our
management assessed the effectiveness of our internal control over financial
reporting as of December 31, 2007. This assessment was based on criteria
established in the framework in Internal Control-Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission. Based on our assessment, management concluded that our
internal control over financial reporting was effective as of December 31,
2007.




This
annual report does not include an attestation report of our registered public
accounting firm regarding internal control over financial reporting.
Management’s report was not subject to attestation by our registered public
accounting firm pursuant to temporary rules of the Securities and Exchange
Commission that permit us to provide only management’s report in this annual
report.





ITEM
8B. OTHER INFORMATION.





None.




PART
III





ITEM
9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS, CONTROL PERSONS AND CORPORATE
GOVERNANCE; COMPLIANCE WITH SECTION 16(a) OF THE EXCHANGE ACT.





The
following table furnishes the information concerning our directors and executive
officers for the fiscal year ended December 31, 2007. Our directors are elected
every year and serve until their successors are duly elected and qualified.
Officers are elected annually by the board and serve at the discretion of the
board.


26





Name
                    
                    Age
                    
                    TitleRonald
      W. Pickett
                    
                    60
                    
                    President
      and DirectorFrank
      T. Matarazzo
                    
                    46
                    
                    Chief
      Executive Officer, Director and SecretaryKeith
      V. Scarzafava
                    
                    44
                    
                    Chief
      Technology Officer and Director of OperationsRichard
      J. Leimbach
                    
                    39
                    
                    Vice
      President FinanceWarren
      V. Musser
                    
                    81
                    
                    Chairman
      of the Board of DirectorsThomas
      C. Lynch
                    
                    65
                    
                    DirectorDr.
      Thomas M. Hall
                    
                    56
                    
                    Director




Ronald W. Pickett, President and
Director





Mr.
Pickett has served as our President and as a director since May 24, 2007. Mr.
Pickett has been a director of MST since January 2006. Mr. Pickett was the
principal investor and co-founder of Telkonet (AMEX: TKO) and was its president
from January 2003, until his resignation in December 2007. Subsequent to his
resignation, he was appointed as Vice Chairman of the Board of Directors of
Telkonet. He also was the founder, and for twenty years served as chairman of
the board of directors and president of Medical Advisory Systems, Inc., a
company providing international medical services and pharmaceutical
distribution, until its merger with Digital Angel Corporation (AMEX: DOC) in
March 2002.





Frank T. Matarazzo, Chief Executive Officer, Secretary
and Director





Mr. Matarazzo has
served as our Chief Executive Officer and as a director since May 24, 2007. Mr.
Matarazzo has been a director and Chief Executive Officer of MST since its
inception in 1982. From 1982 until May 2007, he also held the office of
President of MST. He is in charge of directing our growth and development. Mr.
Matarazzo designed and constructed the first private cable television systems
operated by us and continues to be involved in all technology deployed by us.
Mr. Matarazzo’s experience includes employment for Conrac Avionics from 1980 to
1982, as a prototype design engineer, working on the development of the
guidance/navigation systems for military fighter planes as well as the
development and construction of the FM communication systems and engine
interface units for the Space Shuttle Columbia. Mr. Matarazzo is known in the
private cable television industry, having both written articles for trade
publications and served as a technical consultant to municipalities in the area
of satellite delivered information systems.





Keith V. Scarzafava, Chief Technology Officer and
Director of Operations





Mr.
Scarzafava has served as our Chief Technology Officer and Director of Operations
since May 24, 2007. From June 2000 to July 2006, Mr. Scarzafava served as the
Director of Technology and Research Design at the Warwick Valley Telephone
Company (NASDAQ GM: WWVY), an independent telephone company located in upstate
New York. During his service at Warwick Valley Telephone Company, Mr. Scarzafava
engineered and constructed an Internet division to encompass several counties
and to serve three states, making Warwick the first independent telephone
company in the United States to successfully operate as an ISP. In addition, Mr.
Scarzafava directly assisted Warwick in becoming the first independent telephone
company to construct a high capacity optical network, including a complete IPTV
head-end, to distribute Warwick’s Digital TV service over DSL technology. Mr.
Scarzafava then deployed one of the first fiber to home deployments in the
United States.





Richard J. Leimbach, Vice President of
Finance





Mr.
Leimbach has served as our Vice President of Finance since July 2007 and as
financial consultant to the company since February 2006. He is the Chief
Financial Officer at Telkonet and also served as Telkonet’s Vice President of
Finance and Controller from January 2004 until December 2007. Mr. Leimbach is a
certified public accountant with over fifteen years of public accounting and
private industry experience. Prior to joining Telkonet, from October 2001 to
January 2004, Mr. Leimbach was the Controller with Ultrabridge, Inc., an
applications solution provider. Mr. Leimbach also served as Corporate Accounting
Manager for Snyder Communications, Inc., a global provider of integrated
marketing solutions, from July 1998 to August 2001.


27





Warren V. Musser, Chairman of the Board of
Directors





Mr.
Musser has served as our Chairman since May 24, 2007 and has been the Chairman
of the Board of MST since January 2006. Mr. Musser has been the Chairman of the
Board of Telkonet since January 2003. He is the founder and chairman emeritus of
Safeguard Scientifics, Inc. (NYSE: SFE), a high-tech venture capital company,
formerly known as Safeguard Industries, Inc. Since 2001, Mr. Musser has been the
managing director of The Musser Group, a business consulting firm, and the
founder and president of Musser and Company, Inc., an investment banking firm.
In addition, Mr. Musser is a director of Internet Capital Group, Inc., a
business-to-business venture capital company, and is a director and vice
chairman of Nutri/System, Inc., a weight management company, and a co-chairman
of Eastern Technology Council, a business advisory firm. Mr. Musser serves on a
variety of civic, educational and charitable boards of directors, and serves as
vice president of development, Cradle of Liberty Council, Boy Scouts of America,
vice chairman of The Eastern Technology Council, and chairman of the
Pennsylvania Partnership on Economic Education.





Thomas C. Lynch, Director





Mr. Lynch
has served as a director since May 24, 2007. Mr. Lynch has been a director of
Telkonet since October 2003 and is senior vice president and director of The
Staubach Company’s Federal Sector, a real estate management and advisory
services firm in the Washington, D.C. area. Mr. Lynch joined The Staubach
Company in November 2002 after six years as senior vice president at Safeguard
Scientifics, Inc. (NYSE: SFE), a high-tech venture capital company. While at
Safeguard, he served nearly two years as president and chief operating officer
at CompuCom Systems, a Safeguard subsidiary. After a 31-year career of naval
service, Mr. Lynch retired in the rank of Rear Admiral. Mr. Lynch’s naval
service included Chief, Navy Legislative Affairs, command of the Eisenhower
Battle Group during Operation Desert Shield, Superintendent of the United States
Naval Academy from 1991 to 1994 and Director of the Navy Staff in the Pentagon
from 1994 to 1995. Mr. Lynch presently serves as a Director of Pennsylvania
Eastern Technology Council, Armed Forces Benefit Association, Catholic
Leadership Institute, National Center for the American Revolution at Valley
Forge, and Mikros Systems (OTCBB: MKRS OB).





Thomas M. Hall, M.D, Director





Dr. Hall
has served as a director since May 24, 2007. Dr. Hall has been a director of
Telkonet since April 2004. Dr. Hall is the managing director of Marrell
Enterprises LLC, an international business development company, since its
founding in September 2003. From 2002 until November 2006, he served as
Executive Medical Director at Digital Angel Corp. For 12 years (until it was
acquired in 2002), Dr. Hall was the chief executive officer of Medical Advisory
Systems, Inc., an international medical services and pharmaceutical distribution
company. Dr. Hall holds a bachelor of science and a medical degree from the
George Washington University and a master of international management degree
from the University of Maryland. He is a member of the American College of
Occupational and Environmental Medicine.





There are
no family relationships among our directors and executive officers.





Board
Committees




Audit
Committee




We intend
to establish an audit committee of the board of directors, which will consist of
independent directors, of which at least one director will qualify as a
qualified financial expert as defined in Item 407(d)(5)(ii) of Regulation S-B.
The audit committee’s duties would be to recommend to our board of directors the
engagement of independent auditors to audit our financial statements and to
review our accounting and auditing principles. The audit committee would review
the scope, timing and fees for the annual audit and the results of audit
examinations performed by the internal auditors and independent public
accountants, including their recommendations to improve the system of accounting
and internal controls. The audit committee would at all times be composed
exclusively of directors who are, in the opinion of our board of directors, free
from any relationship which would interfere with the exercise of independent
judgment as a committee member and who possess an understanding of financial
statements and generally accepted accounting principles.





Compensation
Committee




We intend
to establish a compensation committee of the board of directors. The
compensation committee would review and approve our salary and benefits
policies, including compensation of executive officers. The compensation
committee would also administer our stock option plans and recommend and approve
grants of stock options under such plans.





Code
of Ethics





The Board
has approved, and we have adopted, a Code of Ethics that applies to all of our
directors, officers and employees. We will provide a copy of the Code of Ethics
free of charge upon request to any person submitting a written request to our
Chief Executive Officer.





SECTION
16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE





Based
solely upon a review of Forms 3, 4 and 5 and amendments thereto furnished to us,
none of our directors, officers or beneficial owners of more than 10% of our
common stock failed to file on a timely basis any reports required by Section
16(a) of the Exchange Act during the year ended December 31,
2007.


28





ITEM
10. EXECUTIVE COMPENSATION.





Summary
Compensation Table





The
following table sets forth certain information with respect to compensation for
services in all capacities for the years ended December 31, 2007 and 2006 paid
to our Chief Executive Officer (principal executive officer) and the two other
most highly compensated executive officers who were serving as such as of
December 31, 2007 (the “Named Executive Officers”).





Summary
Compensation Table





Name and
      Principal
                                            Position
                                          
                                          Year
                                          
                                          Salary
                                            ($)
                                          
                                          
                                          Bonus
                                            ($)
                                          
                                          
                                          Stock
                                            Awards
                                            ($)
                                            (5)
                                          
                                          
                                          Option
                                            Awards
                                            ($)
                                            (5)
                                          
                                          
                                          All
      Other
                                            Compensation
                                            ($)
                                          
                                          
                                          Total
                                            ($)Ronald W. Pickett
                                          
                                          2007
                                          
                                          $
                                          37,788
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          455,300
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          493,088President (1)Frank T. Matarazzo
                                          
                                          2007
                                          
                                          $
                                          281,780
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          910,600
                                          
                                          
                                          
                                          0
                                          (6)
                                          
                                          $
                                          1,192,380Chief Executive
                                          
                                          2006
                                          
                                          $
                                          229,539
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          30,497
                                          
                                          
                                          $
                                          260,036Officer (2)Keith Scarzafava
                                          
                                          2007
                                          
                                          $
                                          145,558
                                          
                                          
                                          $
                                          2,788
                                          
                                          
                                          $
                                          40,500
                                          (4)
                                          
                                          $
                                          49,172
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          238,018Chief Technology
                                          
                                          2006
                                          
                                          $
                                          61,346
                                          
                                          
                                          $
                                          2,788
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          0
                                          
                                          
                                          $
                                          64,134Officer (3)




(1) Mr.
Pickett was appointed as President of MSTI on May 24, 2007.


(2) Mr.
Matarazzo was appointed Chief Executive Officer on May 24, 2007. Mr. Matarazzo
has been the Chief Executive Officer of MST since its inception in
1982.


(3) Mr.
Scarzafava was appointed Chief Technology Officer and Director of Operations on
May 24, 2007.


(4) Mr.
Scarzafava received 30,000 shares of our common stock for facilitating the
Newport Telecommunications purchase.


(5) Our
assumptions made in the valuation of share-based payments are contained in Note
J of our December 31, 2007 Financial Statements.


(6)
Perquisites and other personal benefits received by Mr. Matarazzo did not exceed
$10,000.





Stock
Incentive Plans




Prior to
the consummation of the reverse merger, our board of directors and stockholders
adopted the 2007 Incentive Stock Plan. The purpose of the 2007 Incentive Stock
Plan is to provide an incentive to attract and retain directors, officers,
consultants, advisors and employees whose services are considered valuable, to
encourage a sense of proprietorship and to stimulate an active interest of such
persons in our development and financial success. Under the 2007 Incentive Stock
Plan, we are authorized to issue incentive stock options intended to qualify
under Section 422 of the Code, non-qualified stock options and restricted stock.
The 2007 Incentive Stock Plan is administered by our board of directors. Upon
consummation of the merger, Mr. Matarazzo and Mr. Pickett were granted ten-year
options to purchase 2,000,000 shares and 1,000,000 shares of our common stock,
respectively, exercisable at $0.65 per share, under the 2007 Incentive Stock
Plan. Such options vest in equal monthly installments over 48
months.





Outstanding
Equity Awards at Fiscal Year-End




The
following table sets forth certain information concerning outstanding stock
awards held by the Named Executive Officers as of December 31,
2007:


29





Outstanding
Equity Awards at Fiscal Year-end





Option AwardsName
                                    
                                    Number Of
                                      Securities
                                      Underlying
                                      Unexercised
                                      Options
                                      (#)
                                      Exercisable
                                    
                                    Number Of
                                      Securities
                                      Underlying
                                      Unexercised
                                      Options
                                      (#)
                                      Unexercisable
                                    
                                    Option
                                      Exercise
                                      Price
                                      ($)
                                    
                                    Option
                                      Expiration
                                      DateRonald W. Pickett (1)
                                    
                                    
                                    187,500
                                    
                                    812,500
                                    
                                    $
                                    0.65
                                    
                                    5/31/2011Frank T. Matarazzo (2)
                                    
                                    
                                    375,000
                                    
                                    1,625,000
                                    
                                    $
                                    0.65
                                    
                                    5/31/2011Keith V. Scarzafava (3)
                                    
                                    
                                    27,000
                                    
                                    81,000
                                    
                                    $
                                    0.65
                                    
                                    5/31/2010




(1)
              On
      May 24, 2007, Mr. Pickett was granted a stock option to purchase 1,000,000
      shares of our common stock, with monthly vesting over four
      years.
 (2)
              On
      May 24, 2007, Mr. Matarazzo was granted a stock option to purchase
      2,000,000 shares of our common stock, with monthly vesting over four
      years.
 (3)
              On
      May 24, 2007, Mr. Scarzafava was granted a stock option to purchase
      108,000 shares of our common stock, with monthly vesting over three
      years.





All stock
options were granted in accordance with our stock option plan.





Employment
Agreements





MST
entered into an employment agreement with Mr. Matarazzo, our Chief Executive
Officer, that provided, among other things, for an annual salary of $250,000.
The agreement had a three-year term which expires on December 31, 2008.
Upon the closing of the reverse merger, we amended Mr. Matarazzo’s employment
agreement to provide for an annual base salary of $300,000 and to extend the
term of the agreement to December 31, 2011. The Agreement also provides
that Mr. Matarazzo will not, directly or indirectly, engage in any business
activities that compete with the business of our company during his term of
employment and for one year thereafter in New York City or any major
metropolitan area where we or Telkonet conducts or has committed to conduct
business, without the prior consent of Telkonet and us.





Director
Compensation





We
currently compensate our directors with equity pursuant to our stock option
plan. We reimburse our directors for reasonable expenses incurred in connection
with their service as directors. The following table sets forth certain
information regarding compensation awarded to our directors during the fiscal
year ended December 31, 2007:





Director
Compensation Table





Name
                                
                                Fees
                                  Earned or
                                  Paid in
                                  Cash
                                  ($)
                                
                                Stock
                                  Awards
                                  ($)
                                
                                Option
                                  Awards
                                  ($) (4)
                                
                                Total
                                  ($)Warren V.
      Musser
                                
                                
                                -
                                
                                -
                                
                                $
                                14,424
                                (1)
                                $
                                14,424Thomas
      M. Hall
                                
                                
                                -
                                
                                -
                                
                                $
                                14,424
                                (2)
                                $
                                14,424Thomas
      C. Lynch
                                
                                
                                -
                                
                                -
                                
                                $
                                14,424
                                (3)
                                $
                                14,424









(1)
              At December 31, 2007, Mr. Musser
      had outstanding options to purchase 144,000 shares of our common stock
      vesting over three years, of which an aggregate of 36,000 were currently
      exercisable.
 (2)
              At
      December 31, 2007, Mr. Hall had outstanding options to purchase 144,000
      shares of our common stock vesting over three years, of which an aggregate
      of 36,000 were currently
exercisable.
 (3)
              At
      December 31, 2007, Mr. Lynch had outstanding options to purchase 144,000
      shares of our common stock vesting over three years, of which an aggregate
      of 36,000 were currently
exercisable.
 (4)
              Based
      upon the aggregate grant date fair value calculated in accordance with the
      Financial Accounting Standards Board (“FASB”) Statement of Financial
      Accounting Standard (FAS”) No. 123R, Share Based Payment. Our policy and
      assumptions made in the valuation of share based payments are contained in
      the Note J to our December 31, 2007 financial
  statements.




30





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





The
following table sets forth, as of March 30, 2008, the beneficial ownership of
our common stock by:





(1) each
person or entity who is known by us to beneficially own more than five percent
(5%) of our common stock;





(2) each
of our directors;





(3) each
Named Executive Officer; and





(4) all
of our directors and executive officers as a group.





The
percentages of common stock beneficially owned are reported on the basis of
regulations of the Securities and Exchange Commission governing the
determination of beneficial ownership of securities. Under the rules of the
Securities and Exchange Commission, a person is deemed to be a beneficial owner
of a security if that person has or shares voting power, which includes the
power to vote or to direct the voting of the security, or investment power,
which includes the power to dispose of or to direct the disposition of the
security. Unless otherwise indicated, each of the stockholders named in the
table below has sole voting and investment power with respect to such shares of
common stock. Except as otherwise indicated, the address of each 5% stockholder
listed below is: c/o 259-263 Goffle Road, Hawthorne, New Jersey 07506. Shares of
common stock subject to options, warrants, or other rights currently exercisable
or exercisable within 60 days of March 30, 2008, are deemed to be beneficially
owned and outstanding for computing the share ownership and percentage of the
stockholder holding such options and warrants, but are not deemed outstanding
for computing the percentage of any other stockholder.





Name of Beneficial Owner
                    
                    Amount and
                      Nature of
                      Beneficial
                      Ownership(1)
                    
                    
                    Percent of
                      Common
                      Stock(2)DIRECTORS
      AND NAMED EXECUTIVE OFFICERS:Warren
      V. Musser
                    
                    
                    36,000
                    (3)
                    
                    
                    *Frank
      T. Matarazzo
                    
                    
                    2,014,860
                    (4)
                    
                    
                    6.7
                    %Ronald
      W. Pickett
                    
                    
                    327,360
                    (5)
                    
                    
                    1.1
                    %Thomas
      C. Lynch
                    
                    
                    172,364
                    (6)
                    
                    
                    *Thomas
      M. Hall, M.D.
                    
                    
                    175,860
                    (7)
                    
                    
                    *Keith
      V. Scarzafava
                    
                    
                    57,000
                    (8)
                    
                    
                    *All
      executive officers and directors as a group (7 persons) (3) – 
      (9)
                    
                    
                    2,814,944
                    
                    
                    
                    9.4
                    %5%
      STOCKHOLDERS:Telkonet,
      Inc.
                      20374
      Seneca Meadows Parkway
                      Germantown,
      Maryland 20876
                    
                    
                    18,500,000
                    (10)
                    
                    
                    62.0
                    %




*  
Represents less than 1%.





(1)
Unless otherwise indicated, includes shares owned by a spouse, minor children,
and relatives sharing the same home, as well as entities owned or controlled by
the named beneficial owner. Unless otherwise noted, shares are owned of record
and beneficially by the named beneficial owner.




(2) Based
on 29,816,552 shares of common stock issued and outstanding as of March 30,
2008.




(3)
Includes 36,000 shares of common stock issuable upon the exercise of stock
options within 60 days.




(4)
Includes 46,420 shares of common stock issuable upon the exercise of warrants
within 60 days. Includes 375,000 shares of common stock issuable upon the
exercise of stock options within 60 days.




31





(5)
Includes 46,420 shares of common stock issuable upon the exercise of warrants
within 60 days. Includes 187,500 shares of common stock issuable upon the
exercise of stock options within 60 days.




(6)
Includes 45,455 shares of common stock issuable upon the exercise of warrants
within 60 days. Includes 36,000 shares of common stock issuable upon the
exercise of stock options within 60 days.




(7)
Includes 46,420 shares of common stock issuable upon the exercise of warrants
within 60 days. Includes 36,000 shares of common stock issuable upon the
exercise of stock options within 60 days.





(8)
Includes 27,000 shares of common stock issuable upon the exercise of stock
options within 60 days.





(9)
Includes 31,500 shares of common stock issuable to Richard Leimbach, our Vice
President of Finance, upon the exercise of stock options within 60
days.





(10)
Excludes shares to be issued as repayment for Telkonet’s payment in their stock
of $1,530,000 towards the acquisition of Newport Telecommunications assets in
July 2007.





Securities
Authorized for Issuance Under Equity Compensation Plan.





The
following table provides information pertaining to compensation plans under
which equity securities are authorized for issuance pursuant to equity
compensation plans previously approved and not previously approved by our
stockholders as of December 31, 2007.





Equity
Compensation Plan Information





Number of securities to be
                        issued upon exercise of
                        outstanding options,
                        warrants and rights
                        (a)
                      
                      
                      Weighted -average exercise
                        price of outstanding options,
                        warrants and rights
                        (b)
                      
                      
                      Number of securities remaining
                        available for future issuance
                        under equity compensation plans
                        (excluding securities reflected in
                        column (a))
                        (c)Equity
      compensation plans approved by security holders
                      
                      
                      13,235,626
                      
                      
                      $
                      0.89
                      
                      
                      
                      222,000Equity
      compensation plans not approved by security holders
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Total
                      
                      
                      13,235,626
                      
                      
                      $
                      0.89
                      
                      
                      
                      222,000




32





ITEM
12. CERTAIN RELATIONSHIPS AND RELATED TRANSATIONS AND DIRECTOR
INDEPENDENCE.





We hold a
50% membership interest in Interactivewifi.com, which is 50%, owned by Global
Transport Logistics, Inc. Global Transport Logistics, Inc. is 100% owned by
Eileen Matarazzo, the sister-in-law of Frank T. Matarazzo, our Chief Executive
Officer. Our joint venture with Global Transport Logistics, Inc. does not
contain a non-competition restriction.




We also
have a one-year professional services agreement with Global Transport Logistics,
Inc., which expires February 1, 2009, for the provision of marketing and
business development consulting services, for which Global Transport Logistics,
Inc. is paid a fee of $10,000 per month. For the years ended December 31, 2007
and 2006, the Company paid and expensed $110,000 and $90,000,
respectively.




Laura
Matarazzo, our Chief Administrative Officer, is our Chief Executive Officer’s
sister and has been employed by us since 1982. Ms. Matarazzo receives an annual
base salary of $133,987, including a car allowance.




On August
17, 2005, we issued a non-interest bearing demand promissory note in the amount
of $100,000 to Frank T. Matarazzo, our Chief Executive Officer, evidencing his
$100,000 loan to us. On May 10, 2007 we issued an additional non-interest
bearing demand promissory note in the amount of $60,000 to him, evidencing an
additional loan by him in the amount of $60,000. As of May 24, 2007, both notes
were repaid in full.




We have a
co-marketing agreement with Telkonet, Inc., which owns approximately 62% of our
outstanding common stock. We have made payments of $19,060 and $136,035 to
Telkonet pursuant to the terms of this agreement in the years ended December 31,
2007 and 2006, respectively.




Telkonet,
Inc. has made approximately $7,004,000 in unsecured loans to MST, bearing
interest at approximately 8% per annum and $5,000,000 of such indebtedness was
converted at the time of the reverse merger into 5,000,000 shares of our common
stock at a conversion price of $1.00 per share. Additionally, on July 18, 2007,
Telkonet issued unregistered shares of its common stock worth approximately
$1,530,000 as consideration for the acquisition of substantially all of the
assets of Newport Telecommunications Co. As of December 31, 2007 we had an
inter-company balance due to Telkonet, Inc. in the amount of $1,270,287 for
loans made to us. The loans between the companies relate to advances from
Telkonet, Inc. of shares of its common stock equal to $1,530,000 in conjunction
with the Newport Telecommunications, Inc. acquisition on July 18, 2007, and net
of inter-company advances of $259,713 which also includes certain shared
services for professional fees, administrative and other operating matters. The
loans are unsecured and bear interest at the prime rate calculated
monthly.





Director
Independence





Our board
of directors is comprised of Warren Musser, Ronald Pickett, Thomas Lynch, Thomas
Hall and Frank Matarazzo. We believe that Warren Musser, Thomas Lynch and Thomas
Hall are “independent directors” as that term is defined by NASDAQ Stock
Marketplace Rule 4200(a)(15). We were not a party to any transactions,
relationships or arrangements with any of our “independent directors” that would
be considered in the determination of such directors independence.





Item
13. Principal Accountant Fees and Services





RBSM LLP
has served as our independent registered public accounting firm since July 2007.
RBSM LLP was also MST’s independent registered public accounting firm prior to
the Merger on May 24, 2007.





(1)
Audit Fees




RBSM LLP
has billed us audit fees in the aggregate amounts of $83,501 and $0 during 2007
and 2006, respectively. These fees relate to the audit of our annual
consolidated financial statements and the review of the interim consolidated
financial statements included in quarterly reports and services in connection
with statutory and regulatory filings or engagements.




(2)
Audit-Related Fees





RBSM LLP
billed us audit-related fees in the aggregate amount of $90,175 during 2007.
These fees relate primarily to the auditors review of our registration
statements and related consents, audit of acquired companies assets and audit
related consulting.





(3)
Tax Fees





No fees
of this sort were billed by RBSM LLP during 2006 and 2007.


33





(4)
All Other Fees





No fees
of this sort were billed by RBSM LLP during 2006 and 2007.


34




Item
14. Exhibits





Exhibit No
      .
                  
                  Description2.1
                  
                  Agreement
      of Merger and Plan of Reorganization, dated as of May 22, 2007, by
      and among Fitness Xpress Software, Inc., Microwave Satellite Technologies,
      Inc., and Microwave Acquisition Corp. (Incorporated herein by reference to
      Exhibit 2.1 to the Company’s Current Report on Form 8-K filed with the
      Securities and Exchange Commission on May 29, 2007 (the “May 29, 2007
      8-K”))2.2
                  
                  Delaware
      Certificate of Merger, dated May 22, 2007, between Microwave
      Satellite Technologies, Inc. and Microwave Acquisition Corp. (Incorporated
      herein by reference to Exhibit 2.2 to the May 29, 2007
  8-K)2.3
                  
                  New
      Jersey Certificate of Merger, dated May 22, 2007, between Microwave
      Satellite Technologies, Inc. and Microwave Acquisition Corp., effective
      May 24, 2007 (Incorporated herein by reference to Exhibit 2.3 to the
      May 29, 2007 8-K)3.1
                  
                  Certificate
      of Incorporation (Incorporated herein by reference to Exhibit 3.1 to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on May 24, 2007)3.2
                  
                  By-laws
      (Incorporated herein by reference to Exhibit 3.2 to the Company’s Current
      Report on Form 8-K filed with the Securities and Exchange Commission filed
      on May 24, 2007)3.3
                  
                  Certificate
      of Amendment to Certificate of Incorporation, dated May 24, 2007
      (Incorporated herein by reference to Exhibit 3.3 to the May 29, 2007
      8-K)




35




10.1
              
              Form
      of Unit Subscription Agreement (Incorporated herein by reference to
      Exhibit 10.1 to the May 29, 2007 8-K)10.2
              
              Form
      of Unit Subscription Addendum (Incorporated herein by reference to Exhibit
      10.2 to the May 29, 2007 8-K)10.3
              
              Form
      of Unit Registration Rights Agreement (Incorporated herein by reference to
      Exhibit 10.3 to the May 29, 2007 8-K)10.4
              
              Form
      of Unit Registration Rights Addendum (Incorporated herein by reference to
      Exhibit 10.4 to the May 29, 2007 8-K)10.5
              
              Form
      of Investor Warrant (Incorporated herein by reference to Exhibit 10.5 to
      the May 29, 2007 8-K)10.6
              
              Form
      of Unit Lockup Agreement (Incorporated herein by reference to Exhibit 10.6
      to the May 29, 2007 8-K)10.7
              
              Securities
      Purchase Agreement for 8% Senior Convertible Debentures, dated
      May 25, 2007, by and among the Company and signatories thereto
      (Incorporated herein by reference to Exhibit 10.7 to the May 29, 2007
      8-K)10.8
              
              Form
      of 8% Secured Convertible Debenture due April 30, 2010 (Incorporated
      herein by reference to Exhibit 10.8 to the May 29, 2007
    8-K)10.9
              
              Form
      of Debenture Warrant (Incorporated herein by reference to Exhibit 10.9 to
      the May 29, 2007 8-K)10.10
              
              Form
      of Debenture Registration Rights Agreement (Incorporated herein by
      reference to Exhibit 10.10 to the May 29, 2007 8-K)10.11
              
              Form
      of Debenture Lockup Agreement (Incorporated herein by reference to Exhibit
      10.11 to the May 29, 2007 8-K)10.12
              
              Form
      of Security Agreement (Incorporated herein by reference to Exhibit 10.12
      to the May 29, 2007 8-K)10.13
              
              Placement
      Agent Agreement, dated May 15, 2007, between Microwave Satellite
      Technologies, Inc. and Palladium Capital Advisors, LLC (Incorporated
      herein by reference to Exhibit 10.13 to the May 29, 2007
    8-K)10.14
              
              Placement
      Agent Agreement, dated May 9, 2007, between Microwave Satellite
      Technologies, Inc. and WFG Investments, Inc. (Incorporated herein by
      reference to Exhibit 10.14 to the May 29, 2007 8-K)10.15
              
              Placement
      Agent Agreement, dated May 22, 2007, between Microwave Satellite
      Technologies, Inc. and Granite Financial Group, LLC (Incorporated herein
      by reference to Exhibit 10.15 to the May 29, 2007 8-K)10.16
      *
              
              Form
      of Directors and Officers Indemnification Agreement (Incorporated herein
      by reference to Exhibit 10.16 to the May 29, 2007 8-K)10.17
      *
              
              Company’s
      2007 Incentive Stock Plan (Incorporated herein by reference to Exhibit
      10.17 to the May 29, 2007
8-K)





10.18
      *
              
              Form
      of 2007 Incentive Stock Option Agreement (Incorporated herein by reference
      to Exhibit 10.18 to the May 29, 2007 8-K)10.19
      *
              
              Form
      of 2007 Non-Qualified Stock Option Agreement (Incorporated herein by
      reference to Exhibit 10.19 to the May 29, 2007 8-K)10.20
              
              Agreement
      of Conveyance, Transfer and Assignment of Assets and Assumption of
      Obligations, made as of May 24, 2007, by Fitness Xpress Software,
      Inc. and FXS Holdings, Inc. (Incorporated herein by reference to Exhibit
      10.26 to the Company’s Current Report on Form 8-K/A filed with the
      Securities and Exchange Commission on May 30,
2007)10.21
              
              Stock
      Purchase Agreement, dated May 24, 2007, by and between the Company
      and Ron Bell (Incorporated herein by reference to Exhibit 10.20 to the
      Company’s Current Report on Form 8-K/A filed with the Securities and
      Exchange Commission on May 30, 2007)10.22
      *
              
              Resignation
      letter from Ron Bell, dated May 24, 2007 (Incorporated herein by
      reference to Exhibit 10.23 to the Company’s Current Report on Form 8-K/A
      filed with the Securities and Exchange Commission on May 30,
      2007)




36





10.23
      *
                
                Employment
      Agreement, dated January 31, 2006, between Microwave Satellite
      Technologies, Inc. and Frank T. Matarazzo (Incorporated herein by
      reference to Exhibit 10.21 to the May 29, 2007 8-K)10.24
      *
                
                Amendment
      to Employment Agreement, dated May 24, 2007, between Microwave
      Satellite Technologies, Inc. and Frank T. Matarazzo (Incorporated herein
      by reference to Exhibit 10.22 to the Company’s Current Report on Form
      8-K/A filed with the Securities and Exchange Commission on May 30,
      2007)10.25
                
                Telecommunications
      Space License Agreement, dated as of February 20, 2006, between
      Microwave Satellite Technologies, Inc. and Rudin Management Company, Inc.
      (Incorporated herein by reference to Exhibit 10.24 to the May 29, 2007
      8-K)10.26
                
                Access
      Agreement entered into in June 2006 between the Company and
      Cablevision of Oakland LLC and Cablevision Lightpath-NJ, Inc.
      (Incorporated herein by reference to Exhibit 10.25 to the May 29, 2007
      8-K)10.27
                
                Program
      Service Agreement, dated June 2, 2007, by and between Microwave Satellite
      Technologies, Inc. and CSI Digital, Inc. (Incorporated herein by reference
      to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed
      with the Securities and Exchange Commission on June 7,
      2007)10.28
                
                Asset
      Purchase Agreement, dated July 16, 2007, by and among Microwave Satellite
      Technologies, Inc., Newport Telecommunications Co. and Telkonet, Inc.
      (Incorporated herein by reference to Exhibit 10.1 to the Company’s Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      July 24, 2007)10.29
                
                Escrow
      Agreement, dated July 16, 2007, by and among Microwave Satellite
      Technologies, Inc., Newport Telecommunications Co. and U.S. Bank National
      Association (Incorporated herein by reference to Exhibit 10.2 to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on July 24, 2007)10.30
                
                Form
      of Letter Agreement by and among the Company and the purchasers of the
      Units (Incorporated herein by reference to Exhibit 10.4 to the Company’s
      Current Report on Form 8-K filed with the Securities and Exchange
      Commission on September 24, 2007)10.31
                
                Form
      of Letter Agreement by and among the Company and the purchasers of the
      Debentures (Incorporated herein by reference to Exhibit 10.5 to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on September 24, 2007)10.32
                
                Form
      of Letter Agreement by and among the Company and the purchasers of the
      Debentures (Incorporated herein by reference to Exhibit 10.1 to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on January 31, 2008)10.33
                
                Form
      of Letter Agreement by and among the Company and the purchasers of the
      Debentures (Incorporated herein by reference to Exhibit 10.1 to the
      Company’s Current Report on Form 8-K filed with the Securities and
      Exchange Commission on February 12, 2008)21.1
                
                List
      of Subsidiaries (Incorporated herein by reference to Exhibit 21.1 to the
      Company’s Registration Statement on Form SB-2 filed with the Securities
      and Exchange Commission on July 23, 2007 (File No.
    333-144786)





31.1
              
              Section
      302 Certification of Principal Executive Officer31.2
              
              Section
      302 Certification of Principal Financial Officer32.1
              
              Section
      906 Certification of Principal Executive Officer and Principal Financial
      Officer


* A
management contract or compensatory plan or arrangement.


37





SIGNATURES




In
accordance with Section 13 or 15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.




MSTI
      HOLDINGS, INC.Date:
      February 23, 2009
                    
                    /s/
      Frank T. MatarazzoFrank
      T. Matarazzo, Chief Executive
Officer





In
accordance with the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the
dates indicated.




Signature
                                  
                                  Capacity
                                  
                                  Date/s/
      Warren V. Musser
                                  
                                  Chairman
      of the Board of Directors
                                  
                                  February
      23, 2009Warren
      V. Musser/s/
      Frank T. Matarazzo
                                  
                                  Chief
      Executive Officer and Director (Principal
                                  
                                  February
      23, 2009Frank
      T. Matarazzo
                                  
                                  Executive
      Officer)/s/
      Ownkar Persaud
                                  
                                  Vice President of Finance (Principal Financial and
                                  
                                  February
      23, 2009Ownkar
      Persaud
                                  
                                  Accounting
      Officer)/s/
      Thomas C. Lynch
                                  
                                  Director
                                  
                                  February
      23, 2009Thomas
      C. Lynch


38


FINANCIAL
STATEMENTS AND SCHEDULES
 
 DECEMBER
31, 2007 AND 2006
 
 FORMING
A PART OF ANNUAL REPORT
 PURSUANT
TO THE SECURITIES EXCHANGE ACT OF 1934
 
 MSTI
HOLDINGS, INC.
  F-1
  MSTI
HOLDINGS, INC.
 
 Index
to Financial Statements
 
  Report
      of independent registered Certified Public Accounting Firm
                  F-3Consolidated
      Balance Sheets at December 31, 2007 and 2006
                  F-4Consolidated
      Statements of Losses for the Years ended December 31, 2007 and
      2006
                  F-5Consolidated
      Statements of Stockholders’ Equity for the Years ended December 31, 2007
      and 2006
                  F-6Consolidated
      Statements of Cash Flows for the Years ended December 31, 2007 and
      2006
                  F-7Notes
      to Consolidated Financial Statements
                  F-9
  F-2
  RBSM
LLP
 CERTIFIED
PUBLIC ACCOUNTANTS
 
 REPORT OF INDEPENDENT
REGISTERED CERTIFIED PUBLIC ACCOUNTING FIRM
 
 Board of
Directors
 MSTI
Holdings, Inc.
 Hawthorne,
New Jersey
 
 We have
audited the accompanying consolidated balance sheets of MSTI Holdings, Inc. and
its subsidiaries (the "Company") as of December 31, 2007 and 2006 and the
related consolidated statements of losses, stockholders' equity, and cash flows
for each of the two years in the period ended December 31, 2007. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based upon
our audit.
 
 We
conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States of America). Those standards require
that we plan and perform the audit to obtain reasonable assurance about whether
the financial statements are free of material misstatements. An audit includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements. An audit also includes assessing the accounting
principles used and significant estimates made by management, as well as
evaluating the overall financial statement presentation. We believe our audits
provide a reasonable basis for our opinion.
 
 In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of MSTI Holdings, Inc. and its
subsidiaries as of December 31, 2007 and 2006, and the results of its operations
and its cash flows for each of the two years in the period ended
December 31, 2007, in conformity with accounting principles generally
accepted in the United States of America.
 
 The
accompanying consolidated financial statements have been prepared assuming the
Company will continue as a going concern. As discussed in Note A to the
consolidated financial statements, the Company has incurred significant
operating losses in current year and also in the past. These factors, among
others, raise substantial doubt about the Company's ability to continue as a
going concern. The financial statements do not include any adjustments that
might result from the outcome of this uncertainty.
 
 /s/
      RBSM LLPCertified
      Public
Accountants
 
 New York,
New York
 April 14,
2008
  F-3
  MSTI
HOLDINGS, INC.
 CONSOLIDATED
BALANCE SHEETS
 DECEMBER
31, 2007 AND 2006
  2007
                  
                  
                  2006ASSETSCurrent
      Assets:Cash
      and cash equivalents
                  
                  $
                  1,022,965
                  
                  
                  $
                  114,468Accounts
      receivable, net of allowance for doubtful accounts of $10,000 at December
      31, 2007 and December 31, 2006
                  
                  
                  241,487
                  
                  
                  
                  100,146Deferred
      income tax - current
                  
                  
                  -
                  
                  
                  
                  261,517Other
      current assets
                  
                  
                  222,872
                  
                  
                  
                  76,056Total
      current assets
                  
                  
                  1,487,324
                  
                  
                  
                  552,187Property and equipment, at
      cost (Note D):Furniture
      and equipment
                  
                  
                  382,214
                  
                  
                  
                  268,514Less:
      accumulated depreciation
                  
                  
                  82,385
                  
                  
                  
                  37,683Total
      property and equipment, net
                  
                  
                  299,829
                  
                  
                  
                  230,831Cable equipment and
      installations, at cost (Note E):Cable
      equipment and installations, at cost
                  
                  
                  5,286,580
                  
                  
                  
                  3,684,237Less:
      accumulated depreciation
                  
                  
                  930,607
                  
                  
                  
                  344,045Total
      Cable equipment and installations, net
                  
                  
                  4,355,973
                  
                  
                  
                  3,340,192Other
      assets:Intangible
      assets, net of accumulated amortization of $703,764 and $282,325 at
      December 31, 2007 and December 31, 2006, respectively (Note
    C)
                  
                  
                  3,740,350
                  
                  
                  
                  2,181,602Goodwill
      (Note B)
                  
                  
                  -
                  
                  
                  
                  1,958,198Financing
      costs, net of accumulated amortization of $168,353
                  
                  
                  697,461
                  
                  
                  
                  -Investment
      in affiliates (Note F)
                  
                  
                  54,803
                  
                  
                  
                  54,803Deposits
                  
                  
                  12,600
                  
                  
                  
                  12,600Total
      other assets
                  
                  
                  4,505,214
                  
                  
                  
                  4,207,203Total
    Assets
                  
                  $
                  10,648,340
                  
                  
                  $
                  8,330,413LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Accounts
      payable and accrued liabilities
                  
                  $
                  1,862,918
                  
                  
                  $
                  955,803Current
      portion of long-term debt (Note H)
                  
                  
                  547
                  
                  
                  
                  6,555Registration
      rights liability (Note G)
                  
                  
                  500,000
                  
                  
                  
                  -Note
      Payable officer
                  
                  
                  -
                  
                  
                  
                  80,444Income
      tax refund due to officer (Note K)
                  
                  
                  291,000
                  
                  
                  
                  291,000Due
      to Parent Company (Note K)
                  
                  
                  1,270,287
                  
                  
                  
                  5,603,310Deferred
      revenue
                  
                  
                  116,851
                  
                  
                  
                  96,463Total
      current liabilities
                  
                  
                  4,041,603
                  
                  
                  
                  7,033,575Long-term
      liabilities:Long-term
      debt - less current portion (Note G and H)
                  
                  
                  4,432,344
                  
                  
                  
                  547Total
      long-term liabilities
                  
                  
                  4,432,344
                  
                  
                  
                  547Total
      Liabilities
                  
                  
                  8,473,947
                  
                  
                  
                  7,034,122Commitments and
      contingencies (Note N)
                  
                  
                  -
                  
                  
                  
                  -Stockholders’ equity
      (Note I)Preferred
      stock, par value $.001 per share; 10,000,000 shares authorized; none
      issued and outstanding at December 31, 2007 and December 31,
      2006
                  
                  
                  -
                  
                  
                  
                  -Common
      stock, $0.001 par value, 90,000,000 shares authorized; 29,816,552 and
      15,000,000 shares issued and outstanding as of December 31, 2007 and
      December 31, 2006
                  
                  
                  29,817
                  
                  
                  
                  15,000Additional
      paid-in capital
                  
                  
                  14,377,130
                  
                  
                  
                  3,502,961Accumulated
      deficit
                  
                  
                  (12,232,554
                  )
                  
                  
                  (2,221,670
                  )Total
      Stockholders’ equity
                  
                  
                  2,174,393
                  
                  
                  
                  1,296,291Total
      Liabilities and Stockholders’ Equity
                  
                  $
                  10,648,340
                  
                  
                  $
                  8,330,413
 
 See
accompanying notes to consolidated financial statements
  F-4
  MSTI
HOLDINGS, INC.
 CONSOLIDATED
STATEMENTS OF LOSSES
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 
 Predecessor
                  
                  
                  SuccessorYear Ended
                    December 31,
                  
                  
                  Month
      Ended
                    January 31,
                  
                  
                  February
      1 to
                    December 31,2007
                  
                  
                  2006
                  
                  
                  2006Revenue,
      net
                  
                  $
                  2,675,750
                  
                  
                  $
                  140,643
                  
                  
                  $
                  1,755,803Cost
      of Sales
                  
                  
                  3,405,599
                  
                  
                  
                  136,139
                  
                  
                  
                  2,210,309Gross
      Profit (Loss)
                  
                  
                  (729,849
                  )
                  
                  
                  4,504
                  
                  
                  
                  (454,506
                  )Operating
      Expenses:Selling,
      General and Administrative
                  
                  
                  4,108,077
                  
                  
                  
                  544,190
                  
                  
                  
                  2,312,441Impairment
      write-down in Goodwill
                  
                  
                  1,958,198Impairment
      write-down in Long Lived Assets
                  
                  
                  493,512Non-Employee
      stock based compensation
                  
                  
                  337,500Employee
      stock based compensation
                  
                  
                  40,500Employee
      stock options
                  
                  
                  308,634
                  
                  
                  
                  -
                  
                  
                  
                  -Depreciation
      and Amortization
                  
                  
                  466,142
                  
                  
                  
                  3,854
                  
                  
                  
                  320,008Total
      Operating Expense
                  
                  
                  7,712,563
                  
                  
                  
                  548,044
                  
                  
                  
                  2,632,449Loss
      from Operations
                  
                  
                  (8,442,412
                  )
                  
                  
                  (543,540
                  )
                  
                  
                  (3,086,955
                  )Other
      Income (Expense):Registration
      rights liquidated damage
                  
                  
                  (500,000
                  )
                  
                  
                  -
                  
                  
                  
                  -Interest
      Income
                  
                  
                  71,480
                  
                  
                  
                  -
                  
                  
                  
                  1,503Interest
      Expense
                  
                  
                  (1,139,952
                  )
                  
                  
                  (4,359
                  )
                  
                  
                  (206,595
                  )Total
      Other (Expenses)
                  
                  
                  (1,568,472
                  )
                  
                  
                  (4,359
                  )
                  
                  
                  (205,092
                  )Loss
      Before Provision for Income Taxes
                  
                  
                  (10,010,884
                  )
                  
                  
                  (547,899
                  )
                  
                  
                  (3,292,047
                  )Provision
      for Income Taxes
                  
                  
                  -
                  
                  
                  
                  924,162
                  
                  
                  
                  (1,070,377
                  )Net
      Loss
                  
                  $
                  (10,010,884
                  )
                  
                  $
                  (1,472,061
                  )
                  
                  $
                  (2,221,670
                  )Loss
      per common share (basic and diluted)
                  
                  $
                  (0.43
                  )
                  
                  $
                  (0.10
                  )
                  
                  $
                  (0.15
                  )Weighted
      average common shares for computation
                  
                  
                  23,439,567
                  
                  
                  
                  15,000,000
                  
                  
                  
                  15,000,000
 
 See
accompanying notes to consolidated financial statements
  F-5
  MSTI
HOLDINGS, INC.
 CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
  Common
                    Shares
                    Issued
                  
                  
                  Common
                    Stock
                    Amount
                  
                  
                  Additional
                    Paid-In
                    Capital
                  
                  
                  Accumulated
                    Earnings
                    (Deficit )
                  
                  
                  TotalBalance
      at December 31, 2005
                  
                  
                  15,000,000
                  
                  
                  $
                  15,000
                  
                  
                  $
                  (89,000
                  )
                  
                  $
                  788,877
                  
                  
                  $
                  714,877Net
      loss at January 31, 2006
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (1,472,061
                  )
                  
                  
                  (1,472,061
                  )Equity
      adjustments related to push down accounting (Telkonet
      acquisition)
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,691,961
                  
                  
                  
                  683,184
                  
                  
                  
                  3,375,145Balance
      at January 31, 2006 (Predecessor period)
                  
                  
                  15,000,000
                  
                  
                  
                  15,000
                  
                  
                  
                  2,602,961
                  
                  
                  
                  0
                  
                  
                  
                  2,617,961Equity
      adjustments related to push down accounting (Telkonet
      acquisition)
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  900,000
                  
                  
                  
                  
                  
                  
                  
                  900,000Net
      loss – February to December 2006
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  (2,221,670
                  )
                  
                  
                  (2,221,670
                  )Balance
      at December 31, 2006
                  
                  
                  15,000,000
                  
                  
                  
                  15,000
                  
                  
                  
                  3,502,961
                  
                  
                  
                  (2,221,670
                  )
                  
                  
                  1,296,291Public
      shares of FXS converted to MSTI
                  
                  
                  3,788,888
                  
                  
                  
                  3,789
                  
                  
                  
                  (3,789
                  )
                  
                  
                  -Loan
      conversion from Parent Company
                  
                  
                  5,000,000
                  
                  
                  
                  5,000
                  
                  
                  
                  4,995,000
                  
                  
                  
                  -
                  
                  
                  
                  5,000,000Issuance
      of shares for private placement
                  
                  
                  5,597,664
                  
                  
                  
                  5,598
                  
                  
                  
                  2,688,422
                  
                  
                  
                  -
                  
                  
                  
                  2,694,020Warrants
      attached to debentures
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  931,465
                  
                  
                  
                  -
                  
                  
                  
                  931,465Beneficial
      Conversion Feature
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,457,815
                  
                  
                  
                  -
                  
                  
                  
                  1,457,815Warrants
      issued for placement services
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  119,052
                  
                  
                  
                  -
                  
                  
                  
                  119,052Stock
      based compensation to consultants
                  
                  
                  400,000
                  
                  
                  
                  400
                  
                  
                  
                  337,100
                  
                  
                  
                  
                  
                  
                  
                  337,500Stock
      based compensation to employee
                  
                  
                  30,000
                  
                  
                  
                  30
                  
                  
                  
                  40,470
                  
                  
                  
                  
                  
                  
                  
                  40,500Stock
      based compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  308,634
                  
                  
                  
                  -
                  
                  
                  
                  308,634Net
      loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (10,010,884
                  )
                  
                  
                  (10,010,884
                  )Balance
      at December 31, 2007
                  
                  
                  29,816,552
                  
                  
                  $
                  29,817
                  
                  
                  $
                  14,377,130
                  
                  
                  $
                  (12,232,554
                  )
                  
                  $
                  2,174,393
 
 See
accompanying footnotes to consolidated financial statements
  F-6
  MSTI
HOLDINGS, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
 
 Twelve months
                    Ended
                  
                  
                  Predecessor
                  
                  
                  SuccessorDecember 31,
                  
                  
                  January 31,
                  
                  
                  February 1 to
                    December 31,2007
                  
                  
                  2006
                  
                  
                  2006Increase
      (Decrease) In Cash and EquivalentsCash
      Flows from Operating Activities:Net
      loss
                  
                  $
                  (10,010,884
                  )
                  
                  $
                  (1,472,061
                  )
                  
                  $
                  (2,221,670
                  )Adjustments
      to reconcile net loss to cash provided by (used in) operating
      activities:Investment
      in affiliate
                  
                  
                  -
                  
                  
                  
                  4,948
                  
                  
                  
                  -Impairment
      of Fixed Assets
                  
                  
                  493,512
                  
                  
                  
                  -
                  
                  
                  
                  -Impairment
      of Goodwill
                  
                  
                  1,958,198
                  
                  
                  
                  -
                  
                  
                  
                  -Registration
      rights liquidated damages
                  
                  
                  500,000
                  
                  
                  
                  -
                  
                  
                  
                  -Amortization
      of the beneficial conversion feature of the convertible notes and
      warrants
                  
                  
                  464,586
                  
                  
                  
                  -
                  
                  
                  
                  -Amortization
      of OID interest
                  
                  
                  307,038
                  
                  
                  
                  -
                  
                  
                  
                  -Stock
      options and warrants issued in exchange of service
                  
                  
                  308,634
                  
                  
                  
                  -
                  
                  
                  
                  -Common
      stock issued in exchange for services
                  
                  
                  337,500
                  
                  
                  
                  -
                  
                  
                  
                  -Stock
      based compensation issued to employees
                  
                  
                  40,500
                  
                  
                  
                  -
                  
                  
                  
                  -Amortization
      of financing costs
                  
                  
                  168,353
                  
                  
                  
                  -
                  
                  
                  
                  -Depreciation,
      including Cable equipment and installations
                  
                  
                  744,953
                  
                  
                  
                  25,691
                  
                  
                  
                  389,476Amortization
                  
                  
                  421,494
                  
                  
                  
                  353
                  
                  
                  
                  282,325Due
      to/from affiliate
                  
                  
                  -
                  
                  
                  
                  19,936
                  
                  
                  
                  -Increase
      / decrease in:Accounts
      receivable, trade and other
                  
                  
                  (141,341
                  )
                  
                  
                  77,928
                  
                  
                  
                  (67,234
                  )Prepaid
      expenses and deposits
                  
                  
                  144,184
                  
                  
                  
                  71,086
                  
                  
                  
                  178,198Customer
      deposits
                  
                  
                  6,000
                  
                  
                  
                  -
                  
                  
                  
                  -Income
      tax payable, net of receivable
                  
                  
                  -
                  
                  
                  
                  147,971
                  
                  
                  
                  38,915Deferred
      income tax and other, net
                  
                  
                  -
                  
                  
                  
                  1,067,191
                  
                  
                  
                  (1,109,292
                  )Deferred
      revenue
                  
                  
                  20,388
                  
                  
                  
                  (5,535
                  )
                  
                  
                  22,140Accrued
      Payroll
                  
                  
                  15,780
                  
                  
                  
                  -
                  
                  
                  
                  -Accounts
      payable, accrued expenses, net
                  
                  
                  775,412
                  
                  
                  
                  178,939
                  
                  
                  
                  64,008Net
      Cash Provided by (Used In) Operating Activities
                  
                  
                  (3,445,698
                  )
                  
                  
                  116,447
                  
                  
                  
                  (2,423,134
                  )Cash
      Flows From Investing Activities:Costs
      of Cable equipment and installations
                  
                  
                  (1,541,491
                  )
                  
                  
                  (111,591
                  )
                  
                  
                  (2,688,855
                  )Purchase
      of Newport assets
                  
                  
                  (1,118,294
                  )
                  
                  
                  -
                  
                  
                  
                  -Purchase
      of property and equipment, net
                  
                  
                  (113,700
                  )
                  
                  
                  (13,744
                  )
                  
                  
                  (21,173
                  )Net
      Cash Used In Investing Activities
                  
                  
                  (2,773,485
                  )
                  
                  
                  (125,335
                  )
                  
                  
                  (2,710,028
                  )Cash
      Flows From Financing Activities:Proceeds
      from (Repayment of) line of credit
                  
                  
                  -
                  
                  
                  
                  45,963
                  
                  
                  
                  (409,055
                  )Advances
      from Parent Company, net
                  
                  
                  (863,023
                  )
                  
                  
                  -
                  
                  
                  
                  5,603,310Proceeds
      from sale of common stock, net of costs
                  
                  
                  2,694,020
                  
                  
                  
                  -
                  
                  
                  
                  -Proceeds
      from issuance of convertible debentures, net of costs
                  
                  
                  6,050,000
                  
                  
                  
                  -
                  
                  
                  
                  -Financing
      costs
                  
                  
                  (746,762
                  )
                  
                  
                  -
                  
                  
                  
                  -Repayments
      of Notes Payable
                  
                  
                  (6,555
                  )
                  
                  
                  (546
                  )
                  
                  
                  (6,009
                  )Net
      Cash Provided By Financing Activities
                  
                  
                  7,127,680
                  
                  
                  
                  45,417
                  
                  
                  
                  5,188,246Net
      Increase In Cash and Cash Equivalents
                  
                  
                  908,497
                  
                  
                  
                  36,529
                  
                  
                  
                  55,084Cash
      and cash equivalents at the beginning of the period
                  
                  
                  114,468
                  
                  
                  
                  22,855
                  
                  
                  
                  59,384Cash
      and cash equivalents at the end of the period
                  
                  $
                  1,022,965
                  
                  
                  $
                  59,384
                  
                  
                  $
                  114,468
 
 See
accompanying notes to consolidated financial statements
  F-7
  MSTI
HOLDINGS, INC.
 CONSOLIDATED
STATEMENTS OF CASH FLOWS (Continued)
 FOR
THE YEARS ENDED DECEMBER 31, 2007 AND 2006
  Twelve monthsended
                  
                  
                  Predecessor
                  
                  
                  SuccessorDecember 31,
                    2007
                  
                  
                  January 31,
                    2006
                  
                  
                  February 1
                    to December 31,
                    2006Supplemental
      Disclosures of Cash Flow Information:Cash
      transactions:Cash
      paid during the period for interest
                  
                  $
                  199,976
                  
                  
                  $
                  4,363
                  
                  
                  $
                  417Income
      taxes paid
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Non-cash
      transactions:Amortization
      expense of the beneficial conversion feature
                  
                  
                  464,586
                  
                  
                  
                  -
                  
                  
                  
                  -Amortization
      expense of warrants issued
                  
                  
                  307,038
                  
                  
                  
                  -
                  
                  
                  
                  -Conversion
      of Parent Company Loan
                  
                  
                  5,000,000
                  
                  
                  
                  -
                  
                  
                  
                  -Acquisition
      by Telkonet, Inc. (Note B):Subscriber
      list - intangible asset
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,463,927Goodwill
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,958,198Investment
      by Telkonet, Inc.
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4,379,259Acquisition
      of Newport:Subscriber
      list - intangible asset
                  
                  
                  1,980,187
                  
                  
                  
                  -
                  
                  
                  
                  -Fixed
      assets acquired
                  
                  
                  668,107
                  
                  
                  
                  -
                  
                  
                  
                  -Common
      stock of parent company
                  
                  
                  (1,530,000
                  )
                  
                  
                  -
                  
                  
                  
                  -Direct
      acquisition costs
                  
                  
                  (98,294
                  )
                  
                  
                  -
                  
                  
                  
                  -Cash
      paid for acquisition
                  
                  
                  (1,020,000
                  )
                  
                  
                  -
                  
                  
                  
                  -
 
 See
accompanying notes to consolidated financial statements
  F-8
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 NOTE
A-SUMMARY OF ACCOUNTING POLICIES
 
 General
  A summary
of the significant accounting policies applied in the preparation of the
accompanying financial statements follows.
 
 Business and Basis of
Presentation
 
 MSTI
Holdings, Inc. (“the Company ”), is a carrier class communications technology
company that specializes in providing true Quad-Play services including video,
voice, high-speed internet and Wi-Fi to Multiple Tenant Units (MTUs) and
Multiple Dwelling Units (MDUs).
 
 In July
2007, the Company through its wholly-owned subsidiary, Microwave Satellite
Technologies, Inc., acquired substantially all of the assets of Newport
Telecommunications Co., a New Jersey general partnership. Pursuant to the terms
of the acquisition, the total consideration paid was $2,550,000, consisting of
unregistered shares of Telkonet’s common stock, equal to $1,530,000, and
$1,020,000 in cash, subject to adjustments. The total consideration will be
increased or decreased depending on the number of subscriber accounts acquired
in the acquisition that were in good standing at that time. The consideration
from escrow was released in October 2007 and a subscriber account adjustment was
not required.
 
 Business Combination and
Corporate Restructure
 
 On May
24, 2007, the Company completed a merger transaction with Fitness Xpress, Inc.
("FXS"), an inactive publicly registered shell corporation with no significant
assets or operations. As a result of the merger, there was a change in
control of the public entity. In accordance with SFAS No. 141, the Company was
the acquiring entity. While the transaction is accounted for using the purchase
method of accounting, in substance the merger is a recapitalization of the
Company's capital structure.
 
 For
accounting purposes, the Company accounted for the transaction as a reverse
acquisition and the Company is the surviving entity. The Company did not
recognize goodwill or any intangible assets in connection with the transaction.
From February 10, 2006 until the date of the merger, FXS was an inactive
corporation with no material assets, liabilities or operations. In connection
with the acquisition, 23,788,888 shares of common stock of the Company were
issued including; (a) 15,000,000 shares issued to existing shareholders of the
Company (b) 5,000,000 shares issued to settle indebtedness to parent company,
and (c) 3,788,888 shares that were retained by the FXS
shareholders.
 
 Effective
with the merger, all previously outstanding shares of common and preferred stock
owned by the Company's shareholders were exchanged for an aggregate of
15,000,000 shares of FXS’s common stock. The value of the stock that was issued
was the historical cost of the FXS net tangible assets, which did not differ
materially from their fair value.
 Effective
with the merger, FXS changed its name to MSTI Holdings, Inc., and increased its
authorized shares of $.001 par value common stock to 90,000,000.
 
 All
references to common stock, share and per share amounts have been retroactively
restated to reflect the exchange ratio of 120,000 shares of FXS common stock for
1 share of the acquirer's common stock outstanding immediately prior to the
merger as if the exchange had taken place as of the beginning of the earliest
period presented.
 
 The
accompanying financial statements present the historical financial condition,
results of operations and cash flows of the Company prior to the merger with
FXS. In accordance with the merger, the Company will maintain a calendar
year-end.
 
 During
the short-year (seven months) ended December 31, 2006, the Company transitioned
from a development stage company to an operating company.
 
 The
accompanying consolidated financial statements present on a consolidated basis
the accounts of the Company and its wholly owned subsidiaries. All significant
intercompany accounts and transactions have been eliminated in
consolidation.
  F-9
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 New Basis of
Accounting
 
 In
January 2006, Telkonet, Inc., a Utah corporation (“Telkonet”) whose stock is
listed for trading on the American Stock Exchange under the symbol (“TKO”),
acquired a 90% interest in MST.
 
 In
accordance with Emerging Issues Task Force Issue No. D-97, Push Down Accounting , as a
result of the change in control of us that occurred on January 31, 2006, the
Company applied “push down” accounting, which requires that the proportionate
basis of the assets acquired and liabilities assumed be “pushed down” to us
based upon their estimated fair market values. The Company makes estimates and
judgments in determining the fair value of the acquired assets and liabilities.
The Company bases its determination on independent appraisal reports, as well as
internal judgments based upon the existing facts and circumstances. If the
Company were to use different judgments or assumptions, the amounts assigned to
the individual assets or liabilities could be materially different.
 
 The
primary changes to the balance sheet reflect:
 
 •
              the recording of the fair value
      of the Company’s subscriber
list;
 
 •
              the recording of the fair value
      of goodwill;
 
 •
              elimination of the accumulated
      earnings; and
 
 •
              an increase in additional paid-in
      capital from these
adjustments.
 
 Although
Microwave Satellite Technologies, Inc. continued as the same legal entity after
the acquisition, the application of push down accounting represents the
termination of the old accounting entity and the creation of a new one. As a
result, the accompanying consolidated statements of operations, cash flows and
stockholders’ equity are presented for two periods: Predecessor and Successor,
which relate to the period preceding the acquisition and the period succeeding
the acquisition, respectively. The Company refers to the operations of Microwave
Satellite Technologies, Inc. for both the Predecessor and Successor
periods.
 
 Going
Concern
 
 The   accompanying   consolidated   financial   statements
have been prepared in conformity with accounting principles generally
accepted in the United States of
America, which contemplate continuation of the Company as a going
concern. However, the Company has reported a net loss and negative cash
flows from operating activities of $10,010,884 and $3,445,698, respectively for
the year ended December 31, 2007; accumulated deficit of $12,232,554 and a
working capital deficit of $2,554,279 as of December 31, 2007.
 
 The
Company believes that anticipated revenues from operations will be insufficient
to satisfy its ongoing capital requirements for at least the next 12
months.  If financial resources are insufficient, the
Company will require additional financing in order to execute its
operating plan and continue as a going concern. The Company cannot predict
whether this additional financing will be in the form of equity or
debt, or be in another form. The Company may not be able to obtain the
necessary additional capital on a
timely basis, on acceptable terms, or at
all.  In any of these events, the Company may be unable to
implement its plan for expansion,
repay its debt obligations as they become due,
or respond to competitive pressures, any of which would
have a material adverse effect on its business, financial condition and results
of operations.
 
 The
Company plans to take the following steps that it believes will be sufficient
to provide it with the ability to continue as a
going concern. The Company intends to raise capital through asset-based
financing and/or the sale of its stock in private placements.  The
Company believes that with this financing, it will be able to generate
additional revenues that will allow it to continue as a
going concern.
  F-10
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 Concentrations of Credit
Risk
  Financial
instruments and related items, which potentially subject the Company to
concentrations of credit risk, consist primarily of cash and cash equivalents.
The Company places its cash and temporary cash investments with credit quality
institutions. At times, such investments may exceed the FDIC insurance limit.
The allowance for doubtful accounts was $10,000 at December 31, 2007 and
December 31, 2006, respectively.
 
 Cash and Cash
Equivalents
 
 For
purposes of the Statements of Cash Flows, the Company considers all highly
liquid debt instruments purchased with a maturity date of three months or less
to be cash equivalents.
 
 Property and
Equipment
 
 Property
and equipment is stated at cost. Depreciation is calculated using the
straight-line method over the estimated useful lives of the assets. The
estimated useful life ranges from 5 to 15 years.
 
 Long-Lived
Assets
 
 The
Company has adopted Statement of Financial Accounting Standards No. 144 (SFAS
144). The Statement requires that long-lived assets and certain identifiable
intangibles held and used by the Company be reviewed for impairment whenever
events or changes in circumstances indicate that the carrying amount of an asset
may not be recoverable. Events relating to recoverability may include
significant unfavorable changes in business conditions, recurring losses, or a
forecasted inability to achieve break-even operating results over an extended
period. The Company evaluates the recoverability of long-lived assets based upon
forecasted discounted cash flows. Should impairment in value be indicated, the
carrying value of intangible assets will be adjusted, based on estimates of
future discounted cash flows resulting from the use and ultimate disposition of
the asset. SFAS No. 144 also requires assets to be disposed of be reported at
the lower of the carrying amount or the fair value less costs to sell. The
Company determined that the value of its capitalized cable and related equipment
has been impaired based upon its assessment of forecasted discounted cash flow
from subscribers revenue and wrote off $493,512 of its value, based on the lower
of the carrying amount or the fair value less costs to sell, for the year ended
December 31, 2007 (Note E).
 
 Goodwill and Other
Intangibles
 
 Goodwill
represents the excess of the cost of businesses acquired over fair value or net
identifiable assets at the date of acquisition. Goodwill is subject to a
periodic impairment assessment by applying a fair value test based upon a
two-step method. The first step of the process compares the fair value of the
reporting unit with the carrying value of the reporting unit, including any
goodwill. The Company utilizes a discounted cash flow valuation methodology to
determine the fair value of the reporting unit. If the fair value of the
reporting unit exceeds the carrying amount of the reporting unit, goodwill is
deemed not to be impaired in which case the second step in the process is
unnecessary. If the carrying amount exceeds fair value, the Company performs the
second step to measure the amount of impairment loss. Any impairment loss is
measured by comparing the implied fair value of goodwill, calculated per SFAS
No. 142, with the carrying amount of goodwill at the reporting unit, with
the excess of the carrying amount over the fair value recognized as an
impairment loss. The Company determined that the value of goodwill has been
impaired based upon management’s assessment of operating results and forecasted
discounted cash flow and has written off the entire $1,958,198 of its value
during the year ended December 31, 2007 (Note C).
 
 Income
Taxes
 
 The
Company has implemented the provisions on Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes" (SFAS 109). SFAS 109 requires
that income tax accounts be computed using the liability method. Deferred taxes
are determined based upon the estimated future tax effects of differences
between the financial reporting and tax reporting bases of assets and
liabilities given the provisions of currently enacted tax laws.
  In June
2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes-an interpretation of FASB Statement No. 109 ("FIN 48"). FIN 48
prescribes a recognition threshold and measurement attribute for the financial
statement recognition and measurement of a tax position taken or expected to be
taken in a tax return. FIN 48 also provides guidance on derecognition,
classification, treatment of interest and penalties, and disclosure of such
positions. Effective January 1, 2007, the Company adopted the provisions of
FIN 48, as required. As a result of implementing FIN 48, there has been no
adjustment to the Company’s financial statements and the adoption of FIN 48 did
not have a material effect on the Company’s consolidated financial statements
for the year ending December 31, 2007.
  F-11
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 Use of
Estimates
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect certain reported amounts and disclosures. Accordingly, actual results
could differ from those estimates.
 
 Revenue
Recognition
 
 For
revenue from product sales, the Company recognizes revenue in accordance with
Staff Accounting Bulletin No. 104, Revenue Recognition
(“SAB104”), which superceded Staff Accounting Bulletin No. 101, Revenue Recognition in Financial
Statements (“SAB101”). SAB 101 requires that four basic criteria must be
met before revenue can be recognized: (1) persuasive evidence of an arrangement
exists; (2) delivery has occurred; (3) the selling price is fixed and
determinable; and (4) collectibility is reasonably assured. Determination of
criteria (3) and (4) are based on management's judgments regarding the fixed
nature of the selling prices of the products delivered and the collectibility of
those amounts. Provisions for discounts and rebates to customers, estimated
returns and allowances, and other adjustments are provided for in the same
period the related sales are recorded. The Company defers any revenue for which
the product has not been delivered or is subject to refund until such time that
the Company and the customer jointly determine that the product has been
delivered or no refund will be required. SAB 104 incorporates Emerging Issues
Task Force 00-21 (“EITF 00-21”), Multiple-Deliverable Revenue
Arrangements. EITF 00-21 addresses accounting for arrangements that may
involve the delivery or performance of multiple products, services and/or rights
to use assets.
 
 The
Company accounts for revenue, costs and expenses related to its residential
cable services as the related services are performed in accordance with SFAS
No. 51, Financial Reporting by Cable Television Companies. Installation
revenue for residential cable services is recognized to the extent of direct
selling costs incurred. Direct selling costs have exceeded installation revenue
in all reported periods. Generally, credit risk is managed by disconnecting
services to customers who are delinquent. The capitalized cost of this equipment
is depreciated from three to ten years, on a straight-line basis down to the
Company's original estimate of the projected value of the equipment at the end
of the scheduled lease term.
 
 Advertising
 
 The
Company expenses advertising costs as incurred. The Company incurred $236,436
and $187,093 in advertising costs during the years ended December 31, 2007 and
2006, respectively.
 
 Liquidity
 
 As shown
in the accompanying financial statements, the Company incurred a net loss of
$10,010,884 and $3,693,731for the years ended December 31, 2007 and 2006,
respectively. As of December 31, 2007, the Company’s current liabilities exceed
its current assets by $2,554,279, with cash and cash equivalents representing
$1,022,965.
 
 Comprehensive
Income
 
 Statement
of Financial Accounting Standards No. 130 ("SFAS 130"), "Reporting Comprehensive
Income," establishes standards for reporting and displaying of comprehensive
income, its components and accumulated balances. Comprehensive income is defined
to include all changes in equity except those resulting from investments by
owners and distributions to owners. Among other disclosures, SFAS 130 requires
that all items that are required to be recognized under current accounting
standards as components of comprehensive income be reported in a financial
statement that is displayed with the same prominence as other financial
statements. The Company does not have any items of comprehensive income in any
of the periods presented.
  F-12
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 Registration Payment
Arrangements
 
 The
Company accounts for registration payment arrangements under Financial
Accounting Standards board (FASB) Staff Position EITF 00-19-2, “Accounting for
Registration Payment Arrangements” (FSP EITF 00-19-2). FSP EITF 00-19-2
specifies that the contingent obligation to make future payments under a
registration payment arrangement should be separately recognized and measured in
accordance with SFAS No. 5, Accounting for Contingencies. FSP EITF 00-19-2 was
issued in December, 2006.  As of December 31, 2007, the Company
accrued an estimated penalty of $500,000 (see Note G).
 
 Reclassifications
 
 Certain
reclassifications have been made in prior year's financial statements to conform
to classifications used in the current year.
 
 Stock Based
Compensation
 
 On
January 1, 2006, the Company adopted Statement of Financial Accounting Standards
No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which
requires the measurement and recognition of compensation expense for all
share-based payment awards made to employees and directors including employee
stock options based on estimated fair values. SFAS 123(R) supersedes the
Company’s previous accounting under Accounting Principles Board Opinion
No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods
beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission
issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS
123(R). The Company has applied the provisions of SAB 107 in its adoption of
SFAS 123(R).
  The
Company adopted SFAS 123(R) using the modified prospective transition method,
which requires the application of the accounting standard as of January 1, 2006,
the first day of the Company’s fiscal year 2006. The Company’s Consolidated
Financial Statements as of and for the year ended December 31, 2006 reflect the
impact of SFAS 123(R). In accordance with the modified prospective transition
method, the Company’s Consolidated Financial Statements for prior periods have
not been restated to reflect, and do not include, the impact of SFAS 123(R).
Stock-based compensation expense recognized under SFAS 123(R) for the years
ended December 31, 2007 and 2006 was $308,634 and $0, respectively, net of tax
effect.
 
 New Accounting
Pronouncements
 
 In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities.” SFAS 159 permits entities to choose
to measure many financial instruments, and certain other items, at fair value.
SFAS 159 applies to reporting periods beginning after November 15, 2007. The
adoption of SFAS 159 is not expected to have a material impact on the Company’s
financial position, results of operations or cash flows.
 
 In
December 2007, the FASB issued Statement of Financial Accounting Standards No.
141(R), “Business Combinations” (“Statement 141(R)”) and Financial Accounting
Standards No. 160, “Noncontrolling Interests in Consolidated Financial
Statements” (“Statement 160”). Statements 141(R) and 160 require most
identifiable assets, liabilities, noncontrolling interests and goodwill acquired
in a business combination to be recorded at “full fair value” and require
noncontrolling interests (previously referred to as minority interests) to be
reported as a component of equity.  Both statements are effective for
fiscal years beginning after December 15, 2008.  Statement 141(R) will
be applied to business combinations occurring after the effective
date.  Statement 160 will be applied prospectively to all
noncontrolling interests, including any that arose before the effective
date.  The Company has not determined the effect, if any, the adoption
of Statements 141(R) and 160 will have on the Company’s financial position,
results of operations or cash flows.
 
 Other
recent accounting pronouncements issued by the FASB (including its Emerging
Issues Task Force), the AICPA, and the SEC did not, or are not believed by
management to, have a material impact on the Company’s present or future
consolidated financial statements.
  F-13
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 NOTE
B - ACQUISITIONS
 
 Acquisition by Telkonet,
Inc..
  On
January 31, 2006, Telkonet acquired a 90% interest in the Company from Frank
Matarazzo, the sole stockholder, in exchange for $1.8 million in cash and 1.6
million unregistered shares of Telkonet’s common stock for an aggregate purchase
price of $9,000,000. The purchase price of $9,000,000 was increased by $117,822
for direct costs related to the acquisition. These direct costs included legal,
accounting and other professional fees. The cash portion of the purchase
price was paid in two installments, $900,000 at closing and $900,000 in February
2007. The stock portion is payable from Telkonet shares held in escrow, 400,000
Telkonet shares at closing and the remaining 1,200,000 “purchase price
contingency” Telkonet shares issued based on the achievement of 3,300 “Triple
Play” subscribers over a three year period. In the year ended December 31, 2006,
Telkonet issued 200,000 shares of the purchase price contingency valued at
$900,000 as an adjustment to Goodwill.
  The
acquisition by Telkonet was accounted for using the purchase method of
accounting in accordance with SFAS 141, “Business Combinations.” The value of
Telkonet common stock issued as a part of the acquisition was determined based
on the average price of Telkonet common stock for several days before and after
the acquisition.
 
 The
components of the purchase price were as follows:
 
 As Reported
                  
                  
                  Including
                    Purchase Price
                    Contingency (*)Telkonet
      Common stock
                  
                  $
                  2,700,000
                  
                  
                  $
                  7,200,000Cash
                  
                  
                  1,800,000
                  
                  
                  
                  1,800,000Direct
      acquisition costs
                  
                  
                  117,822
                  
                  
                  
                  117,822Net
      Purchase price
                  
                  $
                  4,617,822
                  
                  
                  $
                  9,117,822
  In
accordance with Financial Accounting Standard (SFAS) No. 141, Business
Combinations, the total purchase price was allocated to the estimated fair value
of assets acquired and liabilities assumed. The fair value of the assets
acquired was based on the Company’s best estimates. The purchase price was
allocated to the fair value of assets acquired and liabilities assumed as
follows:
 
 As Reported
                  
                  
                  Including
                    Purchase Price
                    Contingency (*)Cash
      and other current assets
                  
                  $
                  346,548
                  
                  
                  $
                  346,548Equipment
      and other assets
                  
                  
                  1,310,125
                  
                  
                  
                  1,310,125Subscriber
      lists
                  
                  
                  2,463,927
                  
                  
                  
                  2,463,927Goodwill
      and other intangible assets
                  
                  
                  1,958,198
                  
                  
                  
                  6,458,198Subtotal
                  
                  
                  6,078,798
                  
                  
                  
                  10,578,798Current
      liabilities
                  
                  
                  1,460,976
                  
                  
                  
                  1,460,976Total
                  
                  $
                  4,617,822
                  
                  
                  $
                  9,117,822
 
 (*) At
the date of the acquisition, the effect of the “purchase price contingency”
shares valued at approximately $5.4 million had not been recorded in accordance
with FAS 141. In the third quarter of 2006, Telkonet issued 200,000 shares of
the purchase price contingency valued at $900,000 as an adjustment to
Goodwill.
 
 Goodwill
and other intangible assets represent the excess of the purchase price over the
fair value of the net tangible assets acquired. The Company used a discounted
cash flow model to determine the value of the intangible assets and to allocate
the excess purchase price to the intangible assets and goodwill as appropriate.
In this model, expected cash flows from subscribers were discounted to their
present value at a rate of return of 20% (incorporating the risk-free rate,
expected inflation, and related business risks) over a period of eight years.
Expected costs such as income taxes and cost of sales were deducted from
expected revenues to arrive at after tax cash flows. In accordance with SFAS
142, goodwill is not amortized and will be tested for impairment at least
annually. The subscriber list was valued at $2,463,927 with an estimated useful
life of eight years.
  F-14
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 The
acquisition of MST resulted in the valuation of MST’s subscriber lists as
intangible assets. This intangible asset is amortized over eight years, and
amortization from the date of the acquisition through December 31, 2007, was
taken as a charge against income in the statement of operations. In accordance
with SFAS 144, Accounting for the Impairment or Disposal of Long-Lived Assets,
the intangible asset subject to amortization was reviewed for impairment at
December 31, 2007. Goodwill of $1,958,198, excluding the remaining purchase
price contingency, represented the excess of the purchase price over the fair
value of the net tangible and intangible assets acquired.
 
 Pursuant
to the impairment test performed by us at December 31, 2007 on the goodwill and
intangibles acquired, the Company determined that there were no changes in the
carrying value of intangibles acquired. However, based on the Company’s
assessment of its operating results and the forecasted discounted cash flow the
goodwill was classified as impaired and the entire balance of $1,958,198 was
written off during the year ended December 31, 2007.
 
 Acquisition of Newport
Telecommunications Co.
  On July
18, 2007, Microwave Satellite Technologies, Inc., the wholly-owned subsidiary of
MSTI Holdings Inc., acquired substantially all of the assets of Newport
Telecommunications Co., a New Jersey general partnership (“NTC”), relating to
NTC’s business of providing broadband internet and telephone services at certain
residential and commercial properties in the development known as Newport in
Jersey City, New Jersey. Pursuant to the terms of the NTC acquisition, the total
consideration paid was $2,550,000, consisting of (i) 866,856 unregistered shares
of Telkonet’s common stock, equal to $1,530,000 (which is based on the average
closing prices for Telkonet common stock for the ten trading days immediately
prior to the closing date), and (ii) $1,020,000 in cash, subject to adjustments.
The total consideration will be increased or decreased depending on the number
of subscriber accounts acquired in the NTC acquisition that were in good
standing at that time. The stock certificates representing Telkonet common
stock, and $510,000 of the cash consideration were paid to an escrow agent to be
released after the final determination of the number of subscriber accounts in
good standing acquired at closing. The consideration from escrow was released in
October 2007.
 
 The
acquisition of Newport was accounted for using the purchase method in accordance
with SFAS 141, “Business Combinations.” The value of Telkonet’s common stock
issued as a part of the acquisition was determined based on the average closing
prices for Telkonet common stock for the ten trading days immediately prior to
the closing date. The results of operations for Newport have been included in
the Consolidated Statements of Operations since the date of acquisition. 
The components of the purchase price were as follows:
 
 As ReportedTelkonet’s
      Common stock
                    
                    $
                    1,530,000Cash
                    
                    
                    1,020,000Direct
      acquisition costs
                    
                    
                    98,294Total
      Purchase Price
                    
                    $
                    2,648,294
 
 In
accordance with SFAS No. 141, the total purchase price was allocated to the
estimated fair value of assets acquired and liabilities assumed. The fair value
of the assets acquired was based on management’s best estimates. The purchase
price was allocated to the fair value of assets acquired and liabilities assumed
as follows:
  Cable
      equipment and installations
                    
                    $
                    668,107Subscriber
      lists
                    
                    
                    1,980,187Total
      assets acquired
                    
                    
                    2,648,294Total
      liabilities assumed
                    
                    
                    -Net
      assets acquired
                    
                    $
                    2,648,294
 
 Goodwill
and other intangible assets represent the excess of the purchase price over the
fair value of the net tangible assets acquired. Due to its recent date of
acquisition, the purchase price allocation to Intangibles and Goodwill is based
upon preliminary data that is subject to adjustment and could change
significantly pending the completion of management’s valuation to accurately
evaluate this allocation. In accordance with SFAS 142, goodwill is not amortized
and will be tested for impairment at least annually. The subscriber list was
valued and could also change significantly pending the completion of
management’s appraisal at $1,980,187 with an estimated useful life of eight
years.
  F-15
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 The
following unaudited condensed combined pro forma results of operations reflect
the pro forma combination of the MST and NTC businesses as if the combination
had occurred at the beginning of the periods presented compared with the actual
results of operations of MST for the same period. The unaudited pro forma
condensed combined results of operations do not purport to represent what the
companies’ combined results of operations would have been if such transaction
had occurred at the beginning of the periods presented, and are not necessarily
indicative of MST’s future results.
  Years EndedDecember 31,Proforma
                  
                  Proforma2007
                  
                  2006Total
      revenues
                  
                  $
                  3,777,779
                  
                  
                  $
                  3,747,581Net
      (loss)
                  
                  $
                  (10,033,634
                  )
                  
                  $
                  (3,627,728
                  )Basic
      (loss) per share
                  
                  $
                  (0.43
                  )
                  
                  $
                  (0.24
                  )Diluted
      (loss) per share
                  
                  $
                  (0.41
                  )
                  
                  $
                  (0.24
                  )
  NOTE
C - INTANGIBLE ASSETS
 
 At
December 31, 2007, intangible assets are stated at their estimated fair market
value (determined June 8, 2006), less amortization from January 31, 2006,
to December 31, 2007. This valuation was obtained in connection with the “push
down” accounting performed as a result of the change in control of the
Company.
 
 Total
identifiable intangible assets acquired and their carrying values at December
31, 2006, are:
 
 Gross
                    Carrying
                    Amount
                  
                  
                  Accumulated
                    Amortization
                  
                  
                  Net
                  
                  
                  Residual
                    Value
                  
                  
                  Amortization
                    Period (Years)Amortized
      Identifiable Intangible Assets:Subscriber
      lists
                  
                  $
                  2,463,927
                  
                  
                  $
                  (282,325
                  )
                  
                  $
                  2,181,602
                  
                  
                  $
                  -
                  
                  
                  
                  8.0Total
      Amortized Identifiable Intangible Assets
                  
                  
                  2,463,927
                  
                  
                  
                  (282,325
                  )
                  
                  
                  2,181,602
                  
                  
                  
                  -Unamortized
      Identifiable Intangible Assets:
                  
                  NoneTotal
                  
                  $
                  2,463,927
                  
                  
                  $
                  (282,325
                  )
                  
                  $
                  2,181,602
                  
                  
                  $
                  -
  Total
identifiable intangible assets acquired and their carrying values at December
31, 2007 are:
  Gross
                          Carrying
                          Amount
                        
                        
                        Accumulated
                          Amortization
                        
                        
                        Net
                        
                        
                        Residual
                          Value
                        
                        
                        Amortization
                          Period (Years)Amortized
      Identifiable Intangible Assets:Subscriber
      lists - Newport
                        
                        $
                        1,980,187
                        
                        
                        $
                        (113,448
                        )
                        
                        $
                        1,866,739
                        
                        
                        $
                        -
                        
                        
                        
                        8.0Subscriber
      lists - Telkonet
                        
                        
                        2,463,927
                        
                        
                        
                        (590,316
                        )
                        
                        
                        1,873,611
                        
                        
                        
                        -
                        
                        
                        
                        8.0Total
      Amortized Identifiable Intangible Assets
                        
                        
                        4,444,114
                        
                        
                        
                        (703,764
                        )
                        
                        
                        3,740,350
                        
                        
                        
                        -Unamortized
      Identifiable Intangible Assets:
                        
                        NoneTotal
                        
                        $
                        4,444,114
                        
                        
                        $
                        (703,764
                        )
                        
                        $
                        3,740,350
                        
                        
                        $
                        -
  F-16


MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 Total
amortization expense charged to operations for the years ended December 31,
2007 and 2006 was $421,494 and $282,325, respectively.
 
 Estimated
amortization expense as of December 31, 2007, is as follows:
  2008
                    
                    $
                    555,5142009
                    
                    
                    555,5142010
                    
                    
                    555,5142011
                    
                    
                    555,5142012
                    
                    
                    555,514Thereafter
                    
                    
                    962,780Total
                    
                    $
                    3,740,350
 
 The
Company maintained intangible assets of $42,688, net of $20,812 accumulated
amortization until January 31, 2006. The amortization expense for January 2006
amounted to $353. The asset was amortized over a 15 year period and subsequently
included in the value of the subscriber list asset as of the January 31, 2006,
acquisition by Telkonet.
  Goodwill
Impairment
 
 Based on
management’s assessment of the Company’s operating results and its forecasted
discounted cash flow, goodwill was classified as impaired and the entire balance
of $1,958,198 was written off during the year ended December 31,
2007.
 
 NOTE
D - PROPERTY, PLANT AND EQUIPMENT
 
 The
Company’s property and equipment at December 31, 2007, and December 31, 2006,
consists of the following:
 
 2007
                  
                  
                  2006Leasehold
      Improvements
                  
                  $
                  264,169
                  
                  
                  $
                  169,636Office
      Fixtures and Furniture
                  
                  
                  118,045
                  
                  
                  
                  98,878Total
                  
                  
                  382,214
                  
                  
                  
                  268,514Accumulated
      Depreciation
                  
                  
                  (82,385
                  )
                  
                  
                  (37,683
                  )Net
      of property and equipment
                  
                  $
                  299,829
                  
                  
                  $
                  230,831
 
 Depreciation
expense was $44,702 and $34,735 for the years ended December 31, 2007 and 2006,
respectively. At January 31, 2006, the Telkonet acquisition date, the Company
adjusted the property, plant and equipment to net book value resulting in a
write-down of accumulated depreciation (see Note A).
 
 NOTE
E - CABLE EQUIPMENT AND INSTALLATIONS
 
 The
Company currently maintain service agreements with approximately twenty two (22)
MDU and MTU properties and the equipment is capitalized under Cable Equipment
and Installations. Generally, under the terms of a service agreement, the
Company provides (i) “bulk services,” which may include one or all of a bundle
of products and services, at a fixed price per month to the owner of the MDU or
MTU property, and contract with individual residents for enhanced services, such
as premium cable channels, for a monthly fee or (ii) contract with
individual residents of the MDU property for one or more basic or enhanced
services for a monthly fee.
 
 Equipment
maintained for customers under Cable Equipment and Installations is recorded at
cost and is depreciated on the straight line basis to its estimated residual
value. Estimated useful lives are three to ten years. Cable equipment and
installations at December 31, 2007, and 2006 consist of the
following:
  F-17
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 December 31,
                    2007
                  
                  
                  December 31,
                    2006Cable
      equipment and installations
                  
                  $
                  5,286,580
                  
                  
                  $
                  3,684,237Less:
      accumulated depreciation
                  
                  
                  (930,607
                  )
                  
                  
                  (344,045
                  )Capitalized
      cable equipment and installations, net of accumulated
      depreciation
                  
                  $
                  4,355,973
                  
                  
                  $
                  3,340,192
 
 Impairment of Long-Lived
Assets
 
 The
Company evaluated its long-lived assets for impairment whenever events or change
in circumstances indicate that the carrying amount of such assets may not be
recoverable. Recoverability of assets to held and used is measured by comparison
of the carrying amount of the asset to the future net undiscounted cash flows
expected to be generated by the asset.
 
 The
Company determined that the value of the capitalized equipment has been impaired
based on its assessment of the forecasted undiscounted cash flow from the
subscribers revenue and has written off $493,512 of its value, based on the
lower of the carrying amount or the fair value less costs to sell, for the year
ended December 31, 2007.
 
 Depreciation
expense was $700,251 and $487,570 for the years ended December 31, 2007 and
2006, respectively. At January 31, 2006, the Telkonet acquisition date, the
Company adjusted the cable equipment and installations to net book value
resulting in a write-down of accumulated depreciation (see Note A).
 
 The
following is a schedule of minimum future rentals under bulk services of
non-cancelable operating agreements as of December 31, 2007:
  2008
                    
                    $
                    512,8142009
                    
                    
                    484,9142010
                    
                    
                    456,9722011
                    
                    
                    315,9342012
                    
                    
                    256,925Thereafter
                    
                    
                    75,305Total
                    
                    $
                    2,102,864
 
 NOTE F - LONG-TERM
INVESTMENTS
  Interactivewifi.com,
LLC
  The
Company has investment in Interactivewifi.com, LLC a privately held company.
This investment represents an equity interest of approximately 50% at December
31, 2007. Interactivewifi.com is engaged in providing internet and related
services to customers throughout metropolitan New York through a joint venture
with us. The Company accounted for this investment under the cost method, as we
do not have the ability to exercise significant influence over operating and
financial policies of the investee. The Company reviewed the assumptions
underlying the operating performance and cash flow forecasts in assessing the
carrying values of the investment. The fair value of the Company’s investment in
Interactivewifi.com amounted to $54,803 as of December 31, 2007 and
2006.
  F-18
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 NOTE
G – SENIOR CONVERTIBLE DEBENTURES
 
 A summary
of convertible promissory notes payable at December 31, 2007, and December 31,
2006, is as follows:
 
 2007
                  
                  
                  2006Senior
      Convertible Debentures, accrue interest at 8% per annum commencing on the
      first anniversary of the original issue date of the debentures, payable
      quarterly in cash or common stock, at The Company’s option, and mature on
      April 30, 2010
                  
                  $
                  6,576,350
                  
                  
                  $
                  -Original
      Issue Discount - net of accumulated amortization of $307,037 and $0 at
      December 31, 2007, and December 31, 2006, respectively.
                  
                  
                  (219,312
                  )
                  
                  
                  -Debt
      Discount - beneficial conversion feature, net of accumulated amortization
      of $283,464 and $0 at December 31, 2007, and December 31, 2006,
      respectively.
                  
                  
                  (1,174,351
                  )Debt
      Discount - value attributable to warrants attached to notes, net of
      accumulated amortization of $181,122 and $0 at December 31, 2007, and
      December 31, 2006, respectively.
                  
                  
                  (750,343
                  )
                  
                  
                  -Total
                  
                  $
                  4,432,344
                  
                  
                  $
                  -Less:
      current portion
                  
                  
                  -
                  
                  
                  
                  -$
                  4,432,344
                  
                  
                  $
                  -
 
 Aggregate
maturities of long-term debt as of December 31, 2007, are as
follows:
 
 Amount2008
                    
                    $
                    -2009
                    
                    
                    -2010
                    
                    
                    6,576,350Total
                    
                    $
                    6,576,350
 
 During
the year ended December 31, 2007, the Company issued senior convertible
debentures (the "Debentures") having a principal value of $6,576,350 to
investors, including an original issue discount of $526,350, in
exchange for $6,050,000 from investors, exclusive of placement fees. The
original issue discount to the Debentures is amortized over 12 months. The
Debentures accrue interest at 8% per annum commencing on the first anniversary
of the original issue date of the Debentures, payable quarterly in cash or
common stock, at the Company’s option, and mature on April 30, 2010. The
Debentures are not callable and are convertible at a conversion price of $0.65
per share into 10,117,462 shares of MSTI Holdings Inc. common stock, subject to
certain limitations. Additionally, the holders of the debentures have a security
interest in all of the Company’s assets and those of its subsidiaries. As a
result, if the Company defaults under its obligations to the Debenture holders,
the Debenture holders could foreclose its security interest and liquidate some
or all of these assets.
 
 In
accordance with Emerging Issues Task Force Issue 98-5, Accounting for
Convertible Securities with a Beneficial Conversion Features or Contingently
Adjustable Conversion Ratios ("EITF 98-5"), the Company recognized an imbedded
beneficial conversion feature present in the notes. The Company allocated a
portion of the proceeds equal to the intrinsic value of that feature to
additional paid in capital included in the Company’s minority interest. The
Company recognized and measured an aggregate of $1,457,815 of the proceeds,
which is equal to the intrinsic value of the imbedded beneficial conversion
feature, to additional paid in capital and a discount against the Notes issued
during the year ended December 31, 2007. The debt discount attributed to the
beneficial conversion feature is amortized over the Notes maturity period (three
years) as interest expense.
  In
connection with the placement of the Debentures, MSTI Holdings Inc. also agreed
to issue to the Noteholders, five-year warrants to purchase an aggregate of
5,058,730 shares of its common stock at an exercise price of $1.00 per share.
MSTI Holdings Inc. valued the warrants in accordance with EITF 00-27 using the
Black-Scholes pricing model and the following assumptions: contractual terms of
5 years, an average risk free interest rate of 5.00%, a dividend yield of 0%,
and volatility of 54%. The $931,465 of debt discount attributed to the value of
the warrants issued is amortized over the Notes maturity period (three years) as
interest expense.
 
 In
connection with the issuance of the Debentures, MSTI Holdings Inc. incurred
placement fees of $423,500. Additionally, the Company issued to such agents
five-year warrants to purchase 708,222 shares of MSTI Holdings Inc. common stock
at an exercise price of $1.00.
  F-19
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 The
Company amortizes the original issue discount, the beneficial conversion feature
and the value of the attached warrants, and recorded non-cash interest expense
in the amount of $307,038, $283,464, and $181,122, respectively, for the year
ended December 31, 2007.
 
 Registration Rights
Liquidated Damages
 
 On
May 24, 2007, the Company’s majority-owned subsidiary, MSTI Holdings, Inc.
completed a private placement, pursuant to which 5,597,664 shares of common
stock and five-year warrants to purchase 2,798,836 shares of common stock were
issued at an exercise price of $1.00 per share, for total proceeds of
$2,694,020.  Additionally, MSTI Holdings, Inc. also sold senior
convertible debentures for total proceeds of $6,050,000.  The
debentures bear interest at a rate of 8% per annum, commencing on the first
anniversary of the original issue date of the debentures, payable quarterly in
cash or common stock, at the Company’s option, and mature on April 30,
2010. The debentures are not callable and are convertible at a price of $0.65
per share into 10,117,462 shares of common stock.  In addition,
holders of the debentures received five-year warrants to purchase an aggregate
of 5,058,730 shares of MSTI Holdings, Inc. common stock at an exercise price of
$1.00 per share.
 
 The
Company agreed to file a “resale” registration statement with the SEC within 60
days after the final closing of the private placement and the issuance of the
debentures covering all shares of common stock sold in the private placement and
underlying the debentures, as well as the warrants attached to the private
placement. The Company has agreed to its best efforts to have such “resale”
registration statement declared effective by the SEC as soon as possible and, in
any event, within 120 days after the initial closing of the private placement
and the issuance of the debentures.
 
 In
addition, with respect to the shares of common stock sold in the private
placement and underlying the warrants, the Company agreed to maintain the
effectiveness of the “resale” registration statement from the effective date
until the earlier of (i) 18 months after the date of the closing of the private
placement or (ii) the date on which all securities registered under the
registration statement (a) have been sold, or (b) are otherwise able to be sold
pursuant to Rule 144, at which time exempt sales may be permitted for purchasers
of the Units, subject to the Company’s right to suspend or defer the use of
the registration statement in certain events.
 
 The
registration rights agreement requires the payment of liquidated damages to the
investors of approximately 1% per month of the aggregate proceeds of $9,128,717,
or the value of the unregistered shares at the time that the liquidated damages
are assessed, until the registration statement is declared effective, payable at
the option of MSTI Holdings, Inc.  In accordance with EITF 00-19-2,
the Company evaluated the likelihood of achieving registration statement
effectiveness.  Accordingly, the Company has accrued an estimate of
$500,000 as of December 31, 2007, to account for these potential liquidated
damages until the expected effectiveness of the registration statement is
achieved.
 
 Waiver from certain
holders
  On
February 11, 2008, the Purchasers executed a letter agreement (the “Letter
Agreement”) with us containing, among other things, the following:
 
 (i)
              The Purchasers waived any
      non-compliance with the Securities Purchase Agreement, along with any and
      all related penalties, damages and claims, in connection with the
      Company’s issuance of (A) $3 million of shares of common stock to
      Telkonet, Inc., (B) shares of common stock in connection with acquisitions
      or strategic transactions approved by the Company’s directors, but not
      including a transaction where the shares are being issued primarily for
      the purpose of raising capital or to an entity whose primary business is
      investing in securities, and (C) 2,000,000 shares of common stock to
      employees and consultants under the Company’s 2007 Stock Incentive Plan at
      an exercise price of no less than $0.65 per
  share;
 
 (ii)
              The Purchasers waived any
      non-compliance with the Registration Right Agreement, along with any
      default, breach or threatened breach, arising under the Registration
      Rights Agreement, the Debentures or the Warrants, and waiving any
      Liquidated Damages, in each case resulting or that could result from the
      Company’s failure to have the Registration Statement declared effective by
      the SEC by the Effectiveness Date. In exchange for the investors
      waiving their rights to Liquidated Damages, the Company agreed to reduce
      the exercise price of the Warrants from $1.00 to
    $0.65;
 
 (iii)
              If Frank Matarazzo ceases being
      the Company’s Chief Executive Officer, that would be an event of default
      under the Debentures; and
 
 (iv)
              The exercise price of all of the
      Company’s outstanding options and warrants was set at $0.65 per
      share.
  F-20
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 Also, the
Company has received waivers from a majority of the unit investors, in a letter
dated February 12, 2008, whereby they waived among other things all rights to
liquidated damages due to the registration statement not being declared
effective by the SEC in a timely manner. The Company agreed to reduce the
exercise price of the Warrants from $1.00 to $0.65.
 
 NOTE
H – NOTE PAYABLE
 
 The
following are the maturities of note payable at December 31:
 
 2007
                  
                  
                  2006
                  
                  Maturity DateNote
      payable in monthly installments of $547 with no interest. The note is
      collateralized by transportation equipment.
                  
                  $
                  547
                  
                  
                  $
                  7,102
                  
                  January
      2008Less:
      current portion
                  
                  
                  547
                  
                  
                  
                  6,555Amount
      Due After One Year
                  
                  $
                  -
                  
                  
                  $
                  547
 
 NOTE
I - CAPITAL STOCK
 
 The
Company has authorized 10,000,000 shares of preferred stock, par value $0.001
per share. As of December 31, 2007 and December 31, 2006, the Company had no
preferred stock issued and outstanding. The Company has authorized 90,000,000
shares of common stock, par value $0.001 per share. As of December 31, 2007 and
2006, the Company had 29,816,552 and 15,000,000 shares of common stock issued
and outstanding, respectively.
 
 On May
22, 2007, MST entered into a Merger Agreement, whereby it was merged into
Fitness Xpress, and MST, as the surviving corporation, became a wholly-owned
subsidiary of Fitness Xpress. Pursuant to the Merger Agreement, Fitness Xpress’
name was changed to MSTI Holdings, Inc (“MSTI”).
 
 Pursuant
to the terms and conditions of the Merger Agreement:
  §
                Each share of MST common stock
      issued and outstanding immediately prior to the closing of the Merger was
      converted into 120,000 shares of MSTI common stock; a total 15,000,000
      shares of common stock were
issued.
 
 §
                $5,000,000 of outstanding
      indebtedness of MST to Telkonet, Inc., MST's 90% shareholder prior to the
      Merger, was converted at $1.00 per share into 5,000,000 shares of MSTI
      common stock.
 
 §
                The remaining shares of the
      common stock of Fitness Xpress were converted to 3,788,888 shares of MSTI
      common stock.
 Additionally,
5,597,664 shares of MSTI common stock were issued pursuant to a private
placement. These shares were valued at $0.55 per share for a purchase price of $
$2,694,020, net of $384,696 in placement fees and other costs. The Company also
issued warrants to purchase 2,798,836 shares of its common stock at an exercise
price of $1.00 per share in this private placement transaction. In connection
with this private placement, the Company issued the placement agent five-year
warrants to purchase an aggregate of 391,838 shares of common stock at an
exercise price of $1.00 per share.
  F-21
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 NOTE
J - STOCK OPTIONS AND WARRANTS
 
 Employee Stock
Options
  The
following table summarizes the changes in options outstanding and the related
prices for the shares of the Company’s common stock issued to its employees
under a non-qualified employee stock option plan.
  Options Outstanding
                                
                                
                                
                                
                                
                                Options ExercisableExercise Prices
                                
                                Number
                                  Outstanding
                                
                                
                                Weighted Average
                                  Remaining
                                  Contractual
                                  Life (Years)
                                
                                
                                Weighted
                                  Average
                                  Exercise Price
                                
                                
                                Number
                                  Exercisable
                                
                                
                                Weighted
                                  Average
                                  Exercise Price$
                                0.65
                                
                                
                                4,278,000
                                
                                
                                
                                9.4
                                
                                
                                $
                                0.65
                                
                                
                                
                                675,000
                                
                                
                                $
                                0.654,278,000
                                
                                
                                
                                9.4
                                
                                
                                $
                                0.65
                                
                                
                                
                                675,000
                                
                                
                                $
                                0.65
 
 Transactions
involving stock options issued to employees are summarized as
follows:
  Number of Shares
                  
                  
                  Weighted
                    Average
                    Price Per ShareOutstanding
      at January 1, 2007
                  
                  
                  -
                  
                  
                  $
                  -Granted
                  
                  
                  4,278,000
                  
                  
                  
                  0.65Exercised
                  
                  
                  -
                  
                  
                  
                  -Canceled
      or expired
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at December 31, 2007
                  
                  
                  4,278,000
                  
                  
                  $
                  0.65
  The
weighted-average fair value of stock options granted to employees during the
period ended December 31, 2007, and 2006 and the weighted-average significant
assumptions used to determine those fair values, using a Black-Scholes option
pricing model are as follows:
 
 2007
                  
                  
                  2006Significant
      assumptions (weighted-average):Risk-free
      interest rate at grant date
                  
                  
                  5.0
                  %
                  
                  
                  -Expected
      stock price volatility
                  
                  
                  54.0
                  %
                  
                  
                  -Expected
      dividend payout
                  
                  
                  -
                  
                  
                  
                  -Expected
      option life-years
                  
                  
                  10.0
                  
                  
                  
                  -Expected
      forfeiture rate
                  
                  
                  -
                  
                  
                  
                  -Fair
      value per share of options granted
                  
                  $
                  0.46
                  
                  
                  $
                  -
 
 The
expected life of awards granted represents the period of time that they are
expected to be outstanding. Upon issuance of the above stock options, the
Company had no historical experience with which to establish a basis for
determining an expected life of these awards. Therefore, the Company only gave
consideration to the contractual terms and do not consider the vesting
schedules, exercise patterns and pre-vesting and post-vesting forfeitures
significant to the expected life of the option award.
  F-22
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 The
Company estimated the volatility of its common stock by evaluating peer group
companies. Peer group companies are chosen based on industry, size and annual
revenue. Based on these criteria, the Company identified 20 companies in the
peer group. These peer group companies include Comcast Corp., Time Warner,
Viacom, Shaw Communications, Lodgenet Entertainment, Crown Media, Speedus Corp.
and The Players Network. The Company has taken an average of the historical
volatility of each of the peer group companies’ common stock to establish the
expected volatility of its common stock over the life of the option
awards.
  The
Company bases the risk-free interest rate used in the Black-Scholes-Merton
option valuation model on the implied yield currently available on U.S. Treasury
zero-coupon issues with an equivalent remaining term equal to the expected life
of the award.
  The
Company has not paid any cash dividends on its common stock and do not
anticipate paying any cash dividends in the foreseeable future. Consequently,
the Company used an expected dividend yield of zero in the Black-Scholes option
valuation model.
 
 Total
stock-based compensation expense related to stock options recognized in the
consolidated statement of losses for the year ended December 31, 2007, was
$308,634, net of tax effect. The aggregate intrinsic value of options
outstanding and unvested at December 31, 2007, is $0. At December 31, 2007,
total unrecognized stock-based compensation expense related to non-vested stock
options was $1,659,246.
 
 Warrants
 
 The
following table summarizes the changes in warrants outstanding and the related
prices for the shares of the Company’s common stock issued to non-employees.
These warrants were granted in lieu of cash compensation for services performed
or financing expenses in connection with the private placement of common stock
and convertible debentures.
 
 Warrants Outstanding
                        
                        
                        
                        
                        Warrants ExercisableExercise Prices
                        
                        Number
                          Outstanding
                        
                        Weighted Average
                          Remaining
                          Contractual
                          Life (Years)
                        
                        
                        Weighed
                          Average
                          Exercise Price
                        
                        Number
                          Exercisable
                        
                        
                        Weighted
                          Average
                          Exercise Price$
                        1.00
                        
                        
                        
                        8,957,626
                        
                        
                        
                        4.9
                        
                        
                        $
                        1.00
                        
                        
                        
                        8,957,626
                        
                        
                        $
                        1.008,957,626
                        
                        
                        
                        4.9
                        
                        
                        $
                        1.00
                        
                        
                        
                        8,957,626
                        
                        
                        $
                        1.00
 
 Transactions
involving warrants are summarized as follows:
  Number of
                      Shares
                    
                    Weighted
                      Average Price
                      Per ShareOutstanding
      at January 1, 2007
                    -
                    
                    $Granted
                    8,957,626
                    
                    
                    1.00Exercised
                    -
                    
                    
                    -Canceled
      or expired
                    -
                    
                    
                    -Outstanding
      at December 31, 2007
                    8,957,626
                    
                    $
                    1.00
  F-23
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 On
May 24, 2007, the Company completed a private placement, pursuant to which
we issued 5,597,664 shares of common stock and five-year warrants to purchase
2,798,836 shares of common stock at an exercise price of $1.00 per share, for
net proceeds of $2,694,020. In connection with this private placement, we
incurred placement agent fees of approximately $215,510, and issued the
placement agent five-year warrants to purchase an aggregate of 391,838 shares of
common stock at an exercise price of $1.00 per share. In addition, we incurred
other professional fees and expenses totaling approximately $336,800 in
connection with the reverse merger and private placement.
 
 On
May 24, 2007, and May 25, 2007, the Company also sold senior
convertible debentures in the aggregate principal amount of $6,050,000 (plus an
8% original issue discount added to such principal amount). The debentures bear
8% interest per annum, commencing on the first anniversary of the original issue
date of the debentures, payable quarterly in cash or common stock, at the
Company’s option, and mature on April 30, 2010. The debentures are not
callable and are convertible at a price of $0.65 per share into 10,117,462
shares of common stock, subject to certain limitations. In addition, holders of
the debentures received five-year warrants to purchase an aggregate of 5,058,730
shares of the Company’s common stock at an exercise price of $1.00 per
share.
 
 In
connection with the issuance of the debentures, we incurred placement agent fees
totaling approximately $423,500, and issued to such placement agents five-year
warrants to purchase 708,222 shares of common stock at an exercise price of
$1.00 per share. The warrants issued to the placement agent were valued at
$119,052, using the Black-Scholes pricing model and the following assumptions:
contractual term of 5 years, an average risk-free interest rate of 5.0% a
dividend yield of 0% and volatility of 54%.
 
 NOTE
K - RELATED PARTY TRANSACTIONS
 
 The
Company has a co-marketing agreement with Telkonet. The Company made payments of
$19,060 and $136,035 to Telkonet pursuant to the terms of this agreement in the
years ended December 31, 2007, and 2006, respectively.
 
 As of
December 31, 2007, and 2006, we have a balance due to Telkonet, Inc., in the
amount of $1,270,287 and $5,603,310, respectively, for loans made to us. The
loans between the companies relate to advances from Telkonet, Inc. for their
common stock equal to $1,530,000 in conjunction with the Newport
Telecommunications, Inc. acquisition on July 18, 2007 and net of inter-company
advances of $259,713 which also includes certain shared services for
professional fees, administrative and other operating matters. The loans are
unsecured and bear interest at the prime rate calculated monthly. In connection
with the Merger, $5,000,000 of such indebtedness was converted into 5,000,000
shares of the Company’s common stock at a conversion prime of $1.00 per
share.
  On August
17, 2005, we issued a non-interest bearing demand promissory note in the amount
of $100,000 due to Frank Matarazzo, the Company’s Chief Executive Officer,
evidencing his $100,000 loan to the Company. On May 10, 2007, we issued an
additional non-interest bearing demand promissory note in the amount of $60,000
to Mr. Matarazzo, evidencing an additional loan by him in such amount. Both
notes were repaid in full in July 2007. An estimated $291,000 income tax
receivable due to us for certain carry-back tax losses of MST for the period
prior to the Company’s acquisition is payable to Frank Matarazzo.
 
 In
February 2006, the Company entered into a one-year professional services
agreement with Global Transport Logistics, Inc. (“GTI”), for consulting services
for which GTI is paid a fee of $10,000 per month. GTI is 100% owned by Eileen
Matarazzo, the sister-in-law of MST’s Chief Executive Officer. The agreement has
been extended through February 2009. For the years ended December 31, 2007 and
2006, the Company paid and expensed $110,000 and $90,000,
respectively.
 
 The
Company’s Chief Administrative Officer is the sister of the Chief Executive
Officer of MST and receives an annual base salary of approximately $134,000 with
bonuses and benefits based upon the Company’s internal policies.
 
 NOTE
L - INCOME TAXES
 
 The
Company has adopted Financial Accounting Standard No. 109 which requires the
recognition of deferred tax liabilities and assets for the expected future tax
consequences of events that have been included in the financial statement or tax
returns. Under this method, deferred tax liabilities and assets are determined
based on the difference between financial statements and tax bases of assets and
liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse.
 
 For the
successor period February 1 to December 31, 2006, the Company was included in
the consolidated tax return of Telkonet, Inc. and Subsidiaries. For purposes of
preparing separate financial statements, the Company has elected to use the
separate return method of allocating tax expense.
  F-24
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
  Significant
components of the provision (benefit) for income taxes for the following years
are as follows:
 
 Period Ended
                    December 31, 2007
                  
                  
                  Successor
                    February 1 to
                    December 31,
                    2006
                  
                  
                  Predecessor
                    January 31, 2006Current:Federal
                  
                  $
                  —
                  
                  
                  $
                  —
                  
                  
                  $
                  (143,109
                  )State
                  
                  
                  —
                  
                  
                  
                  —
                  
                  
                  
                  ——
                  
                  
                  
                  —
                  
                  
                  
                  (143,109
                  )Deferred:Federal
                  
                  
                  —
                  
                  
                  
                  (896,219
                  )
                  
                  
                  913,201State
                  
                  
                  —
                  
                  
                  
                  (174,158
                  )
                  
                  
                  154,070$
                  —
                  
                  
                  $
                  (1,070,377
                  )
                  
                  $
                  1,067,191Total
      income tax expense (benefit)
                  
                  $
                  —
                  
                  
                  $
                  (1,070,377
                  )
                  
                  $
                  924,162
  A
reconciliation of tax expense computed at the statutory federal tax rate on loss
from operations before income taxes to the actual income tax expense is as
follows:
  Period Ended
                          December 31, 2007
                        
                        
                        Successor
                          February 1 to
                          December 31,
                          2006
                        
                        
                        Predecessor
                          January 31, 2006Tax provision computed at the statutory rate
                        
                        $
                        (3,403,701
                        )
                        
                        $
                        (1,118,519
                        )
                        
                        $
                        845,258Deferred
      state income taxes, net of federal income tax benefit
                        
                        
                        
                        
                        
                        
                        (256,935
                        )
                        
                        
                        (20,168
                        )Payment
      to shareholder
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        98,940Stock
      Compensation
                        
                        
                        216,117
                        
                        
                        
                        —
                        
                        
                        
                        —Goodwill
      Impairment
                        
                        
                        665,787
                        
                        
                        
                        —
                        
                        
                        
                        —Book
      expenses not deductible for tax purposes
                        
                        
                        114,013
                        
                        
                        
                        7,454
                        
                        
                        
                        132Change in valuation allowance for deferred tax
      assets
                        
                        
                        2,407,784
                        
                        
                        
                        297,623
                        
                        
                        
                        —Income tax expense
                        
                        $
                        —
                        
                        
                        $
                        (1,070,377
                        )
                        
                        $
                        924,162
  F-25
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 Deferred
income taxes include the net tax effects of net operating loss (“NOL”)
carryforwards and the temporary differences between the carrying amounts of
assets and liabilities for financial reporting purposes and the amounts used for
income tax purposes. Significant components of the Company's deferred tax assets
are as follows:
 
 2007
                      
                      
                      2006Deferred
      Tax Assets:Net
      operating loss carryforwards
                      
                      $
                      3,403,140
                      
                      
                      $
                      1,211,995Property
      and equipment
                      
                      
                      281,913
                      
                      
                      
                      —Reserve
                      
                      
                      214,065
                      
                      
                      
                      —Other
                      
                      
                      43,478
                      
                      
                      
                      20,438Total
      deferred tax assets
                      
                      
                      3,942,595
                      
                      
                      
                      1,232,433Deferred
      Tax Liabilities:Property
      and equipment, principally due to differences in
    depreciation
                      
                      
                      
                      
                      
                      
                      (14,678
                      )Acquired
      intangibles
                      
                      
                      (781,837
                      )
                      
                      
                      (913,570
                      )Beneficial
      Conversion
                      
                      
                      (502,774
                      )
                      
                      
                      —Other
                      
                      
                      (3,490
                      )
                      
                      
                      (6,562
                      )Total
      deferred tax liabilities
                      
                      
                      (1,288,101
                      )
                      
                      
                      (934,810
                      )Valuation
      allowance
                      
                      
                      (2,654,494
                      )
                      
                      
                      (297,623
                      )Net
      deferred tax assets
                      
                      $
                      —
                      
                      
                      $
                      —
 
 The
Company has provided a valuation allowance against the full amount of its net
deferred tax assets at December 31, 2006 and December 31, 2007, because in the
opinion of management, it is more likely than not that these tax assets will not
be realized.
 
 At
December 31, 2007 and December 31, 2006, the Company has net operating loss
carryforwards of approximately $8.0 million and $2.8 million, respectively, for
federal income tax purposes which will expire beginning in 2027. Federal NOLs
generated prior to the acquisition date are to be carried back to
pre-acquisition tax periods.
  The
Company has established a contingency reserve related to income taxes in
accordance with SFAS No. 5. These reserves predominantly relate to the
tax treatment of compensation from Microwave Satellite Technologies, Inc.’s
pre-acquisition period. This reserve was recorded  through book
expense in a prior period .
 
 The
Company’s post-acquisition NOL may be significantly limited under Section 382 of
the Internal Revenue Code (IRC). NOLs are limited under Section 382 when there
is a significant “ownership change” as defined in the IRC. Subsequent to the
acquisition in 2006, the Company may have experienced such an ownership change.
Since NOLs generated prior to the acquisition are carried back to a
pre-acquisition period, a section 382 limitation would not apply to their
utilization.
  The
limitation imposed by Section 382 would place an annual limitation on the amount
of NOL and tax credit carryovers that can be utilized. When the Company
completes the necessary studies, the amount of NOL carryovers available may be
reduced significantly. However, since the valuation allowance fully reserves for
all available carryovers, the effect of the reduction would be offset by a
reduction in the valuation allowance.
  F-26
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 NOTE
M – ACCOUNTS PAYABLE AND ACCRUED LIABILITIES
 
 Accounts
payable and accrued liabilities at December 31, 2007, and 2006 are as
follows:
  2007
                
                
                2006Accounts
      payable
                
                $
                1,036,684
                
                
                $
                473,760Accrued
      payroll and payroll taxes
                
                
                98,605
                
                
                
                60,471Other
                
                
                727,629
                
                
                
                421,572Total
                
                $
                1,862,918
                
                
                $
                955,803
  NOTE
N - COMMITMENTS AND CONTINGENCIES
 
 Office Leases
Obligations
 
 The
Company leases approximately 12,600 square feet of office and warehouse space in
Hawthorne, New Jersey for approximately $6,897 per month. The current lease term
expires on April 30, 2010 at which time the Company will have the option to
extend the lease for an additional five-year period. The Company also rents
office space from 25 River Drive South Urban Renewal Co. for approximately
$2,500 per month. This lease will expire in December 2009.
 
 The
Company leases approximately 64 square feet at a collocation facility located in
New York City for its telecommunications and video equipment, at a monthly rent
of $1,664.
  The
Company has a license to maintain a major point-of-presence at the Trump
International Hotel and Tower Condominium located at Columbus Circle in New York
City. Pursuant to the license agreement, the Company has the right to install
antennas and other equipment on the building’s rooftop and in certain equipment
storage areas for a license fee of $3,800 per month. The term of the agreement
expires on June 30, 2012.
 
 The
Company believes its current facilities are adequately covered by insurance, and
are adequate for its immediate and near-term needs. Additional space may be
required as the Company expands its activities. The Company does not currently
foresee any significant difficulties in obtaining any required additional
facilities.
 
 Effective
January 1, 2007, the Company entered into a license and right of entry agreement
with Hudson Conduit Associates, LLC for the right use a certain conduit. In
accordance with the agreement, the Company shall pay annual license fees of
$30,000 for the initial term of the agreement. The initial term of this
agreement shall expire on December 31, 2016, with the option to renew and extend
the term for two additional five year periods.
 
 Commitments
for minimum rentals under non cancelable leases at December 31, 2007, are as
follows:
  2008
                    
                    $
                    177,0562009
                    
                    
                    169,6262010
                    
                    
                    57,5882011
                    
                    
                    30,000Thereafter
                    
                    
                    150,000Total
                    
                    $
                    584,270
 
 Rental
expenses charged to operations for the year ended December 31, 2007, and 2006
are $106,485 and $77,264, respectively.
  F-27
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
 
 Contingencies
  Comcast
of Jersey City LLC has petitioned the City of Jersey City Board of Public
Utilities (“BPU”) for access to certain buildings that currently receive
telephone and internet services from the Company. In prior years, BPU has
adopted decisions granting such access to various buildings served by the
Company. Newport Associates Development Co. has appealed these decisions;
however, Comcast has been a second supplier of internet service in certain
buildings since 2003. In March 2007, BPU in two separate decisions granted
Comcast access to two additional buildings known as Pacific and Abraham
Lincoln.
 
 The
owners of other buildings served by the Company have received written requests
from Comcast for access to said buildings to construct and install facilities to
serve the residents therein.
  The
Company is subject to other litigation in the normal course of business.
Management does not believe these matters will have a material adverse effect on
the financial position or results of operations.
 
 Senior Convertible
Debentures
 
 On
February 11, 2008, the Purchasers executed a letter agreement with MSTI
containing, among other things, in the event Frank Matarazzo ceases being the
Chief Executive Officer of MSTI that would be an event of default under the
Debentures.
 
 Employment and Consulting
Agreements
 
 The
Company’s Chief Executive Officer is employed pursuant to an employment
agreement that provides for an annual salary of $300,000 and expires December
31, 2011.
 
 The
Company has employment agreements with certain of its key employees which
include non-disclosure and confidentiality provisions for protection of the
Company’s proprietary information.
 
 The
Company has consulting agreements with outside contractors to provide marketing
and financial advisory services. The Agreements are generally for a term of 12
months from inception and renewable automatically from year to year unless
either we or Consultant terminates such engagement by written
notice.
 
 NOTE
O - 401K PROFIT SHARING PLAN
 
 The
Company maintains a defined contribution profit sharing plan for employees (the
“401(k)”), administered by a committee of trustees appointed by the Company. All
Company employees are eligible to participate upon the completion of
three months of employment, subject to minimum age requirements. Each year
the Company makes a contribution to the 401(k) without regard to current or
accumulated net profits of the Company. These contributions are allocated to
participants in amounts of 100% of the participants’ contributions up to 1% of
each participant’s gross pay, then 10% of the next 5% of each participant’s
gross pay (a higher contribution percentage may be determined at the Company’s
discretion). In addition, the Company makes a one-time, annual contribution of
3% of each participant’s gross pay to each participant’s contribution account in
the 401(k) plan. Participants become vested in equal portions of their Company
contribution account for each year of service until full vesting occurs upon the
completion of six years of service. Distributions are made upon retirement,
death or disability in a lump sum or in installments. The expense for these
benefits was $65,812 for the year ended December 31, 2007.
  NOTE
P - SUBSEQUENT EVENTS
 
 Amendment to Securities
Purchase Agreement
 
 In the
Company’s May 2007 private offering of convertible debentures (the “Debentures”)
and warrants (the “Warrants”), the Company entered into (a) a Securities
Purchase Agreement with the purchasers of the Debentures and Warrants (the
“Purchasers”), which prohibited the Company from issuing shares of common stock
or common stock equivalents until 90 days after a registration statement
registering all of the common stock underlying the Debentures and Warrants (the
“Registration Statement”) is declared effective by the Securities and Exchange
Commission (the “SEC”), subject to certain limited exceptions, and (b) a
Registration Rights Agreement with the Purchasers, which stated that if the
Registration Statement was not declared effective by the SEC on or before
November 21, 2007 (the “Effectiveness Date”), the Company would be required to
pay to each Purchaser, for each month in which the Registration Statement had
not been declared effective, an amount in cash equal to 1% of the aggregate
purchase price paid by such Purchaser for any unregistered securities then held
by such Purchaser (“ Liquidated Damages
”).
  F-28
  MSTI
HOLDINGS, INC.
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2007 AND 2006
  On
February 11, 2008 the Purchasers executed a “Letter Agreement” with the Company
containing among other things to waive clause (a) and (b) above The Company
agreed to reduce the exercise price of the Warrants from $1.00 to
$0.65.
 
 Also, the
Company received waivers from a majority of the Unit Investors, in a letter
dated February 12, 2008, whereby they waived among other things all rights to
liquidated damages due to the registration statement not being declared
effective by the SEC in a timely manner. The Company agreed to reduce the
exercise price of the Warrants from $1.00 to $0.65.
 
 Amendment to Private
Placement Agreement
 
 In
connection with the Company’s May 2007 private offering of shares of common
stock (the “Shares”) and warrants to purchase common stock (the “Warrants”), the
Company entered into a Registration Rights Agreement, as amended, with the
purchasers of the Shares and Warrants (the “Purchasers”), which stated that if
the Registration Statement was not declared effective by the SEC on or before
November 21, 2007 (the “Effectiveness Date”), the Company would be required to
pay to each Purchaser, for each month in which the Registration Statement had
not been declared effective, an amount in cash equal to 1% of the aggregate
purchase price paid by such Purchaser for any unregistered securities then held
by such Purchaser (“Liquidated Damages”).
 
 On March
31, 2008, the Purchasers executed a letter agreement (the “Letter Agreement”)
containing, among other things, the following:
  (i)
              The Purchasers waived any
      non-compliance with the registration requirements discussed above, along
      with any default, breach or threatened breach, arising under the
      Registration Rights Agreement and any other documents, including the
      Warrants and related subscription agreements, and waiving any Liquidated
      Damages, in each case resulting or that could result from the Company’s
      failure to have the Registration Statement declared effective by the SEC
      by the Effectiveness Date. In exchange for the investors waiving their
      rights to Liquidated Damages, the Company agreed to reduce the exercise
      price of the Warrants from $1.00 to $0.65;
  and
 
 (ii)
              The exercise price of all of the
      Company’s outstanding options and warrants was set at $0.65 per
      share.
  F-29