UNITED
        STATES SECURITIES AND EXCHANGE COMMISSION
 Washington,
        D.C. 20549
  
  ANNUAL
        REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR
        THE
        FISCAL YEAR ENDED **DECEMBER 31, 2006**
  COMMISSION
        FILE NUMBER **333-67232**
  **XFONE,
        INC.**
 (Name
        of small business issuer in its charter)
  **Nevada**
              **11-3618510******(State
                  or other jurisdiction
                of
                  incorporation or organization)
              (I.R.S.
                  Employer
                Identification
                  No.)
 
 
 **2506
        Lakeland Drive, Suite 100**
 **Flowood,
        MS 39232** **,** **USA**
 (Address
        of principal executive offices) (Zip Code)
  **601.983.3800**
 (Registrant's
        telephone number, including area code)
  Registrant
        has filed all reports required to be filed by Section 13 or 15(d) of the
        Securities Exchange Act of 1934 during the preceding 12 months and has been
        subject to such filing requirements for the past 90 days.
  Check
        if there is no disclosure of delinquent filers in response to Item 405 of
        Regulation S-B which is not 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 reference in Part III of this Form
        10-KSB
        or any amendment to this Form 10-KSB. [X]
  The
        issuer's revenues for its most recent fiscal year were £19,353,771
        ($37,914,037).
  The
        aggregate market value of the voting and non-voting common equity held by
        non-affiliates was $17,166,984 as
        determined by the closing price of $2.48 , as
        quoted
        on the American Stock Exchange on March 29, 2007.
  As
        of March 29, 2007, there were 11,518,671 shares of our common stock issued
        and
        outstanding.
  Transitional
        Small Business Disclosure Format (Check one): Yes [ ] No [X]
  -1-
  **XFONE,
        INC.**
  **INDEX**
 
 **Part
                  I**Item
                  1. Description of BusinessItem
                  2. Description of PropertyItem
                  3. Legal ProceedingsItem
                  4. Submission of Matters to a Vote of Security Holders**Part
                  II**Item
                  5. Market for Common Equity and Related Stockholder
                  MattersItem
                  6. Management's Discussion and Analysis or Plan of
                  OperationItem
                  7. Financial StatementsItem
                  8. Changes in and Disagreements with Accountantsand
                  Financial DisclosureItem
                  8A. Controls and ProceduresItem
                  8B. Other Information**Part
                  III**Item
                  9. Directors, Executive Officers, Promoters and ControlPersons
                  and corporate governance; Compliance with Section 16(a) of the
                  Exchange
                  ActItem
                  10. Executive CompensationItem
                  11. Security Ownership of Certain Beneficial Owners andManagement
                  and Related Stockholder MattersItem
                  12. Certain Relationships and Related Transactionsand director independenceItem
                  13. ExhibitsItem
                  14. Principal Accountant Fees and Services
 
 -2-
 **PART
        I**
 
 ITEM
        1. DESC RIPTION
        OFBUSINESS
 
 **Background**
 
 Xfone,
        Inc. was incorporated in Nevada, U.S.A. in September 2000. We are a holding
        company providing international voice, video and data communications services
        with operations in the United Kingdom, the United States and Israel offering
        a
        wide range of services, including: local,
        long distance and international telephony services; prepaid and postpaid
        calling
        cards; cellular services; Internet services; messaging services (Email/Fax
        Broadcast, Email2Fax and Cyber-Number); and reselling opportunities .
        We
        serve customers across Europe, Asia, North America, South America, Australia
        and
        Africa. In February 2007, we moved our principal
        executive offices to
        Flowood, Mississippi, sharing executive office space with our wholly owned
        U.S.
        subsidiary, Xfone USA, Inc.
 
 On
        October 4, 2000, we acquired Swiftnet Limited which had a business plan to
        provide comprehensive telecommunication services and products by integrating
        new
        and old products, services and ideas through one website. Swiftnet was
        incorporated in 1990 under the laws of the United Kingdom and is headquartered
        in London, England. Until 1999, the main revenues for Swiftnet were derived
        from
        messaging and fax broadcast services. During 2000, Swiftnet shifted its business
        focus and its focus has remained on telephony voice services offering
        comprehensive support packages to resellers and new services. Utilizing
        automation and proprietary software packages, Swiftnet's strategy is to grow
        without the need for heavy investments and with lower expenses for operations
        and registration of new customers.
 
 On
        April
        15, 2004, we established an Israel based subsidiary, Xfone Communication
        Ltd.
        (which changed its name to Xfone 018 Ltd. in March 2005). On July 4, 2004,
        the
        Ministry of Communications of the State of Israel granted Xfone 018 a license
        to
        provide international telecom services in Israel. We started providing services
        in Israel through Xfone 018 as of mid-December 2004. Headquartered in Petach
        Tikva, Israel, Xfone 018 Ltd. is a telecommunications service provider that
        owns
        and operates its own facilities-based telecommunications switching system.
        Xfone
        018 provides residential and business customers with high quality international
        carrier services.
 
 On
        May
        28, 2004, we entered into an agreement and Plan of Merger to acquire WS Telecom,
        Inc., a Mississippi corporation, and its two wholly owned subsidiaries, eXpeTel
        Communications, Inc. and Gulf Coast Utilities, Inc., through the merger of
        WS
        Telecom into our wholly owned U.S. subsidiary Xfone USA, Inc. On July 1,
        2004,
        Xfone USA entered into a management agreement with WS Telecom which provided
        that Xfone USA provide management services to WS Telecom pending the
        consummation of the merger. The management agreement provided that all revenues
        generated from WS Telecom business operations would be assigned and transferred
        to Xfone USA. The term of the management agreement commenced on July 1, 2004,
        and continued until the consummation of the merger on March 10, 2005. 
Headquartered in Jackson, Mississippi, Xfone USA, Inc. is an integrated
        telecommunications service provider that owns and operates its own
        facilities-based, telecommunications switching system and network. Xfone
        USA
        provides residential and business customers with high quality local, long
        distance and high-speed broadband Internet services, as well as cable television
        services in certain planned residential communities in Mississippi. Xfone
        USA is
        licensed to provide telecommunications services in Alabama, Florida, Georgia,
        Louisiana and Mississippi. Xfone USA utilizes integrated multi-media offerings
        -
        combining digital voice, data and video services over broadband technologies
        -
        all on one single itemized bill.
 
 On
        August
        18, 2005, we entered into an Agreement and Plan of Merger to acquire I-55
        Internet Services, Inc., a Louisiana corporation (the “I-55 Internet Merger
        Agreement”). On September 13, 2005, we filed a Form 8-K discussing the impact of
        Hurricane Katrina on the transaction contemplated by the I-55 Internet Merger
        Agreement. On October 10, 2005, we entered into a First Amendment to the
        Merger
        Agreement, by and among I-55 Internet Services, Xfone, Inc, Xfone USA, Inc.,
        our
        wholly-owned United States subsidiary and Hunter McAllister and Brian Acosta,
        key employees of I-55 Internet Services, in order to induce Xfone, Inc and
        Xfone
        USA not to terminate the I-55 Internet Merger Agreement due to the material
        adverse effect that Hurricane Katrina has had on the assets and business
        of I-55
        Internet Services. As part of the amendment and since, at that time, the
        merger
        of I-55 Internet Services with and into Xfone USA had not been consummated
        yet,
        in the interim, the parties agreed and entered into on October 11, 2005 a
        Management Agreement (the "I-55 Internet Management Agreement") that provided
        that I-55 Internet Services hired and appointed Xfone USA as manager to be
        responsible for the operation and management of all of I-55 Internet Services
        business operations, including among other things personnel, accounting,
        contracts, policies and budget. In consideration of the management services
        provided under the I-55 Internet Management Agreement, I-55 Internet Services
        assigned and transferred to Xfone USA all revenues generated and expenses
        incurred in the ordinary course of business during the term of the I-55 Internet
        Management Agreement. The term of the I-55 Internet Management Agreement
        commenced on October 11, 2005 and continued until the consummation of the
        merger
        on March 31, 2006.
 
 -3-
 In
        conjunction with the consummation of the merger and in exchange for all of
        the
        capital stock of I-55 Internet Services, we issued a total of 789,863 shares
        of
        our common stock valued at $2,380,178 and 603,939 warrants exercisable for
        a
        period of five years into shares of our common stock, with an exercise price
        of
        $3.31, valued based on the Black Scholes option-pricing model (the "Xfone
        Stock
        and Warrant Consideration"). A portion of the Xfone Stock and Warrant
        Consideration issued at closing was placed in an escrow. The First Amendment
        to
        the Merger Agreement provides for an adjustment to the consideration paid
        based
        on changes in customer billings as determined pursuant to a certain formula
        (the
        "Customer Billing Adjustment Amount"). The Company has determined that the
        Customer Billing Adjustment Amount is $247,965.57 and on March 27, 2007,
        sent a
        claim for this amount against the escrowed portion of the Xfone Stock and
        Warrant Consideration.
 
 In
        conjunction with that certain Letter Agreement dated October 10, 2005 with
        MCG
        Capital Corporation (the "Letter Agreement"), a major creditor of I-55 Internet
        Services, and upon the consummation of the merger on March 31, 2006, we issued
        to MCG Capital 667,998 shares of our common stock, valued at fair value of
        $2,010,006, in return for ** retiring
        its loan with I-55 Internet Services *.*
 
 I-55
        Internet Services provided Internet access and related services, such as
        installation of various networking equipment, website design, hosting and
        other
        Internet access installation services, throughout the Southeastern United
        States
        to individuals and businesses located predominantly in rural markets in
        Louisiana and Mississippi. As a result of the merger with and into Xfone
        USA,
        these services are now available in expanded markets throughout Louisiana
        and
        Mississippi. The Internet service offerings include dial-up, DSL, high speed
        dedicated Internet access, web services, email, the World Wide Web, Internet
        relay chat, file transfer protocol and Usenet news access to both residential
        and business customers. The I-55 Internet Services offerings provided various
        prices and packages that allowed I-55 Internet Services subscribers to customize
        their subscription with services that met customers’ particular requirements.
        Xfone USA now provides bundled services of voice and data (broadband Internet)
        to customers throughout its service areas.
 
 On
        August
        26, 2005, we entered into an Agreement and Plan of Merger to acquire I-55
        Telecommunications, LLC, a Louisiana corporation (the “I-55 Telecom Merger
        Agreement”). On September 13, 2005, we filed a Form 8-K discussing the impact of
        Hurricane Katrina on the transaction contemplated by the I-55 Telecom Merger
        Agreement. In order to demonstrate our intention to continue on with the
        transaction contemplated by the I-55 Telecom Merger Agreement, the parties
        entered into on October 12, 2005 a Management Agreement (the “I-55 Telecom
        Management Agreement”) that provided that I-55 Telecommunications hired and
        appointed Xfone USA as manager to be responsible for the operation and
        management of all of I-55 Telecommunications’ business operations. In
        consideration of the management services provided under the I-55 Telecom
        Management Agreement, I-55 Telecommunications assigned and transferred to
        Xfone
        USA all revenues generated and expenses incurred in the ordinary course of
        business during the term of the I-55 Telecom Management Agreement. The term
        of
        the I-55 Telecom Management Agreement commenced on October 12, 2005 and
        continued until the consummation of the merger on March 31, 2006.
 
 In
        conjunction with the consummation of the merger and in exchange for all of
        the
        capital stock of I-55 Telecommunications, we issued a total of 223,702 shares
        of
        our common stock valued at $671,687 and 79,029 warrants exercisable into
        shares
        of our common stock, with an exercise price of $3.38, valued based on the
        Black
        Scholes option-pricing model.
 
 In
        conjunction with certain Agreements to Purchase Promissory Notes dated October
        31, 2005 / February 3, 2006 with Randall Wade James Tricou; Rene Tricou -
        Tricou
        Construction; Rene Tricou - Bon Aire Estates; Rene Tricou - Bon Aire Utility;
        and Danny Acosta, creditors of I-55 Telecommunications (the "Creditors"),
        and
        upon the consummation of the merger on March 31, 2006, we issued to the
        Creditors an aggregate of 163,933 restricted shares of common stock and an
        aggregate of 81,968 warrants, exercisable at $3.38 per share, at a total
        value
        of $492,220, in return for retiring their individual loans with I-55
        Telecommunications.
 
 I-55
        Telecommunications provided voice, data and related services throughout
        Louisiana and Mississippi to both individuals and businesses. Prior to the
        merger with and into Xfone USA, I-55 Telecommunications was a licensed facility
        based CLEC operating in Louisiana and Mississippi with a next generation
        class 5
        carrier switching platform. I-55 Telecommunications provided a complete package
        of local and long distance services to residential and business customers
        across
        both states. As a result of the merger, Xfone USA has now expanded its On-Net
        (facilities) service area, through I-55 Telecommunications, into New Orleans,
        Louisiana and surrounding areas, including Hammond, Louisiana and Baton Rouge,
        Louisiana. Xfone USA is expanding its sales offices to include New Orleans,
        in
        an effort to continue revenue growth and increase market share in the
        revitalized city, as well as into Biloxi, Mississippi, Hammond, Louisiana
        and
        Baton Rouge, Louisiana. Regulations affecting the telecommunications industry
        began in March 2006; conversions of all circuits affected were completed
        in
        April 2006. The competition in secondary markets, such as Jackson, Mississippi,
        Baton Rouge, Louisiana, and Biloxi, Mississippi, as opposed to Tier 1 markets
        such as Atlanta, Georgia, is also rapidly declining due to the removal of
        UNE-P and the decline in the competitive local exchange providers that had
        been
        dependent on UNE-P as their only source for providing competitive local
        telephone services in those markets. This provides for a unique opportunity
        for Xfone USA to gain market share, by utilizing its existing network and
        to
        expand its facilities into these opportunity areas becoming a primary
        alternative to the monopoly Incumbent Local
        Exchange Company.
 
 -4-
 On
        January 1, 2006, Xfone USA, Inc., our wholly owned subsidiary, entered into
        an
        Agreement with EBI Comm, Inc. (“EBI”), a privately held Internet Service
        Provider, to purchase the assets of EBI. EBI provided a full range of Internet
        access options for both commercial and residential customers in north
        Mississippi. Based in Columbus, Mississippi, EBI’s services included Dial-up,
        DSL, T1 Dedicated Access and Web Hosting. The customer base, numbering
        approximately 1,500 Internet users, is largely concentrated in the Golden
        Triangle area, which includes Columbus, West Point and Starkville, Mississippi.
        The acquisition was structured as an asset purchase, providing for Xfone
        USA to
        pay EBI total consideration equal to 50% of the monthly collected revenue
        from
        the customer base during the first 12 months, beginning January 2006. Acquired
        assets include the customer base and customer lists, trademarks and all related
        intellectual property, fixed assets and all account receivables. As of December
        31, 2006, we paid $85,699 (£43,746) in consideration of this
        acquisition. The acquisition was not significant from an accounting
        perspective.
 
 On
        January 10, 2006 (effective as of January 1, 2006), Xfone USA, Inc., our
        wholly
        owned subsidiary, entered into an Asset Purchase Agreement with Canufly.net,
        Inc. (“Canufly.net”), an Internet Service Provider based in Vicksburg,
        Mississippi, and its principal shareholder, Mr. Michael Nassour. Canufly.net
        provided residential and business customers with high-speed Internet services
        and utilized the facilities-based network of Xfone USA, as an alternative
        to
        BellSouth, to provide Internet connectivity to its customers. Canufly.net
        also
        provided Internet services through a small wireless application in certain
        areas
        in Vicksburg, Mississippi. The transaction was closed on January 24, 2006.
        We
        agreed to pay a total purchase price of up to $710,633, payable as follows:
        (i)
        $185,000 in cash payable in twelve equal monthly payments, the first installment
        was paid at closing, and as of December 31, 2006, the entire amount was paid
        in
        full and in accordance with the Asset Purchase Agreement; (ii) $255,633 in
        cash,
        paid at closing, to pay off the loan with the B&K Bank; (iii) 33,768
        restricted shares of common stock and 24,053 warrants exercisable at $2.98
        per
        share for a period of five years were issued to the shareholders of Canufly.net
        during May 2006. Following the closing in 2006 and due to the satisfaction
        of
        certain earnout provisions in the Asset Purchase Agreement the Company issued
        in
        March 2007 an additional 20,026 restricted shares of common stock and 14,364
        warrants exercisable at $2.98 per share for a period of five years to the
        shareholders of Canufly.net. The acquisition was not significant from an
        accounting perspective.
 
 On
        May
        10, 2006, we, Story Telecom, Inc., Story Telecom Limited, Story Telecom
        (Ireland) Limited, Nir Davison, and Trecastle Holdings Limited, a company
        controlled by Mr. Davison, entered into a Stock Purchase Agreement. Pursuant
        to
        the Stock Purchase Agreement, we increased our ownership interest in Story
        Telecom from 39.2% to 69.6% in a cash transaction valued at $1,200,000. $900,000
        of the total consideration was applied to payables owed by Story Telecom
        to us
        and our subsidiary Swiftnet Limited for back-end telecommunications services.
        The balance of $300,000 was paid to Story Telecom, and is being used as working
        capital. Story Telecom, Inc., a telecommunication service provider, operated
        in
        the United Kingdom through its two wholly owned subsidiaries, Story Telecom
        Limited and Story Telecom (Ireland) Limited (which was dissolved on February
        23,
        2007). Story Telecom operates as a division of our operations in the United
        Kingdom. Founder and CEO of Story Telecom, Nir Davison, remained as Managing
        Director of the division. The stock purchase pursuant to the Stock Purchase
        Agreement was completed on May 16, 2006. The transaction contemplated by
        the
        Stock Purchase Agreement was not significant from an accounting
        perspective.
 
 On
        May
        25, 2006, we and the shareholders of Equitalk.co.uk Limited, a privately
        held
        telephone company based in the United Kingdom ("Equitalk") entered into an
        Agreement relating to the sale and purchase of Equitalk (the "Equitalk
        Agreement"). The Equitalk Agreement provided for us to acquire Equitalk in
        a
        restricted common stock and warrant transaction valued at $1,650,000. The
        acquisition was completed on July 3, 2006, and on that date Equitalk became
        our
        wholly owned subsidiary. In conjunction with the completion of the acquisition
        and in exchange for all of the capital stock of Equitalk, we issued a total
        of
        402,192 restricted shares of our common stock and a total of 281,872 warrants
        exercisable at $3.025 per share for a period of five years. Founded in December
        1999, Equitalk, a VC-financed company, was the first fully automated e-telco
        in
        the United Kingdom. Equitalk provides both residential and business customers
        with low-cost IDA and CPS voice services, broadband and
        teleconferencing.
 
 -5-
 **Recent
        Financings**
 
 On
        June
        19, 2006, we entered into a Securities Purchase Agreement to sell to Central
        Fund for the Payment of Severance Pay of the First International Bank of
        Israel
        Ltd.; Meiron Provident Fund for Self Employed Persons of the First International
        Bank of Israel Ltd.; Atidoth Provident and Compensation Fund of the First
        International Bank of Israel Ltd.; Tohelet Provident and Compensation Fund
        of
        the first International Bank of Israel Ltd.; Mishtalem Funds for Continuing
        Education of the First International Bank of Israel Ltd.; Keren
        Hashefa Provident and Compensation Fund of the First International Bank of
        Israel Ltd.; Hamelacha Provident and Compensation Fund of the First
        International Bank of Israel Ltd.; Teuza Provident and Compensation Fund
        of the
        First International Bank of Israel Ltd.; Kidma Provident Funds Management
        Company Ltd. for Menifa Provident Fund for Bank of Israel Employees; and
        Security Pension Fund for Artisans Industrialists and Self Employed Persons
        Ltd.
        an aggregate of 344,825 restricted shares of common stock, at a purchase
        price
        of $2.90 per share, together with an aggregate of 172,415 warrants to purchase
        shares of common stock, at an exercise price of $3.40 per share and with
        a term
        of five years. The financial transaction was closed on September 28, 2006.
        The
        net proceeds of the financial transaction are being used for general working
        capital and/or investment in equipment and/or acquisition and/or business
        development. The financial transaction resulted in dilution in the percentage
        of
        common stock owned by the Company's existing shareholders, although the price
        paid was in excess of the net tangible book value per share and accordingly
        was
        not economically dilutive.
 
 On
        December 24, 2006, the Company entered into an Agreement to sell to
        Halman-Aldubi Provident Funds Ltd. and Halman-Aldubi Pension Funds Ltd. an
        aggregate of 344,828 restricted shares of its common stock, at a purchase
        price
        of $2.90 per share, together with an aggregate of 172,414 warrants to purchase
        shares of its common stock, at an exercise price of $3.40 per share and with
        a
        term of five years. The financial transaction was closed on February 8, 2007.
        The net proceeds of the financial transaction are being used for general
        working
        capital and/or investment in equipment and/or acquisition and/or business
        development. The financial transaction resulted in dilution in the percentage
        of
        common stock owned by the Company's existing shareholders, although the price
        paid was in excess of the net tangible book value per share and accordingly
        was
        not economically dilutive.
 
 **Our
        Principal Services and their Markets**
 
 We
        provide through our United Kingdom operations (Swiftnet, Equitalk, Story
        Telecom
        and Auracall) the following telecommunication products /
        services :
 
 ***Services
        provided by Swiftnet***
 
 *Telephony
        Services*
 
 ·
              Carrier
                  Pre Select (CPS): CPS is a telephony service which enables customers
                  to
                  benefit from our low call usage charges, without having to make
                  any
                  changes to their existing telephone lines or numbers. The service
                  allows
                  customers to route all their outgoing calls over our network. This
                  gives
                  them access to competitive call rates and a wide range of services.
                  Customers using CPS only pay line rental to their service operator,
                  while
                  we bill them for all call charges. CPS is available nationally
                  provided
                  the customer is connected to a BT local
                  exchange
 
 ·
              Indirect
                  Access: This is a telephony service which enables customers to
                  benefit
                  from our low call usage charges, without having to make any changes
                  to
                  their existing telephone lines or numbers. The service allows customers
                  to
                  route a specific outgoing call over our network by using the prefix
                  code
                  "1689".
 
 ·
              Calling
                  Cards: This service is available to all our subscribers. The Calling
                  Card
                  works by using an access number and a PIN code, and offers a convenient
                  and easy way to make calls virtually anywhere in the UK, as well
                  as from
                  27 other destinations worldwide.
 
 -6-
 *Messaging
        Services*
 
 ·
              Email2Fax:
                  Allows users to send fax messages directly from their email or
                  web
                  software.
 
 ·
              Cyber-Number:
                  Allows users to receive fax messages directly to their email software
                  via
                  a personal number.
 
 ·
              Email/Fax
                  Broadcast: This service allows the user to send multiple personalized
                  faxes and emails to thousands of users in
                  minutes.
 
 *Internet
        Based Customer Service*
 
 ·
              Our
                  Internet based customer service and on-line registration (found
                  at
                  www.swiftnet.co.uk) includes full details on all our products and
                  services.
 
 Our
        UK
        based subsidiary, Swiftnet Limited owns and operates its own facilities-based
        telecommunications switching system.
 
 ***Services
        provided by Equitalk.co.uk***
 
 *Telephony
        Services*
 
 ·
              Carrier
                  Pre Select (CPS): CPS is a telephony service which enables customers
                  to
                  benefit from our low call usage charges, without having to make
                  any
                  changes to their existing telephone lines or numbers. The service
                  allows
                  customers to route all their outgoing calls over our network. This
                  gives
                  them access to competitive call rates and a wide range of services.
                  Customers using CPS only pay line rental to their service operator,
                  while
                  we bill them for all call charges. CPS is available nationally
                  provided
                  the customer is connected to a BT local
                  exchange.
 
 ·
              Indirect
                  Access: This is a telephony service which enables customers to
                  benefit
                  from our low call usage charges, without having to make any changes
                  to
                  their existing telephone lines or numbers. The service allows customers
                  to
                  route a specific outgoing call over our network by using the prefix
                  code
                  "1664".
 
 ·
              Internet/Data
                  Service: We provide high-speed Internet access to residential customers
                  utilizing the digital data network of Griffin Internet. Our ADSL
                  service
                  provides up to 8 Mbps of streaming speed combined with Static IP
                  addresses, as well as multiple mailboxes. Our Internet/Data services
                  are
                  bundled with our voice services for residential and business
                  customers.
 
 ·
              Conference
                  Service: We provide web-managed low cost teleconferencing services
                  through
                  our partnership with Auracall Limited. Up to 10 people can call
                  in to a
                  conference circuit and be joined together by dialing the same PIN.
                  There
                  is no need to reserve a conference call in advance and each caller
                  pays
                  for their own call.
 
 -7-
 *Internet
        Based Customer Service and Billing Interface*
 
 ·
              Our
                  Internet based customer service and billing interface (found at
                  www.equitalk.co.uk) includes on-line registration, full account
                  control,
                  and payment and billing functions and information
                  retrieval.
 
 ***Services
        provided by Story Telecom***
  ·
              Prepaid
                  Calling Cards: Story Telecom initiates, markets and distributes
                  Prepaid
                  Calling Cards that are served by our switch and systems. Story
                  Telecom
                  supplies the Prepaid Calling Cards to retail stores through its
                  network of
                  dealers. The Calling Card enables the holder to call anywhere in
                  the world
                  by dialing either a toll free number or a local access number from
                  any
                  telephone that routes the holder’s call to our Interactive Voice Response
                  System that automatically asks for the holder’s private PIN code,
                  validates the code dialed by the customer, and tells the credit
                  balance of
                  the card. The holder is then instructed to dial to his or her desired
                  destination, at which time our Interactive Voice Response System
                  tells the
                  holder how long he or she can speak according to the balance on
                  the card
                  and what the cost per minute is. The holder of the card can use
                  the card
                  repeatedly until the balance is
                  zero.
 
 ·
              Story
                  Direct and Story Mobile: These services allow any individual with
                  either a
                  BT line or a mobile phone to make international calls at a lower
                  cost and
                  without prepayment for setting up an account with another carrier.
                  These
                  services can be accessed by any business or residential user through
                  Story
                  Telecom website, found at www.storytelecom.com. When customers
                  need to
                  make an international or national call they can dial the appropriate
                  designed number for that country and save on calling rates over
                  the
                  current BT published rates or their network operator’s rates by gaining
                  access to our switch and providing savings on a per minute
                  basis.
 
 *Internet
        Based Customer Service and Billing Interface*
 
 ·
              Our
                  Internet based customer service (found at www.storytelecom.co.uk)
                  includes full details on all our products and
                  services.
  ***Services
          provided by Auracall
          Limited************(******a
          32.5% Equity
          Investment)*********
  ·
              The
                  Auracall service allows any individual with a BT line to make
                  international calls at a lower cost and without prepayment for
                  setting up
                  an account with another carrier. The Auracall service can be accessed
                  by
                  any business or residential user through our website at www.auracall.com.
                  When customers need to make an international or national call they
                  can
                  dial the appropriate designed number for that country and save
                  on calling
                  rates over the current BT published rates by gaining access to
                  our switch
                  and providing savings on a per minute
                  basis.
 
 *Internet
        Based Customer Service and Billing Interface*
 
 ·
              Our
                  Internet based customer service(found
                  at www.auracall.co.uk) includes full details on all our products
                  and
                  services.
 
 -8-
 We
        provide through our United States operations (Xfone USA) the following
        telecommunication products / services :
 
 ·
              Local
                  Telephone Service: Using our own network in concentrated local
                  areas
                  throughout Mississippi and Louisiana and utilizing the underlying
                  network
                  of BellSouth****Telecommunications,
                  Inc. (the new ATT), outside of our local areas, we provide local
                  dial tone
                  and calling features, such as hunting, call forwarding and call
                  waiting to
                  both business and residential customers throughout Alabama, Florida,
                  Georgia, Louisiana and Mississippi, including T-1 and PRI local
                  telephone
                  services to business customers.
 
 ·
              Long
                  Distance Service: We use our own network where available and QWEST,
                  a
                  nationwide long distance carrier, as our underlying long distance
                  network
                  provider. In conjunction with Local Telephone Services, we provide
                  Long
                  Distance Services to our residential and business customers. We
                  provide
                  two different categories of long distance services - Switched Services
                  to
                  both residential and small business customers, which include 1+
                  Outbound
                  Service, Toll Free Inbound Service and Calling Card Service. For
                  larger
                  business customers we also provide Dedicated Services such as T-1
                  and PRI
                  Services. Our long distance services are only available to customers
                  who
                  use our local telephone services.
 
 ·
              Internet/Data
                  Service: We provide high-speed broadband Internet access to residential
                  and business customers utilizing our own integrated digital data
                  network
                  and utilizing the broadband gateway network of the new ATT. Our
                  DSL
                  service provides up to 3 Mbps of streaming speed combined with
                  Dynamic IP
                  addresses, as well as multiple mailboxes and Web space. Our DSL
                  services
                  also include spam filter, instant messaging, pop-up blocking, web
                  mail
                  access, and parental controls. We also provide dial-up Internet
                  access
                  service for quick and dependable connection to the web. Our Internet/Data
                  services are stand-alone products or are bundled with our voice
                  services
                  for residential and business
                  customers.
 
 ·
              Customer
                  Service: Customer Service is paramount at Xfone USA and is one
                  of our
                  major differentiating characteristics, thus tantamount to being
                  one of our
                  product offerings. Customers have been conditioned to accept poor
                  customer
                  service from the larger monopoly companies because they have never
                  had any
                  real choice in service providers, especially in the residential
                  market.
                  Our attentive customer service department is an additional "product
                  offering" which sells - as well as retains - customers. The full
                  scope of
                  communications service entails network service, customer service,
                  and
                  repair service.
 
 Our
        US
        based subsidiary, Xfone USA, Inc. owns and operates its own facilities-based
        telecommunications carrier class switching platform.
 
 We
        provide through our Israeli operations (Xfone 018) the following
        telecommunication products / services :
 
 ·
              International
                  Telephony Services: We provide international telephony services
                  with the
                  prefix code of "018". We provide these services both to our subscribers
                  and to subscribers of other Israeli carriers. The service is offered
                  to
                  both residential and business
                  customers.
 
 ·
              XFONECARD:
                  We provide an international toll free calling card service, available
                  in
                  over 40 countries around the globe. XFONECARD has a unique feature
                  which
                  allows its user to receive messages to a personal message
                  box.
 
 -9-
 ·
              SIMPLE:
                  The SIMPLE is a pre programmed, rechargeable, mobile SIM card which
                  can be
                  used with any unlocked GSM (Global System for Mobiles) mobile phone
                  virtually anywhere in the world. SIMPLE allows us to deliver call
                  savings,
                  by diverting the customer dialing command away from the local mobile
                  operator that the phone is connected to, and instead, it sends
                  the call to
                  one of the UK's largest mobile operators with whom we hold a special
                  agreement. We offer for sale or rent two types of SIM Cards - a
                  local SIM
                  Card which may be used only from a specific country, and a global
                  SIM Card
                  which may be used from over 90 countries around the
                  globe.
 
 ·
              International
                  Telephony Access: We provide international telephony access to
                  the Israeli
                  telephone network by selling incoming call minutes to various
                  international operators across the
                  globe.
 
 Our
        Israel based subsidiary Xfone 018 owns and operates its own facilities-based
        telecommunications carrier class switching platform.
 
 **Our
        Distribution and Marketing Methods**
 
 We
        use
        the following distribution methods to market our services:
 ·
              We
                  use employed, direct sales executives to sell to medium to large
                  size
                  business customers; these sales executives have quota attainment
                  requirements and receive a monthly salary, allowance and are paid
                  commissions.
 ·
              We
                  actively recruit independent contractor agents and resellers who
                  purchase
                  telephone traffic directly from us at a discount, and who then
                  resell this
                  telephone traffic to their customers at a mark-up according to
                  their own
                  price lists;
 ·
              We
                  utilize agents that sell our services directly to customers at
                  our
                  established prices; these agents receive a commission of approximately
                  5%-12% of the total sale amount less any bad
                  debts;
 ·
              We
                  use third party direct sales organizations (telesales and door-to-door)
                  to
                  register new customers.
 ·
              We
                  cooperate with major companies and worker's
                  councils.
 ·
              We
                  use direct marketing, including by newspaper and radio
                  advertisements;
 ·
              We
                  attend telecommunications trade shows to promote our
                  services;
 ·
              We
                  utilize the Internet as an additional distribution channel for
                  our
                  services. We utilize Xfone.com as our brand name for our new e-commerce
                  telecommunications operations.
 
 **Our
        Billing Practices**
 
 We
        charge
        our customers based on a monthly fixed amount or on actual usage by full
        or
        partial minutes. Our rates vary with distance, duration, time, and type of
        call,
        but are not dependent upon the facilities selected for the call transmission.
        The standard terms for our regular telephone customers require that payments
        are
        due 30 days from the date of the invoice, or 90 days when the invoice is
        issued
        by the local operator. Our supplier's standard terms are payment within 30
        to 90
        days from invoice date; however, some new suppliers ask for shorter payment
        terms.
 
 -10-
 **Carriers
        and Negotiating Lower Rates**
 
 Our
        increased sales in 2004, 2005 and 2006 have enabled us to negotiate
        significantly lower rates with the carriers we use to carry our international
        call traffic, which gives us the opportunity to increase our margins or offer
        significant reductions to secure deals with major clients. If our sales
        increase, we anticipate that we will continue to negotiate for lower rates.
        There can be no assurance that we will be successful in negotiating lower
        rates.
 
 **Divisions**
 
 We
        operate the following divisions:
 ·
              Partner
                  Division-
                  Our Partner Division operates as a separate profit center by attempting
                  to
                  recruit new resellers and agents to market our products and services
                  and
                  to provide support and guidance to resellers and
                  agents.
 ·
              Customer
                  Service Division-
                  In the United Kingdom and the United States we operate a live customer
                  service center that operates 24 hours a day, 7 days a week. In
                  Israel our
                  customer service center operates 6 days a
                  week.
 ·
              Operations
                  Division-
                  Our Operations Division provides the following operational functions
                  to
                  our business: (a) 24 hour/7 day a week technical support; (b)
                  inter-company network; (c) hardware and software installations;
                  and (d)
                  operating switch and other
                  platforms.
 ·
              Administration
                  Division-
                  Our Administration Division provides the billing, collection, credit
                  control, and customer support aspects of our
                  business.
 ·
              Research
                  and Development-
                  The function of our Research and Development Division is to develop
                  and
                  improve our billing system, switch and telephony platforms, websites
                  and
                  special projects.
 ·
              Retail-
                  Our Retail Division is responsible for our marketing and selling
                  campaigns
                  that target potential and existing retail
                  customers.
 
 **Geographic
        Markets**
 
 Our
        primary geographic markets are the United States, the United Kingdom and
        Israel.  However, we serve customers across Europe, Asia, North
        America, South America, Australia and Africa.
 
 **Competitive
        Business Conditions**
 
 *The
        U.K. Market*
 
 The
        communications and information services industry in the U.K. is highly
        competitive and varied. In 2006, we had only approximately 0.1% of the market
        share of the United Kingdom telecommunication market (not including mobiles
        revenues), based on our revenues of $17.0 million (approximately £8.7 million)
        during 2006, compared with the approximately $10.1 billion telecommunication
        market (not including mobiles revenues) in the United Kingdom, according
        to the
        United Kingdom regulatory oversight of these companies, the Office of
        Communications - United Kingdom, otherwise known as Ofcom, the website of
        which
        may be accessed at  www.ofcom.org.uk.
 
 -11-
 *The
        U.S. Market*
 
 In
        2006
        we had approximately 13,500 End-User Switched Access telephone lines in the
        Alabama, Louisiana and Mississippi market through the combination of Xfone
        USA
        and I-55 Telecommunications, LLC or approximately 0.2% of market share. This
        total market size in 2006 represented 5,789,992 telephone lines, with BellSouth
        Telecommunications maintaining its monopoly market share with 4,877,791
        telephone lines or approximately 84% of the market. All CLECs combined made
        up
        the remaining 921,201 telephone lines or approximately 16% of the tri-state
        market, according to the 2006 FCC Report - Trends in Local Telephone
        Competition.
 
 *The
        Israeli Market*
 
 Since
        the
        opening of the international telephony market in Israel to competition in
        1996,
        and until 2004, only three companies have provided international telephony
        services in Israel. The market, estimated at that time to be 2 billion minutes
        per year, was more or less equally divided between the three companies. On
        July
        4, 2004, the Ministry of Communications of the State of Israel granted our
        subsidiary, Xfone 018 a license to provide international telecom services
        in
        Israel. We started providing services in Israel through Xfone 018 as of
        mid-December 2004. In 2004, two other new providers of international telephony
        services launched their services. The international telephony market is highly
        competitive and therefore all six providers had to offer low prices in order
        to
        attract or retain subscribers and call minutes.
 
 During
        2006, two significant mergers occurred in the Israeli international telephony
        market, leaving only four companies in the competition. The implications
        of
        these two mergers are yet to be noticed. However, we believe that the mergers
        will result in a moderate rates increase which may raise Xfone 018 revenues
        in
        2007. The aforementioned mergers enabled Xfone 018 to execute, as of December
        2006, a new business strategy, according to which it re-priced its services
        by
        distinguishing the rates for its subscribed customers from the rates for
        its
        non-subscribed customers. We believe that the new strategy shall prove to
        be
        successful, and that in 2007 no significant market share will be lost as
        a
        result of its implementation.
 
 In
        2006,
        the Israeli international telephony market was estimated to be 2.6 billion
        minutes. We estimate our market share as of December 31, 2006, as approximately
        5.5% of the Israeli market.
 
 **Principal
        Suppliers**
 
 In
        2006,
        our principal suppliers of telephone routing and switching services according
        to
        the percentage of the costs of revenues were:
 ·
              “the
                  new ATT” (formerly BellSouth Telecommunications) -
                  31%
 ·
              British
                  Telecommunications - 28%
 ·
              Bezeq
                  The Israel Telecommunication Corp -
                  5%
 
 We
        are
        dependent on several of our suppliers. However, these suppliers are required
        to
        provide us with services according to the relevant regulations and their
        licenses to operate as a telecommunications provider in the relevant
        jurisdictions.
 
 -12-
 **Major
        Customers**
 
 We
        have
        six major types of customers:
 ·
              Residential-
                  in the U.S. - pre-subscribed customers; outside of the U.S. -
                  pre-subscribed customers and customers who must dial a special
                  code to
                  access our switch or acquire a box that dials automatically,
 ·
              Commercial-
                  we serve small to complex business customers around the
                  world.
 ·
              Governmental
                  agencies-
                  Including the United Nations World Economic Forum, the Argentine
                  Embassy,
                  the Spanish Embassy and the Israeli
                  Embassy.
 ·
              Resellers-
                  We provide them with our telephone and messaging services for a
                  wholesale
                  price.
 ·
              Telecommunications
                  companies-
                  We provide our services through telecommunication companies (such
                  as
                  British Telecom and Bezeq The Israel Telecommunication Corp) which
                  collect
                  the fees relating to such services and forward them to
                  us.
 ·
              Mobile
                  Users-
                  including customers who can access our switch utilizing their free
                  cross-network minutes and thereafter able to make low-cost international
                  calls; customers who purchase, via a reversed billed SMS, pre-paid
                  credit
                  for international calls and those using our international roaming
                  SIM
                  cards.
 
 Certain
        Telecommunication operators act as collection channels for the Company. In
        2006
        we had two major collection channels, one in the U.K. and one in Israel.
        Collections through these channels accounted to approximately 18% and 5%
        of our
        total revenues in 2006, and 23% and 19% of our total revenues in 2005. With
        respect to collection of monies for us, these Telecommunication operators
        are
        not deemed to be customers of the Company.
 
 Our
        largest non affiliated reseller is WorldNet Global Communications Ltd. which
        generated approximately 1% of our total revenues during the year 2006. We
        provide WorldNet Global Communications with the billing system. We anticipate
        that WorldNet will continue to contribute approximately the same amount of
        UKP
        to our revenues in year 2007.
 
 Collectively,
        in 2006 the United Kingdom accounts for approximately 44.7% of our revenues,
        the
        United States accounts for approximately 40.8% of our revenues and Israel
        accounts for approximately 14.5% of our revenues.
 
 Our
        integrated revenue approach led to revenue from each source as described
        above
        and is partially driven by the activities of other revenue sources. Our revenues
        are dependent upon the following factors:
 ·
              Price
                  competition in telephone rates;
 ·
              Demand
                  for our services;
 ·
              Individual
                  economic conditions in our markets;
                  and
 ·
              Our
                  ability to market our services.
 
 **Patents
        and trademarks**
 
 On
        September 14, 2000, Equitalk received notification from the Trademarks Registry
        Office of Great Britain that its trademark, “ **Equitalk** ”,
        was
        registered by that government agency.
 
 On
        January 9, 2004, we received notification from the Trademarks Registry Office
        of
        Great Britain that as of August 8, 2003, our trademark, “ **Xfone** ”,
        was
        registered by that government agency.
 
 -13-
 On
        April
        22, 2005, Xfone USA received notification from the United States Patent and
        Trademark Office that as of April 12, 2005, its Mark, “ **eXpeTel** ”,
        was
        registered by that government agency.
 
 We
        do not
        have any other patents or registered trademarks.
 
 **Regulatory
        Matters**
 
 In
        1996,
        our subsidiary, Swiftnet Limited was granted a license to operate a
        telecommunications system from the Secretary of State for Trade and Industry
        of
        the United Kingdom. On July 25 2003 the regulatory situation within the United
        Kingdom changed dramatically with the ending of the licensing regime and
        the
        withdrawal and revocation of the Telecommunication Act.
 
 The
        licensing regime has been replaced by a general authorization regime with
        the
        introduction of the General Conditions of Entitlement.
 
 Swiftnet
        Limited, Equitalk.co.uk Limited and Story Telecom Limited are now affected
        by regulations introduced by the Office of Communications ("Ofcom"). Ofcom
        is
        the regulator for the UK communications industries, with responsibilities
        across
        television, radio, telecommunications and wireless communications services.
        We
        do not believe that any regulations introduced by Ofcom will interfere with
        or
        substantially impair our business.
 
 On
        April
        15, 2004, we established Xfone Communication Ltd. and renamed it Xfone 018
        Ltd
        in March 2005. On July 4, 2004 the Ministry of Communications of the State
        of
        Israel granted Xfone 018 a license to provide international telecom services
        in
        Israel. The license may be revoked by this agency in the occurrence of certain
        events such as breach of telecommunication laws and regulations or breach
        of
        certain provisions of the license.
 
 On
        May
        31, 2006, Xfone 018 was granted permission by the Ministry of Communications
        of
        the State of Israel to commence experimental deployment of Voice over Broadband
        (VoB) services.
 
 On
        August
        21, 2006, the Ministry of Communications of the State of Israel granted Xfone
        018 a license to operate in Israel as an ISP, thus enabling Xfone 018 to
        provide
        Internet access, Email and EDI (electronic data interchange)
        services.
 
 Xfone
        USA
        is licensed as a CLEC and an Inter-exchange Carrier to provide local telephone
        and long distance services in the states of Alabama, Florida, Georgia, Louisiana
        and Mississippi. Internet and data services provided by Xfone USA are not
        regulated services.
 
 As
        of
        March 10, 2005, and upon consummation of the merger of WS Telecom, with and
        into
        Xfone USA, Inc., we became subject to applicable US state and federal
        telecommunications laws and regulations. Compliance with such laws involved
        higher costs than we had in Europe during 2004.
 
 -14-
 On
        March
        9, 2005, the Mississippi Public Service Commission (“Commission”) issued an
        Order opening a Generic Change of Law Proceeding (“Commission Proceeding”) to
        consider amendments to existing Interconnection Agreements between BellSouth
        Telecommunications, Inc. and all (CLECs) in Mississippi. As an interested
        party
        and as a CLEC, Xfone USA petitioned and was granted permission to intervene
        in
        the Commission Proceeding for regulatory purposes. On October 26, 2005, the
        Commission held its hearing on the Commission Proceeding and took the results
        of
        the Proceeding under advisement. On October 20, 2006 the Commission issued
        its
        Order in this matter, requiring various changes to Interconnection Agreements
        between BellSouth Telecommunications, Inc. and all CLECs in Mississippi,
        including the Interconnection Agreement under which Xfone USA operates. The
        issues addressed by the Commission in this Proceeding were regulatory in
        nature
        and did not involve monetary damages **.**
 
 From
        time
        to time Xfone USA may be required to seek regulatory approval before applicable
        state public utility commissions of certain transactions, including business
        combinations with other telecommunications providers. During 2005,
        upon request of Xfone USA, the Mississippi Public Service Commission and
        the Louisiana Public Service Commission granted regulatory approval
        of the sale and transfer of the assets and the customer base of
        I-55 Telecommunications to Xfone USA. This transaction was closed on March
        31,
        2006.
 
 We
        provide our services in many countries, all of which have different regulations,
        standards and controls related to licensing, telecommunications, import/export,
        currency and trade. We believe that we are in substantial compliance with
        these
        laws and regulations.
 
 **Research
        and Development Activities**
 
 During
        fiscal year 2005, we spent £6,896 ($11,896) on research and development
        activities. During fiscal year 2006, we spent £23,333 ($45,709) on research and
        development activities. Other than developing and expanding our
        telecommunications applications and our websites, we do not intend to undertake
        any significant research and development activities in 2007.
  **Cost
        of Compliance with Environmental Laws**
 
 We
        currently have no costs associated with compliance with environmental
        regulations. We do not anticipate any future costs associated with environmental
        compliance; however, there can be no assurance that we will not incur such
        costs
        in the future.
 
 **Employees**
 
 We
        currently have 20 employees in the United Kingdom, 79 employees in the United
        States, and 40 employees in Israel.
 
 -15-
 **Code
        of Conduct and Ethics**
 
 The
        Audit
        Committee of the Board of Directors of the Company has adopted and approved
        a
        Code of Conduct and Ethics (the “Code”) to apply to all the directors, officers
        and employees of the Company. The Code which was ratified by the Board of
        Directors of the Company is intended to promote ethical conduct and compliance
        with laws and regulations, to provide guidance with respect to the handling
        of
        ethical issues, to implement mechanisms to report unethical conduct, to foster
        a
        culture of honesty and accountability, to deter wrongdoing and to ensure
        fair
        and accurate financial reporting. The Code became effective on August 15,
        2006.
 
 **Reports
        to Security Holders**
 
 We
        are
        subject to the informational requirements of the Securities Exchange Act
        of
        1934. Accordingly, we file annual, quarterly and other reports and information
        with the Securities and Exchange Commission. You may read and copy these
        reports
        in Washington, D.C. Our filings are also available to the public from commercial
        document retrieval services and the Internet world wide website maintained
        by
        the U.S. Securities and Exchange Commission at www.sec.gov.
 
 ITEM
        2. DESCRIPTION OF PROPERTY.
 
 In
        February 2007, we moved our principal
        executive offices to
        Flowood, Mississippi, USA, sharing executive office space with our wholly
        owned
        U.S. subsidiary, Xfone USA, Inc.
 
 The
        headquarters of Xfone USA are located at 2506 Lakeland Drive, Flowood,
        Mississippi 39232. This 7,500 square foot facility has ten offices, one large
        open area fitted with work stations for provisioning, billing and network
        operations, another large area fitted with work stations for customer service
        and one board room, one computer room, reception area, accounting, secretarial
        Executive offices and two kitchens. Xfone USA's office spaces are located
        on the
        first, fourth and fifth floors of a six floor building with two elevators
        and
        parking facilities. Its premises are leased on a 3-year term, which is due
        to
        expire in December 2007. The yearly lease payments are approximately $104,000.
 
 Xfone
        USA
        has another Mississippi office located at 1907 Pass Road Suite D, Biloxi,
        Mississippi. This 1,000 square foot office space is primarily used as a
        sales office and dispatch center and contains four offices, a reception area,
        small kitchen and bathroom. These premises are leased on a 2-year term that
        is due to expire in June 2008. The yearly lease payments are approximately
        $14,500. The company also has two Louisiana locations, one in Hammond, Louisiana
        and the other in downtown New Orleans, Louisiana.
 
 The
        Hammond, Louisiana location primarily houses upper level customer support,
        field
        technicians and the company’s web design division. Xfone USA recently downsized
        the existing office space of the two-story building and now utilizes
        approximately 75% of the second floor, only. The building is located at 211
        E.
        Thomas Street in downtown Hammond, Louisiana and has eight offices and two
        bathrooms. Xfone USA executed a new 3-year lease and pays $5,000 monthly,
        which
        includes utilities. The New Orleans office is located at 650 Poydras Street
        on
        the 10 th floor,
        Suite 1000, of the 650 Poydras Office Building in downtown New Orleans,
        Louisiana. The 3,645 square foot facility is a sales office and operations
        office supporting the company’s carrier switch and network facilities, which is
        adjacent to this office on the same floor. The office has a glass front entry
        reception area, six offices, one conference room, two large open areas that
        can
        be fitted with work stations for additional sales personnel, provisioning
        and
        network operations, a kitchen and a large storage room. The lease is a five-year
        term and is set to terminate in October 2008. The yearly lease payments are
        $58,320.
 
 -16-
 The
        headquarters of Swiftnet, Equitalk and Story Telecom are located at 960
        High Road, London N12 9RY - United Kingdom. This is a six-floor
        building with a concierge, two elevators and parking facilities. We lease
        space on the fifth and sixth floors. For our office on the fifth floor we
        renewed our lease for a period of ten years on December 20, 2002, with a
        five
        year cancellation option. Our current lease for the fifth floor
        expires on December 20, 2012 and the annual lease payments are £49,134
        ($96,254). This 3,000 square foot facility has seven offices, one board
        room, one computer room, one operation room that controls the computer room,
        entrance hall, main hall, accounting, secretarial and administration and
        two
        kitchens. In December 2006, we took a lease for the sixth floor,
        ending on April 5, 2009. This 3,000 square foot facility has an open-plan
        administration area plus six offices, one computer room and one kitchen.
        The annual lease payments are £40,119 ($78,593).
  The
        headquarters of Xfone 018 are located at 1 Haodem Street, Petach Tikva, Israel.
        This 3,593 square foot facility has eight offices, one board room, one computer
        room, one operation room that controls the computer room, open space with
        costumer service stations, accounting, secretarial and administration, one
        kitchen, entrance hall and main hall. Our offices are located on the third
        floor
        of a four floor building with an elevator and parking facilities. Our premises
        were leased on a five year term which is due to expire on August 1, 2009.
        However, we have the option to extend the term of the lease for an additional
        five year period, subject to a prior notice to be given no later than June
        1,
        2009. The lease payments for the first 30 months are $1,670 per month. The
        lease
        payments for the 31-48 months are $2,004 per month. The lease payments for
        the
        49-60 months are $2,171 per month. The lease payments for the 61-72 months
        are
        $2,338 per month. The lease payments for the 73-84 months are $2,505 per
        month.
        The lease payments for the 85 th month
        are $2,672 per month. We also pay $50 a month for each parking spot. We
        presently use four parking spaces. As of September 1, 2006, an additional
        2,367
        square foot facility with six offices, one board room, one kitchen, entrance
        hall and main hall, in the first floor of the same building, is leased under
        the
        same terms and conditions as set forth above. Xfone, Inc. has guaranteed
        all
        Xfone 018 obligations under this lease agreement.
 
 In
        addition, we have two switches which are located at two different locations
        in
        Israel. We rent the cages in which our switches are located from unrelated
        third
        parties. The cages are in good condition.
 
 Our
        offices are in good condition and are sufficient to conduct our operations.
 
 We
        do not
        own any property nor do we have any plans to acquire any property in the
        future.
        We do not intend to renovate, improve or develop any properties; however,
        from
        time to time we improve leased office space in order to comply with local
        legislation and to provide an office environment necessary to conduct business
        in the markets in which we operate. We are not subject to competitive conditions
        for property. We have no policy with respect to investments in real estate
        or
        interests in real estate and no policy with respect to investments in real
        estate mortgages. We have no policy with respect to investments in securities
        of
        or interests in persons primarily engaged in real estate
        activities.
 
 -17-
 ITEM 3. LEGAL PROCEEDINGS.
  **I.
        MG Telecom Ltd.**
  In
        August
        2002, Swiftnet Limited, the Company’s wholly-owned U.K. based subsidiary, filed
        a summary procedure lawsuit in the Magistrate Court of Tel - Aviv, Israel
        against MG Telecom Ltd. and its Chief Executive Officer, Mr. Avner Shur.
        In this
        lawsuit, we allege an unpaid debt due to us in the amount of $50,000 from
        MG
        Telecom for services rendered by us to MG Telecom. The debt arose from an
        agreement between us and MG Telecom, at that time a provider of calling card
        services, in which traffic originating from MG Telecom calling cards was
        delivered through our system in London, England. Mr. Shur signed a personal
        guarantee agreement to secure MG Telecom’s obligations under the agreement. On
        August 16, 2005, the Magistrate Court rendered a judgment in this matter,
        rejecting our claims. On October 16, 2005, Swiftnet filed an appeal with
        the
        District Court of Tel - Aviv. On December 28, 2006, the District Court rescinded
        the judgment of the Magistrate Court. The case was returned to the Magistrate
        Court for writing a new reasoned judgment.
  **II.
        MCI WorldCom Limited**
 
 Swiftnet
        Limited , the Company’s wholly-owned U.K. based subsidiary, was served with a
        claim on October 11, 2005 that was filed by MCI WorldCom Limited (“MCI”) in an
        English court for the sum of £1,640,440 ($3,213,622) plus interest accruing at a
        daily rate of £401 ($786) which at the date of claim had amounted to £92,317
        ($180,849). MCI’s claim is for telecommunication services MCI claims it provided
        to Swiftnet. Swiftnet has been in dispute with MCI regarding amounts due
        to MCI
        for telecommunications services provided by MCI to Swiftnet. Swiftnet alleges
        that the disputed charges were improperly billed by MCI to its account for
        a long time and therefore MCI should credit Swiftnet for a certain amount
        of the
        claim.  Swiftnet has defended the claim by stating that in relation to the
        invoices that MCI is claiming remain unpaid, £307,094 ($601,597) is not
        justified according to the rates agreed at various meetings and equates to
        an over-billing by such amount, although Swiftnet does not have written evidence
        for many of the agreed rates. Swiftnet has also submitted a counterclaim
        stating that it is owed a further £671,111 ($1,314,706) in credits in relation
        to amounts paid on account and wrongly attributed by MCI to over-billed
        invoices. In addition, MCI continues to send traffic to Swiftnet for
        termination via Xfone 018's network. Swiftnet is claiming that the amounts
        owed by MCI to Swiftnet in this regard should be set off against any amounts
        being claimed by MCI in the dispute. There is a further counterclaim for
        additional accounting costs and loss of management time incurred by Swiftnet
        due
        to the incorrect billing. Our financial statements carry the full amount
        Swiftnet has calculated that it owes to MCI based on the data held in Swiftnet’s
        billing systems.
 
 **III.
        Famous Telecommunications**
 
 In
        August
        2006, Story Telecom Limited, the Company's majority-owned U.K. based subsidiary,
        filed a lawsuit in the Barnet County Court, London, United Kingdom, against
        “Famous Telecommunications”, a reseller of calling cards, and its owner, Mr.
        Tanvir Babar. In this lawsuit, Story Telecom alleged an unpaid debt in the
        amount of £52,000 ($101,868) from Famous Telecommunications and/or Mr. Baber for
        services rendered by it. The debt arose from an agreement between Story Telecom
        and famous Telecommunications and/or Mr. Baber, in which Story Telecom supplied
        Famous Telecommunications and/or Mr. Baber with calling cards which they
        in turn
        distributed in the market. In September 2006, the court rendered a Judgment
        in
        Default in favor of Story Telecom. According to the judgment Famous
        Telecommunications and/or Mr. Baber must pay the debt plus interest
        forthwith, approximately £54,000 ($105,786). Famous Telecommunications and/or
        Mr. Baber failed to comply with the court's order and as a result thereof
        Story
        Telecom applied for a Third Party Debt Order, requesting the court to order
        Mr.
        Baber’s bank, Halifax plc, to make available to Story Telecom any monies
        currently available within Mr. Baber's account. In October 2006, the court
        made
        an Interim Order ordering Halifax plc to hold any amounts available within
        Mr. Baber’s account (up to the amount of the judgment being £54,000) in favor of
        Story Telecom until full hearing takes place. Full hearing took place on
        January
        18, 2007, during which the court ordered Halifax plc to pay Story Telecom
        any
        monies held in Mr. Baber’s account. Halifax plc transferred approximately £1,200
        ($2,351) to Story Telecom’s account as these were all the monies available. On
        March 3, 2007, the court, following Story Telecom’s request, ordered Mr. Baber
        to attend court on April 3, 2007, for questioning regarding his financial
        situation whereby he will also be required to detail all his assets. Following
        such questioning Story Telecom will look to pursue the most likely to succeed
        course of action in collecting the monies due.
 
 -18-
 ITEM
        4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
  On
        December 28, 2006, an Annual Meeting of shareholders was held at the offices
        of
        Gersten Savage, LLP in New York. The following proposals were approved by
        the
        shareholders at the above-mentioned Annual Meeting, in addition to the election
        of eight members of our Board of Directors: (1) The appointment of
        Stark, Winter, Scheinkein & Co., LLP as the Company’s Independent Certified Public
        Accountants, for the fiscal year ending December 31, 2006, and the first
        three
        quarters of the fiscal year ending December 31, 2007 (“Proposal II”). 7,128,368
        shares were voted for Proposal II, 2,050 shares were voted **** against
        and 2,000 shares were abstained. No "broker non-votes" participated in the
        vote
        for Proposal II; ( 2) An
        amendment to the Company’s Articles of Incorporation (the "Articles of Incorporation") whereby the Articles of Incorporation will
        be
        amended to provide for an authorized capital of 75,000,000 shares of Common
        Stock $0.001  par
        value. In addition, the amendment will eliminate the 50,000,000 authorized
        shares of Preferred Stock (“Proposal III”). 7,116,918 shares were voted for
        Proposal III, 12,400 shares
        were voted **** against
        and 3,100 shares
        were abstained. No "broker non-votes" participated in the vote for Proposal
        III;
        (3) Any and all issuances of warrants to Mr. Wade Spooner, pursuant to Section
        3.4 (“ Acquisition Bonus”) of that certain Employment Agreement dated March 10, 2005, between the
        Company’s wholly-owned subsidiary, Xfone USA, Inc. and Mr. Wade Spooner
        (“Proposal IV”). 7,117,868 shares
        were voted for Proposal IV, 11,000 shares
        were voted **** against
        and 3,550 shares
        were abstained. No "broker non-votes" participated in the vote for Proposal
        IV;
        (4) Any and all issuances of warrants to Mr. Ted Parsons, pursuant to Section
        3.4 (“Acquisition Bonus”) of that certain Employment Agreement dated March 10,
        2005, between the Company’s wholly-owned subsidiary, Xfone USA, Inc. and Mr. Ted
        Parsons (“Proposal V”). 7,118,868 shares
        were voted for Proposal V, 11,000 shareholders
        voted **** against
        and 2,550 shareholders abstained. No "broker non-votes" participated in the vote for
        Proposal V.
 
 -19-
 **PART
        II**
 
 ITEM
        5. MARKET FOR COMMON EQUITY AND RELATED STOCKHOLDER MATTERS.
  **Market
        Information**
 
 As
        of
        June 8, 2005, our common stock is quoted and traded under the symbol “XFN” on
        the American Stock Exchange (“AMEX“). As of July 24, 2006, our common stock is
        also quoted and traded under the symbol “XFN” on the Tel Aviv Stock Exchange
        (“TASE”).
 
 As
        of
        December 31, 2006, the closing price of our common stock was $2.89 (AMEX)
        /
        11.74 NIS (TASE). As of March 29, 2007, the closing price of our common stock
        was $2.48 (AMEX)
        /
        10.58 NIS
        (TASE).
 
 There
        is
        a limited trading market for our common stock. There is no assurance that
        a
        regular trading market for our common stock will develop or if developed
        that it
        will be sustained. A shareholder in all likelihood, therefore, may not be
        able
        to resell his securities should he or she desire to do so when eligible for
        public resale. Furthermore, it is unlikely that a lending institution will
        accept our securities as pledged collateral for loans unless a regular trading
        market develops.
 
 Below
        is
        the market information pertaining to the range of the high and low bid
        information of our common stock for each quarter since year 2002. The quotations
        reflect inter-dealer prices, without retail mark-up, mark-down or commission
        and
        may not represent actual transactions.
 
 **Period**
              
              **Low**
              
              **High****2006**Fourth
                  Quarter
              
              $
              2.26
              
              $
              2.90Third
                  Quarter
              
              $
              2.18
              
              $
              2.85Second
                  Quarter
              
              $
              2.65
              
              $
              3.01First
                  Quarter
              
              $
              2.68
              
              $
              3.84**2005**Fourth
                  Quarter
              
              $
              2.30
              
              $
              3.09Third
                  Quarter
              
              $
              2.90
              
              $
              3.40Second
                  Quarter
              
              $
              2.80
              
              $
              3.30First
                  Quarter
              
              $
              2.50
              
              $
              4.29**2004**Fourth
                  Quarter
              
              $
              1.95
              
              $
              3.35Third
                  Quarter
              
              $
              2.90
              
              $
              3.75Second
                  Quarter
              
              $
              2.80
              
              $
              3.90First
                  Quarter
              
              $
              3.35
              
              $
              5.75**2003**Fourth
                  Quarter
              
              $
              3.15
              
              $
              6.25Third
                  Quarter
              
              $
              0.51
              
              $
              3.60Second
                  Quarter
              
              $
              0.30
              
              $
              0.64First
                  Quarter
              
              $
              0.30
              
              $
              0.77**2002**Fourth
                  Quarter
              
              $
              0.66
              
              $
              1.45Third
                  Quarter
              
              $
              0.70
              
              $
              1.33Second
                  Quarter
              
              $
              0.70
              
              $
              3.65First
                  Quarter
              
              $
              0.00
              
              $
              0.00
  The
        source of the above information is http://www.amex.com.
 -20-
 **Holders**
  On
        March
        29, 2007, there were 345 holders of record of our common stock.
  **Dividends**
 
 No
        cash
        dividend was declared in 2005 and 2006.
 
 On
        September 27, 2005, a Securities Purchase Agreement (the "Securities Purchase
        Agreement") was entered for a $2,000,000 financial transaction by and among
        the
        Company, Xfone USA, Inc., eXpeTel Communications, Inc., Gulf Coast Utilities,
        Inc. and Laurus Master Fund, Ltd. The investment, which took the form of
        a
        Convertible Term Note secured by the Company's United States assets, has
        a 3
        year term and bears interest at a rate equal to prime plus 1.5% per annum.
        The
        Term Note is convertible, under certain conditions, into shares of the Company's
        common stock at an initial conversion price equal to $3.48 per share. In
        conjunction with this financial transaction, we issued to Laurus Master Fund
        157,500 warrants which are exercisable at $3.80 per share for a period of
        five
        years. The closing of the financial transaction was on September 28, 2005.
        The
        Securities Purchase Agreement provides that for so long as twenty five percent
        (25%) of the principal amount of the Term Note is outstanding, the Company,
        without the prior written consent of Laurus Master Fund, shall not, and shall
        not permit any of the Subsidiaries (as defined in the Securities Purchase
        Agreement) to directly or indirectly declare or pay any dividends, other
        than
        dividends paid to the Company or any of its wholly-owned
        Subsidiaries.
 
 **Securities
        Authorized For Issuance Under Equity Compensation Plans**
 
 Equity
        Compensation Plan Information
 As
        of December 31, 2006
 
 **Plan
                  category**
              **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 the
                  plan**(a)
              (b)
              (c)Equity
                  compensation plans approved by security holders
              5,350,000*
              $3.50
              150,000*Total
              5,350,000
              $3.50
              150,000
  * On
        November 24, 2004, our board of directors approved and adopted the principal
        items forming our 2004 Stock Option Plan (the “2004 Plan”) which is designated
        for the benefit of employees, officers, directors, consultants and
        subcontractors of the Company including its subsidiaries. On November 1,
        2005,
        the 2004 Plan was approved by our board of directors, and on March 13, 2006
        by
        our shareholders, at a Special Meeting. Under the 2004 Plan, the Plan
        Administrator is authorized to grant Options to acquire up to a total of
        5,500,000 shares of common stock.
 
 -21-
 **Recent
        Sales of Unregistered Securities**
 
 On
        March
        8, 2006, due to the termination of Nick Matsoukis’ employment, his 50,000
        options (which were granted under the Company’s 2004 Stock Option Plan) were
        terminated.
 
 On
        March
        28, 2006, we issued to Gersten Savage, LLP 755 restricted shares of our common
        stock as consideration for legal services. We relied upon the exemption from
        registration provided by Section 4(2) of the Act. We believed that the exemption
        was available because: (i) the offer and sale of the securities did not involve
        a public offering or an underwriter; (ii) the shares issued were restricted
        as to transfer and the certificates representing the shares were marked with
        a
        restrictive legend; (iii) the investor represented that he was sophisticated
        enough to evaluate the merits of his investment; and (iv) the investor had
        a
        preexisting relationship with the Company's President and Chief Executive
        Officer, Mr. Guy Nissenson.
 
 On
        March
        28, 2006, we issued to Oberon Securities, LLC 30,144 shares of our common
        stock
        pursuant to that certain Letter Agreement dated November 15, 2005, between
        the
        Company and Oberon Securities. We relied upon the exemption from registration
        provided by Section 4(2) of the Act. We believed that the exemption was
        available because: (i) the offer and sale of the securities did not involve
        a
        public offering or an underwriter; (ii) the shares issued were restricted
        as to transfer and the certificates representing the shares were marked with
        a
        restrictive legend; (iii) the investor represented that he was sophisticated
        enough to evaluate the merits of his investment; and (iv) the investor had
        a
        preexisting relationship with the Company's President and Chief Executive
        Officer, Mr. Guy Nissenson.
 
 On
        March
        31, 2006, and in conjunction with a Letter Agreement dated October 10, 2005
        with
        MCG Capital Corporation, a major creditor of I-55 Internet Services, we issued
        to MCG Capital 667,998 shares of our common stock, valued at fair value of
        $2,010,006, in
        return
        for retiring its loan with I-55 Internet Services .
        We
        relied upon the exemption from registration provided by Section 4(2) of the
        Act.
        We believed that the exemption was available because: (i) the offer and
        sale of the securities did not involve a public offering or an
        underwriter; (ii) the shares issued were restricted as to transfer and
        the certificate representing the shares was marked with a restrictive
        legend; and (iii) the investor was provided with a Proxy
        Statement which enabled him to evaluate the merits of his
        investment.
 
 On
        April
        6, 2006, we sold 80,000 restricted shares of our common stock, 20,000 warrants
        exercisable at $3.00 per share, and 20,000 warrants exercisable at $3.25
        per
        share to Mercantile Discount-Provident Funds. The warrants are exercisable
        for a
        period of 5 years. We relied upon the exemption from registration provided
        by
        Section 4(2) of the Act. We believed that the exemption was available because:
        (i) the offer and sale of the securities did not involve a public offering
        or an
        underwriter; (ii) the shares issued were restricted as to transfer and the
        certificates representing the securities were marked with a restrictive legend;
        (iii) the investor represented that he was sophisticated enough to evaluate
        the
        merits of his investment; and (iv) the investor had a preexisting relationship
        with the Company's President and Chief Executive Officer, Mr. Guy
        Nissenson.
 
 On
        April
        6, 2006, we sold 90,000 restricted shares of our common stock, 22,500 warrants
        exercisable at $3.00 per share, and 22,500 warrants exercisable at $3.25
        per
        share to Hadar Insurance Company Ltd. The warrants are exercisable for a
        period
        of 5 years. We relied upon the exemption from registration provided by Section
        4(2) of the Act. We believed that the exemption was available because: (i)
        the
        offer and sale of the securities did not involve a public offering or an
        underwriter; (ii) the shares issued were restricted as to transfer and the
        certificates representing the securities were marked with a restrictive legend;
        (iii) the investor represented that he was sophisticated enough to evaluate
        the
        merits of his investment; and (iv) the investor had a preexisting relationship
        with the Company's President and Chief Executive Officer, Mr. Guy
        Nissenson.
 
 -22-
 On
        April
        6, 2006, we sold 110,000 restricted shares of our common stock, 27,500 warrants
        exercisable at $3.00 per share, and 27,500 warrants exercisable at $3.25
        per
        share to the Israeli Phoenix Assurance Company Ltd. The warrants are exercisable
        for a period of 5 years. We relied upon the exemption from registration provided
        by Section 4(2) of the Act. We believed that the exemption was available
        because: (i) the offer and sale of the securities did not involve a public
        offering or an underwriter; (ii) the shares issued were restricted as to
        transfer and the certificates representing the securities were marked with
        a
        restrictive legend; (iii) the investor represented that he was sophisticated
        enough to evaluate the merits of his investment; and (iv) the investor had
        a
        preexisting relationship with the Company's President and Chief Executive
        Officer, Mr. Guy Nissenson.
 
 On
        April
        6, 2006, we sold 44,000 restricted shares of our common stock, 11,000 warrants
        exercisable at $3.00 per share, and 11,000 warrants exercisable at $3.25
        per
        share to Gaon Gemel Ltd. The warrants are exercisable for a period of 5 years.
        We relied upon the exemption from registration provided by Section 4(2) of
        the
        Act. We believed that the exemption was available because: (i) the offer
        and
        sale of the securities did not involve a public offering or an underwriter;
        (ii)
        the shares issued were restricted as to transfer and the certificates
        representing the securities were marked with a restrictive legend; (iii)
        the
        investor represented that he was sophisticated enough to evaluate the merits
        of
        his investment; and (iv) the investor had a preexisting relationship with
        the
        Company's President and Chief Executive Officer, Mr. Guy Nissenson.
 
 On
        May
        10, 2006, we issued in exchange for services 25,000 warrants exercisable
        at
        $4.00 per share, 25,000 warrants exercisable at $4.50 per share, 25,000 warrants
        exercisable at $5.00 per share, and 25,000 warrants exercisable at $5.50
        per
        share to Elite Financial Communications Group, LLC. The term of the warrants
        shall expire at the later of: (i) 36 months from the day of grant; (ii) 6
        months
        after the underlying shares are effective. In the event we elect early
        termination of our agreement with Elite Financial Communications Group, then
        any
        warrants that have not yet reached their vesting date will be deemed null
        and
        void. We relied upon the exemption from registration provided by Section
        4(2) of
        the Act. We believed that the exemption was available because: (i) the offer
        and
        sale of the securities did not involve a public offering or an underwriter;
        (ii)
        the certificates representing the warrants were marked with a restrictive
        legend; (iii) the investor represented that he was sophisticated enough to
        evaluate the merits of his investment; and (iv) the investor had a preexisting
        relationship with the Company's President and Chief Executive Officer, Mr.
        Guy
        Nissenson.
 
 During
        May 2006, and in conjunction with a January 10, 2006 Asset Purchase Agreement
        by
        and among Xfone USA, Inc. and Canufly.net, Inc., we issued to the following
        shareholders of Canufly.net 33,768 restricted shares of our common stock
        and
        24,053 warrants, exercisable at $2.98 per share for a period of five years:
        J.
        Michael Nassour - 7,734 shares and 5,509 warrants; Ann S. Nassour - 1,933
        shares
        and 1,377 warrants; John A. Nassour - 1,933 shares and 1,377 warrants; Mike
        A.
        Gatti - 1,547 shares 1,102 warrants; Clara Booth Pinkston - 1,289 shares
        and 918
        warrants; Robert Portwood - 1,933 shares and 1,377 warrants; Beverly Roggenkamp
        - 644 shares and 459 warrants; Ashley Zweifel - 644 shares and 459 warrants;
        Larry Roggenkamp - 644 shares and 459 warrants; Becky & Grey Cobb - 1,289
        shares and 918 warrants; Sharon E. & Norman R. Francingues, Jr. - 1,289
        shares and 918 warrants; Salena & Mickey Greenlee - 1,289 shares and 918
        warrants; Dawn & Clifton Burroughs, Jr. - 1,289 shares and 918 warrants;
        Mynette & Harry Gibson - 1,289 shares and 918 warrants; Jimmy Boyd - 644
        shares and 459 warrants; Tracey Boyd - 644 shares and 459 warrants; Wayne
        M.
        Pitre - 1,289 shares and 918 warrants; Nancy H. & Robert C. Clingan, JTWROS
        - 1,289 shares and 918 warrants; Dana Allen - 1,289 shares and 918 warrants;
        Betty Joe & Hugh A. Allen, Sr. JTWROS - 1,289 shares and 918 warrants;
        Anthony Bruce McCall - 1,289 shares and 918 warrants; Travis Wayne Vance
        - 1,289
        shares and 918 warrants. We relied upon the exemption from registration provided
        by Section 4(2) of the Act. We believed that the exemption was available
        because: (i) the offer and sale of the securities did not involve a public
        offering or an underwriter; and (ii) the shares issued were restricted
        as to transfer and the certificates representing the securities were marked
        with
        a restrictive legend.
 
 -23-
 During
        May 2006, and in conjunction with the merger that consummated on March 31,
        2006,
        we issued to the following shareholders of I-55 Internet Services, Inc. 789,863
        restricted shares of our common stock valued at $2,380,178 and 603,939 warrants
        valued at $1,284,722, based on the Black Scholes option-pricing model: Brian
        Acosta - 53,008 shares and 40,531 warrants; Trustmark National Bank as Escrow
        Agent for Brian Acosta - 53,008 shares and 40,530 warrants; Hunter McAllister
        -
        26,504 shares and 20,265 warrants; Trustmark National Bank as Escrow Agent
        for
        Hunter McAllister - 26,504 shares and 20,265 warrants; Terry Cooper - 79,512
        shares and 60,796 warrants; Trustmark National Bank as Escrow Agent for Terry
        Cooper - 79,511 shares and 60,795 warrants; Brian Harper - 79,512 shares
        and
        60,796 warrants; Trustmark National Bank as Escrow Agent for Brian Harper
        -
        79,511 shares and 60,795 warrants; Danny Acosta - 6,626 shares and 5,067
        warrants; Trustmark National Bank as Escrow Agent for Danny Acosta - 6,626
        shares and 5,066 warrants; Jason Hunt - 1,325 shares and 1,014 warrants;
        Trustmark National Bank as Escrow Agent for Jason Hunt - 1,325 shares and
        1,013
        warrants; Kevin Hunt - 1,325 shares and 1,014 warrants; Trustmark National
        Bank
        as Escrow Agent for Kevin Hunt - 1,325 shares and 1,013 warrants; C.R. Miller,
        JR. - 14,842 shares and 11, 349 warrants; Trustmark National Bank as Escrow
        Agent for C.R. Miller, JR. - 14,842 shares and 11, 348 warrants; Wayne Cooper
        -
        26,504 shares and 20,265 warrants; Trustmark National Bank as Escrow Agent
        for
        Wayne Cooper - 26,504 shares and 20,265 warrants; Chad Soileau - 2,651 shares
        and 2,027 warrants; Trustmark National Bank as Escrow Agent for Chad Soileau
        -
        2,650 shares and 2,026 warrants; Dennis Moss - 1,325 shares and 1,014 warrants;
        Trustmark National Bank as Escrow Agent for Dennis Moss - 1,325 shares and
        1,013
        warrants; Randy Moss - 1,325 shares and 1,014 warrants; Trustmark National
        Bank
        as Escrow Agent for Randy Moss - 1,325 shares and 1,013 warrants; MCG Capital
        Corporation - 100,474 shares and 76,823 warrants; Trustmark National Bank
        as
        Escrow Agent for MCG Capital Corporation - 100,474 shares and 76,822 warrants.
        The warrants are exercisable on a one to one basis into restricted shares
        of our
        common stock at an exercise price of $3.31 per share, and have a term of
        five
        years. We relied upon the exemption from registration provided by Section
        4(2)
        of the Act and Regulation D promulgated thereunder. We believed that the
        exemption was available because: (i) the offer and sale of the securities
        did
        not involve a public offering or an underwriter; (ii) there were less than
        35 non-accredited purchasers; (iii) the shares issued were restricted as to
        transfer and the certificates representing the securities were marked with
        a
        restrictive legend; and (iv) the investors were provided with a Proxy
        Statement containing the information required by Rule 502 of Regulation D
        which enabled them to evaluate the merits of their
        investment.
 
 During
        May 2006, and in conjunction with the merger that consummated on March 31,
        2006,
        we issued to the sole shareholder of I-55 Telecommunications, LLC. 223,702
        restricted shares of our common stock valued at $671,687 and 79,029 warrants
        valued at $166,667, based on the Black Scholes option-pricing model with
        90%
        volatility. The shares and warrants were issued as follows: Randall Wade
        James
        Tricou - 111,851 shares and 39,515 warrants; Trustmark National Bank as Escrow
        Agent for Randall Wade James Tricou - 111,851 shares and 39,514 warrants.
        The
        warrants are exercisable on a one to one basis into restricted shares of
        our
        common stock at an exercise price of $3.38 per share, and have a term of
        five
        years. We relied upon the exemption from registration provided by Section
        4(2)
        of the Act and Regulation D promulgated thereunder. We believed that the
        exemption was available because: (i) the offer and sale of the securities
        did
        not involve a public offering or an underwriter; (ii) there were less than
        35 non-accredited purchasers; (iii) the shares issued were restricted as to
        transfer and the certificates representing the securities were marked with
        a
        restrictive legend; and (iv) the investors were provided with a Proxy
        Statement containing the information required by Rule 502 of Regulation D
        which enabled them to evaluate the merits of their
        investment.
 
 During
        May 2006, and in conjunction with Agreements to Purchase Promissory Notes
        dated
        October 31, 2005 / February 3, 2006 with certain creditors of I-55
        Telecommunications, LLC, we issued to the following creditors of I-55
        Telecommunications 163,933 restricted shares of our common stock and 81,968
        warrants at a total value of $492,220, in
        return
        for retiring their individual loans with I-55 Telecommunications :
        Randall
        Wade James Tricou - 84,359 shares and 42,180 warrants; Rene Tricou - Tricou
        Construction - 25,986 shares and 12,993 warrants; Rene Tricou - Bon Aire
        Estates
        - 20,019 shares and 10,010 warrants; Rene Tricou - Bon Aire Utility - 7,997
        shares and 3,999 warrants; Danny Acosta - 25,572 shares and 12,786 warrants.
        The
        warrants are exercisable on a one to one basis into restricted shares of
        our
        common stock at an exercise price of $3.38 per share, and have a term of
        five
        years. We relied upon the exemption from registration provided by Section
        4(2)
        of the Act. We believed that the exemption was available because: (i) the
        offer and sale of the securities did not involve a public offering or an
        underwriter; and (ii) the shares issued were restricted as to transfer
        and the certificates representing the securities were marked with a restrictive
        legend.
 
 -24-
 On
        May
        30, 2006, we issued 2,736 restricted shares of our common stock to Elite
        Financial Communications Group, LLC in exchange for services. We relied upon
        the
        exemption from registration provided by Section 4(2) of the Act. We believed
        that the exemption was available because: (i) the offer and sale of the
        securities did not involve a public offering or an underwriter; (ii)
        the shares issued were restricted as to transfer and the certificate
        representing the shares was marked with a restrictive legend; (iii) the investor
        represented that he was sophisticated enough to evaluate the merits of his
        investment; and (iv) the investor had a preexisting relationship with the
        Company's President and Chief Executive Officer, Mr. Guy Nissenson.
 
 On
        June
        28, 2006, we cancelled 5,000 restricted shares of our common stock which
        were
        issued in 2000 to Ofer Weisglass. The shares were issued to Mr. Weisglass
        in
        return for services; however Mr. Weisglass failed to provide the services
        to the
        Company.
 
 On
        July 3
        2006, we issued to Preiskel & Co LLP 5,236 restricted shares of our common
        stock as consideration for legal services. We relied upon the exemption from
        registration provided by Section 4(2) of the Act. We believed that the exemption
        was available because: (i) the offer and sale of the securities did not involve
        a public offering or an underwriter; (ii) the shares issued were restricted
        as to transfer and the certificates representing the shares were marked with
        a
        restrictive legend; (iii) the investor represented that he was sophisticated
        enough to evaluate the merits of his investment; and (iv) the investor had
        a
        preexisting relationship with the Company's President and Chief Executive
        Officer, Mr. Guy Nissenson.
 
 On
        July
        5, 2006, and in conjunction with the acquisition that was completed on July
        3,
        2006, we issued to the shareholders of Equitalk.co.uk Limited a total of
        402,192
        restricted shares of our common stock and a total of 281,872 warrants exercisable at
        $3.025
        per share for a period of five years. The shares and warrants were issued
        as
        follows: Abel-Smith David - 7,685 shares and 5,386 warrants; Aird James -
        1,443
        shares and 1,011 warrants; Aird Lady M - 2,407 shares and 1,687 warrants;
        Aird
        Rebecca - 965 shares and 676 warrants; Aird Sir John - 16,010 shares and
        11,221
        warrants; Barrett Norma - 4,792 shares and 3,358 warrants; Bell Group Pension
        Scheme - 8,387 shares and 5,878 warrants; Burton Jennifer Susan - 4,792 shares
        and 3,358 warrants; Burton John Mark - 31,673 shares and 22,198 warrants;
        Cantay
        Investments Limited - 3,842 shares and 2,693 warrants; Cary John Lucius Arthur
        -
        15 shares and 11 warrants; Cronk Angela - 8,017 shares and 5,618 warrants;
        Cronk
        JJT - 2,508 shares and 1,757 warrants; Cronk Michael AJ - 27,785 shares and
        19,472 warrants; Dennis Arthur Jeremy Dyke - 2,893 shares and 2,028 warrants;
        Dennis Henry Dyke - 2,893 shares and 2,028 warrants; Fast Guides Limited
        -
        10,980 shares and 7,695 warrants; Guerin Charles & Jennifer - 208 shares and
        146 warrants; Hillyard Pamela - 201 shares and 141 warrants; Jackson John
        BH -
        2,809 shares and 1,968 warrants; Larpent Newton Holdings Limited - 3,194
        shares
        and 2,239 warrants; Meiklejohn Simon Donald - 8,719 shares and 6,110 warrants;
        Mint House Nominees Limited - 5,293 shares and 3,710 warrants; Nowshadi Farshid
        & Maria - 46 shares and 32 warrants; Omnicom Limited - 3,356 shares and
        2,352 warrants; Oxford Technology 2 Venture Capital Trust plc - 80,715 shares
        and 56,568 warrants; Oxford Technology 3 Venture Capital Trust plc - 53,972
        shares and 37,826 warrants; Oxford Technology Venture Capital Trust plc -
        21,072
        shares and 14,768 warrants; Phelps Roland - 1,543 shares and 1,081 warrants;
        Price John Duncan - 4,197 shares and 2,942 warrants; Price Jonathan - 6,828
        shares and 4,786 warrants; Price Rachel - 6,828 shares and 4,786 warrants;
        QTP
        (General Partner) Limited - 3,989 shares and 2,796 warrants; Ruane James
        Joseph
        - 31,450 shares and 22,041 warrants; Gill Carol - 478 shares and 335 warrants;
        Vessey Richard - 30,207 shares and 21,170 warrants. We relied upon the exemption
        from registration provided by Section 4(2) of the Act. We believed that the
        exemption was available because: (i) the offer and sale of the securities
        did
        not involve a public offering or an underwriter; and (ii) the shares
        issued were restricted as to transfer and the certificates representing the
        securities were marked with a restrictive legend.
 
 On
        July
        11, 2006, and in conjunction with a March 10, 2005 Employment Agreement between
        Xfone USA, Inc. and Wade Spooner, its President and Chief Executive Officer,
        we
        issued to Mr. Spooner an “Acquisition Bonus” of 32,390 warrants. We were advised
        by AMEX that the approval of the shareholders of the Company is required
        in
        order to allow the issuance and listing of the shares underlying said warrants.
        The required approval was obtained on December 28, 2006. The warrants are
        exercisable on a one to one basis into restricted shares of our common stock
        at
        an exercise price of $3.285, and have a term of five years. These warrants
        do
        not necessarily constitute the entire Aggregate Transaction Consideration
        as
        defined in the Employment Agreement. We relied upon the exemption from
        registration provided by Section 4(2) of the Act. We believed that the exemption
        was available because: (i) the offer and sale of the securities did not involve
        a public offering or an underwriter; (ii) the certificate representing the
        warrants was marked with a restrictive legend.
 -25-
 
 On
        July
        11, 2006, and in conjunction with a March 10, 2005 Employment Agreement between
        Xfone USA, Inc. and Ted Parsons, its Vice President and Chief Marketing Officer,
        we issued to Mr. Parsons an “Acquisition Bonus” of 16,195 warrants. We were
        advised by AMEX that the approval of the shareholders of the Company is required
        in order to allow the issuance and listing of the shares underlying said
        warrants. The required approval was obtained on December 28, 2006. The warrants
        are exercisable on a one to one basis into restricted shares of our common
        stock
        at an exercise price of $3.285, and have a term of five years. These warrants
        do
        not necessarily constitute the entire Aggregate Transaction Consideration
        as
        defined in the Employment Agreement. We relied upon the exemption from
        registration provided by Section 4(2) of the Act. We believed that the exemption
        was available because: (i) the offer and sale of the securities did not involve
        a public offering or an underwriter; (ii) the certificate representing the
        warrants was marked with a restrictive legend.
 
 On
        July
        11, 2006, and in conjunction with a Letter Agreement dated June 15, 2006
        between
        the Company and Oberon Securities, LLC, we issued to Oberon Securities 243,100
        warrants at an exercise price of $2.86 and 37,200 warrants at an exercise
        price
        of $3.34. The warrants are exercisable on a one to one basis into restricted
        shares of our common stock, and have a term of five years. We relied upon
        the
        exemption from registration provided by Section 4(2) of the Act. We believed
        that the exemption was available because: (i) the offer and sale of the
        securities did not involve a public offering or an underwriter; (ii) the
        certificates representing the warrants were marked with a restrictive legend;
        (iii) the investor represented that he was sophisticated enough to evaluate
        the
        merits of his investment; and (iv) the investor had a preexisting relationship
        with the Company's President and Chief Executive Officer, Mr. Guy
        Nissenson.
 
 On
        July
        11, 2006, and in conjunction with a June 19, 2006 Securities Purchase Agreement
        we issued an aggregate of 172,415 warrants as follows: Central Fund for the
        Payment of Severance Pay of the First International Bank of Israel Ltd. -
        27,974
        warrants; Meiron Provident Fund for Self Employed Persons of the First
        International Bank of Israel Ltd. - 26,121 warrants; Atidoth Provident and
        Compensation Fund of the First International Bank of Israel Ltd. - 21,552
        warrants; Tohelet Provident and Compensation Fund of the first International
        Bank of Israel Ltd. - 517 warrants; Mishtalem Funds for Continuing Education
        of
        the First International Bank of Israel Ltd. - A - 27,974 warrants; Keren
        Hashefa Provident and Compensation Fund of the First International Bank of
        Israel Ltd. - 29,828 warrants; Mishtalem Funds for Continuing Education of
        the
        First International Bank of Israel Ltd. - B - 21,552 warrants; Hamelacha
        Provident and Compensation Fund of the First International Bank of Israel
        Ltd. -
        862 warrants; Teuza Provident and Compensation Fund of the First International
        Bank of Israel Ltd. - 12,069 warrants; Kidma Provident Funds Management Company
        Ltd. for Menifa Provident Fund for Bank of Israel Employees - 3,707 warrants;
        Security Pension Fund for Artisans Industrialists and Self Employed Persons
        Ltd.
        - 259 warrants. The warrants are exercisable on a one to one basis into
        restricted shares of our common stock, at an exercise price of $3.40, and
        have a
        term of five years. We relied upon the exemption from registration provided
        by
        Section 4(2) of the Act. We believed that the exemption was available because:
        (i) the offer and sale of the securities did not involve a public offering
        or an
        underwriter; (ii) the certificates representing the warrants were marked
        with a
        restrictive legend; and (iii) the investor represented that he was sophisticated
        enough to evaluate the merits of his investment.
 
 On
        July
        11, 2006, and in conjunction with a July 3, 2006 Service Agreement between
        the
        Company, Swiftnet Limited and John
        Mark
        Burton,  the
        Managing Director of our UK based subsidiaries, Swiftnet Limited and
        Equitalk.co.uk Limited, the
        Company’s Board of Directors approved the grant of 300,000 options, under and
        subject to our 2004 Stock Option Plan, to Mr.
        Burton. The
        options are exercisable on a one to one basis into restricted shares of our
        common stock, at an exercise price of $3.50, and have a term of ten years.
        The
        vesting of the options will be over a period of 4 years as follows: 75,000
        options are vested on July 3, 2007. Thereafter, 18,750 options are vested
        every
        3 months for the following 3 years. We relied upon the exemption from
        registration provided by Section 4(2) of the Act. We believed that the exemption
        was available because the offer and sale of the securities did not involve
        a
        public offering or an underwriter.
 
 On
        August
        17, 2006, due to Arie Czertok's resignation from the Board of Directors,
        his
        25,000 options (which were granted under the Company’s 2004 Stock Option Plan)
        were terminated.
 
 -26-
 On
        September 5, 2006, and in conjunction with a June 19, 2006 Securities Purchase
        Agreement we issued an aggregate of 344,825 restricted shares of common stock
        as
        follows: Central
        Fund for the Payment of Severance Pay of the First International Bank of
        Israel
        Ltd. -
        55,948
        shares; Meiron Provident Fund for Self Employed Persons of the First
        International Bank of Israel Ltd. - 52,241 shares; Atidoth Provident and
        Compensation Fund of the First International Bank of Israel Ltd. - 43,103
        shares; Tohelet Provident and Compensation Fund of the first International
        Bank
        of Israel Ltd. - 1,034 shares; Mishtalem Funds for Continuing Education of
        the
        First International Bank of Israel Ltd. - A - 55,948 shares; Keren
        Hashefa Provident and Compensation Fund of the First International Bank of
        Israel Ltd. - 59,655 shares; Mishtalem Funds for Continuing Education of
        the
        First International Bank of Israel Ltd. - B - 43,103 shares; Hamelacha Provident
        and Compensation Fund of the First International Bank of Israel Ltd. - 1,724
        shares; Teuza Provident and Compensation Fund of the First International
        Bank of
        Israel Ltd. - 24,138 shares; Kidma Provident Funds Management Company Ltd.
        for
        Menifa Provident Fund for Bank of Israel Employees - 7,414 shares; Security
        Pension Fund for Artisans Industrialists and Self Employed Persons Ltd. -
        517
        shares. We relied upon the exemption from registration provided by Section
        4(2)
        of the Act. We believed that the exemption was available because: (i) the
        offer
        and sale of the securities did not involve a public offering or an underwriter;
        (ii) the shares issued were restricted as to transfer and the certificates
        representing the securities were marked with a restrictive legend; and (iii)
        the
        investor represented that he was sophisticated enough to evaluate the merits
        of
        his investment.
 
 On
        September 19, 2006, and in conjunction with a Letter Agreement dated June
        15,
        2006 between the Company and Oberon Securities, LLC, we issued to Oberon
        Securities 90,000 restricted shares of common stock. We relied upon the
        exemption from registration provided by Section 4(2) of the Act. We believed
        that the exemption was available because: (i) the offer and sale of the
        securities did not involve a public offering or an underwriter; (ii)
        the shares issued were restricted as to transfer and the certificates
        representing the securities were marked with a restrictive legend; (iii)
        the
        investor represented that he was sophisticated enough to evaluate the merits
        of
        his investment; and (iv) the investor had a preexisting relationship with
        the
        Company's President and Chief Executive Officer, Mr. Guy Nissenson.
 
 On
        September 19, 2006, and pursuant to the Service Agreement dated December
        6,
        2005, that was terminated on August 28, 2006, we cancelled 64,360 of the
        100,000
        warrants which were issued to Elite Financial Communications Group, LLC on
        May
        10, 2006.
 
 On
        October 30, 2006, the Company’s Board of Directors approved a grant of 25,000
        options to Itzhak Almog under and subject to the Company’s 2004 Stock Option
        Plan. The options were granted according to the following terms: Date of
        Grant -
        October 30, 2006; Option exercise price - $3.50; Vesting Date **-** 12
        months from the Date of Grant; Expiration Date **-** 5 years
        from the Vesting Date. We relied upon the exemption from registration provided
        by Section 4(2) of the Act. We believed that the exemption was available
        because
        the offer and sale of the securities did not involve a public offering or
        an
        underwriter.
 
 On
        November 1, 2006, we issued 6,994 restricted shares of our common stock to
        Elite
        Financial Communications Group, LLC in exchange for services. We relied upon
        the
        exemption from registration provided by Section 4(2) of the Act. We believed
        that the exemption was available because: (i) the offer and sale of the
        securities did not involve a public offering or an underwriter; (ii)
        the shares issued were restricted as to transfer and the certificate
        representing the shares was marked with a restrictive legend; (iii) the investor
        represented that he was sophisticated enough to evaluate the merits of his
        investment; and (iv) the investor had a preexisting relationship with the
        Company's President and Chief Executive Officer, Mr. Guy Nissenson.
 
 On
        November 20, 2006, we issued in exchange for services 36,000 warrants
        exercisable at $3.50 per share, 36,000 warrants exercisable at $4.00 per
        share,
        and 36,000 warrants exercisable at $4.50 per share to Institutional Marketing
        Services, Inc. The warrants have a term of five years. In the event we elect
        early termination of our agreement with Institutional Marketing Services,
        then
        any warrants that have not yet reached their vesting date will be cancelled.
        We
        relied upon the exemption from registration provided by Section 4(2) of the
        Act.
        We believed that the exemption was available because: (i) the offer and sale
        of
        the securities did not involve a public offering or an underwriter; (ii)
        the
        certificates representing the warrants were marked with a restrictive legend;
        and (iii) the investor represented that he was sophisticated enough to evaluate
        the merits of his investment.
 
 -27-
 On
        November 27, 2006, we issued in exchange for services 117,676 warrants
        exercisable at $3.50 per share to Crestview Capital Master, LLC. The warrants
        have a term of five years and shall vest as follows: 29,419 warrants
        immediately, 29,419 warrants on February 10, 2007, 29,419 warrants on May
        10,
        2007, and 29,419 warrants on August 10, 2007. We relied upon the exemption
        from
        registration provided by Section 4(2) of the Act. We believed that the exemption
        was available because: (i) the offer and sale of the securities did not involve
        a public offering or an underwriter; (ii) the certificates representing the
        warrants were marked with a restrictive legend; (iii) the investor represented
        that he was sophisticated enough to evaluate the merits of his investment;
        and
        (iv) the investor had a preexisting relationship with the Company's President
        and Chief Executive Officer, Mr. Guy Nissenson.
 
 On
        December 26, 2006, and in conjunction with a December 25, 2006 oral stock
        purchase agreement, the Company repurchased from Abraham Keinan, its Chairman
        of
        the Board, 100,000 restricted shares of its common stock at a price of $2.70
        per
        share (market price at that day was $2.80 per share). The 100,000 shares
        were
        returned to the Company for cancellation. The Agreement was approved by all
        non-interested members of the Board of Directors, following a review and
        discussion by the Company’s Audit Committee.
 
 ITEM
        6. MANAGEMENT'S DISCUSSION AND ANALYSIS ORPLAN OF
        OPERATION.
 
 ***FORWARD-LOOKING
        STATEMENTS***
 
 *The
        information set forth in Management's Discussion and Analysis of Financial
        Condition and Results of Operations ("MD&A") contains certain
        "forward-looking statements" within the meaning of Section 27A of the Securities
        Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934,
        as
        amended, and the Private Securities Litigation Reform Act of 1995, including,
        among others (i) expected changes in the Company's revenues and profitability,
        (ii) prospective business opportunities and (iii) the Company's strategy
        for
        financing its business. Forward-looking statements are statements other than
        historical information or statements of current condition. Some forward-looking
        statements may be identified by use of terms such as "believes", "anticipates",
        "intends" or "expects". These forward-looking statements relate to the plans,
        objectives and expectations of the Company for future operations. Although
        the
        Company believes that its expectations with respect to the forward-looking
        statements are based upon reasonable assumptions within the bounds of its
        knowledge of its business and operations, in light of the risks and
        uncertainties inherent in all future projections, the inclusion of
        forward-looking statements in this Annual Report should not be regarded as
        a
        representation by the Company or any other person that the objectives or
        plans
        of the Company will be achieved.*
 
 *You
        should read the following discussion and analysis in conjunction with the
        Financial Statements and Notes attached hereto, and the other financial data
        appearing elsewhere in this Annual Report.*
 
 *The
        Company's revenues and results of operations could differ materially from
        those
        projected in the forward-looking statements as a result of numerous factors,
        including, but not limited to, the following: the risk of significant natural
        disaster, the inability of the Company to insure against certain risks,
        inflationary and deflationary conditions and cycles, currency exchange rates,
        changing government regulations domestically and internationally affecting
        our
        products and businesses.*
 
 **OVERVIEW**
 
 Xfone,
        Inc. was incorporated in Nevada, U.S.A. in September 2000. We are a holding
        company providing international voice, video and data communications services
        with operations in the United Kingdom, the United States and Israel offering
        a
        wide range of services, including: local,
        long distance and international telephony services; prepaid and postpaid
        calling
        cards; cellular services; Internet services; messaging services (Email/Fax
        Broadcast, Email2Fax and Cyber-Number); and reselling opportunities .
        We
        serve customers across Europe, Asia, North America, South America, Australia
        and
        Africa. In February 2007, we moved our principal
        executive offices to
        Flowood, Mississippi, sharing executive office space with our wholly owned
        U.S.
        subsidiary, Xfone USA, Inc.
 
 -28-
 On
        October 4, 2000, we acquired Swiftnet Limited which had a business plan to
        provide comprehensive telecommunication services and products by integrating
        new
        and old products, services and ideas through one website. Swiftnet was
        incorporated in 1990 under the laws of the United Kingdom and is headquartered
        in London, England. Until 1999, the main revenues for Swiftnet were derived
        from
        messaging and fax broadcast services. During 2000, Swiftnet shifted its business
        focus and its focus has remained on telephony voice services offering
        comprehensive support packages to resellers and new services. Utilizing
        automation and proprietary software packages, Swiftnet's strategy is to grow
        without the need for heavy investments and with lower expenses for operations
        and registration of new customers.
 
 On
        April
        15, 2004, we established an Israel based subsidiary, Xfone Communication
        Ltd.
        (which changed its name to Xfone 018 Ltd. in March 2005). On July 4, 2004,
        the
        Ministry of Communications of the State of Israel granted Xfone 018 a license
        to
        provide international telecom services in Israel. We started providing services
        in Israel through Xfone 018 as of mid-December 2004. Headquartered in Petach
        Tikva, Israel, Xfone 018 Ltd. is a telecommunications service provider that
        owns
        and operates its own facilities-based telecommunications switching system.
        Xfone
        018 provides residential and business customers with high quality international
        carrier services.
 
 **Mergers,
        Acquisitions and Financings**
 
 On
        May
        28, 2004, we entered into an agreement and Plan of Merger to acquire WS Telecom,
        Inc., a Mississippi corporation, and its two wholly owned subsidiaries, eXpeTel
        Communications, Inc. and Gulf Coast Utilities, Inc., through the merger of
        WS
        Telecom into our wholly owned U.S. subsidiary Xfone USA, Inc. On July 1,
        2004,
        Xfone USA entered into a management agreement with WS Telecom which provided
        that Xfone USA provide management services to WS Telecom pending the
        consummation of the merger. The management agreement provided that all revenues
        generated from WS Telecom business operations would be assigned and transferred
        to Xfone USA. The term of the management agreement commenced on July 1, 2004,
        and continued until the consummation of the merger on March 10, 2005. 
Headquartered in Jackson, Mississippi, Xfone USA, Inc. is an integrated
        telecommunications service provider that owns and operates its own
        facilities-based, telecommunications switching system and network. Xfone
        USA
        provides residential and business customers with high quality local, long
        distance and high-speed broadband Internet services, as well as cable television
        services in certain planned residential communities in Mississippi. Xfone
        USA is
        licensed to provide telecommunications services in Alabama, Florida, Georgia,
        Louisiana and Mississippi. Xfone USA utilizes integrated multi-media offerings
        -
        combining digital voice, data and video services over broadband technologies
        -
        all on one single itemized bill.
 
 On
        August
        18, 2005, we entered into an Agreement and Plan of Merger to acquire I-55
        Internet Services, Inc., a Louisiana corporation (the “I-55 Internet Merger
        Agreement”). On September 13, 2005, we filed a Form 8-K discussing the impact of
        Hurricane Katrina on the transaction contemplated by the I-55 Internet Merger
        Agreement. On October 10, 2005, we entered into a First Amendment to the
        Merger
        Agreement, by and among I-55 Internet Services, Xfone, Inc, Xfone USA, Inc.,
        our
        wholly-owned United States subsidiary and Hunter McAllister and Brian Acosta,
        key employees of I-55 Internet Services, in order to induce Xfone, Inc and
        Xfone
        USA not to terminate the I-55 Internet Merger Agreement due to the material
        adverse effect that Hurricane Katrina has had on the assets and business
        of I-55
        Internet Services. As part of the amendment and since, at that time, the
        merger
        of I-55 Internet Services with and into Xfone USA had not been consummated
        yet,
        in the interim, the parties agreed and entered into on October 11, 2005 a
        Management Agreement (the "I-55 Internet Management Agreement") that provided
        that I-55 Internet Services hired and appointed Xfone USA as manager to be
        responsible for the operation and management of all of I-55 Internet Services
        business operations, including among other things personnel, accounting,
        contracts, policies and budget. In consideration of the management services
        provided under the I-55 Internet Management Agreement, I-55 Internet Services
        assigned and transferred to Xfone USA all revenues generated and expenses
        incurred in the ordinary course of business during the term of the I-55 Internet
        Management Agreement. The term of the I-55 Internet Management Agreement
        commenced on October 11, 2005 and continued until the consummation of the
        merger
        on March 31, 2006.
 
 -29-
 In
        conjunction with the consummation of the merger and in exchange for all of
        the
        capital stock of I-55 Internet Services, we issued a total of 789,863 shares
        of
        our common stock valued at $2,380,178 and 603,939 warrants exercisable for
        a
        period of five years into shares of our common stock, with an exercise price
        of
        $3.31, valued based on the Black Scholes option-pricing model (the "Xfone
        Stock
        and Warrant Consideration"). A portion of the Xfone Stock and Warrant
        Consideration issued at closing was placed in an escrow. The First Amendment
        to
        the Merger Agreement provides for an adjustment to the consideration paid
        based
        on changes in customer billings as determined pursuant to a certain formula
        (the
        "Customer Billing Adjustment Amount"). The Company has determined that the
        Customer Billing Adjustment Amount is $247,965.57 and on March 27, 2007,
        sent a
        claim for this amount against the escrowed portion of the Xfone Stock and
        Warrant Consideration.
 
 In
        conjunction with that certain Letter Agreement dated October 10, 2005 with
        MCG
        Capital Corporation (the "Letter Agreement"), a major creditor of I-55 Internet
        Services, and upon the consummation of the merger on March 31, 2006, we issued
        to MCG Capital 667,998 shares of our common stock, valued at fair value of
        $2,010,006, in return for ** retiring
        its loan with I-55 Internet Services *.*
 
 I-55
        Internet Services provided Internet access and related services, such as
        installation of various networking equipment, website design, hosting and
        other
        Internet access installation services, throughout the Southeastern United
        States
        to individuals and businesses located predominantly in rural markets in
        Louisiana and Mississippi. As a result of the merger with and into Xfone
        USA,
        these services are now available in expanded markets throughout Louisiana
        and
        Mississippi. The Internet service offerings include dial-up, DSL, high speed
        dedicated Internet access, web services, email, the World Wide Web, Internet
        relay chat, file transfer protocol and Usenet news access to both residential
        and business customers. The I-55 Internet Services offerings provided various
        prices and packages that allowed I-55 Internet Services subscribers to customize
        their subscription with services that met customers’ particular requirements.
        Xfone USA now provides bundled services of voice and data (broadband Internet)
        to customers throughout its service areas.
 
 On
        August
        26, 2005, we entered into an Agreement and Plan of Merger to acquire I-55
        Telecommunications, LLC, a Louisiana corporation (the “I-55 Telecom Merger
        Agreement”). On September 13, 2005, we filed a Form 8-K discussing the impact of
        Hurricane Katrina on the transaction contemplated by the I-55 Telecom Merger
        Agreement. In order to demonstrate our intention to continue on with the
        transaction contemplated by the I-55 Telecom Merger Agreement, the parties
        entered into on October 12, 2005 a Management Agreement (the “I-55 Telecom
        Management Agreement”) that provided that I-55 Telecommunications hired and
        appointed Xfone USA as manager to be responsible for the operation and
        management of all of I-55 Telecommunications’ business operations. In
        consideration of the management services provided under the I-55 Telecom
        Management Agreement, I-55 Telecommunications assigned and transferred to
        Xfone
        USA all revenues generated and expenses incurred in the ordinary course of
        business during the term of the I-55 Telecom Management Agreement. The term
        of
        the I-55 Telecom Management Agreement commenced on October 12, 2005 and
        continued until the consummation of the merger on March 31, 2006.
 
 In
        conjunction with the consummation of the merger and in exchange for all of
        the
        capital stock of I-55 Telecommunications, we issued a total of 223,702 shares
        of
        our common stock valued at $671,687 and 79,029 warrants exercisable into
        shares
        of our common stock, with an exercise price of $3.38, valued based on the
        Black
        Scholes option-pricing model.
 
 In
        conjunction with certain Agreements to Purchase Promissory Notes dated October
        31, 2005 / February 3, 2006 with Randall Wade James Tricou; Rene Tricou -
        Tricou
        Construction; Rene Tricou - Bon Aire Estates; Rene Tricou - Bon Aire Utility;
        and Danny Acosta, creditors of I-55 Telecommunications (the "Creditors"),
        and
        upon the consummation of the merger on March 31, 2006, we issued to the
        Creditors an aggregate of 163,933 restricted shares of common stock and an
        aggregate of 81,968 warrants, exercisable at $3.38 per share, at a total
        value
        of $492,220, in return for retiring their individual loans with I-55
        Telecommunications.
 
 -30-
 I-55
        Telecommunications provided voice, data and related services throughout
        Louisiana and Mississippi to both individuals and businesses. Prior to the
        merger with and into Xfone USA, I-55 Telecommunications was a licensed facility
        based CLEC operating in Louisiana and Mississippi with a next generation
        class 5
        carrier switching platform. I-55 Telecommunications provided a complete package
        of local and long distance services to residential and business customers
        across
        both states. As a result of the merger, Xfone USA has now expanded its On-Net
        (facilities) service area, through I-55 Telecommunications, into New Orleans,
        Louisiana and surrounding areas, including Hammond, Louisiana and Baton Rouge,
        Louisiana. Xfone USA is expanding its sales offices to include New Orleans,
        in
        an effort to continue revenue growth and increase market share in the
        revitalized city, as well as into Biloxi, Mississippi, Hammond, Louisiana
        and
        Baton Rouge, Louisiana. Regulations affecting the telecommunications industry
        began in March 2006; conversions of all circuits affected were completed
        in
        April 2006. The competition in secondary markets, such as Jackson, Mississippi,
        Baton Rouge, Louisiana, and Biloxi, Mississippi, as opposed to Tier 1 markets
        such as Atlanta, Georgia, is also rapidly declining due to the removal of
        UNE-P and the decline in the competitive local exchange providers that had
        been
        dependent on UNE-P as their only source for providing competitive local
        telephone services in those markets. This provides for a unique opportunity
        for Xfone USA to gain market share, by utilizing its existing network and
        to
        expand its facilities into these opportunity areas becoming a primary
        alternative to the monopoly Incumbent Local
        Exchange Company.
 
 On
        September 27, 2005, a Securities Purchase Agreement was entered for a $2,000,000
        financial transaction by and among us, Xfone USA, Inc., eXpeTel Communications,
        Inc., Gulf Coast Utilities, Inc. and Laurus Master Fund, Ltd. The investment
        took the form of a convertible term note secured by our United States assets.
        The Term Note has a 3 year term, bears interest at a rate equal to prime
        plus
        1.5% per annum, and is convertible, under certain conditions, into shares
        of our
        common stock at an initial conversion price equal to $3.48 per share. In
        conjunction with the financial transaction, we issued to Laurus Master Fund
        157,500 warrants which are exercisable at $3.80 per share for a period of
        five
        years. The closing of the financial transaction was on September 28, 2005.
        The
        conversion of the Term Note will result in dilution in the percentage of
        common
        stock owned by the company's existing shareholders, although the conversion
        price was in excess of the net tangible book value per share and accordingly
        was
        not economically dilutive.
 
 On
        September 28, 2005, a Securities Purchase Agreement was entered for a $2,212,500
        financial transaction by and among us, Crestview Capital Master, LLC, Burlingame
        Equity Investors, LP, Burlingame Equity Investors II, LP, Burlingame Equity
        Investors (Offshore), Ltd., and Mercantile Discount - Provident Funds. Upon
        the
        closing of the financial transaction on October 31, 2005, we issued to the
        investors an aggregate of 885,000 shares of common stock at a purchase price
        of
        $2.50 per share together with, 221,250 warrants exercisable at $3.00 per
        share
        and 221,250 warrants exercisable at $3.25 per share. The financial transaction
        resulted in dilution in the percentage of common stock owned by the Company's
        existing shareholders, although the price paid was in excess of the net tangible
        book value per share and accordingly was not economically dilutive.
 
 On
        November 23, 2005, a Securities Purchase Agreement was entered for a $810,000
        financial transaction by and among us, Mercantile Discount-Provident Funds,
        Hadar Insurance Company Ltd., the Israeli Phoenix Assurance Company Ltd.,
        and
        Gaon Gemel Ltd. In conjunction with the financial transaction, we issued
        an
        aggregate of 324,000 shares of common stock at a purchase price of $2.50
        per
        share together with 81,000 warrants exercisable at $3.00 per share for a
        period
        of five years and 81,000 warrants exercisable at $3.25 per share for a period
        of
        five years. The financial transaction was closed on April 6, 2006. The financial
        transaction resulted in dilution in the percentage of common stock owned
        by the
        Company's existing shareholders, although the price paid was in excess of
        the
        net tangible book value per share and accordingly was not economically
        dilutive.
 
 On
        January 1, 2006, Xfone USA, Inc., our wholly owned subsidiary, entered into
        an
        Agreement with EBI Comm, Inc. (“EBI”), a privately held Internet Service
        Provider, to purchase the assets of EBI. EBI provided a full range of Internet
        access options for both commercial and residential customers in north
        Mississippi. Based in Columbus, Mississippi, EBI’s services included Dial-up,
        DSL, T1 Dedicated Access and Web Hosting. The customer base, numbering
        approximately 1,500 Internet users, is largely concentrated in the Golden
        Triangle area, which includes Columbus, West Point and Starkville, Mississippi.
        The acquisition was structured as an asset purchase, providing for Xfone
        USA to
        pay EBI total consideration equal to 50% of the monthly collected revenue
        from
        the customer base during the first 12 months, beginning January 2006. Acquired
        assets include the customer base and customer lists, trademarks and all related
        intellectual property, fixed assets and all account receivables. As of December
        31, 2006, we paid $85,699 (£43,746) in consideration of this acquisition. The
        acquisition was not significant from an accounting perspective.
 
 -31-
 On
        January 10, 2006 (effective as of January 1, 2006), Xfone USA, Inc., our
        wholly
        owned subsidiary, entered into an Asset Purchase Agreement with Canufly.net,
        Inc. (“Canufly.net”), an Internet Service Provider based in Vicksburg,
        Mississippi, and its principal shareholder, Mr. Michael Nassour. Canufly.net
        provided residential and business customers with high-speed Internet services
        and utilized the facilities-based network of Xfone USA, as an alternative
        to
        BellSouth, to provide Internet connectivity to its customers. Canufly.net
        also
        provided Internet services through a small wireless application in certain
        areas
        in Vicksburg, Mississippi. The transaction was closed on January 24, 2006.
        We
        agreed to pay a total purchase price of up to $710,633, payable as follows:
        (i)
        $185,000 in cash payable in twelve equal monthly payments, the first installment
        was paid at closing, and as of December 31, 2006, the entire amount was paid
        in
        full and in accordance with the Asset Purchase Agreement; (ii) $255,633 in
        cash,
        paid at closing, to pay off the loan with the B&K Bank; (iii) 33,768
        restricted shares of common stock and 24,053 warrants exercisable at $2.98
        per
        share for a period of five years were issued to the shareholders of Canufly.net
        during May 2006. Following the closing in 2006 and due to the satisfaction
        of
        certain earnout provisions in the Asset Purchase Agreement the Company issued
        in
        March 2007 additional 20,026 restricted shares of common stock and 14,364
        warrants exercisable at $2.98 per share for a period of five years to the
        shareholders of Canufly.net. The acquisition was not significant from an
        accounting perspective.
 
 On
        May
        10, 2006, we, Story Telecom, Inc., Story Telecom Limited, Story Telecom
        (Ireland) Limited, Nir Davison, and Trecastle Holdings Limited, a company
        controlled by Mr. Davison, entered into a Stock Purchase Agreement. Pursuant
        to
        the Stock Purchase Agreement, we increased our ownership interest in Story
        Telecom from 39.2% to 69.6% in a cash transaction valued at $1,200,000. $900,000
        of the total consideration was applied to payables owed by Story Telecom
        to us
        and our subsidiary Swiftnet Limited for back-end telecommunications services.
        The balance of $300,000 was paid to Story Telecom, and is being used as working
        capital. Story Telecom, Inc., a telecommunication service provider, operated
        in
        the United Kingdom through its two wholly owned subsidiaries, Story Telecom
        Limited and Story Telecom (Ireland) Limited (which was dissolved on February
        23,
        2007). Story Telecom operates as a division of our operations in the United
        Kingdom. Founder and CEO of Story Telecom, Nir Davison, remained as Managing
        Director of the division. The stock purchase pursuant to the Stock Purchase
        Agreement was completed on May 16, 2006. The transaction contemplated by
        the
        Stock Purchase Agreement was not significant from an accounting
        perspective.
 
 On
        May
        25, 2006, we and the shareholders of Equitalk.co.uk Limited, a privately
        held
        telephone company based in the United Kingdom ("Equitalk") entered into an
        Agreement relating to the sale and purchase of Equitalk (the "Equitalk
        Agreement"). The Equitalk Agreement provided for us to acquire Equitalk in
        a
        restricted common stock and warrant transaction valued at $1,650,000. The
        acquisition was completed on July 3, 2006, and on that date Equitalk became
        our
        wholly owned subsidiary. In conjunction with the completion of the acquisition
        and in exchange for all of the capital stock of Equitalk, we issued a total
        of
        402,192 restricted shares of our common stock and a total of 281,872 warrants
        exercisable at $3.025 per share for a period of five years. Founded in December
        1999, Equitalk, a VC-financed company, was the first fully automated e-telco
        in
        the United Kingdom. Equitalk provides both residential and business customers
        with low-cost IDA and CPS voice services, broadband and
        teleconferencing.
 
 On
        June
        19, 2006, we entered into a Securities Purchase Agreement to sell to Central
        Fund for the Payment of Severance Pay of the First International Bank of
        Israel
        Ltd.; Meiron Provident Fund for Self Employed Persons of the First International
        Bank of Israel Ltd.; Atidoth Provident and Compensation Fund of the First
        International Bank of Israel Ltd.; Tohelet Provident and Compensation Fund
        of
        the first International Bank of Israel Ltd.; Mishtalem Funds for Continuing
        Education of the First International Bank of Israel Ltd.; Keren
        Hashefa Provident and Compensation Fund of the First International Bank of
        Israel Ltd.; Hamelacha Provident and Compensation Fund of the First
        International Bank of Israel Ltd.; Teuza Provident and Compensation Fund
        of the
        First International Bank of Israel Ltd.; Kidma Provident Funds Management
        Company Ltd. for Menifa Provident Fund for Bank of Israel Employees; and
        Security Pension Fund for Artisans Industrialists and Self Employed Persons
        Ltd.
        an aggregate of 344,825 restricted shares of common stock, at a purchase
        price
        of $2.90 per share, together with an aggregate of 172,415 warrants to purchase
        shares of common stock, at an exercise price of $3.40 per share and with
        a term
        of five years. The financial transaction was closed on September 28, 2006.
        The
        financial transaction resulted in dilution in the percentage of common stock
        owned by the Company's existing shareholders, although the price paid was
        in
        excess of the net tangible book value per share and accordingly was not
        economically dilutive.
 
 -32-
 On
        December 24, 2006, the Company entered into an Agreement to sell to
        Halman-Aldubi Provident Funds Ltd. and Halman-Aldubi Pension Funds Ltd. an
        aggregate of 344,828 restricted shares of its common stock, at a purchase
        price
        of $2.90 per share, together with an aggregate of 172,414 warrants to purchase
        shares of its common stock, at an exercise price of $3.40 per share and with
        a
        term of five years. The financial transaction was closed on February 8, 2007.
        The financial transaction resulted in dilution in the percentage of common
        stock
        owned by the Company's existing shareholders, although the price paid was
        in
        excess of the net tangible book value per share and accordingly was not
        economically dilutive.
 
 **RESULTS
        OF OPERATIONS FOR THE YEAR ENDED DECEMBER 31, 2006**
  **U.K.
        Operations - 2006**
 
 Our
        U.K. subsidiary, Swiftnet Limited operates switching and computer systems
        offering a range of innovate, in-house developed, telecommunications services.
        Swiftnet's strategy is to grow without the need for heavy investments and
        with
        lower operational expenses through the use of
        automation. A comprehensive range of telecommunication services
        and products are sold to directly end-users, through a web
        site integrating all Swiftnet's services. The services are
        mainly telephone related services to customers dialing local and international
        destinations. Swiftnet provides value added services such as fax broadcast,
        email to fax and various other messaging services. Swiftnet also provides
        services for a range of resellers and partners to sell to their customers.
        These
        resellers and partners include Auracall Limited, Story Telecom Limited and
        Equitalk.co.uk Limited. Swiftnet's telecommunications services are
        used by subscribers in the U.K. and worldwide.
 
 Our
        U.K. subsidiary, Equitalk.co.uk Limited is an automated e-telco providing
        post-paid, telecommunications services to customers across the whole of the
        U.K. These customers are typically making calls within the UK. Equitalk's
        strategy is to grow through acquiring customers directly through sales and
        marketing activities.
 
 Our
        U.K. subsidiary, Story Telecom Limited provides international
        calling services through calling cards and special access numbers
        available for use from mobile phone and landlines. Story
        Telecom's strategy is to grow through adding additional products and services
        targeted at customers making international calls.
 
 In
        2006 we had only approximately 0.1 %
        of the market share of the United Kingdom telecommunication market (not
        including mobiles revenues), based on our revenues of $ 17.0
        million (approximately 8.7
        million United Kingdom pounds) during 2006, compared with approximately 19.8 billion U.S. dollars telecommunication market (not including mobiles revenues)
        in the United Kingdom (approximately 10.1 billion United Kingdom pounds).
 
 We
        had four major types of customers in the U.K.: Residential, Commercial,
        Governmental agencies and Resellers. During 2006, there was one U.K.
        customer that accounted for 5% or more of our revenues - Auracall
        Limited (a 32.5% equity investment), represented approximately 7.5% of our
        U.K.
        revenues .
        Our largest non affiliated reseller was WorldNet Global Communications Ltd.
        ("WorldNet") that generated approximately 3% of our U.K. revenues during
        2006.
        We provide WorldNet with the billing system. We anticipate that WorldNet
        will
        continue to contribute approximately the same amount of UKP to our revenues
        in
        year 2007. However, should our agreements involving Auracall or WorldNet
        be
        cancelled, our revenues will be negatively affected.
 
 In
        2006, approximately 44.7% of our revenues were derived from our operations
        in
        the United Kingdom.
 
 -33-
 The
        U.K.
        market is highly competitive and our U.K. operations have a strong track
        record
        in innovation and in staying ahead of the competition. With a good pipeline
        of
        new products and ideas in development, we expect this to continue into
        2007.
 
 During
        2006 some sectors of the U.K. telecommunications market have experienced
        reduced
        competition as a result of large mergers between Carphone Warehouse, Tele2
        and
        Onetel. On-going regulation of the British Telecommunications plc (the incumbent
        monopoly) is designed to produce a level playing field for competition and
        the
        benefits of this are being felt by us.
 
 With
        a
        continued focus on quality and operational efficiencies, we expect to be
        able to
        support continued organic growth in sales and profits during 2007. Growth
        is
        projected to come from products introduced during 2006 as a result of increased
        marketing activity and on-going product improvements.
 
 The
        U.K.
        operations will continue to search for suitable acquisitions in Europe to
        give
        non-organic growth. These will be assessed on their ability to increase
        shareholder value, on criteria which include their EPS contribution, size,
        cost,
        operational fit and quality of management.
 
 **U.S.
        Operations - 2006**
 
 Our
        U.S. subsidiary, Xfone USA, Inc. provides voice, data and related services
        throughout Louisiana and Mississippi to both individuals and businesses.
        Xfone
        USA is a licensed facility based CLEC operating in Louisiana and Mississippi
        with a next generation class 5-carrier switching platform. Xfone USA offers
        a
        complete package of local and long distance services to residential and business
        customers across both states.
 
 In
        2006
        we had approximately 13,500 End-User Switched Access telephone lines in the
        Alabama, Louisiana and Mississippi market through the combination of Xfone
        USA
        and I-55 Telecommunications, LLC or approximately 0.2% of market share. This
        total market size in 2006 represented 5,789,992 telephone lines, with BellSouth
        Telecommunications maintaining its monopoly market share with 4,877,791
        telephone lines or approximately 84% of the market. All CLECs combined made
        up
        the remaining 921,201 telephone lines or approximately 16% of the tri-state
        market, according to the 2006 FCC Report - Trends in Local Telephone
        Competition .
 
 In
        2006, approximately 40.8% of our revenues were derived from our operations
        in
        the United States.
 
 With
        continued cross selling to Xfone USA Customers as well as projected expansion
        into specific targeted wire centers, we expect to continue revenue growth
        and
        increase market share. Regulations affecting the telecommunications industry
        began in March 2006; conversions of all circuits affected were completed
        in
        April 2006. The competition in rural markets is also rapidly declining due
        to
        the removal of UNE-P and the decline in the competitive local exchange providers
        that had been dependent on UNE-P as their only source for providing competitive
        local telephone services in those communities. We believe that this provides
        for
        a unique opportunity for Xfone USA to gain market share, by utilizing its
        existing network and to expand it facilities into these areas becoming a
        primary
        alternative to the monopoly Incumbent Local Exchange Company.
 
 -34-
 The
        overall trend for 2006 showed improving wire line margins in the Business
        markets and slightly improving margins in the Residential (Consumer) markets
        for
        facilities based providers, and this will continue into 2007. Mergers and
        acquisitions continued throughout 2006, primarily with mega mergers, such
        as
        BellSouth and ATT, as a major component for offsetting the line loss felt
        throughout the CLEC industry due to the regulatory changes. The industry
        will
        see continued merger and acquisition activity in 2007 for companies that
        have
        cash and public equity resources, and for the same reasons mentioned for
        2006.
        These transactions will continue to change the landscape in the
        telecommunications industry. Analysts still believe there will be more
        consolidation opportunity over the next two years in both wire line and wireless
        markets.
 
 As
        a result of regulatory changes, the competitive landscape continues to change,
        creating additional opportunity for facilities based competitive carriers
        to
        gain a larger market share in a shorter period of time in certain geographic
        markets, through internal growth (sales) and external growth (mergers and
        acquisitions) due to the continued departure of non-faculties based providers
        through either termination of their business or through
        acquisitions.
 
 Demands
        in the market show the increase of interest in providing Telco TV, VOIP products
        and rapid growth in the Broadband market, heating up competition with the
        Regional Bell Carriers and cable providers. DSL services should continue
        to grow
        due to aggressive pricing with higher speeds becoming the norm delivering
        download speeds of 6 Meg in certain areas.
 
 Xfone
        USA's business plan for 2007 continues to include expansion of market share
        in
        both Business and Residential markets with focus in its specific geographic
        service areas primarily in Mississippi and Louisiana, and in those markets
        where
        the company has deployed its own network and Central Offices (CO's), which
        are
        the highest margin areas. The Business markets will be expanded through Direct
        Sales and Independent sales efforts, while the Residential markets will be
        expanded through radio, direct mail, email marketing and other low cost
        advertising and message delivery opportunities.
 
 The
        Company's business plan in 2007 also includes growth through acquisitions,
        which
        makes sense for several reasons: (i) faster results in achieving large top
        line
        revenue performance; (ii) significant synergies impact from consolidating
        corporate functions; and (iii) relatively easy integration of acquired companies
        because of facilities and network architecture.
 
 Xfone
        USA is also planning for the future and emergence of the "Third Network"
        and has
        scale and availability to implement VoIP, Telco TV, WiFi and WiMax network
        architecture, as they become more viable into the future. However, these
        deployments are currently under much scrutiny and are being implemented in
        larger metropolitan areas such as New York City, Philadelphia, and San
        Francisco.
 
 Xfone
        USA, being a facilities based fully integrated communications carrier, is
        better
        positioned in 2007 to continue to take full advantage of the regulatory
        opportunities afforded to facilities-based providers as a result of the FCC
        TRRO
        ruling in 2005, as well as to take advantage of the consolidation momentum
        started in 2006.
 
 **Israeli
        Operations - 2006**
 
 Since
        the opening of the international telephony market in Israel to competition
        in
        1996, and until 2004, only three companies have provided international telephony
        services in Israel. The market, estimated at that time to be 2 billion minutes
        per year, was more or less equally divided between the three companies. On
        July
        4, 2004, the Ministry of Communications of the State of Israel granted our
        subsidiary, Xfone 018 a license to provide international telecom services
        in
        Israel. We started providing services in Israel through Xfone 018 as of
        mid-December 2004. In 2004, two other new providers of international telephony
        services launched their services. The international telephony market is highly
        competitive and therefore all six providers had to offer low prices in order
        to
        attract or retain subscribers and call minutes.
 
 -35-
 During
        2006, two significant mergers occurred in the Israeli international telephony
        market, leaving only four companies in the competition. The implications
        of
        these two mergers are yet to be noticed. However, we believe that the mergers
        will result in a moderate rates increase which may raise Xfone 018 revenues
        in
        2007. The aforementioned mergers enabled Xfone 018 to execute, as of December
        2006, a new business strategy, according to which it re-priced its services
        by
        distinguishing the rates for its subscribed customers from the rates for
        its
        non-subscribed customers. We believe that the new strategy shall prove to
        be
        successful, and that in 2007 no significant market share will be lost as
        a
        result of its implementation.
 
 In
        2006,
        the Israeli international telephony market was estimated to be 2.6 billion
        minutes. We estimate our market share as of December 31, 2006, as approximately
        5.5% of the Israeli market.
 
 We
        have two major types of customers in Israel: Residential and Commercial.
 
 In
        2006, approximately 14.5% of our revenues were derived from our operations
        in
        Israel.
 
 Xfone
        018 is operating with significantly lower overhead than its three competitors
        in
        the Israeli market by utilizing and building on our previous business models.
        We
        therefore believe that Xfone 018 will increase its market share in the
        international communication market, will generate a greater part of our revenues
        and will have a major contribution to our expected growth.
 
 Our
        primary geographic markets are the United Kingdom, the United States and
        Israel.  However, we serve customers across Europe, Asia, North
        America, South America, Australia and Africa.
 
 **COMPARISON
        OF THE YEARS ENDED DECEMBER 31, 2006 AND 2005**
  **Comparison
        Financial Information Years ended December 31, 2006 and 2005 - Percentage
        of
        Revenues:**
 
 **Year
                  Ended**
                **December
                  31,****2006**
              
              **2005**Revenues
              
              
              100
              %
              
              100
              %Cost
                  of Revenues
              
              
              -58
              %
              
              -66
              %Gross
                  Profit
              
              
              42
              %
              
              34
              %Operating
                  Expenses:Research
                  and Development
              
              
              0
              %
              
              0
              %Marketing
                  and Selling
              
              
              -13
              %
              
              -9
              %General
                  and Administrative
              
              
              -26
              %
              
              -26
              %Total
                  Operating Expenses
              
              
              -39
              %
              
              -35
              %Income
                  before Taxes
              
              
              2
              %
              
              1
              %Net
                  Income
              
              
              2
              %
              
              0
              %
 
 -36-
 **Years
        ended December 31, 2006 and 2005:**
  **Revenues.** Revenues for the year ended December 31, 2006 increased 37% to £19,353,771
        ($37,914,037) from £14,113,748 ($24,346,215) for the same period in 2005. The
        increase in our revenues is primarily attributable to the operation of Xfone
        USA
        and Xfone 018. During year 2006, the revenues of Xfone USA increased 75%
        to
£7,899,033 ($15,474,206) from £4,516,472 ($7,790,914) for the same period in
        2005. Increase in the revenues in the U.S. is mainly a result of acquisitions
        that were completed during 2006. During year 2006, the revenues of Xfone
        018
        increased 92% to £2,801,793 ($5,488,712) from £1,455,511 ($2,510,755) for the
        same period in 2005. The increase in the revenues of Xfone 018 is mainly
        a
        result of expanding its customer base and introducing a new product to the
        market.
  **Cost
        of Revenues**
  Cost
        of revenues consists primarily of traffic time purchased from telephony
        companies and other related charges. Cost of revenues for the year ended
        December 31, 2006, increased 21% to £11,214,394 ($21,968,998) from £9,254,597
        ($15,964,180) for the same period in 2005. The increase in our revenues is
        primarily attributable to the operation of Xfone USA and Xfone 018. Cost
        of
        revenues as a percentage of revenues decreased to approximately 58% in 2006,
        from approximately 66% in 2005, primarily attributable to the growth of sales
        in
        the U.S. were our margins are higher than in the operations in the U.K. and
        Israel.
  **GENERAL
        ANALYSIS**
  **Research
        and Development** .
        Research and development expenses were £23,333 ($45,709). Research and
        development expenses consist of labor costs of our research and development
        manager and other related costs. We estimate that research and development
        expenses will remain in the same level in 2007.
 **Marketing
          and Selling Expenses.**Marketing and selling expenses for the year ended
          December 31, 2006, increased 100% to £2,520,167 ($4,937,007) from £1,262,182
          ($2,177,264) for the same period in 2005. Approximately £200,000 (391,800) of
          the increase is primarily attributable to the operation of Story Telecom
          which
          was not consolidated into our consolidated operations until May 10, 2006.
          Approximately £450,000 ($881,550) of the increase is attributable to marketing
          activities in the U.S. markets, and approximately £600,000 ($1,175,400) is
          attributable to agents’ commission.
  **General
          and Administrative Expenses**. General and administrative expenses for
          the year ended December 31, 2006, increased 39% to £5,067,535 ($9,927,301$) from
£3,635,819 ($6,271,788) for the same period in 2005. The increase is primarily
          attributable to acquisition activity that consummated in 2006.
 **Marketing
        and Selling Expenses.** Marketing
        and selling expenses for the year ended December 31, 2006, increased 100%
        to
£2,520,167 ($4,937,007) from £1,262,182 ($2,177,264) for the same period in
        2005. Approximately £200,000 ($391,800) of the increase are primarily
        attributable to the operation of Story Telecom which was not consolidated
        into
        our consolidated operations. £450,000 ($881,550) is attributable to marketing
        activities in the U.S. markets.
  **General
        and Administrative Expenses** .
        General and administrative expenses for the year ended December 31, 2006,
        increased 39% to £5,067,535 ($9,927,301) from £3,635,819 ($6,271,788) for the
        same period in 2005. The increase is primarily attributable to acquisition
        activity that consummated in 2006.
 
 **Financing
        Expenses.** Financing
        expenses, net, for the year ended December 31, 2006, increased 126% to £276,002
        ($540,668) from £122,338 ($211,033) for the same period in 2005.
  **Net
        Income.** Net
        Income for the year ended December 31, 2006 was £337,262 ($660,696) compared
        with a £26,078 ($44,983) for the same period in 2005.
 
 **Earning
        Per Share.** The
        earning per share of common stock for the year ended December 31, 2006 was
        £0.033.
 
 -37-
 **BALANCE
        SHEET**
 
 **Comparison
        of the balance sheet as of December 31, 2006 and December 31, 2005**
 
 **Current
        Assets** .
        Current assets amounted to £5,253,433 ($10,291,475) as of December 31, 2006, as
        compared with £6,895,592 ($11,594,897) as of December 31, 2005. The decrease in
        the current assets is mainly attributable to the decrease in cash in the
        amount
        of £1,872,977 used mainly for investing activities and repayment of long term
        loans.
  **Loan
        to Shareholder** .
        Loan to the shareholder, Mr. Abraham Keinan, our Chairman of the Board of
        Directors was fully repaid during the year ended December 31, 2006.
 
 **Fixed
        Assets.** Fixed
        assets net, amounted to £2,279,759 ($4,466,048) as of December 31, 2006, as
        compared with £2,051,315 ($3,538,518) as of December 31, 2005.
 
 **Current
        Liabilities.** As
        of December 31, 2006, current liabilities amounted to £5,727,849 ($11,220,856)
        as of December 31, 2006, as compared with £5,423,951 ($9,356,315) as of December
        31, 2005.
 
 **Long-term
        liabilities.** As
        of December 31, 2006, long-term liabilities amounted to £1,191,337 ($2,333,830)
        as of December 31, 2006, as compared with £1,471,211 ($2,537,839) as of December
        31, 2005.
 
 **LIQUIDITY
        AND CAPITAL RESOURCES**
 
 Cash
        as of December 31, 2006, amounted to £621,946 ($1,218,392) as of December 31,
        2006, as compared with £2,494,923 ($4,887,556) as of December 31,
        2005.
  Our
        capital investments are primarily for the purchase of equipment and software
        for
        services that we provide or intend to provide.
 
 Capital
        lease obligations: we are the lessee of switching and other telecom equipment
        under capital leases expiring in various dates from 2007 through 2009; during
        2006 we repaid £89,348 ($175,033) of our capital lease obligations.
 
 The
        minimum future lease payments are as set forth in the table below:
 
 **December
                  31,**
              **December
                  31,******
              ****
              ****
              ****
              ****
              **2006**
              **2006******
              ****
              ****
              ****
              ****
              ****
              **U.S.$**2007
              
              
              
              
              £66,984
              131,2212008
              
              
              
              
              60,248
              118,0262009
              
              
              
              
              16,328
              31,987Total
              
              
              
              
              £143,560
              $281,234
 
 -38-
 We
        shall continue to finance our operations and fund the current commitments
        for
        capital expenditures mainly from the cash provided from operating activities
        and
        from private and/or public placements.
 
 On
        April 18, 2002, Swiftnet Limited received a First Party Charge over
        credit balances by way of security in the sum of £50,000
        ($97,950) plus interest and charges held to the credit of the account due
        or to
        become due from Swiftnet to Bank Leumi (UK) plc on any account
        whatsoever.
 
 On
        February 5, 2005, Swiftnet Limited received credit facilities from Barclays
        Asset Financing in the form of a Confidential Invoice Discounting Agreement
        whereby Barclays would purchase Trade Debtors from Swiftnet in advance of
        customer payments up to a maximum of £750,000 ($1,469,250). As part of the
        Agreement a Debenture charge was raised on all the assets of
        Swiftnet. This Agreement was subsequently terminated and this Debenture
        charge has been cancelled on December 21, 2006.
 
 As
        of April 10, 2003, Equitalk.co.uk Limited, our U.K. based subsidiary since
        July
        2006, has received loan facilities from Barclays Bank plc in the form of
        a
        Government Small Firms Loan Guarantee Scheme Loan Agreement whereby
        Barclays would lend Equitalk £150,000 ($293,850). The loan plus interest is
        repaid monthly and payments are up to date. As part of the agreement a
        Debenture charge was raised on all the assets of Equitalk. The balance as
        of
        December 31, 2006 due is £ 58,333 ($ 114,274 ).
 
 Our
        U.S. subsidiary, Xfone USA, Inc. has certain loan facilities with certain
        liens
        on our fixed assets in the form of installment loan agreements. The total
        aggregate amount of these loans as of December 31, 2006 is £284,197 ($556,742).
 
 Upon
        the assignment of the Interconnection Agreement between WS Telecom, Inc.
        and
        BellSouth Telecommunications, Inc. to Xfone USA, Inc., and consummation of
        the
        merger on March 10, 2005, we, the ultimate parent company and our subsidiaries
        Swiftnet Limited and Xfone 018 Ltd., individually and/or jointly, agreed
        to
        guarantee all undisputed debts owing to BellSouth Telecommunications by Xfone
        USA in accordance with the assigned Interconnection Agreement. The guarantee
        was
        given on December 16, 2004, and became effective upon the consummation of
        the
        merger on March 10, 2005.
 
 Our
        Israel based subsidiary, Xfone 018 Ltd. has received credit facilities from
        Bank
        Hapoalim B.M. in Israel in order to finance its start-up activities. As of
        December 31, 2006, the credit facilities include a revolving credit line
        of
        500,000 NIS (£ 60,600 )
        ($118,715), a short-term credit line of 2,550,000 NIS (£ 309,060 )
        ($ 605,449 ),
        and long-term credit line of 1,290,000 NIS (£ 156,348 )
        ($ 306,286 ).
        In addition, the bank made available to Xfone 018 a long-term facility of
        3,150,000 NIS (£ 381,780 )
        ($ 747,907 )
        to procure equipment. The credit facilities are secured with: (a) a floating
        charge on Xfone 018 assets; (b) a fixed charge on its telecommunication
        equipment (including switches); (c) subordination of a Term Note of $800,000
        (£ 408,372 ).
        This Term Note was executed in July 2004 by Xfone 018 in favor of the Company;
        (d) assignment of rights by way of pledge on the Partner Communications
        Company Ltd. contract, the Cellcom Israel Ltd. contract, the Pelephone
        Communications Ltd. contract, and the credit companies contracts with Xfone
        018;
        (e) personal collateral by Abraham Keinan and Guy Nissenson, which includes
        a
        pledge on 1,000,000 shares of common stock of the Company owned by Mr. Keinan,
        and an undertaking to provide Bank Hapoalim with an additional financial
        guarantee of up to $500,000 (£ 255,232 )
        under certain circumstances. We agreed to indemnify Abraham Keinan and/or
        Guy
        Nissenson on account of any damage and/or loss and/or expense (including
        legal
        expenses) that they may incur in connection with the stock pledge and/or
        any
        other obligation made by them to Bank Hapoalim in connection with the
        collateral; (f) We and Swiftnet Limited issued a Letter of Guarantee, unlimited
        in amount, in favor of the bank, guaranteeing all debt and indebtedness of
        Xfone
        018 towards the bank; (g) subordination of the Minority Partner Loan (as
        defined
        below) in the amount of $400,000 (£ 793,600 ).
        As of December 31, 2006, we have a balance due of $647,557(£330,555) under the credit facility.
 
 -39-
 According
        to an agreement between us, Xfone 018 Ltd. and our 26% minority interest
        partner
        in Xfone 018 (the "Minority Partner"), the Minority Partner provided in 2004
        a
        bank guarantee of 10,000,000 New Israeli Shekels ("NIS") (£1, 206,505) ($2, 366,864 )
        to the Ministry of Communications of the State of Israel which replaced an
        existing bank guarantee given by the Company in connection with Xfone 018’s
        license to provide international telecom services in Israel. As part of the
        agreement, the Company agreed to indemnify the Minority Partner for any damage
        caused to him due to the forfeiture of the bank guarantee with the Ministry
        of
        Communications on account of any act and/or omission of Xfone 018, provided
        that
        the said act or omission is performed against the opinion of the Minority
        Partner or without his knowledge. Further, the Company agreed that if at
        the end
        of the first two years of Xfone 018 business activity, its revenues shall
        be
        less than $2,000,000 (£1, 021,000 ),
        or if it shall cease business activity (at any time), the Company shall secure
        the return of the bank guarantee to the Minority Partner.
 
 According
        to the above-mentioned agreement with the Minority Partner, the Minority
        Partner
        provided in the fourth quarter of year 2004, a shareholder loan of approximately
        $400,000 (£204,200) to Xfone 018 (the "Minority Partner Loan"). The Minority
        Partner Loan is for four years with annual interest of 4% and linkage to
        the
        Israeli consumer price index.
 
 As
        of December 31, 2006, Xfone, Inc. provided to Xfone 018 a shareholder loan
        in an
        aggregate amount of $ 1,150,049 (£ 587,100 ).
 
 As
        of December 31, 2006, our Israeli subsidiary activities were financed by
        the
        shareholders loans and by using 5,888,768 NIS (£714,603) ($1,399,907) of the
        credit facility from Bank Hapoalim.
 
 On
        September 27, 2005, a Securities Purchase Agreement was entered for a $2,000,000
        financial transaction by and among the Company, Xfone USA, Inc., eXpeTel
        Communications, Inc., Gulf Coast Utilities, Inc. and Laurus Master Fund,
        Ltd.
        The investment, which took the form of a convertible term note secured by
        the
        Company’s United States assets, has a 3 year term and bears interest at a rate
        equal to prime plus 1.5% per annum. The Term Note is convertible, under certain
        conditions, into shares of the Company’s common stock at an initial conversion
        price equal to $3.48 per share. In conjunction with the financial transaction,
        we issued to Laurus Master Fund 157,500 warrants which are exercisable at
        $3.80
        per share for a period of five years. The closing of the financing was on
        September 28, 2005. Net proceeds from the financing were mainly used for
        procurement of capital equipment and general working capital purposes for
        the
        Company and Xfone USA, eXpeTel Communications and Gulf Coast Utilities, Inc.
        The
        conversion of the Term Note will result in dilution in the percentage of
        common
        stock owned by the Company’s existing shareholders, although the conversion
        price was in excess of the net tangible book value per share and accordingly
        was
        not economically dilutive. The potential or actual resale of the shares
        underlying the note could have an adverse effect on the price of our common
        stock. The balance as of December 31, 2006 due to Laurus Master Fund is £714,603
        ($1,399,907).
  On
        September 28, 2005, a Securities Purchase Agreement was entered for a $2,212,500
        financial transaction by and among the Company, Crestview Capital Master,
        LLC,
        Burlingame Equity Investors, LP, Burlingame Equity Investors II, LP, Burlingame
        Equity Investors (Offshore), Ltd., and Mercantile Discount - Provident Funds.
        Upon the closing of the financial transaction on October 31, 2005, the Company
        issued to the investors an aggregate of 885,000 shares of common stock at
        a
        purchase price of $2.50 per share together with 221,250 warrants at $3.00
        per
        share for a period of five years and 221,250 warrants at $3.25 per share
        for a
        period of five years. The net proceeds of the financing were used for general
        working capital and/or investment in equipment and/or acquisitions and/or
        business development. The financial transaction resulted in dilution in the
        percentage of common stock owned by the Company’s existing shareholders,
        although the price paid was in excess of the net tangible book value per
        share
        and accordingly was not economically dilutive. The potential or actual resale
        of
        the shares could have an adverse effect on the price of our common
        stock.
  -40-
 On
        November 23, 2005, a Securities Purchase Agreement was entered for a $810,000
        financial transaction by and among the Company, Mercantile Discount-Provident
        Funds, Hadar Insurance Company Ltd., the Israeli Phoenix Assurance Company
        Ltd.,
        and Gaon Gemel Ltd. In conjunction with the financial transaction, the Company
        issued an aggregate of 324,000 shares of common stock at a purchase price
        of
        $2.50 per share together with 81,000 warrants at $3.00 per share for a period
        of
        five years and 81,000 warrants at $3.25 per share for a period of five years.
        The financial transaction was closed on April 6, 2006. The net proceeds of
        the
        financing were used for general working capital and/or investment in equipment
        and/or acquisitions and/or business development. The financial transaction
        resulted in dilution in the percentage of common stock owned by the Company's
        existing shareholders, although the price paid was in excess of the net tangible
        book value per share and accordingly was not economically dilutive. The
        potential or actual resale of the shares could have an adverse effect on
        the
        price of our common stock.
 
 The
        above-mentioned November 23, 2005 financial transaction was approved at a
        Special Meeting of the shareholders of the Company, held on March 13, 2006.
        The
        shareholders approval was required by the American Stock Exchange rules because
        the financial transaction coupled with the Company’s earlier financings
        described herein would constitute more than 20% of the Company’s outstanding
        common stock. The issuance and listing of the related shares of common stock
        of
        the Company were approved by the American Stock Exchange on March 27, 2006.
 
 On
        January 1, 2006, Xfone USA, Inc., our wholly owned subsidiary, entered into
        an
        Agreement with EBI Comm, Inc. (“EBI”), a privately held Internet Service
        Provider, to purchase the assets of EBI. EBI provided a full range of Internet
        access options for both commercial and residential customers in north
        Mississippi. Based in Columbus, Mississippi, EBI’s services included Dial-up,
        DSL, T1 Dedicated Access and Web Hosting. The customer base, numbering
        approximately 1,500 Internet users, is largely concentrated in the Golden
        Triangle area, which includes Columbus, West Point and Starkville, Mississippi.
        The acquisition was structured as an asset purchase, providing for Xfone
        USA to
        pay EBI total consideration equal to 50% of the monthly collected revenue
        from
        the customer base during the first 12 months, beginning January 2006. Acquired
        assets include the customer base and customer lists, trademarks and all related
        intellectual property, fixed assets and all account receivables. As of December
        31, 2006, we paid $85,699 (£43,746) in consideration of this acquisition. The
        acquisition was not significant from an accounting perspective.
 
 On
        January 10, 2006 (effective as of January 1, 2006), Xfone USA, Inc., our
        wholly
        owned subsidiary, entered into an Asset Purchase Agreement with Canufly.net,
        Inc. (“Canufly.net”), an Internet Service Provider based in Vicksburg,
        Mississippi, and its principal shareholder, Mr. Michael Nassour. Canufly.net
        provided residential and business customers with high-speed Internet services
        and utilized the facilities-based network of Xfone USA, as an alternative
        to
        BellSouth, to provide Internet connectivity to its customers. Canufly.net
        also
        provided Internet services through a small wireless application in certain
        areas
        in Vicksburg, Mississippi. The transaction was closed on January 24, 2006.
        We
        agreed to pay a total purchase price of up to $710,633, payable as follows:
        (i)
        $185,000 in cash payable in twelve equal monthly payments, the first installment
        was paid at closing, and as of December 31, 2006, the entire amount was paid
        in
        full and in accordance with the Asset Purchase Agreement; (ii) $255,633 in
        cash,
        paid at closing, to pay off the loan with the B&K Bank; (iii) 33,768
        restricted shares of common stock and 24,053 warrants exercisable at $2.98
        per
        share for a period of five years were issued to the shareholders of Canufly.net
        during May 2006. Following the closing in 2006 and due to the satisfaction
        of
        certain earnout provisions in the Asset Purchase Agreement the Company issued
        on
        March 20 2007, additional 20,026 restricted shares of common stock and 14,364
        warrants exercisable at $2.98 per share for a period of five years to the
        shareholders of Canufly.net. The acquisition was not significant from an
        accounting perspective.
 
 On
        May
        10, 2006, we, Story Telecom, Inc., Story Telecom Limited, Story Telecom
        (Ireland) Limited, Nir Davison, and Trecastle Holdings Limited, a company
        controlled by Mr. Davison, entered into a Stock Purchase Agreement. Pursuant
        to
        the Stock Purchase Agreement, we increased our ownership interest in Story
        Telecom from 39.2% to 69.6% in a cash transaction valued at $1,200,000. $900,000
        of the total consideration was applied to payables owed by Story Telecom
        to us
        and our subsidiary Swiftnet Limited for back-end telecommunications services.
        The balance of $300,000 was paid to Story Telecom, and is being used as working
        capital. Story Telecom, Inc., a telecommunication service provider, operates
        in
        the United Kingdom through its two wholly owned subsidiaries, Story Telecom
        Limited and Story Telecom Limited (which was dissolved on February 23, 2007).
        Story Telecom operates as a division of our operations in the United Kingdom.
        Founder and CEO of Story Telecom, Nir Davison, remained as Managing Director
        of
        the division. The stock purchase pursuant to the Stock Purchase Agreement
        was
        completed on May 16, 2006. The transaction contemplated by the Stock Purchase
        Agreement was not significant from an accounting perspective.
 
 -41-
 Pursuant
        to the above-mentioned Stock Purchase Agreement, at certain dates and provided
        Story Telecom meets certain business and financial covenants, Nir Davison
        and
        Trecastle Holdings Limited shall have the option to sell to the Company all
        of
        their shares in Story Telecom for U.S. $450,000 in cash, or equivalent in
        the
        Company's common stock (to be decided by the Company). In addition, at certain
        dates and provided Story Telecom meets certain business and financial covenants,
        the Company shall have the option to buy from Nir Davison and Trecastle Holdings
        Limited all of their shares in Story Telecom for U.S. $900,000 in cash, or
        equivalent in the Company's common stock (to be decided by the Company).
        The
        Stock Purchase Agreement further provides that upon request from Story Telecom,
        and provided certain conditions are met, the Company shall provide all consents
        necessary to make Story Telecom a publicly traded company through a distribution
        of its shares as a dividend to the shareholders of the Company, or a similar
        transaction. If the Company will fail to provide all necessary consents it
        shall
        have to buy from Nir Davison and Trecastle Holdings Limited all their shares
        of
        Story Telecom for $1,000,000, paid 70% in the Company’s shares, valued at market
        price on an average of 30 trading days, and 30% in cash.
 As
          of May 10, 2006 the Company had a £1,010,030 receivable from Global VOIP
          Services Limited ("Global VOIP"), an Irish company which provided telecom
          services. Story Telecom, Inc. and/or its subsidiaries owed £1,010,030 to Global
          VOIP. In separate agreements, subsequent to the May 10, 2006 Stock
          Purchase Agreement, Story Telecom, Inc and/or its subsidiaries were
          assigned the £1,010,030 receivable and payable on Global VOIP's
          books. The assignment of Global VOIP's receivable and payable resulted in a
          non-cash transaction that removed Globe VOIP's receivable from the books
          of the
          Company and results in inter-company receivables and payables that eliminate
          in
          consolidation. There is no income statement effect to these
          transactions.
  On
        May 25, 2006, the Company and the shareholders of Equitalk.co.uk Limited,
        a
        privately held telephone company based in the United Kingdom ("Equitalk")
        entered into an Agreement relating to the sale and purchase of Equitalk (the
        "Equitalk Agreement"). The Equitalk Agreement provides that we will acquire
        Equitalk in a restricted common stock and warrant transaction valued at
        $1,650,000. The acquisition was completed on July 3, 2006, and on that date
        Equitalk become our wholly owned subsidiary. In conjunction with the completion
        of the acquisition and in exchange for all of the capital stock of Equitalk,
        the
        Company issued a total of 402,192 restricted shares of our common stock and
        a
        total of 281,872 warrants exercisable at $3.025 per share for a period of
        five
        years. Founded in December 1999, Equitalk, a VC-financed company, was the
        first
        fully automated e-telco in the United Kingdom. Equitalk provides both
        residential and business customers with low-cost IDA and CPS voice services,
        broadband and teleconferencing.
 
 On
        June 19, 2006, we entered into a Securities Purchase Agreement to sell to
        Central Fund for the Payment of Severance Pay of the First International
        Bank of
        Israel Ltd.; Meiron Provident Fund for Self Employed Persons of the First
        International Bank of Israel Ltd; Atidoth Provident and Compensation Fund
        of the
        First International Bank of Israel Ltd; Tohelet Provident and Compensation
        Fund
        of the first International Bank of Israel Ltd.; Mishtalem Funds for Continuing
        Education of the First International Bank of Israel Ltd; Keren
        Hashefa Provident and Compensation Fund of the First International Bank of
        Israel Ltd; Hamelacha Provident and Compensation Fund of the First International
        Bank of Israel Ltd; Teuza Provident and Compensation Fund of the First
        International Bank of Israel Ltd; Kidma Provident Funds Management Company
        Ltd,
        for Menifa Provident Fund for Bank of Israel Employees; and Security Pension
        Fund for Artisans Industrialists and Self Employed Persons Ltd. an aggregate
        of
        344,825 restricted shares of its common stock, at a purchase price of $2.90
        per
        share, together with an aggregate of 172,415 warrants to purchase shares
        of its
        common stock, at an exercise price of $3.40 per share and with a term of
        five
        years. The financial transaction was closed on September 28, 2006. The net
        proceeds of the financial transaction are being used for general working
        capital
        and/or investment in equipment and/or acquisition and/or business development.
        The financial transaction resulted in dilution in the percentage of common
        stock
        owned by our existing shareholders, although the price paid was in excess
        of the
        net tangible book value per share and accordingly was not economically dilutive.
        The potential or actual resale of the shares could have an adverse effect
        on the
        price of our common stock.
 
 On
        December 24, 2006, the Company entered into an Agreement to sell to
        Halman-Aldubi Provident Funds Ltd. and Halman-Aldubi Pension Funds Ltd. an
        aggregate of 344,828 restricted shares of its common stock, at a purchase
        price
        of $2.90 per share, together with an aggregate of 172,414 warrants to purchase
        shares of its common stock, at an exercise price of $3.40 per share and with
        a
        term of five years. The financial transaction was closed on February 8, 2007.
        The net proceeds of the financial transaction are being used for general
        working
        capital and/or investment in equipment and/or acquisition and/or business
        development. The financial transaction resulted in dilution in the percentage
        of
        common stock owned by the Company's existing shareholders, although the price
        paid was in excess of the net tangible book value per share and accordingly
        was
        not economically dilutive. The potential or actual resale of the shares could
        have an adverse effect on the price of our common stock.
 
 -42-
 As
        a result of the September 27, 2005, September 28, 2005, November 23, 2005,
        June
        19, 2006 and December 24, 2006 financial transactions described above (the
        "Financial Transactions"), the Company increased the amount of shares
        outstanding resulting in a dilution in the percentage of common stock owned by
        the Company’s existing stockholders, although the price paid was in excess of
        the net tangible book value per share and accordingly was not economically
        dilutive. In addition, as a result of the issuance and registration of shares
        pursuant to the Financial Transactions, a substantial number of our shares
        of
        common stock become available for immediate resale, which could have an adverse
        effect on the price of our common stock. In the event that the sale of such
        shares results in a decline in our stock price it may cause other shareholders
        to sell their shares or even engage in short sales of the Company's common
        stock
        which could cause the price to further decline. Any such decreases in the
        price
        of our common stock may cause stockholders to lose some or all of their
        investment. To the extent any of the investors in the Financial Transactions
        exercise any of their warrants, and then resell the shares of common stock
        issued to them upon such exercise, the price of our common stock may decrease
        even further due to the additional shares of common stock in the market.
        The
        exercise of the warrants and the conversion of the secured convertible note
        into
        common stock will substantially dilute the percentage of common stock owned
        by
        existing stockholders and will likely have a negative affect on the market
        price
        of our common stock. We lack control over the timing of any exercise or the
        number of shares offered or sold.
 
 On
        September 27, 2006, a Shareholders Loan Agreement was entered by and between
        Auracall Limited, an affiliated company, Swiftnet Limited, a wholly owned
        U.K.
        subsidiary and the Managing Director of Auracall who holds 67.5% of Auracall.
        As
        part of this agreement, Swiftnet agreed to provide a loan of £24,000 ($47,016)
        to Auracall, free of interest, to be repaid within one year. The loan was
        funded
        on October 13, 2006.
  On
        August 24, 2006, the Company announced by Press Release that it has filed
        with
        the Israel Securities Authority (“ISA”) and the Tel Aviv Stock Exchange (“TASE”)
        a preliminary draft prospectus for a proposed public offering of convertible
        debentures to be listed and traded on the TASE (the “Proposed Public Offering”).
        The total amount proposed to be raised in the Proposed Public Offering is
        approximately $12 million. The Proposed Public Offering was subject to the
        approval of the ISA and the TASE, as well as the execution of an underwriting
        agreement and final pricing. On November 9, 2006 the Company was informed
        that
        the TASE decided to seek a No-Action Letter from the U.S. Securities and
        Exchange Commission and that until such No-Action Letter is granted to the
        TASE
        the Proposed Public Offering is delayed. There can be no assurance that the
        Proposed Public Offering will be consummated. The Company is currently exploring
        a certain capital
        raising process in Israel together
        with the TASE and the ISA.
 
 We
        will consider raising additional capital through private and/or public
        placements to fund possible acquisitions and business development activities
        and
        for working capital.
 
 **IMPACT
        OF INFLATION AND CURRENCY FLUCTUATIONS**
 
 As
        of December 31, 2006, our main functional currency remains the UKP as a
        significant portion of our revenues is derived from our United Kingdom based
        subsidiaries. Following the acquisition of our United States subsidiary in
        March
        10, 2005, a large potion of our business is in U.S. Dollars. In addition,
        we
        started to do business in Israel with the Israeli currency (NIS) as of mid
        December 2004. In 2006 14.5% of our revenues were derived from our Israeli
        subsidiary. Approximately 37.5% of the direct traffic costs in Israel are
        in UKP
        and the rest in NIS. We believe that the U.S. and Israeli portions of our
        revenues will increase during 2007. Most of our revenues, current assets
        and
        long-term loans to a shareholder are in UKP and U.S. Dollars.
 
 Our
        costs of revenues are mainly in UKP and U.S. Dollars.
 
 -43-
 Most
        of our liabilities, operating and financing expenses are in UKP and U.S.
        Dollars. The remainder of the assets, liabilities, revenues and expenditures
        are
        in NIS. We anticipate that in 2007 the portion of U.S. Dollars will be greater
        and will probably turn to our main functional currency although the portion
        of
        UKP will stay significant.
 
 A
        devaluation of the UKP or the NIS in relation to the U.S. Dollar will have
        the
        effect of decreasing the U.S. Dollar value of all assets or liabilities that
        are
        in UKP or NIS.
 
 Conversely,
        any increase in the value of the UKP in relation to the U.S. Dollar has the
        effect of increasing the U.S. Dollar value of all UKP assets and the U.S.
        Dollar
        amounts of any UKP liabilities and expenses.
 
 Inflation
        in any of the countries where we operate would affect our operational results
        if
        we shall not be able to match our revenues with growing expenses caused by
        inflation.
 
 If
        the rate of inflation causes a rise in salaries or other expenses and the
        market
        conditions don’t allow us to raise prices proportionally, it will have a
        negative effect on the value of our assets and on our potential
        profitability.
 
 -44-
 ITEM
        7. FINANCIAL STATEMENTS
 
 **Xfone,
                  Inc. and Subsidiaries****CONSOLIDATED
                  FINANCIAL STATEMENTS****As
                  of December 31, 2006****CONTENTS**
 
  Report
                  of Independent Registered Public Accounting
                  Firm
              
              
              F-1Balance
                  Sheet
              
              
              F-2Statements
                  of Operations
              
              
              F-4Statements
                  of Changes in Shareholders'
                  Equity
              
              
              F-5Statements
                  of Cash Flows
              
              
              F-6Notes
                  to Consolidated Financial Statements
              
              
              F-8
 
 -45-
 **REPORT
        OF INDEPENDENT REGI** **STEREDPUBLIC
        ACCOUNTING FIRM**
 
 To
        the
        Board of Directors
 Xfone,
        Inc.
 
 We
        have
        audited the accompanying consolidated balance sheet of Xfone, Inc. as of
        December 31,
        2006,
        and the related consolidated statements of income, stockholders' equity and
        cash
        flows for the years ended December 31, 2006 and 2005. These consolidated
        financial statements are the responsibility of the Company's
        management. Our responsibility is to express an opinion on these consolidated financial
        statements based on our audit. We did not audit the financial statements
        of
        Xfone 018, Ltd.,
        a
        69% owned subsidiary, which statements reflect 9% of total consolidated assets
        as of December 31, 2006 and 14% of consolidated revenues for the year ended
        December 31, 2006. Those
        financial statements were audited by other auditors whose report has been
        furnished to us, and our opinion, insofar as it relates to the amounts included
        for Xfone 018, Ltd. as of December 31,
        2006
        and for the year ended December 31, 2006 is based solely on the report of
        the
        other auditor.
 
 We
        conducted our audits in accordance with the standards of the Public Company
        Accounting Oversight Board (United States). Those standards require that
        we plan
        and perform the audit to obtain reasonable assurance about whether the
        consolidated financial statements are free of material misstatement. 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 that
        our
        audits provide a reasonable basis for our opinion.
 
 In
        our
        opinion, and based on that of the other auditor, the consolidated financial
        statements referred to above present fairly, in all material respects, the
        consolidated financial position of Xfone, Inc. as of December 31, 2006, and
        the
        consolidated results of its operations and cash flows for the years ended
        December 31, 2006 and 2005, in conformity with accounting principles generally
        accepted in the United States of America.
 
 /s/
        Stark
        Winter Schenkein & Co., LLP
  Denver,
        Colorado
 March
        28,
        2007
  F-1-
 
 **Xfone,
                  Inc. andSubsidiaries****BALANCE
                  SHEET****December
                  31,**
              
              **December
                  31,****2006**
              
              **2006****Convenience
                  translation into U.S.$****CURRENT
                  ASSETS:**Cash
              
              £
              621,946
              
              $
              1,218,392Accounts
                  receivable, net
              
              
              3,871,620
              
              
              7,584,504Prepaid
                  expenses and other receivables (Note 3)
              
              
              759,867
              
              
              1,488,579**Total****current assets**
              
              
              5,253,433
              
              
              10,291,475**INVESTMENTS
                  (NOTE 5)**
              
              
              98,758
              
              
              193,467**MINORITY
                  INTEREST**
              
              
              155,717
              
              
              305,050**LONG
                  TERM RECEIVABLES**
              
              
              362,229
              
              
              709,607**FIXED
                  ASSETS, NET (NOTE 4)**
              
              
              2,279,759
              
              
              4,466,048**OTHER
                  ASSETS, NET (NOTE 6)**
              
              
              8,709,187
              
              
              17,061,297**Total****assets**
              
              £
              16,859,083
              
              $
              33,026,944The
                  accompanying notes are an integral part of these consolidated financial
                  statements
 
 F-2-
 **Xfone,
                  Inc. and Subsidiaries****BALANCE
                  SHEET****December
                  31,**
              
              **December
                  31,****2006**
              
              **2006****Convenience
                  translation into U.S.$****CURRENT
                  LIABILITIES:**Notes
                  payable - current portion (Note 8)
              
              £
              1,002,249
              
              $
              1,963,406Trade
                  payables
              
              
              3,425,244
              
              
              6,710,053Other
                  liabilities and accrued expenses (Note 7)
              
              
              1,233,368
              
              
              2,416,168Obligations
                  under capital leases - current portion
              
              
              66,988
              
              
              131,229**Total****current liabilities**
              
              
              5,727,849
              
              
              11,220,856**DEFERRED
                  TAXES (NOTE 10)**
              
              
              90,522
              
              
              177,333**NOTES
                  PAYABLE (NOTE 8)**
              
              
              989,411
              
              
              1,938,256**OBLIGATIONS
                  UNDER CAPITAL LEASES**
              
              
              60,249
              
              
              118,028**SEVERANCE
                  PAY**
              
              
              51,155
              
              
              100,213**Total****liabilities**
              
              £
              6,919,186
              
              $
              13,554,686**COMMITMENTS
                  AND CONTINGENT LIABILITIES (NOTE 11)****SHAREHOLDERS'
                  EQUITY:**Preferred
                  stock - 50,000,000 shares authorised, none issuedCommon
                  stock:25,000,000
                  shares authorised, $.001 par value;11,153,817
                  issued and outstanding
              
              
              6,651
              
              
              13,029Contributions
                  in excess of par value
              
              
              9,702,817
              
              
              19,007,819Foreign
                  currency translation adjustment
              
              
              (704,799
              )
              
              (1,380,701
              )Deferred
                  stock compensation
              
              
              (261,048
              )
              
              (511,393
              )Retained
                  earnings
              
              
              1,196,276
              
              
              2,343,505**Total****shareholders' equity**
              
              
              9,939,897
              
              
              19,472,259**Total****liabilities and shareholders' equity**
              
              £
              16,859,083
              
              $
              33,026,945The
                  accompanying notes are an integral part of these consolidated financial
                  statements
 
 F-3-
 **Xfone,
                  Inc. and Subsidiaries****STATEMENT
                  OF OPERATIONS****Years
                  Ended**
              
              **Year
                  Ended****December
                  31**
              
              **December
                  31****2006**
              
              **2005**
              
              **2006****Convenience
                  translation into U.S.$****Revenues**
              
              £
              19,353,771
              
              £
              14,113,748
              
              $
              37,914,037**Cost
                  of revenues**
              
              
              (11,214,394
              )
              
              (9,254,597
              )
              
              (21,968,998
              )Gross
                  profit
              
              
              8,139,377
              
              
              4,859,151
              
              
              15,945,039**Operating
                  expenses:**Research
                  and development
              
              
              (23,333
              )
              
              (6,896
              )
              
              (45,709
              )Marketing
                  and selling
              
              
              (2,520,167
              )
              
              (1,262,182
              )
              
              (4,937,007
              )General
                  and administrative
              
              
              (5,067,535
              )
              
              (3,635,819
              )
              
              (9,927,301
              )Totaloperating expenses
              
              
              (7,611,035
              )
              
              (4,904,897
              )
              
              (14,910,017
              )Operating
                  profit (loss)
              
              
              528,342
              
              
              (45,746
              )
              
              1,035,022Financing
                  expenses, net
              
              
              (276,002
              )
              
              (122,338
              )
              
              (540,688
              )Equity
                  in income of affiliated company
              
              
              30,921
              
              
              76,800
              
              
              60,574Loss
                  from a change of holding of affiliated company
              
              
              (29,848
              )
              
              -
              
              
              (58,472
              )Loss
                  from hurricane Katrina
              
              
              -
              
              
              (38,703
              )
              
              -Other
                  income
              
              
              43,248
              
              
              104,646
              
              
              84,723Income
                  (loss) before minority interest and taxes
              
              
              296,661
              
              
              (25,341
              )
              
              581,159Minority
                  interest
              
              
              41,757
              
              
              113,960
              
              
              81,802Income
                  before taxes
              
              
              338,418
              
              
              88,619
              
              
              662,961Taxes
                  on income
              
              
              (1,156
              )
              
              (62,541
              )
              
              (2,265
              )Net
                  income
              
              £
              337,262
              
              £
              26,078
              
              $
              660,696Basic
                  net profit per share
              
              £
              0.033
              
              £
              0.004
              
              £
              0.065Diluted
                  net profit per share
              
              £
              0.033
              
              £
              0.003
              
              £
              0.065Weighted
                  average number of shares used for computing:Basic
                  profit per share
              
              
              10,135,874
              
              
              6,868,471
              
              
              10,135,874Diluted
                  profit per share
              
              
              10,135,874
              
              
              7,943,184
              
              
              10,135,874The
                  accompanying notes are an integral part of these consolidated financial
                  statements
 
 F-4-
 **Xfone,
                  Inc. andSubsidiaries****STATEMENT
                  OF CHANGES IN SHAREHOLDERS' EQUITY****Number
                  of**
              
              
              
              **Contributions**
              
              **Foreign
                  currency**
              
              **Deferred**
              
              
              
              **Total****Ordinary**
              
              **Share**
              
              **in
                  excess of**
              
              **translation**
              
              **Stock**
              
              **Retained**
              
              **Shareholders'****Shares**
              
              **Capital**
              
              **par
                  value**
              
              **adjustments**
              
              **Compensation**
              
              **Earnings**
              
              **Equity**Balance
                  at January 1, 2005
              
              
              6,220,871
              
              £
              4,290
              
              £
              1,373,556
              
              £
              1,210
              
              £
              -
              
              £
              832,936
              
              £
              2,211,992Redemption
                  of stock
              
              
              (100,000
              )
              
              (58
              )
              
              (142,108
              )
              
              -
              
              
              -
              
              
              -
              
              
              (142,166
              )Stock
                  issued during the period,
                  net ofissuance expenses:
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              -For
                  acquisition transaction
              
              
              663,650
              
              
              370
              
              
              1,188,204
              
              
              -
              
              
              -
              
              
              -
              
              
              1,188,574For
                  services
              
              
              3,150
              
              
              2
              
              
              (2
              )
              
              -
              
              
              -
              
              
              -
              
              
              -For
                  cash
              
              
              885,000
              
              
              496
              
              
              832,665
              
              
              -
              
              
              -
              
              
              -
              
              
              833,161Exercise
                  of share options
              
              
              500,000
              
              
              290
              
              
              115,129
              
              
              -
              
              
              -
              
              
              -
              
              
              115,419Warrants
                  issued during the period
              
              
              
              
              
              
              
              
              756,322
              
              
              
              
              
              
              
              
              
              
              
              756,322Beneficial
                  conversion featurerelating to convertible note
              
              
              -
              
              
              -
              
              
              140,190
              
              
              -
              
              
              -
              
              
              -
              
              
              140,190Currency
                  translation
              
              
              -
              
              
              -
              
              
              -
              
              
              (117,618
              )
              
              -
              
              
              -
              
              
              (117,618
              )Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              26,078
              
              
              26,078Balance
                  at December 31, 2005
              
              
              8,172,671
              
              £
              5,390
              
              £
              4,263,956
              
              £
              (116,408
              )
              £
              -
              
              £
              859,014
              
              £
              5,011,952Balance
                  at January 1, 2006
              
              
              8,172,671
              
              £
              5,390
              
              £
              4,263,956
              
              £
              (116,408
              )
              £
              -
              
              £
              859,014
              
              £
              5,011,952Deferred
                  stock compensation, net
              
              
              -
              
              
              -
              
              
              377,300
              
              
              -
              
              
              (377,300
              )
              
              -
              
              
              -Amortization
                  of deferred compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              116,252
              
              
              -
              
              
              116,252Redemption
                  of stock
              
              
              (100,000
              )
              
              (51
              )
              
              (137,704
              )
              
              -
              
              
              -
              
              
              -
              
              
              (137,755
              )Stock
                  issued during the period,
                  net ofissuance expenses :For
                  services
              
              
              40,629
              
              
              24
              
              
              13,977
              
              
              -
              
              
              -
              
              
              -
              
              
              14,001For
                  cash
              
              
              663,825
              
              
              362
              
              
              521,040
              
              
              -
              
              
              -
              
              
              -
              
              
              521,402For
                  acquisitions
              
              
              1,544,761
              
              
              822
              
              
              3,022,394
              
              
              -
              
              
              -
              
              
              -
              
              
              3,023,216For
                  loan repayment
              
              
              831,931
              
              
              104
              
              
              1,424,529
              
              
              -
              
              
              -
              
              
              -
              
              
              1,424,633Warrants
                  granted to consultantsfor services and others
              
              
              -
              
              
              -
              
              
              217,325
              
              
              -
              
              
              -
              
              
              -
              
              
              217,325Currency
                  translation
              
              
              -
              
              
              -
              
              
              -
              
              
              (588,391
              )
              
              -
              
              
              -
              
              
              (588,391
              )Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              337,262
              
              
              337,262Balance
                  at December 31, 2006
              
              
              11,153,817
              
              £
              6,651
              
              £
              9,702,817
              
              £
              (704,799
              )
              £
              (261,048
              )
              £
              1,196,276
              
              £
              9,939,897**Convenience
                  translation into U.S.$:**Balance
                  at January 1, 2006
              
              
              8,172,671
              
              $
              10,559
              
              $
              8,353,089
              
              $
              (228,043
              )
              $
              -
              
              $
              1,682,809
              
              $
              9,818,414Deferred
                  stock compensation, net
              
              
              -
              
              
              -
              
              
              739,131
              
              
              -
              
              
              (739,131
              )
              
              -
              
              
              -Amortization
                  of deferred compensation
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              227,738
              
              
              -
              
              
              227,738Redemption
                  of stock
              
              
              (100,000
              )
              
              (100
              )
              
              (269,762
              )
              
              -
              
              
              -
              
              
              -
              
              
              (269,862
              )Stock
                  issued during the period,
                  net ofissuance
                expenses :For
                  services
              
              
              40,629
              
              
              47
              
              
              27,381
              
              
              -
              
              
              -
              
              
              -
              
              
              27,428For
                  cash
              
              
              663,825
              
              
              709
              
              
              1,020,717
              
              
              -
              
              
              -
              
              
              -
              
              
              1,021,426For
                  acquisitions
              
              
              1,544,761
              
              
              1,610
              
              
              5,920,870
              
              
              -
              
              
              -
              
              
              -
              
              
              5,922,480For
                  loan repayment
              
              
              831,931
              
              
              204
              
              
              2,790,652
              
              
              -
              
              
              -
              
              
              -
              
              
              2,790,856Warrants
                  granted to consultantsfor services and others
              
              
              -
              
              
              -
              
              
              425,740
              
              
              -
              
              
              -
              
              
              -
              
              
              425,740Currency
                  translation
              
              
              -
              
              
              -
              
              
              -
              
              
              (1,152,658
              )
              
              -
              
              
              -
              
              
              (1,152,658
              )Net
                  income
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              660,696
              
              
              660,696Balance
                  at December 31, 2006
              
              
              11,153,817
              
              $
              13,029
              
              $
              19,007,818
              
              $
              (1,380,701
              )
              $
              (511,393
              )
              $
              2,343,505
              
              $
              19,472,258The
                  accompanying notes are an integral part of these consolidated financial
                  statements
 
 F-5-
 **Xfone,
                  Inc. and Subsidiaries****STATEMENTS
                  OF CASH FLOWS****Years
                  Ended**
              
              **Years
                  Ended****December
                  31 ,**
              
              **December
                  31 ,****2006**
              
              **2005**
              
              **2006****Convenience
                  translation into U.S.$****Cash
                  flow from operating activities:**Net
                  income
              
              £
              337,262
              
              £
              £26,078
              
              $
              660,696Adjustments
                  required to reconcile net incometo
                  net cash provided by (used in)operating
                  activities:Depreciation
                  and amortization
              
              
              557,470
              
              
              246,443
              
              
              1,092,085Stock,
                  warrants and options issued for professional services
              
              
              130,253
              
              
              24,377
              
              
              255,166Minority
                  Interest
              
              
              (41,757
              )
              
              (113,960
              )
              
              (81,802
              )Currency
                  differences on convertible notes and loans
              
              
              188
              
              
              97,572
              
              
              368Loss
                  from a change of holding of affiliated company
              
              
              29,848
              
              
              -
              
              
              58,472Changes
                  in earnings of equity investments
              
              
              (30,921
              )
              
              (76,800
              )
              
              (60,574
              )Capital
                  gain (loss) from the sale of fixed assets
              
              
              -
              
              
              (5,398
              )
              
              -(Increase)
                  decrease in account receivables
              
              
              (681,735
              )
              
              (1,013,747
              )
              
              (1,335,519
              )Increase
                  (decrease) in Severence pay
              
              
              32,315
              
              
              (4,565
              )
              
              63,305(Increase)
                  decrease in other receivables
              
              
              393,832
              
              
              (11,361
              )
              
              771,517Decrease
                  in shareholder loans receivable
              
              
              123,965
              
              
              123,966
              
              
              242,847Increase
                  (decrease) in trade payables
              
              
              (769,842
              )
              
              957,861
              
              
              (1,508,120
              )Increase
                  (decrease) in other payables
              
              
              (230,454
              )
              
              521,970
              
              
              (451,460
              )Increase
                  (decrease) deferred taxes
              
              
              (26,369
              )
              
              82,079
              
              
              (51,657
              )**Net
                  cash provided by (used in) operating activities**
              
              
              (175,945
              )
              
              854,515
              
              
              (344,676
              )**Cash
                  flow from investing activities:**Purchase
                  of other assets
              
              
              (642
              )
              
              (117,348
              )
              
              (1,258
              )Purchase
                  of equipment
              
              
              (445,124
              )
              
              (388,580
              )
              
              (871,998
              )Change
                  in long-term receivables
              
              
              (54,239
              )
              
              (87,000
              )
              
              (106,254
              )Proceeds
                  from sale of fixed assets
              
              
              -
              
              
              57,971
              
              
              -Repayment
                  of capital lease obligation
              
              
              -
              
              
              (229,358
              )
              
              -Net
                  cash acquired through purchase of WS Telecom
              
              
              -
              
              
              (167,614
              )
              
              -Acquisition
                  of EBI
              
              
              (50,726
              )
              
              -
              
              
              (99,372
              )Acquisition
                  of Canufly
              
              
              (258,644
              )
              
              -
              
              
              (506,684
              )Acquisition
                  of I-55 Internet Services
              
              
              (53,374
              )
              
              -
              
              
              (104,560
              )Acquisition
                  of I-55 Telecommunications
              
              
              (15,414
              )
              
              -
              
              
              (30,196
              )Net
                  cash acquired from the acquisition of Equitalk
              
              
              74,976
              
              
              -
              
              
              146,878Net
                  cash acquired from the acquisition of Story Telecom
              
              
              33,476
              
              
              -
              
              
              65,579**Net
                  cash (used in) investing activities**
              
              
              (769,711
              )
              
              (931,929
              )
              
              (1,507,865
              )**Cash
                  flow from financing activities:**Repayment
                  of long term loans from banks and others
              
              
              (1,299,104
              )
              
              (72,773
              )
              
              (2,544,945
              )Increase
                  in capital lease obligation
              
              
              26,805
              
              
              -
              
              
              52,511Increase
                  (decrease) in short-term bank credit, net
              
              
              122,842
              
              
              -
              
              
              240,647Proceeds
                  from long term loans from banks
              
              
              156,923
              
              
              -
              
              
              307,412Repayment
                  of convertible notes
              
              
              (318,434
              )
              
              -
              
              
              (623,812
              )Proceeds
                  from issuance of convertable notes, net
              
              
              -
              
              
              842,889
              
              
              -Proceeds
                  from issuance of sharesand detachable warrants, net of issuance expenses
              
              
              383,647
              
              
              1,005,123
              
              
              751,564**Net
                  cash provided by (used in) financing activities**
              
              
              (927,321
              )
              
              1,775,239
              
              
              (1,816,623
              )Net
                  (decrease) increase in cash and cash equivalents
              
              
              (1,872,977
              )
              
              1,697,825
              
              
              (3,669,164
              )Cash
                  and cash equivalents at the beginning of year
              
              
              2,494,923
              
              
              797,098
              
              
              4,887,556Cash
                  and cash equivalents at the end of year
              
              £
              621,946
              
              £
              2,494,923
              
              $
              1,218,392The
                  accompanying notes are an integral part of these consolidated financial
                  statements
  F-6-
 **Supplemental
                  disclosure of non cash investing and financing
                  activities:**Cash
                  paid for:Interest
                  paid
              
              £
              148,241
              
              £
              92,023
              
              $
              290,404Tax
                  paid
              
              £
              £57,100
              
              £
              23,490
              
              $
              111,859Acquisision
                  of WS Telecom
              
              £
              -
              
              £
              1,862,000
              
              $
              -Acquisition
                  of communication license
              
              £
              -
              
              £
              61,256
              
              $
              -Acquisition
                  of EBI
              
              £
              90,008
              
              £
              -
              
              $
              176,326Acquisition
                  of Canufly
              
              £
              180,915
              
              £
              -
              
              $
              354,412Acquisition
                  of I-55 Internet Services
              
              £
              1,631,087
              
              £
              -
              
              $
              3,195,299Acquisition
                  of I-55 Telecommunication
              
              £
              417,822
              
              £
              -
              
              $
              818,513Acquisition
                  of Equitalk
              
              £
              142,662
              
              £
              -
              
              $
              279,475The
                  accompanying notes are an integral part of these consolidated financial
                  statements
 
 F-7-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**





**Note
      1 -**  **Organization
      and Nature of Business**





A.
            Xfone,
                Inc. ("**Xfone**")
                was incorporated in Nevada, U.S.A. in September 2000 and is a provider
                of
                voice, video and data telecommunications services, including: local,
                long
                distance and international telephony services; prepaid and postpaid
                calling cards; cellular services; Internet services; messaging services
                (Email/Fax Broadcast, Email2Fax and Cyber-Number); and reselling
                opportunities, with operations in the United Kingdom, the United
                States
                and Israel.





Xfone’s
      holdings in subsidiaries are as follows:


-
            Swiftnet
                Limited ("**Swiftnet**")
                - wholly owned U.K. subsidiary.


-
            Equitalk.co.uk
                Limited ("**Equitalk**")
                - wholly owned U.K. subsidiary.


-
            Xfone
                USA, Inc. and its two wholly owned subsidiaries, eXpeTel Communications,
                Inc. and Gulf Coast Utilities, Inc. (collectively, "**Xfone
                USA**")
                - wholly owned U.S. subsidiary.


-
            Story
                Telecom, Inc. and its two wholly owned subsidiaries, Story Telecom
                Limited
                and Story Telecom (Ireland) Limited (which was dissolved on February
                23,
                2007) (collectively, "**Story
                Telecom**")
                - majority owned U.S. subsidiary, in which Xfone holds a 69.9% ownership
                share.


-
            Xfone
                018 Ltd. ("**Xfone
                018**")
                - wholly owned Israeli subsidiary in which Xfone holds a 69% ownership
                share.





B.
            On
                October 4, 2000, Xfone acquired Swiftnet Limited which had a business
                plan
                to provide comprehensive telecommunication services and products
                by
                integrating new and old products, services and ideas through one
                website.
                Swiftnet was incorporated in 1990 under the laws of the United Kingdom
                and
                is headquartered in London, England. Until 1999, the main revenues
                for
                Swiftnet were derived from messaging and fax broadcast services.
                During
                2000, Swiftnet shifted its business focus and its focus has remained
                on
                telephony voice services offering comprehensive support packages
                to
                resellers and new services. Utilizing automation and proprietary
                software
                packages, Swiftnet's strategy is to grow without the need for heavy
                investments and with lower expenses for operations and registration
                of new
                customers.





C.
            On
                April 15, 2004, Xfone established an Israel based subsidiary, Xfone
                Communication Ltd. (which changed its name to Xfone 018 Ltd. in March
                2005). On July 4, 2004, the Ministry of Communications of the State
                of
                Israel granted Xfone 018 a license to provide international telecom
                services in Israel. Xfone started providing services in Israel through
                Xfone 018 as of mid-December 2004. Headquartered in Petach Tikva,
                Israel,
                Xfone 018 Ltd. is a telecommunications service provider that owns
                and
                operates its own facilities-based telecommunications switching
                system.





D.
            On
                May 28, 2004, Xfone entered into an agreement and Plan of Merger
                to
                acquire WS Telecom, Inc., a Mississippi corporation, and its two
                wholly
                owned subsidiaries, eXpeTel Communications, Inc. and Gulf Coast Utilities,
                Inc., through the merger of WS Telecom into Xfone's wholly owned
                U.S.
                subsidiary Xfone USA, Inc. On July 1, 2004, Xfone USA entered into
                a
                management agreement with WS Telecom which provided that Xfone USA
                provide
                management services to WS Telecom pending the consummation of the
                merger.
                The management agreement provided that all revenues generated from
                WS
                Telecom business operations would be assigned and transferred to
                Xfone
                USA. The term of the management agreement commenced on July 1, 2004,
                and
                continued until the consummation of the merger on March 10, 2005. 
                Headquartered in Jackson, Mississippi, Xfone USA. is an integrated
                telecommunications service provider that owns and operates its own
                facilities-based, telecommunications switching system and network.
                Xfone
                USA provides residential and business customers with high quality
                local,
                long distance and high-speed broadband Internet services, as well
                as cable
                television services in certain planned residential communities in
                Mississippi. Xfone USA is licensed to provide telecommunications
                services
                in Alabama, Florida, Georgia, Louisiana and Mississippi. Xfone USA
                utilizes integrated multi-media offerings - combining digital voice,
                data
                and video services over broadband technologies - all on one single
                itemized bill.





F-8-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**  E.
            On
                August 18, 2005, Xfone entered into an Agreement and Plan of Merger
                to
                acquire I-55 Internet Services, Inc., a Louisiana corporation (the
“I-55
                Internet Merger Agreement”). On September 13, 2005, Xfone filed a Form 8-K
                discussing the impact of Hurricane Katrina on the transaction contemplated
                by the I-55 Internet Merger Agreement. On October 10, 2005, Xfone
                entered
                into a First Amendment to the Merger Agreement, by and among I-55
                Internet
                Services, Xfone, Inc, Xfone USA, Inc. and Hunter McAllister and Brian
                Acosta, key employees of I-55 Internet Services, in order to induce
                Xfone
                and Xfone USA not to terminate the I-55 Internet Merger Agreement
                due to
                the material adverse effect that Hurricane Katrina has had on the
                assets
                and business of I-55 Internet Services. As part of the amendment
                and
                since, at that time, the merger of I-55 Internet Services with and
                into
                Xfone USA had not been consummated yet, in the interim, the parties
                agreed
                and entered into on October 11, 2005 a Management Agreement (the
                "I-55
                Internet Management Agreement") that provided that I-55 Internet
                Services
                hired and appointed Xfone USA as manager to be responsible for the
                operation and management of all of I-55 Internet Services business
                operations, including among other things personnel, accounting, contracts,
                policies and budget. In consideration of the management services
                provided under the I-55 Internet Management Agreement, I-55 Internet
                Services assigned and transferred to Xfone USA all revenues generated
                and
                expenses incurred in the ordinary course of business during the term
                of
                the I-55 Internet Management Agreement. The term of the I-55 Internet
                Management Agreement commenced on October 11, 2005 and continued
                until the
                consummation of the merger on March 31,
                2006.





In
      conjunction with the consummation of the merger and in exchange for all of
      the
      capital stock of I-55 Internet Services, Xfone issued a total of 789,863 shares
      of its common stock valued at $2,380,178 and 603,939 warrants exercisable for
      a
      period of five years into shares of its common stock, with an exercise price
      of
      $3.31, valued based on the Black Scholes option-pricing model (the "Xfone Stock
      and Warrant Consideration"). A portion of the Xfone Stock and Warrant
      Consideration issued at closing was placed in an escrow. The First Amendment
      to
      the I-55 Merger Agreement provides for an adjustment to the consideration paid
      based on changes in customer billings as determined pursuant to a certain
      formula (the "Customer Billing Adjustment Amount"). Xfone has determined that
      the Customer Billing Adjustment Amount is $247,965 and on March 27, 2007, sent
      a
      claim for this amount against the escrowed portion of the Xfone Stock and
      Warrant Consideration.





I-55
      Internet Services provided Internet access and related services, such as
      installation of various networking equipment, website design, hosting and other
      Internet access installation services, throughout the Southeastern United States
      to individuals and businesses located predominantly in rural markets in
      Louisiana and Mississippi. As a result of the merger with and into Xfone USA,
      these services are now available in expanded markets throughout Louisiana and
      Mississippi. The Internet service offerings include dial-up, DSL, high speed
      dedicated Internet access, web services, email, the World Wide Web, Internet
      relay chat, file transfer protocol and Usenet news access to both residential
      and business customers. The I-55 Internet Services offerings provided various
      prices and packages that allowed I-55 Internet Services subscribers to customize
      their subscription with services that met customers’ particular requirements.
      Xfone USA now provides bundled services of voice and data (broadband Internet)
      to customers throughout its service areas.





F-9-
 
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31,
                  2006**  The
        following table summarizes the fair values of the assets acquired and
        liabilities assumed, as of March 31, 2006:





**I-55
                Internet Services, Inc.****US$**Current
                Assets, excluding cash acquired
            
            £
            516,602
            
            $
            955,197Fixed
                Assets
            
            
            117,227
            
            
            216,753Other
                Assets
            
            
            459
            
            
            849Total
                Assets acquired
            
            
            634,288
            
            
            1,242,570Current
                Liabilities
            
            
            862,123
            
            
            1,688,899Long-term
                Liabilities
            
            
            1,083,083
            
            
            2,121,760Total
                liabilities
            
            
            1,945,206
            
            
            3,810,659Net
                liabilities assumed
            
            £
            (1,310,918
            )
            $
            (2,568,089
            )Purchase
                price:Cash
                acquired, net
            
            £
            (6,673
            )
            $
            (13,072
            )Acquisition
                costs
            
            
            60,047
            
            
            117,632Fair
                market value of stock and warrant issued
            
            
            1,631,087
            
            
            3,195,299Total
            
            £
            1,684,461
            
            $
            3,299,859Goodwill
            
            
            2,732,257
            
            
            5,352,492Customer
                relations
            
            
            128,655
            
            
            252,035Stock
                and warrants redeemable
            
            
            134,467
            
            
            263,421





The
      value
      assigned to the customer relations is amortized on a straight-line basis over
      6
      or 7 years.





F-10-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**  F.
            On
                August 26, 2005, Xfone entered into an Agreement and Plan of Merger
                to
                acquire I-55 Telecommunications, LLC, a Louisiana corporation (the
“I-55
                Telecom Merger Agreement”). On September 13, 2005, Xfone filed a Form 8-K
                discussing the impact of Hurricane Katrina on the transaction contemplated
                by the I-55 Telecom Merger Agreement. In order to demonstrate Xfone's
                intention to continue on with the transaction contemplated by the
                I-55
                Telecom Merger Agreement, the parties entered into on October 12,
                2005 a
                Management Agreement (the “I-55 Telecom Management Agreement”) that
                provided that I-55 Telecommunications hired and appointed Xfone USA
                as
                manager to be responsible for the operation and management of all
                of I-55
                Telecommunications’ business operations. In consideration of the
                management services provided under the I-55 Telecom Management Agreement,
                I-55 Telecommunications assigned and transferred to Xfone USA all
                revenues
                generated and expenses incurred in the ordinary course of business
                during
                the term of the I-55 Telecom Management Agreement. The term of the
                I-55
                Telecom Management Agreement commenced on October 12, 2005 and continued
                until the consummation of the merger on March 31,
                2006.





In
      conjunction with the consummation of the merger and in exchange for all of
      the
      capital stock of I-55 Telecommunications, Xfone issued a total of 223,702 shares
      of its common stock valued at $671,687 and 79,029 warrants exercisable into
      shares of its common stock, with an exercise price of $3.38, valued based on
      the
      Black Scholes option-pricing model.





I-55
      Telecommunications provided voice, data and related services throughout
      Louisiana and Mississippi to both individuals and businesses. Prior to the
      merger with and into Xfone USA, I-55 Telecommunications was a licensed facility
      based CLEC operating in Louisiana and Mississippi with a next generation class
      5
      carrier switching platform. I-55 Telecommunications provided a complete package
      of local and long distance services to residential and business customers across
      both states. As a result of the merger, Xfone USA has now expanded its On-Net
      (facilities) service area, through I-55 Telecommunications, into New Orleans,
      Louisiana and surrounding areas, including Hammond, Louisiana and Baton Rouge,
      Louisiana. Xfone USA is expanding its sales offices to include New Orleans,
      in
      an effort to continue revenue growth and increase market share in the
      revitalized city, as well as into Biloxi, Mississippi, Hammond, Louisiana and
      Baton Rouge, Louisiana. Regulations affecting the telecommunications industry
      began in March 2006; conversions of all circuits affected were completed in
      April 2006. The competition in secondary markets, such as Jackson, Mississippi,
      Baton Rouge, Louisiana, and Biloxi, Mississippi, as opposed to Tier 1 markets
      such as Atlanta, Georgia, is also rapidly declining due to the removal of
      UNE-P and the decline in the competitive local exchange providers that had
      been
      dependent on UNE-P as their only source for providing competitive local
      telephone services in those markets. This provides for a unique opportunity
      for Xfone USA to gain market share, by utilizing its existing network and to
      expand its facilities into these opportunity areas becoming a primary
      alternative to the monopoly Incumbent Local
      Exchange Company.





F-11-
 
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31,
                  2006**  The
        following table summarizes the fair values of the assets acquired and
        liabilities assumed, as of March 31, 2006:





**I-55
                Telecommunication, LLC.****US$**Current
                Assets, excluding cash acquired
            
            £
            989,339
            
            
            1,938,115Fixed
                Assets
            
            
            1,869
            
            
            3,661Other
                Assets
            
            
            -
            
            
            -Total
                Assets acquired
            
            
            991,208
            
            
            1,941,776Current
                Liabilities
            
            
            1,061,757
            
            
            2,079,982Long-term
                Liabilities
            
            
            417,822
            
            
            818,513Total
                liabilities
            
            
            1,479,579
            
            
            2,898,495Net
                liabilities assumed
            
            £
            (488,371
            )
            $
            (956,719
            )Purchase
                price:Cash
                acquired, net
            
            £
            -
            
            $
            -Acquisition
                costs
            
            
            15,414
            
            
            30,196Fair
                market value of stock and warrant issued
            
            
            418,677
            
            
            820,188Total
            
            £
            434,091
            
            $
            850,384Goodwill
            
            
            682,544
            
            
            1,337,103Customer
                relations
            
            
            239,918
            
            
            470,000





The
      value
      assigned to the customer relations is amortized on a straight-line basis over
      6
      or 7 years.





F-12-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**  G.
            On
                January 1, 2006, Xfone USA, Inc., entered into an Agreement with
                EBI Comm,
                Inc. (“EBI”), a privately held Internet Service Provider, to purchase the
                assets of EBI. EBI provided a full range of Internet access options
                for
                both commercial and residential customers in north Mississippi. Based
                in
                Columbus, Mississippi, EBI’s services included Dial-up, DSL, T1 Dedicated
                Access and Web Hosting. The customer base, numbering approximately
                1,500
                Internet users, is largely concentrated in the Golden Triangle area,
                which
                includes Columbus, West Point and Starkville, Mississippi. The acquisition
                was structured as an asset purchase, providing for Xfone USA to pay
                EBI
                total consideration equal to 50% of the monthly collected revenue
                from the
                customer base during the first 12 months, beginning January 2006.
                Acquired
                assets include the customer base and customer lists, trademarks and
                all
                related intellectual property, fixed assets and all account receivables.
                As of December 31, 2006, Xfone paid $85,699 (£43,746) in consideration of
                this acquisition, recorded as other
                assets.





The
      following table summarizes the fair values of the assets acquired and
      liabilities assumed, as of January 1, 2006:





**EBI
                Comm, Inc.**
            
            
            
            **U.S.$**Current
                Assets, excluding cash acquired
            
            £
            -
            
            $
            -Total
                Assets acquired
            
            
            -
            
            
            -Total
                liabilities
            
            
            90,008
            
            
            176,326Net
                liabilities assumed
            
            £
            90,008
            
            $
            176,326Purchase
                price:Cash
                paid
            
            £
            43,746
            
            $
            85,698Acquisition
                costs
            
            
            6,980
            
            
            13,674£
            50,726
            
            $
            99,372Goodwill
            
            
            140,734
            
            
            275,698





H.
            On
                January 10, 2006 (effective as of January 1, 2006), Xfone USA, Inc.,
                entered into an Asset Purchase Agreement with Canufly.net, Inc.
                (“Canufly.net”), an Internet Service Provider based in Vicksburg,
                Mississippi, and its principal shareholder, Mr. Michael Nassour.
                Canufly.net provided residential and business customers with high-speed
                Internet services and utilized the facilities-based network of Xfone
                USA,
                as an alternative to BellSouth, to provide Internet connectivity
                to its
                customers. Canufly.net also provided Internet services through a
                small
                wireless application in certain areas in Vicksburg, Mississippi.
                The
                transaction was closed on January 24, 2006. Xfone agreed to pay a
                total
                purchase price of up to $710,633, payable as follows: (i) $185,000
                in cash
                payable in twelve equal monthly payments, the first installment was
                paid
                at closing, and as of December 31, 2006, the entire amount was paid
                in
                full and in accordance with the Asset Purchase Agreement; (ii) $255,633
                in
                cash, paid at closing, to pay off the loan with the B&K Bank; (iii)
                33,768 restricted shares of common stock and 24,053 warrants exercisable
                at $2.98 per share for a period of five years were issued to the
                shareholders of Canufly.net during May 2006. Following the closing
                in 2006
                and due to the satisfaction of certain earnout provisions in the
                Asset
                Purchase Agreement Xfone issued in March 2007 additional 20,026 restricted
                shares of common stock and 14,364 warrants exercisable at $2.98 per
                share
                for a period of five years to the shareholders of Canufly.net.





F-13-
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31,
                  2006**


The
      following table summarizes the fair values of the assets acquired and
      liabilities assumed, as of January 1, 2006:





**Canufly.net,
                Inc.**
            
            
            
            **US$**Current
                Assets, excluding cash acquired
            
            £
            -
            
            $
            -Fixed
                Assets
            
            
            18,761
            
            
            36,753Total
                Assets acquired
            
            
            18,761
            
            
            36,753Current
                Liabilities
            
            
            -
            
            
            -Long-term
                Liabilities
            
            
            -
            
            
            -Total
                liabilities
            
            
            -
            
            
            -Net
                Assets assumed
            
            £
            18,761
            
            $
            36,753Purchase
                price:Cash
                acquired or commitment in cash, net
            
            £
            252,947
            
            $
            495,524Acquisition
                costs
            
            
            5,697
            
            
            11,160Fair
                market value of stock and warrant issued
            
            
            99,005
            
            
            193,951Total
            
            
            357,649
            
            
            700,635Goodwill
            
            £
            338,888
            
            $
            663,882





I.
            On
                May 10, 2006, Xfone, Story Telecom, Inc., Story Telecom Limited,
                Story
                Telecom (Ireland) Limited, Nir Davison, and Trecastle Holdings Limited,
                a
                company controlled by Mr. Davison, entered into the Stock Purchase
                Agreement. Pursuant to the Stock Purchase Agreement, Xfone increased
                its
                ownership interest in Story Telecom from 39.2% to 69.6% in a cash
                transaction valued at $1,200,000. $900,000 of the total consideration
                was
                applied to payables owed by Story Telecom to Xfone and its subsidiary
                Swiftnet Limited for back-end telecommunications services. The balance
                of
                $300,000 was paid to Story Telecom, and is being used as working
                capital.
                Story Telecom, Inc., a telecommunication service provider, operated
                in the
                United Kingdom through its two wholly owned subsidiaries, Story Telecom
                Limited and Story Telecom (Ireland) Limited (which was dissolved
                on
                February 23, 2007). Story Telecom operates as a division of Xfone's
                operations in the United Kingdom. Founder and CEO of Story Telecom,
                Nir
                Davison, remained as Managing Director of the division. The stock
                purchase
                pursuant to the Stock Purchase Agreement was completed on May 16,
                2006.





Pursuant
      to the above-mentioned Stock Purchase Agreement, at certain dates and provided
      Story Telecom meets certain business and financial covenants, Nir Davison and
      Trecastle Holdings Limited shall have the option to sell to the Company all
      of
      their shares in Story Telecom for U.S. $450,000 in cash, or equivalent in the
      Company's common stock (to be decided by the Company). In addition, at certain
      dates and provided Story Telecom meets certain business and financial covenants,
      the Company shall have the option to buy from Nir Davison and Trecastle Holdings
      Limited all of their shares in Story Telecom for U.S. $900,000 in cash, or
      equivalent in the Company's common stock (to be decided by the Company). The
      Stock Purchase Agreement further provides that upon request from Story Telecom,
      and provided certain conditions are met, the Company shall provide all consents
      necessary to make Story Telecom a publicly traded company through a distribution
      of its shares as a dividend to the shareholders of the Company, or a similar
      transaction. If the Company will fail to provide all necessary consents it
      shall
      have to buy from Nir Davison and Trecastle Holdings Limited all their shares
      of
      Story Telecom for $1,000,000, paid 70% in the Company’s shares, valued at market
      price on an average of 30 trading days, and 30% in cash.





F-14-
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31,
                  2006**





**Story
                Telecom, Inc.****In
                U.S.$**Current
                Assets, excluding cash acquired
            
            £
            362,529
            
            $
            710,194Fixed
                Assets
            
            
            1,123
            
            
            2,200Other
                Assets
            
            
            -
            
            
            -Total
                Assets acquired
            
            
            363,652
            
            
            712,394Current
                Liabilities
            
            
            1,807,922
            
            
            3,541,719Long-term
                Liabilities
            
            
            -
            
            
            -Total
                liabilities
            
            
            1,807,922
            
            
            3,541,719Net
                liabilities assumed
            
            £
            1,444,270
            
            $
            2,829,325Purchase
                price:Cash
                acquired, net
            
            £
            (33,476
            )
            $
            (65,579
            )Acquisition
                costs
            
            
            -
            
            
            -Total
            
            £
            (33,476
            )
            $
            (65,579
            )Goodwill
            
            
            1,383,286
            
            
            2,690,786Trade
                name
            
            
            37,508
            
            
            72,960





The
      value
      assigned to the trade name is amortized on a straight-line basis over 7
      years.





J.
            As
                of May 10, 2006 the Company had a £1,010,030 receivable from Global VOIP
                Services Limited ("Global VOIP"), an Irish company which provided
                telecom
                services. Story Telecom, Inc. and/or its subsidiaries owed £1,010,030 to
                Global VOIP. In separate agreements, subsequent to the May 10,
                2006 Stock Purchase Agreement, Story Telecom, Inc and/or its subsidiaries
                were assigned the £1,010,030 receivable and payable on Global
                VOIP's books. The assignment of Global VOIP's receivable and payable
                resulted in a non-cash transaction that removed Globe VOIP's receivable
                from the books of the Company and results in inter-company receivables
                and
                payables that eliminate in consolidation. There is no income
                statement effect to these
                transactions.





K.
            On
                May 25, 2006, Xfone and the shareholders of Equitalk.co.uk Limited,
                a
                privately held telephone company based in the United Kingdom ("Equitalk")
                entered into an Agreement relating to the sale and purchase of Equitalk
                (the "Equitalk Agreement"). The Equitalk Agreement provided for Xfone
                to
                acquire Equitalk in a restricted common stock and warrant transaction
                valued at $1,650,000. The acquisition was completed on July 3, 2006,
                and
                on that date Equitalk became Xfone's wholly owned subsidiary. In
                conjunction with the completion of the acquisition and in exchange
                for all
                of the capital stock of Equitalk, Xfone issued a total of 402,192
                restricted shares of its common stock and a total of 281,872 warrants
                exercisable at $3.025 per share for a period of five years. Founded
                in
                December 1999, Equitalk, a VC-financed company, was the first fully
                automated e-telco in the United Kingdom. Equitalk provides both
                residential and business customers with low-cost IDA and CPS voice
                services, broadband and
                teleconferencing.





F-15-
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31,
                  2006**





**Equitalk.co.uk
                Limited****In
                U.S.$**Current
                Assets, excluding cash acquired
            
            £
            146,836
            
            $
            276,442Fixed
                Assets
            
            
            2,258
            
            
            4,251Other
                Assets
            
            
            -
            
            
            -Total
                Assets acquired
            
            
            149,094
            
            
            280,693Current
                Liabilities
            
            
            237,153
            
            
            446,478Long-term
                Liabilities
            
            
            75,000
            
            
            141,200Total
                liabilities
            
            
            312,153
            
            
            587,678Net
                liabilities assumed
            
            £
            (163,059
            )
            $
            (306,985
            )Purchase
                price:Cash
                acquired, net
            
            £
            (82,346
            )
            $
            (155,030
            )Acquisition
                costs
            
            
            7,370
            
            
            13,875Fair
                market value of stock and warrant issued
            
            
            754,553
            
            
            1,420,567Total
            
            £
            679,577
            
            $
            1,279,412Goodwill
            
            
            741,245
            
            
            1,395,513Customer
                relations
            
            
            101,391
            
            
            190,884





The
      value
      assigned to the customer relations is amortized on a straight-line basis over
      7
      years.




The
      financial statements consolidate the operations of Xfone, Swiftnet, Equitalk,
      Xfone USA, Story Telecom, and Xfone 018 - (collectively the " **Company** ").




L.
            The
                financial statements of the Company have been prepared in Sterling
                ("£")
                since this is the currency of the prime economic environment, the
                U.K., in
                which the majority of the operations of the Company are
                conducted.





M.
            The
                financial statements have been translated into U.S. dollars using
                the rate
                of exchange of the U.S. dollar at December 31, 2006. The translation
                was
                made solely for the convenience of the readers. It should be noted
                that
                the £ figures do not necessarily represent the current cost amounts of
                the
                various elements presented and that the translated U.S. dollars figures
                should not be construed as a representation that the £ currency amounts
                actually represented, or could be converted into, U.S. dollars. The
                representative rate of exchange of the £ at December 31, 2006 was £1 =
                $1.959.


F-16-




**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**  **Note
      2 -**  **Significant
      Accounting Policies**





The
      financial statements are prepared in accordance with generally accepted
      accounting principles in the United States. The significant accounting policies
      followed in the preparation of the financial statements, applied on a consistent
      basis, are as follows:




A.
            Principles
                of Consolidation and Basis of Financial Statement
                Presentation





The
      consolidated financial statements have been prepared in conformity with
      accounting principles generally accepted in the United States of America (GAAP)
      and include the accounts of the Company and its wholly-owned subsidiaries.
      All
      significant inter-company balances and transactions have been eliminated in
      consolidation. A minority interest in the loss of a subsidiary will be recorded
      according to the respective equity interest of the minority and up to its
      exposure and/or legal obligation to cover the subsidiary losses in case of
      equity reduced to zero or below.





B.
            Accounts
                Receivable





Accounts
      receivable are recorded at net realizable value consisting of the carrying
      amount less the allowance for uncollectible accounts.





The
      Company uses the allowance method to account for uncollectible accounts
      receivable balances. Under the allowance method, estimate of uncollectible
      customer balances is made using factors such as the credit quality of the
      customer and the economic conditions in the market. An allowance for doubtful
      accounts is determined with respect to those amounts that the Company has
      determined to be doubtful of collection. When an account balance is past due
      and
      attempts have been made to collect the receivable through legal or other means
      the amount is considered uncollectible and is written off against the allowance
      balance.





As
      of
      December 31, 2006 the accounts receivable are presented net of an allowance
      for
      doubtful accounts of £1,286,548.





C.
            Investments





Investments
      in affiliates over which the Company have a significant influence, but not
      a
      controlling interest, are accounted for using the equity method of accounting.
      All equity investments are periodically reviewed to determine if declines in
      fair value below cost basis are other than temporary. If the decline in fair
      value is determined to be other than temporary, an impairment loss is recorded
      and the investment is written down to a new carrying value. In case of losses
      the equity of such investments is reduced to zero.





D.
            Fixed
                Assets





Fixed
      Assets are stated at cost. Depreciation is calculated based on a straight-line
      method over the estimated useful lives of the assets. Annual rates of
      depreciation are as follows:





**Useful
                Life**Switching
                equipment
            
            
            10
                yearsMachinery
                and equipment
            
            
            3-4
                yearsFurniture
                and fixtures
            
            
            4-14
                yearsMotor
                vehicles
            
            
            4
                years





F-17-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**  E.
            Other
                intangible assets





Other
      intangible assets with determinable lives consist of license for communication
      services and are amortized over the 20 year term of the license.





Customer
      base and trade name related to merger and acquisitions are amortized over a
      period between 6-7 years from the date of the purchase.





F.
            Long-Lived
                Assets





The
      Company periodically evaluate the recoverability of the carrying amount of
      long-lived assets (including property, plant and equipment, and intangible
      assets with determinable lives) whenever event or changes in circumstances
      indicate that the carrying amount of an asset may not be fully recoverable.
      The
      Company evaluates events or changes in circumstances based on a number of
      factors including operating results, business plans and forecasts, general
      and
      industry trends and, economic projections and anticipated cash flows.
      Impairment, if any, is assessed when the undiscounted expected future cash
      flows
      derived from an asset are less than its carrying amount. Impairment losses
      are
      measured as the amount by which the carrying value of an asset exceeds its
      fair
      value and are recognized in earnings. The Company also continually evaluates
      the
      estimated useful lives of all long-lived assets and periodically revises such
      estimates based on current events.





G.
            Revenue
                Recognition





The
      Company’s source of revenues results from charges to customers for the call
      minutes they use while on the Company’s telecommunications system. Such revenues
      are recognized at the time this service is rendered. Amounts prepaid by
      customers are deferred and recorded as a liability and then recorded as revenue
      when the customer utilizes the service. Messaging services customers are being
      charged on a per minute basis, per fax page or email. Commissions to agents
      are
      accounted as marketing costs for the Company.





Revenue
      for services is recognized when the related services are provided. Payments
      received in advance are deferred until the service is provided.





H.
            Use
                of Estimates





The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the reported amounts of assets and liabilities and disclosure of
      contingent assets and liabilities at the date of the financial statements,
      and
      the reported amounts of revenues and expenses during the reported period. Actual
      results could differ from those estimates.





I.
            Earnings
                Per Share





Basic
      earning per share (EPS) is computed by dividing income available to common
      stockholders by the weighted average number of common shares outstanding for
      the
      period. Diluted EPS reflects the potential dilution that could occur if
      securities or other contracts to issue common stock were exercised or converted
      into common stock or resulted in the issuance of common stock that then shared
      in the earnings of the entity.





J.
            Income
                Taxes





Deferred
      tax liabilities or assets reflect temporarily differences between amounts of
      assets and liabilities for financial and tax reporting and are adjusted, as
      appropriate, to reflect changes in tax rates expected to be in effect when
      the
      temporary differences reverse.





F-18-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**  K.
            Stock-Based
                Compensation





The
      Company accounts for equity-based compensation arrangements in accordance with
      the provisions of Accounting Principles Board (“APB”) Opinion No. 25,
“Accounting for Stock Issued to Employees,” and related interpretations, and
      complies with the disclosure provisions of SFAS No. 123, “Accounting for
      Stock-Based Compensation.” All equity-based awards to non-employees are
      accounted for at their fair value in accordance with SFAS No. 123. Under APB
      No.
      25, compensation expense is based upon the difference, if any, on the date
      of
      grant, between the fair value of the Company’s stock and the exercise price. Pro
      forma information (see Note 14) regarding the Company’s net income and net
      earnings per share is required by SFAS No. 123 and has been determined as if
      the
      Company had accounted for its employee stock options under the fair value method
      prescribed by SFAS No. 123.





Effective
      the beginning of the first quarter of fiscal year 2006, the Company adopted
      the
      provisions of SFAS 123R using the modified prospective transition method. Under
      this method, prior periods are not restated. The Company use the Black-Scholes
      option pricing model which requires extensive use of accounting judgment and
      financial estimates, including estimates of the expected term participants
      will
      retain their vested stock options before exercising them, the estimated
      volatility of its common stock price over the expected term, and the number
      of
      options that will be forfeited prior to the completion of their vesting
      requirements. Application of alternative assumptions could produce significantly
      different estimates of the fair value of stock-based compensation and
      consequently, the related amounts recognized in the Consolidated Statements
      of
      Operations. The provisions of SFAS 123R apply to new stock options and stock
      options outstanding, but not yet vested, on the date the Company adopted SFAS
      123R. Stock-based compensation expense was included in applicable departmental
      expense categories in the Consolidated Statements of Operations.





L.
            Foreign
                Currency Translation





Assets
      and liabilities of subsidiaries operating outside United Kingdom with a
      functional currency other than Pound are translated into Pounds using year
      end
      exchange rates, costs and expenses are translated at the average exchange rate
      effective during the year. Foreign currency translation gains and losses are
      included in the shareholders equity section.





M.
            Goodwill
                and Indefinite-Lived Purchased Intangible
                Assets





In
      accordance with SFAS No. 142, "Goodwill and Other Intangible Assets", goodwill
      acquired in business combination is assigned to reporting units that are
      expected to benefit from the synergies of the combination as of the acquisition
      date. The company assesses goodwill and indefinite-lived intangible assets
      for
      impairment annually at the end of each year and more frequently if events and
      circumstances indicate impairment may have occurred in accordance with SFAS
      No.
      142. SFAS 142 also requires that the fair value of indefinite-lived purchased
      intangible assets be estimated and compared to the carrying value. The Company
      recognizes an impairment loss when the estimated fair value of the
      indefinite-lived purchased intangible assets is less than the carrying value.
      No
      impairment was recorded at December 31, 2006 and 2005.





N.
            Recent
                Accounting Pronouncements


*1)
      FIN 48*


In
      June
      2006, the Financial Accounting Standards Board (“FASB”) issued FIN 48,
      "Accounting for Uncertainty in Income Taxes--an interpretation of FASB Statement
      No. 109," which seeks to reduce the diversity in practice associated with the
      accounting and reporting for uncertainty in income tax positions. This
      Interpretation prescribes a comprehensive model for the financial statement
      recognition, measurement, presentation and disclosure of uncertain tax positions
      taken or expected to be taken in an income tax return. FIN 48 presents a
      two-step process for evaluating a tax position. The first step is to determine
      whether it is more-likely-than-not that a tax position will be sustained upon
      examination, based on the technical merits of the position. The second step
      is
      to measure the benefit to be recorded from tax positions that meet the
      more-likely-than-not recognition threshold, by determining the largest amount
      of
      tax benefit that is greater than 50 percent likely of being realized upon
      ultimate settlement, and recognizing that amount in the financial statements.
      FIN 48 is effective for fiscal years beginning after December 15, 2006. The
      Company is currently in the process of evaluating the effect, if any, the
      adoption of FIN 48 will have on its consolidated results of operations,
      financial position, or cash flows.





F-19-
 
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31,
                  2006**


*2)
      FAS 157*


In
      September 2006, the FASB issued SFAS No. 157, "Fair Value Measurements," which
      provides enhanced guidance for using fair value to measure assets and
      liabilities. SFAS No. 157 provides a common definition of fair value and
      establishes a framework to make the measurement of fair value in generally
      accepted accounting principles more consistent and comparable. SFAS No. 157
      also
      requires expanded disclosures to provide information about the extent to which
      fair value is used to measure assets and liabilities, the methods and
      assumptions used to measure fair value, and the effect of fair value measures
      on
      earnings. SFAS No. 157 is effective for financial statements issued in fiscal
      years beginning after November 15, 2007 and to interim periods within those
      fiscal years. The Company is currently in the process of evaluating the effect,
      if any, the adoption of SFAS No. 157 will have on its consolidated results
      of
      operations, financial position, or cash flows.




*3)
      SAB 108*


In
      September 2006, the Securities and Exchange Commission issued Staff Accounting
      Bulletin ("SAB") No. 108, "Considering the Effects of Prior Year Misstatements
      when Quantifying Misstatements in Current Year Financial Statements". SAB No.
      108 was issued in order to eliminate the diversity in practice surrounding
      how
      public companies quantify financial statement misstatements. SAB No. 108
      requires that registrants quantify errors using both a balance sheet (iron
      curtain) approach and an income statement (rollover) approach then evaluate
      whether either approach results in a misstated amount that, when all relevant
      quantitative and qualitative factors are considered, is material. SAB No. 108
      is
      effective for fiscal years ending after November 15, 2006. The Company has
      adopted the bulletin during 2006. The adoption did not have a material effect
      on
      its consolidated results of operations, financial position, or cash
      flows.




**Note
      3 -** **** **Prepaid
      Expenses, Other Receivables and Deposits**




**December
                31,**
            
            **December**
              **31,****2006**
            
            **2006**US$Deferred
                Taxes
            
            £
            31,246
            
            $
            61,211Prepaid
                acquisition costs
            
            
            77,534
            
            
            151,889Due
                from Swift Global Limited (non-affiliated entity)
            
            
            5,243
            
            
            10,271Prepaid
                expenses
            
            
            129,041
            
            
            252,792Accrued
                income
            
            
            171,209
            
            
            335,398Tax
                authorities
            
            
            50,264
            
            
            98,467Income
                receivable
            
            
            74,352
            
            
            145,656Other
                receivables
            
            
            220,978
            
            
            432,895£
            759,867
            
            $
            1,488,579




F-20-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**




**December**
              **31,**
            
            **December**
              **31,****2006**
            
            **2006**US$**Cost**Equipment
                held under capital lease
            
            £
            555,150
            
            $
            1,087,539Office
                furniture and equipment
            
            
            1,019,450
            
            
            1,997,103Development
                costs
            
            
            232,737
            
            
            455,931Computer
                equipment
            
            
            1,333,028
            
            
            2,611,401Motor
                vehicles
            
            
            116,069
            
            
            227,380Building
                and Plant
            
            
            646,399
            
            
            1,266,2963,902,833
            
            
            7,645,650**Accumulated
                Depreciation**Equipment
                held under capital lease
            
            
            157,548
            
            
            308,636Office
                furniture and equipment
            
            
            510,107
            
            
            999,300Development
                costs
            
            
            134,849
            
            
            264,169Computer
                equipment
            
            
            381,205
            
            
            746,781Motor
                vehicles
            
            
            12,889
            
            
            25,249Building
                and Plant
            
            
            426,476
            
            
            835,4671,623,074
            
            
            3,179,602£
            2,279,759
            
            $
            4,466,048




**Note
      5 - Investments**




As
      of
      December 31, 2005, Swiftnet had an equity investments of 47.5% of Auracall
      Limited (“Auracall”), which operates in the U.K. Auracall is a reseller of
      Swiftnet's telecommunications services. On January 1, 2006 and in compliance
      with an agreement dated August 21, 2003, Auracall issued shares to a current
      shareholder of Auracall. As a result of this issuance, Swiftnet's equity in
      Auracall was reduced from 47.5% to 32.5%.





On
      September 27, 2006, a Shareholders Loan Agreement was entered by and between
      Auracall, Swiftnet, and the Managing Director of Auracall who holds 67.5% of
      Auracall. As part of this agreement, Swiftnet agreed to provide a loan of
£24,000 ($47,016) to Auracall, free of interest, to be repaid within one year.
      The loan was funded on October 13, 2006.





The
      income that was recorded in the Company's statement of operations for the year
      ended December 31, 2006 which was related to the holding in Auracall amounted
      to
£30,921 ($60,574).


F-21-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**




**December
                31,**
            
            **December
                31,****2006**
            
            **2006**US$Cost:Goodwill
            
            £
            8,074,242
            
            $
            15,817,438Customer
                relations
            
            
            501,505
            
            
            982,448Trade
                name
            
            
            37,508
            
            
            73,478License
            
            
            168,639
            
            
            330,3648,781,894
            
            
            17,203,728Accumulated
                amortization:Customer
                relations
            
            
            49,036
            
            
            96,057Trade
                name
            
            
            3,426
            
            
            6,716License
            
            
            20,245
            
            
            39,65872,707
            
            
            142,431Other
                assets, net
            
            £
            8,709,187
            
            $
            17,061,297




**Note
      7 - Other Liabilities and Accrued Expenses**




**December
                31,**
            
            **December
                31,****2006**
            
            **2006**US$Related
                party
            
            £
            32,494
            
            $
            63,656Corporate
                taxes
            
            
            93,898
            
            
            183,946Government
                authorities
            
            
            529,230
            
            
            1,036,762Payroll
                and other taxes
            
            
            85,924
            
            
            168,325Accrued
                expense
            
            
            322,972
            
            
            632,701Others
            
            
            168,850
            
            
            330,778£
            1,233,368
            
            $
            2,416,168




F-22-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**




**December
                31,**
            
            **December
                31,****Annual
                Interest rate**
            
            **2006**
            
            **2006**US$Short
                term bank credit
            
            
            Prime
                + 0.0% - 1.0%
            
            £
            330,555
            
            $
            647,557Convertible
                note
            
            
            Prime
                + 1.5%
            
            
            714,603
            
            
            1,399,907Note
                payable to others, due on demand, monthly interest payments
                only
            
            
            5%
                - 7%
            
            
            284,197
            
            
            556,742Bank
                loans
            
            
            8.5%
            
            
            58,333
            
            
            114,274Loans
                payable over 5 years
            
            
            Prime
                + 1.0%
            
            
            382,109
            
            
            748,552Loan
            
            
            Israeli
                Consumer Price Index + 4.0%
            
            
            221,863
            
            
            434,6301,991,660
            
            
            3,901,662less
                current portion
            
            
            
            
            
            1,002,249
            
            
            1,963,406Long
                term portion
            
            
            
            
            £
            989,411
            
            $
            1,938,256





The
      notes
      payable matures as follows:


****
            
            ********
            ****
            
            ******Year**2007
            
            £
            1,002,249
            
            $
            1,963,4062008
            
            
            729,357
            
            
            1,428,8102009
            
            
            166,505
            
            
            326,1822010
            
            
            72,018
            
            
            141,0842011
            
            
            21,531
            
            
            42,180£
            1,991,660
            
            $
            3,901,662





F-23-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**





The
      assets and liabilities under capital leases are recorded at the lower of the
      present value of the minimum lease payments or the fair value of the asset.
      The
      assets are depreciated over their estimated productive lives. Depreciation
      of
      assets under capital leases is included in depreciation expense. ****





Future
      minimum lease payments under capital leases as of December 31, 2006
      are:





**December
                31,**
            ****
            **December
                31,**
            ********
            ****
            **2006**
            ****
            **2006**U.S.$2007
            
            £
            66,984
            
            $
            131,2212008
            
            
            60,248
            
            
            118,0262009
            
            
            16,328
            
            
            31,987Total
            
            £
            143,560
            
            $
            281,234Total
                minimum lease payments
            
            £
            157,459
            
            $
            308,462Less:
                amount representing interest
            
            
            (13,899
            )
            
            (27,228
            )Present
                value of net minimum lease payment
            
            £
            143,560
            
            $
            281,234




**Note
      10 - Income Taxes**




The
      Company accounts for income taxes under the provisions of SFAS 109. SFAS No.
      109
      requires the recognition of deferred tax assets and liabilities for both the
      expected impact of differences between the financial statement and tax basis
      of
      assets and liabilities and for the expected future tax benefit to be derived
      from tax loss and tax credit carry forward. The Company does not file
      consolidated tax returns.





F-24-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**





December
                31, 2006U.S.$Deferred
                Tax Liabilities:Accelerated
                tax write off of fixed assets
            
            £
            90,522
            
            $
            177,333Deferred
                Tax Assets:Carry
                forward losses
            
            
            31,246
            
            
            61,211Accrued
                Vacation and severance pay
            
            
            9,450
            
            
            18,513Net
                deferred taxes liabilities
            
            £
            49,826
            
            $
            97,609




The
      provision for income taxes differs from the amount computed by applying the
      statutory income tax rates to income before taxes as follows:




Years
                Ended
            
            Year
                EndedDecember
              31,
            
            December
                31,2006
            
            2006U.S.$Income
                tax computed at statutory rate
            
            £
            106,296
            
            $
            208,234Effect
                of tax authority adjustments
            
            
            (1,328
            )
            
            (2,602
            )Current
                income (losses) for which no deferred tax expense (benefit) has been
                recorded
            
            
            (153,871
            )
            
            (301,432
            )Difference
                between income reported for tax purposes and income for financial
                reporting purposes - net
            
            
            43,694
            
            
            85,596Taxes
                in respect of prior years
            
            
            6,365
            
            
            12,469Provision
                for income taxes
            
            £
            1,156
            
            $
            2,265




**Note
      11 - Commitments contingent liabilities**




**LEGAL
      PROCEEDINGS**




A.
            In
                August 2002, Swiftnet filed a summary procedure lawsuit in the Magistrate
                Court of Tel - Aviv, Israel against MG Telecom Ltd. and its Chief
                Executive Officer, Mr. Avner Shur. In this lawsuit, Swiftnet alleged
                an
                unpaid debt due to Swiftnet in the amount of $50,000 from MG Telecom
                for
                services rendered by Swiftnet to MG Telecom. The debt arose from
                an
                agreement between Swiftnet and MG Telecom, at that time a provider
                of
                calling card services, in which traffic originating from MG Telecom
                calling cards was delivered through our system in London, England.
                Mr.
                Shur signed a personal guarantee agreement to secure MG Telecom’s
                obligations under the agreement. On August 16, 2005, the Magistrate
                Court
                rendered a judgment in this matter, rejecting our claims. On October
                16,
                2005, Swiftnet filed an appeal with the District Court of Tel - Aviv.
                On
                December 28, 2006, the District Court rescinded the judgment of the
                Magistrate Court. The case was returned to the Magistrate Court for
                writing a new reasoned judgment.





F-25-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**  B.
            Swiftnet
                was served with a claim on October 11, 2005 that was filed by MCI
                WorldCom
                Limited (“MCI”) in an English court for the sum of £1,640,440 ($3,213,622)
                plus interest accruing at a daily rate of £401 ($786) which at the date of
                claim had amounted to £92,317 ($180,849). MCI’s claim is for
                telecommunication services MCI claims it provided to Swiftnet. Swiftnet
                has been in dispute with MCI regarding amounts due to MCI for
                telecommunications services provided by MCI to Swiftnet. Swiftnet
                alleges
                that the disputed charges were improperly billed by MCI to its
                account for a long time and therefore MCI should credit Swiftnet for
                a certain amount of the claim.  Swiftnet has defended the claim by
                stating that in relation to the invoices that MCI is claiming remain
                unpaid, £307,094 ($601,597) is not justified according to the rates agreed
                at various meetings and equates to an over-billing by such amount,
                although Swiftnet does not have written evidence for many of the
                agreed
                rates. Swiftnet has also submitted a counterclaim stating that it is
                owed a further £671,111 ($1,314,706) in credits in relation to amounts
                paid on account and wrongly attributed by MCI to over-billed
                invoices. In addition, MCI continues to send traffic to Swiftnet for
                termination via Xfone 018's network. Swiftnet is claiming that the
                amounts owed by MCI to Swiftnet in this regard should be set off
                against
                any amounts being claimed by MCI in the dispute. There is a further
                counterclaim for additional accounting costs and loss of management
                time
                incurred by Swiftnet due to the incorrect billing. Our financial
                statements carry the full amount Swiftnet has calculated that it
                owes to
                MCI based on the data held in Swiftnet’s billing systems.





C.
            In
                August 2006, Story Telecom Limited filed a lawsuit in the Barnet
                County
                Court, London, United Kingdom, against “Famous Telecommunications”, a
                reseller of calling cards, and its owner, Mr. Tanvir Babar. In this
                lawsuit, Story Telecom alleged an unpaid debt in the amount of £52,000
                ($101,868) from Famous Telecommunications and/or Mr. Baber for services
                rendered by it. The debt arose from an agreement between Story Telecom
                and
                famous Telecommunications and/or Mr. Baber, in which Story Telecom
                supplied Famous Telecommunications and/or Mr. Baber with calling
                cards
                which they in turn distributed in the market. In September 2006,
                the court
                rendered a Judgment in Default in favor of Story Telecom. According
                to the
                judgment Famous Telecommunications and/or Mr. Baber must pay the debt
                plus interest forthwith, approximately £54,000 ($105,786). Famous
                Telecommunications and/or Mr. Baber failed to comply with the court's
                order and as a result thereof Story Telecom applied for a Third Party
                Debt
                Order, requesting the court to order Mr. Baber’s bank, Halifax plc, to
                make available to Story Telecom any monies currently available within
                Mr.
                Baber's account. In October 2006, the court made an Interim Order
                ordering
                Halifax plc to hold any amounts available within Mr. Baber’s account
                (up to the amount of the judgment being £54,000) in favor of Story Telecom
                until full hearing takes place. Full hearing took place on January
                18,
                2007, during which the court ordered Halifax plc to pay Story Telecom
                any
                monies held in Mr. Baber’s account. Halifax plc transferred approximately
                £1,200 ($2,351) to Story Telecom’s account as these were all the monies
                available. On March 3, 2007, the court, following Story Telecom’s request,
                ordered Mr. Baber to attend court on April 3, 2007, for questioning
                regarding his financial situation whereby he will also be required
                to
                detail all his assets. Following such questioning Story Telecom will
                look
                to pursue the most likely to succeed course of action in collecting
                the
                monies due.




**Note
      12 - Capital Structure, Stock Options**




**Shares
      and Warrants**




A.
            The
                holders of common stock are entitled to one vote for each share held
                of
                record on all matters submitted to a vote of the stockholders. The
                common
                stock has no pre-emptive or conversion rights or other subscription
                rights. There are no sinking fund provisions applicable to the common
                stock.




B.
            In
                February 2005, Xfone granted 11,400 shares to employees, agents and
                subcontractors from itscompensation
                fund stock pool the shares value as of the granting day was:
                £18,171.




C.
            In
                March 2005 Xfone granted 8,419 warrants for consulting services,
                valued
                £4,505. Each Warrant is valid for 5 years andexercisable
                into one shareof
                restricted common stock at an exercise price of $5.50 per
                share.




D.
            During
                May 2005 and in connection with the acquisition of W.S. Telecom,
                Xfone
                issued 663,650 restricted sharesof
                its common stock representing a market value of £1,170,400, and 561,216
                warrants with a value£691,600.
                Each Warrant is valid for 5 years and exercisable into one share
                with a
                strikeprice
                that is 10% above the closing price of Xfone's common stock at the
                date of
                the acquisition.




F-26-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**  E.
            During
                July 2005, Xfone granted 3,150 shares to a subcontractor. The value
                at the
                granting day was: £5,478.




F.
            In
                connection with Xfone's September 28, 2005 financing transaction
                with
                Laurus Master Fund, Ltd. Xfone issued 157,500 warrants with a value
                of
                £21,740 (see also Note 9). Each warrant is valid for 5 years and
                exercisable into one share of common stock at $3.80 per
                share.




G.
            On
                September 28, 2005 a Securities Purchase Agreement was entered for
                a
                financial transaction by and among Xfone, Crestview Capital Master,
                LLC,
                Burlingame Equity Investors, LP, Burlingame Equity Investors II, LP,
                Burlingame Equity Investors (Offshore), Ltd. and Mercantile Discount
                -
                Provident Funds. The proceeds of the financial transaction were used
                for
                general working capital and/or investment in equipment and/or for
                acquisitions and/or business development. Upon the closing of the
                financial transaction on October 31, 2005, Xfone issued to the investors
                an aggregate of 885,000 shares of common stock at a purchase price
                of
                $2.50 per share together with, 221,250 warrants at $3.00 per share
                and
                221,250 warrants at $3.25 per
                share.




H.
            On
                September 28, 2005, Xfone sold to Laurus Master Fund Ltd. in return
                for
                $2,000,000 a Secured Convertible Term Note for 574,713 shares of
                common
                stock, and 157,500 warrants which are exercisable at $3.80 per share.
                The
                warrants are exercisable for a period of 5
                years




I.
            During
                November 2005, Xfone granted 320,370 warrants to service providers
                and
                subcontractors valued £77,671according to Black-Scholes option pricing model. Each Warrant is
                valid for
                5 years andexercisable
                into one shareof
                restricted common stock at an exercise price of $3.15 to $6.80 per
                share.




J.
            In
                connection with a Stock Purchase Agreement, clarified on July 30,
                2001,
                Campbeltown Business Limited (“Campbeltown”), an entity owned by the
                Nissenson family including Xfone’s President and Chief Executive Officer,
                a shareholder, holds options from Xfone and one of its directors
                to
                purchase 500,000 additional shares of Xfone for the amount of $200,000
                (£115,942).
                This option was exercised on December 29, 2005.




K.
            On
                December 29, 2005, the Board of Directors of Xfone entered into an
                oral
                Stock Purchase Agreement with Mr. Keinan pursuant to which it repurchased
                100,000 restricted shares of its common stock at a price of $2.50
                per
                share (market price at that day was $2.75 per share). The 100,000
                shares
                were returned to Xfone for cancellation. The Agreement was approved
                by a
                majority of the non-interested members of the Board of Directors
                of
                Xfone.




L.
            On
                March 28, 2006, Xfone issued to Gersten Savage, LLP 755 restricted
                shares
                of its common stock as consideration for legal services with a value
                of
                £1,480 ($2,900).


M.
            On
                March 28, 2006, Xfone issued to Oberon Securities, LLC 30,144 shares
                of
                its common stock pursuant to that certain Letter Agreement dated
                November
                15, 2005, between Xfone and Oberon Securities with a value of £54,302
                ($106,378).


N.
            On
                March 31, 2006, and in conjunction with a Letter Agreement dated
                October
                10, 2005 with MCG Capital Corporation, a major creditor of I-55 Internet
                Services, Xfone issued to MCG Capital 667,998 shares of its common
                stock,
                valued at fair value of $2,010,006, in return for retiring its loan
                with I-55 Internet Services.


O.
            On
                April 6, 2006, Xfone sold 80,000 restricted shares of its common
                stock,
                20,000 warrants exercisable at $3.00 per share, and 20,000 warrants
                exercisable at $3.25 per share to Mercantile Discount-Provident Funds.
                The
                warrants are exercisable for a period of 5 years. The total value
                of the
                shares and warrants is £110,072 ($215,630).


P.
            On
                April 6, 2006, Xfone sold 90,000 restricted shares of its common
                stock,
                22,500 warrants exercisable at $3.00 per share, and 22,500 warrants
                exercisable at $3.25 per share to Hadar Insurance Company Ltd. The
                warrants are exercisable for a period of 5 years. The total value
                of the
                shares and warrants is £123,831 ($242,584).


Q.
            On
                April 6, 2006, Xfone sold 110,000 restricted shares of its common
                stock,
                27,500 warrants exercisable at $3.00 per share, and 27,500 warrants
                exercisable at $3.25 per share to the Israeli Phoenix Assurance Company
                Ltd. The warrants are exercisable for a period of 5 years. The total
                value
                of the shares and warrants is £151,348 ($296,492).


R.
            On
                April 6, 2006, Xfone sold 44,000 restricted shares of its common
                stock,
                11,000 warrants exercisable at $3.00 per share, and 11,000 warrants
                exercisable at $3.25 per share to Gaon Gemel Ltd. The warrants are
                exercisable for a period of 5 years. The total value of the shares
                and
                warrants is £60,539 ($118,597).


S.
            During
                May 2006, and in conjunction with a January 10, 2006 Asset Purchase
                Agreement by and among Xfone USA, Inc. and Canufly.net, Inc., Xfone
                issued
                to the shareholders of Canufly.net 33,768 restricted shares of its
                common
                stock and 24,053 warrants, exercisable at $2.98 per share for a period
                of
                five years. The total value of the shares and warrants is £60,752
                ($112,330).






F-27-
 
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31,
                  2006**


T.
            On
                May 10, 2006, Xfone issued in exchange for services 25,000 warrants
                exercisable at $4.00 per share, 25,000 warrants exercisable at $4.50
                per
                share, 25,000 warrants exercisable at $5.00 per share, and 25,000
                warrants
                exercisable at $5.50 per share to Elite Financial Communications
                Group,
                LLC. The term of the warrants shall expire at the later of: (i) 36
                months
                from the day of grant; (ii) 6 months after the underlying shares
                are
                effective. In the event Xfone elects early termination of its agreement
                with Elite Financial Communications Group, then any warrants that
                have not
                yet reached their vesting date will be deemed null and void.


U.
            During
                May 2006, and in conjunction with the merger that consummated on
                March 31,
                2006, Xfone issued to the shareholders of I-55 Internet Services,
                Inc.
                789,863 restricted shares of its common stock valued at $2,380,178
                and
                603,939 warrants valued at $1,284,722, based on the Black Scholes
                option-pricing model. The warrants are convertible on a one to one
                basis
                into restricted shares of Xfone's common stock at an exercise price
                of
                $3.31 per share, and have a term of five years.


V.
            During
                May 2006, and in conjunction with the merger that consummated on
                March 31,
                2006, Xfone issued to the sole shareholder of I-55 Telecommunications,
                LLC. 223,702 restricted shares of its common stock valued at $671,687
                and
                79,029 warrants valued at $166,667, based on the Black Scholes
                option-pricing model. The warrants are convertible on a one to one
                basis
                into restricted shares of Xfone's common stock at an exercise price
                of
                $3.38 per share, and have a term of five years.


W.
            During
                May 2006, and in conjunction with Agreements to Purchase Promissory
                Notes
                dated October 31, 2005 / February 3, 2006 with certain creditors
                of I-55
                Telecommunications, LLC, Xfone issued to the creditors of I-55
                Telecommunications 163,933 restricted shares of its common stock
                and
                81,968 warrants at a total value of $492,220, in return for retiring
                their
                individual loans with I-55 Telecommunications. The warrants are
                convertible on a one to one basis into restricted shares of Xfone's
                common
                stock at an exercise price of $3.38 per share, and have a term of
                five
                years.


X.
            On
                May 30, 2006, Xfone issued 2,736 restricted shares of its common
                stock to
                Elite Financial Communications Group, LLC in exchange for services.
                The
                value of the shares is £4,955 ($9,707).


Y.
            On
                June 28, 2006, Xfone cancelled 5,000 restricted shares of its common
                stock
                which were issued in 2000 to Ofer Weisglass. The shares were issued
                to Mr.
                Weisglass in return for services; however Mr. Weisglass failed to
                provide
                the services to Xfone.


Z.
            On
                July 3 2006, Xfone issued to Preiskel & Co LLP 5,236 restricted shares
                of its common stock as consideration for legal services. The value
                of the
                shares is £7,500 ($1,469).


AA.
            On
                July 5, 2006, and in conjunction with the acquisition that was completed
                on July 3, 2006, Xfone issued to the shareholders of Equitalk.co.uk
                Limited a total of 402,192 restricted shares of its common stock
                and a
                total of 281,872 warrants exercisable at $3.025 per share for a period
                of
                five years. The total value of the shares and warrants is £717,167
                ($1,404,930).


BB.
            On
                July 11, 2006, and in conjunction with a March 10, 2005 Employment
                Agreement between Xfone USA, Inc. and Wade Spooner, its President
                and
                Chief Executive Officer, Xfone issued to Mr. Spooner an “Acquisition
                Bonus” of 32,390 warrants. Xfone was advised by AMEX that the approval of
                the shareholders of Xfone is required in order to allow the issuance
                and
                listing of the shares underlying said warrants. The required approval
                was
                obtained on December 28, 2006. The warrants are convertible on a
                one to
                one basis into restricted shares of Xfone's common stock at an exercise
                price of $3.285, and have a term of five years. The value of the
                warrants
                is £11,010 ($21,569).


CC.
            On
                July 11, 2006, and in conjunction with a March 10, 2005 Employment
                Agreement between Xfone USA, Inc. and Ted Parsons, its Vice President
                and
                Chief Marketing Officer, Xfone issued to Mr. Parsons an “Acquisition
                Bonus” of 16,195 warrants. Xfone was advised by AMEX that the approval of
                the shareholders of Xfone is required in order to allow the issuance
                and
                listing of the shares underlying said warrants. The required approval
                was
                obtained on December 28, 2006. The warrants are convertible on a
                one to
                one basis into restricted shares of Xfone's common stock at an exercise
                price of $3.285, and have a term of five years. The value of the
                warrants
                is £5,506 ($10,785).


DD.
            On
                July 11, 2006, and in conjunction with a Letter Agreement dated June
                15,
                2006 between Xfone and Oberon Securities, LLC, Xfone issued to Oberon
                Securities 243,100 warrants at an exercise price of $2.86 and 37,200
                warrants at an exercise price of $3.34. The warrants are convertible
                on a
                one to one basis into restricted shares of Xfone's common stock,
                and have
                a term of five years. The value of the warrants is £180,140
                ($352,895).


EE.
            On
                July 11, 2006, and in conjunction with a June 19, 2006 Securities
                Purchase
                Agreement Xfone issued to several investors an aggregate of 172,415
                warrants. The warrants are convertible on a one to one basis into
                restricted shares of Xfone's common stock, at an exercise price of
                $3.40,
                and have a term of five years. The value of the warrants is £91,186
                ($178,633).






F-28-
 
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31,
                  2006**


FF.
            On
                September 5, 2006, and in conjunction with a June 19, 2006 Securities
                Purchase Agreement Xfone issued to several investors an aggregate
                of
                344,825 restricted shares of common stock. The value of the shares
                is
                £531,163 ($1,040,549).


GG.
            On
                September 19, 2006, and in conjunction with a Letter Agreement dated
                June
                15, 2006 between Xfone and Oberon Securities, LLC, Xfone issued to
                Oberon
                Securities 90,000 restricted shares of common stock. The value of
                the
                shares is £119,512 ($234,124).


HH.
            On
                September 19, 2006, and pursuant to the Service Agreement dated December
                6, 2005, that was terminated on August 28, 2006, Xfone cancelled
                64,360 of
                the 100,000 warrants which were issued to Elite Financial Communications
                Group, LLC on May 10, 2006.


II.
            On
                November 1, 2006, Xfone issued 6,994 restricted shares of its common
                stock
                to Elite Financial Communications Group, LLC in exchange for services.
                The
                value of the shares is £9,044 ($17,717).


JJ.
            On
                November 20, 2006, Xfone issued in exchange for services 36,000 warrants
                exercisable at $3.50 per share, 36,000 warrants exercisable at $4.00
                per
                share, and 36,000 warrants exercisable at $4.50 per share to Institutional
                Marketing Services, Inc. The warrants have a term of five years.
                In the
                event Xfone elects early termination of its agreement with Institutional
                Marketing Services, then any warrants that have not yet reached their
                vesting date will be cancelled. The value of the warrants is
                £27,341($53,561).


KK.
            On
                November 27, 2006, Xfone issued in exchange for services 117,676
                warrants
                exercisable at $3.50 per share to Crestview Capital Master, LLC.
                The
                warrants have a term of five years and shall vest as follows: 29,419
                warrants immediately, 29,419 warrants on February 10, 2007, 29,419
                warrants on May 10, 2007, and 29,419 warrants on August 10, 2007.
                The
                value of the warrants is £89,662
                ($175,648).




LL.
            On
                December 26, 2006, and in conjunction with a December 25, 2006 oral
                stock
                purchase agreement, Xfone repurchased from Abraham Keinan, its Chairman
                of
                the Board, 100,000 restricted shares of its common stock at a price
                of
                $2.70 per share (market price at that day was $2.80 per share). The
                100,000 shares were returned to Xfone for cancellation. The Agreement
                was
                approved by all non-interested members of the Board of Directors,
                following a review and discussion by Xfone’s Audit
                Committee.




**Stock
      Option Plan**




A.
            In
                November 2004, Xfone’s board of directors approved the adoption of the
                principal items forming Xfone’s 2004 stock option plan (The “Plan”) for
                the benefit of employees, officers, directors, consultants and
                subcontractors of the Company including its subsidiaries. This plan
                was
                approved by a special meeting of shareholders on March 13, 2006.
                The
                purpose of the Plan is to enable the Company to attract and retain
                the
                best available personnel for positions of substantial responsibility,
                to
                provide an incentive to such persons presently engaged with the Company
                and to promote the success of the Company business. The Plan will
                provide
                for the grant of options an aggregate of 5,500,000 shares of Xfone’s
                common stock. The Plan shall be administered by the board to determine
                the
                persons to whom options are granted, the number of options that are
                granted, the number of shares to be covered by each option, the options
                may be exercised and whether the options is an incentive or non-statutory
                option.




B.
            At
                November 24, 2004 3,200,000 options were granted under the plan described
                above according to the following terms: Option exercise price - $3.50,
                vesting date - 12 month from the date of grant, expiration date -
                5 years
                from the vesting date.




C.
            On
                February 6, 2005, Xfone’s board of directors approved a grant to employees
                of 730,000 options under and subject to the 2004 Stock Option Plan
                of
                Xfone according to the following terms: Option exercise price of
                $3.50;
                Vesting Date**-**the vesting of the options will be over a period of 4 years as follows:
                25% of the options are vested after a year from the Date of Grant.
                Thereafter, 1/16 of the options are vested every 3 months for the
                following 3 years; Expiration Date**-**5.5 years from the Grant Date.




F-29-
 
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31, 2006**


D.
            On
                November 13, 2005, Xfone's Board of Directors ratified the grant
                of 600,000 options to Wade Spooner and 300,000 options to Ted
                Parsons on March 10, 2005, under its 2004 Stock Option Plan, pursuant
                to the terms described in their March 10, 2005 employment agreements.
                The
                stock options will provide for a five (5) year term from the vesting
                date,
                a strike price that is 10% above the closing price of the Registrant’s
                common stock on the date of issue of the Options.




E.
            On
                June 8, 2005, Xfone’s board of directors approved a grant to Xfone's Chief
                Financial Officer, of 300,000 options under and subject to the 2004
                Stock
                Option Plan of Xfone according to the following terms: Option exercise
                price of $3.50; Vesting Date**-**the vesting of the options will be over a period of 4 years as follows:
                25% of the options are vested after a year from the Date of Grant.
                Thereafter, 1/16 of the options are vested every 3 months for the
                following 3 years; Expiration Date**-**5.5
                years from the grant date.




F.
            On
                July 11, 2006, and in conjunction with a July 3, 2006 Service Agreement
                between Xfone, Swiftnet Limited and John Mark Burton, the Managing
                Director of Xfone's UK based subsidiaries, Swiftnet Limited and
                Equitalk.co.uk Limited Xfone’s Board of Directors approved the grant of
                300,000 options, under and subject to its 2004 Stock Option Plan,
                to Mr.
                Burton. The options are convertible on a one to one basis into restricted
                shares of Xfone's common stock, at an exercise price of $3.50, and
                have a
                term of ten years. The vesting of the options will be over a period
                of 4
                years as follows: 75,000 options are vested on July 3, 2007. Thereafter,
                18,750 options are vested every 3 months for the following 3
                years.




G.
            On
                October 30, 2006, Xfone’s Board of Directors approved a grant of 25,000
                options to Itzhak Almog under and subject to Xfone’s 2004 Stock Option
                Plan. The options were granted according to the following terms:
                Date of
                Grant - October 30, 2006; Option exercise price - $3.50; Vesting
                Date - 12
                months from the Date of Grant; Expiration Date - 5 years from the
                Vesting
                Date.




H.
            As
                of December 31, 2006 there are 5,350,000 options outstanding out
                of this
                plan, of which 325,000 options were granted in 2006. Transactions
                related
                to the above Plan during the year ending December 31, 2006 were as
                follows:




Year
                Ended December 31, 2006Number
                of options
            
            Weighted
                average exercise priceOptions
                outstanding at the beginning of the year
            
            
            5,130,000
            
            $
            3.70Granted
            
            
            325,000
            
            $
            3.50Forfeited
            
            
            (105,000
            )
            $
            3.50Options
                outstanding at the end of the year
            
            
            5,350,000
            
            $
            3.69Options
                vested as exercisable
            
            
            3,665,625
            
            $
            3.50Weighted
                average fair value of options granted
            
            
            
            
            $
            1.21




F-30-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**




Options
                OutstandingRange
                price ($)
            Number
                of options
            Weighted
                average remaining contractual life (years)
            Weighted
                average exercise price3.50
                - 4.62
            5,350,000
            4.8
            $3.69




**Note
      13 - Earnings Per Share**




**Year
                Ended December 31 , 2006**Weighted
                Average**Income**
            
            **Shares**
            
            **Per
                Share**
            
            **Per
                Share****Amounts**
            
            **Amounts**U.S.$Net
                Income
            
            
            
            
            £
            337,262**Basic
                EPS:**Income
                available to common stockholders
            
            
            
            
            £
            337,262
            
            
            10,135,874
            
            £
            0.033
            
            $
            0.065Effect
                of dilutive securities:Options
                and warrants
            
            
            (*
            )
            
            -
            
            
            -
            
            
            -
            
            
            -**Diluted
                EPS:**Income
                available to common stockholders
            
            
            
            
            £
            337,262
            
            
            10,135,874
            
            £
            0.033
            
            $
            0.065


(*)
      Anti-diluted




**Year
                Ended December 31 , 2005****Weighted
                Average****Income**
            
            **Shares**
            
            **Per
                Share**
            
            **Per
                Share****Amounts**
            
            **Amounts**U.S.$Net
                Income
            
            £
            26,078**Basic
                EPS:**Income
                available to common stockholders
            
            £
            26,078
            
            
            6,868,471
            
            £
            0.004
            
            $
            0.007Effect
                of dilutive securities:Options
                and warrants
            
            
            -
            
            
            1,074,713
            
            
            (0.001
            )
            
            (0.001
            )**Diluted
                EPS:**Income
                available to common stockholders
            
            £
            26,078
            
            
            7,943,184
            
            £
            0.003
            
            $
            0.006




F-31-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**




Years
                ended
            
            Years
                endedDecember 
                31,
            
            December
                31,**2006**
            
            **2005**
            
            **2006**US$**Campbeltown
                Business:**Fees
            
            £
            83,400
            
            £
            83,400
            
            $
            163,381Accrued
                Expenses
            
            
            6,950
            
            
            6,950
            
            
            13,615**Vision
                Consultants Limited:**Fees
            
            
            -
            
            
            83,400
            
            
            163,381Accrued
                expenses
            
            
            -
            
            
            6,950
            
            
            -Abraham
                KeinanFees
            
            
            51,409
            
            
            -
            
            
            100,710Accrued
                expenses
            
            
            5,905
            
            
            -
            
            
            11,568**Story
                Telecom Limited:**Revenues
                (*)
            
            
            1,472,150
            
            
            3,203,663
            
            
            2,883,942Commissions
                (*)
            
            
            159,418
            
            
            172,144
            
            
            312,300Due
                from related Story Telecom (net)
            
            
            627,528
            
            
            1,290,702
            
            
            1,229,327**Auracall
                Limited:**Related
                revenues
            
            
            766,254
            
            
            211,099
            
            
            1,501,092Commissions
            
            
            541,735
            
            
            143,364
            
            
            1,061,259Due
                to Auracall (net)
            
            
            72,809
            
            
            120,395
            
            
            142,633Short-term
                loan from Auracall Limited
            
            
            24,000
            
            
            -
            
            
            47,016**Dionysos
                Investments (1999) Limited:**Fees
            
            
            36,000
            
            
            36,000
            
            
            70,524Accrued
                Expenses
            
            
            3,000
            
            
            3,000
            
            
            5,877**Balance:**Loan
                to Abraham Keinan
            
            
            -
            
            
            123,965
            
            
            -Guy
                Nissenson
            
            
            -
            
            
            (11,542
            )
            
            (22,611
            )Abraham
                Keinan
            
            
            -
            
            
            (18,201
            )
            
            (62,670
            )


(*)
      Amount represents the period for which Story Telecom Limited was not
      consolidated into the Company's financial reports.




F-32-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**




A.
            The
                Company leases its facilities in the UK, USA and Israel under operating
                lease agreement, which will expire in 2009 through 2012. The minimum
                lease
                payments under non-cancelable operating leases are as
                follows:




Year
                ended December 31,2007
            
            £
            223,8872008
            
            
            166,6122009
            
            
            108,8182010
            
            
            49,1342011
            
            
            49,1342012
            
            
            49,134




B.
            On
                April 2, 2002, Xfone’s Board of Directors approved a bonus and success fee
                whereby if the Company receives monthly revenues in excess of $485,000
                then Mr. Keinan and Campbeltown Business shall receive 1% of such
                monthly
                revenues, up to a maximum of one million dollars (the “Bonus and Success
                Fee”). On April 10, 2003, Mr. Keinan and Campbeltown Business waived
                their
                right to receive 1% of the revenues generated by Story Telecom. This
                bonus
                and success fee was separate from our consulting agreement with
                Campbeltown Business, involving a monthly payment of £2000, along with an
                additional monthly performance bonus. On February 8, 2007, an Agreement
                was entered by and between Xfone, Swiftnet, Campbeltown Business,
                and Mr.
                Keinan (the “February 8, 2007 Agreement”). The February 8, 2007 Agreement
                provides that effective as of January 1, 2007, the Bonus and Success
                Fee
                is cancelled, and that Mr. Keinan and Campbeltown Business shall
                have no
                further right to any percentage of our
                revenue.




C.
            On
                May 11, 2000, Swiftnet Limited, which is now our wholly owned subsidiary,
                and our Chairman of the Board of Directors, Abraham Keinan, entered
                into
                an 18-month renewable consulting agreement with Campbeltown Business
                Ltd.,
                a private company incorporated in the British Virgin Island which
                is owned
                by Guy Nissenson, our President, Chief Executive Officer, Treasurer,
                Chief
                Financial Officer, Principal Accounting Officer and Director and
                other
                family members of Mr. Nissenson. This agreement provided that Swiftnet
                will hire Campbeltown Business as its financial and business development
                consultant and will pay Campbeltown Business £2,000 per month, along with
                an additional monthly performance bonus based upon Swiftnet attaining
                the
                following revenue levels, for consulting services in the area of
                business
                development and management activities:




TARGET
                AMOUNT OFREVENUES
                PER MONTH
            
            ADDITIONAL
                MONTHLY BONUSLess
                than £125,000
            
            
            £0Between
                £125,000 - £150,000
              (approximately
                $244,875 - $293,850)
            
            
            £1,250
              (approximately
                $2,449)Between
                £150,000 - £175,000
              (approximately
                $293,850 - $342,825)
            
            
            £2,500
              (approximately
                $4,898)Over
                £175,000
              (approximately
                $342,825)
            
            
            £2,750
              (approximately
                $5,387)





The
      agreement with Campbeltown Business involving the aforementioned monthly payment
      of £2000, along with an additional monthly performance bonus, was separate from
      a bonus and success fee arrangement that was approved by our Board of Directors
      on April 2, 2002.





F-33-
 
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31, 2006**


The
      May
      11, 2000 agreement was for 18 months, but provided that it will be renewed
      by
      mutual agreement of Swiftnet and Campbeltown Business. On November 5, 2001,
      May
      11, 2003, November 10, 2004, and May 11, 2006 this agreement was renewed for
      additional 18 month periods. On February 8, 2007, an Agreement was entered
      by
      and between Xfone, Swiftnet, Campbeltown Business, and Mr. Keinan (the “February
      8, 2007 Agreement”). The February 8, 2007 Agreement provides that effective as
      of January 1, 2007, the aforementioned consulting agreement is terminated.





Stock
      Purchase Agreement





On
      June
      19, 2000, Swiftnet Limited entered into a Stock Purchase Agreement with Abraham
      Keinan and Campbeltown Business Ltd. a company owned and controlled by Guy
      Nissenson and his family. This agreement provides that:




·
            Abraham
                Keinan confirmed that all his businesses activities and initiatives
                in the
                field of telecommunications are conducted through Swiftnet, and would
                continue for at least 18 months after the conclusion of this
                transaction.


·
            Campbeltown
                Business declared that it is not involved in any business that competes
                with Swiftnet and would not be involved in such business at least
                for 18
                months after this transaction is concluded.


·
            Campbeltown
                Business would invest $100,000 in Swiftnet, in exchange for 20% of
                the
                total issued shares of Swiftnet;


·
            Campbeltown
                Business would also receive 5% of our issued and outstanding shares
                following our acquisition with Swiftnet. In June 2000, Campbeltown
                Business invested the $100,000 in Swiftnet. Xfone acquired Swiftnet
                and
                Campbeltown received 720,336 shares of our common stock for its 20%
                interest in Swiftnet.


·
            Swiftnet
                and Abraham Keinan would guarantee that Campbeltown Business' 20%
                interest
                in the outstanding shares of Swiftnet would be exchanged for at least
                10%
                of our outstanding shares and that Campbeltown Business would have
                in
                total at least 15% of our total issued shares after our acquisition
                occurred.


·
            Campbeltown
                Business would have the right to nominate 33% of the members of our
                board
                of directors and Swiftnet’s board of directors. When Campbeltown Business
                ownership in our common stock was less than 7%, Campbeltown Business
                would
                have the right to nominate only 20% of our board members but always
                at
                least one member. In the case that Campbeltown Business ownership
                in our
                common stock was less than 2%, this right would
                expire.


·
            Campbeltown
                Business would have the right to nominate a vice president in Swiftnet.
                Mr. Guy Nissenson was nominated as of the time of the June 19, 2000
                agreement. If for any reason Guy Nissenson will leave his position,
                Campbeltown Business and Abraham Keinan will agree on another nominee.
                The
                Vice President will be employed with suitable
                conditions.


·
            Campbeltown
                Business will have the right to participate under the same terms
                and
                conditions in any investment or transaction that involve equity rights
                in
                Swiftnet or us conducted by Abraham Keinan at the relative ownership
                portion.


·
            Keinan
                and Campbeltown Business have signed a right of first refusal agreement
                for the sale of their shares.




Until
      Xfone conducts a public offering or is traded on a stock market, we are not
      permitted to issue any additional shares or equity rights without a written
      agreement from Campbeltown Business. This right expires when Campbeltown no
      longer owns any equity interest or shares in Xfone or Swiftnet.




D.
            The
                Company has commission agreements with various agents that are entitled
                to
                commission of approximately 5%-12% of the total sale amount less
                any bad
                debts.




**Note
      16 - Economic Dependency and Credit Risk**




A.  Certain
      Telecommunication operators act as collection channels for the Company. In
      2006
      the Company had two major collection channels, one in the U.K. and one in
      Israel. Collections through these channels accounted to approximately 18% and
      5%
      of the Company's total revenues in 2006, and 23% and 19% of the Company's total
      revenues in 2005. With respect to collection of monies for the Company, these
      Telecommunication operators are not deemed to be customers of the
      Company.




F-34-
 
 **Xfone,
                  Inc. and Subsidiaries****NOTES
                  TO CONSOLIDATED FINANCIAL STATEMENTS**
                **DECEMBER
                  31, 2006**


B.
            Approximately,
                31%, 28% and 5% of the Company’s purchases are from three suppliers for
                the year ended December 31, 2006, and 21%, 16%, 15% and 14% are from
                four
                suppliers for the year ended December 31,
                2005.




**Note
      17 - Segment Information**




The
      percentage of the Company’s revenues is derived from the following Geographical
      segments:




Years
                Ended
            
            Years
                EndedDecember
                31,
            
            December
                31,2006
            
            2005
            
            2006US$Revenues:England
            
            £
            8,652,945
            
            £
            8,141,765
            
            $
            16,951,119United
                states
            
            
            7,899,033
            
            
            4,516,472
            
            
            15,474,206Israel
            
            
            2,801,793
            
            
            1,455,511
            
            
            5,488,712Total
                revenues
            
            
            19,353,771
            
            
            14,113,748
            
            
            37,914,037Cost
                of revenuesEngland
            
            
            6,041,075
            
            
            6,104,496
            
            
            11,834,466United
                states
            
            
            3,922,771
            
            
            2,146,386
            
            
            7,684,708Israel
            
            
            1,250,548
            
            
            1,003,715
            
            
            2,449,824Total
                cost of revenues
            
            
            11,214,394
            
            
            9,254,597
            
            
            21,968,998Direct
                gross Profit:England
            
            
            2,611,870
            
            
            2,037,269
            
            
            5,116,653United
                states
            
            
            3,976,262
            
            
            2,370,086
            
            
            7,789,497Israel
            
            
            1,551,245
            
            
            451,796
            
            
            3,038,8898,139,377
            
            
            4,859,151
            
            
            15,945,039Operating
                expenses:England
            
            
            1,828,572
            
            
            1,826,754
            
            
            3,582,173United
                states
            
            
            3,398,811
            
            
            (*)
                1,707,604
            
            
            6,658,270Israel
            
            
            1,638,303
            
            
            823,048
            
            
            3,209,4366,865,686
            
            
            (*)
                4,357,406
            
            
            13,449,879Operating
                Profit:England
            
            
            783,298
            
            
            210,515
            
            
            1,534,480United
                states
            
            
            577,451
            
            
            (*)
                662,482
            
            
            1,131,227Israel
            
            
            (87,058
            )
            
            (371,252
            )
            
            (170,547
            )1,273,691
            
            
            (*)
                501,745
            
            
            2,495,160Expenses
                related to Headquarter in the US
            
            
            745,349
            
            
            (*)
                547,491
            
            
            1,460,138Operating
                Profit
            
            £
            528,342
            
            £
            (45,746
            )
            $
            1,035,022





(*)
      Amounts were reclassified in order to present segment information without the
      effect of expenses related to operating a Headquarter in the US.




F-35-


**Xfone,
                Inc. and Subsidiaries****NOTES
                TO CONSOLIDATED FINANCIAL STATEMENTS**
              **DECEMBER
                31,
                2006**




A. On
          January 16, 2007, and in conjunction with a December 24, 2006 Securities
          Purchase Agreement we issued an aggregate of 344,828 restricted shares
          of our
          common stock to Halman-Aldubi Provident Funds Ltd. and Halman-Aldubi Pension
          Funds Ltd .





B.  On
      February 2, 2007, and in conjunction with a December 24, 2006 Securities
      Purchase Agreement we issued an aggregate of 172,414 warrants to Halman-Aldubi
      Provident Funds Ltd. and Halman-Aldubi Pension Funds Ltd. The warrants are
      exercisable on a one to one basis into restricted shares of our common stock,
      at
      an exercise price of $3.40, and have a term of five years.





C. On
          February 23, 2007, Story Telecom (Ireland) Limited, a wholly-owned subsidiary
          of
          Story Telecom, Inc., the Company's majority-owned subsidiary, was
          dissolved.
  D.
          Following the closing in 2006, and due to the satisfaction of certain earnout
          provisions in the Asset Purchase Agreement with Canufly.net and Mr. Michael
          Nassour, the Company issued on March 20, 2007 an additional 20,026 restricted
          shares of its common stock and 14,364 warrants exercisable at $2.98 per
          share
          for a period of five years to the shareholders of
          Canufly.net.


F-36-


ITEM
        8. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS AND FINANCIAL DISCLOSURE
 
 On
        January 18, 2006, the Audit Committee of the Company, in accordance with
        its
        rotation of independent auditors policy, has replaced Chaifetz & Schreiber,
        P.C. as independent auditors and appointed Stark Winter Schenkein &
Co., LLP (“SWS”), an independent member of BKR International, as independent
        auditors of the Company. There were no reportable events, disagreements or
        dissatisfaction with Chaifetz & Schreiber to report as defined in Regulation
        S-B Item 304(a)(2). Chaifetz & Schreiber P.C. were replaced as part of the
        Company policy of rotating its lead and reviewing audit partners after five
        consecutive years. On January 31, 2006, we filed with the U.S. Securities
        and
        Exchange Commission an amended current report on Form 8-K disclosing the
        appointment of SWS as our new auditors. On December 28, 2006, our
        shareholders approved the appointment of SWS as our Independent Certified
        Public
        Accountants for the fiscal year ending December 31, 2006, and the first three
        quarters of the fiscal year ending December 31, 2007.
  ITEM
        8A. CONT ROLS
        AND PROCEDURES.
 
 As
        of December 31, 2006, an evaluation was performed under the supervision and
        with
        the participation of our management, including our Chief Executive Officer
        and
        Principal Financial Officer, of the effectiveness of the design and operation
        of
        our disclosure controls and procedures. Based on that evaluation, our
        management, including our Chief Executive Officer and Principal Financial
        Officer, concluded that our disclosure controls and procedures were effective
        as
        of December 31, 2006.
 
 There
        have been no significant changes in our internal control over financial
        reporting during the fiscal year ended December 31, 2006, or subsequent to
        December 31, 2006 that have materially affected or are reasonably likely
        to
        materially affect, our internal control over financial reporting.
  ITEM
        8B. OTHER INFORMATION
 
 **Asset
        Purchase Agreement with Canufly.net, Inc.**
 
 As
        previously disclosed on Current Report on Form 8-K filed January 31, 2006,
        on
        January 10, 2006 (effective as of January 1, 2006), Xfone USA, Inc., our
        wholly
        owned subsidiary, entered into an Asset Purchase Agreement with Canufly.net,
        Inc. (“Canufly.net”), an Internet Service Provider based in Vicksburg,
        Mississippi, and its principal shareholder, Mr. Michael Nassour. Canufly.net
        provided residential and business customers with high-speed Internet services
        and utilized the facilities-based network of Xfone USA, as an alternative
        to
        BellSouth, to provide Internet connectivity to its customers. Canufly.net
        also
        provided Internet services through a small wireless application in certain
        areas
        in Vicksburg, Mississippi. The transaction was closed on January 24, 2006.
 
 We
        agreed
        to pay a total purchase price of up to $710,633, payable as follows: (i)
        $185,000 in cash payable in twelve equal monthly payments, the first installment
        was paid at closing, and as of December 31, 2006, the entire amount was paid
        in
        full and in accordance with the Asset Purchase Agreement; (ii) $255,633 in
        cash,
        paid at closing, to pay off the loan with the B&K Bank; (iii) 33,768
        restricted shares of common stock and 24,053 warrants exercisable at $2.98
        per
        share for a period of five years were issued to the shareholders of Canufly.net
        during May 2006.
 
 Following
        the closing in 2006 and due to the satisfaction of certain earnout provisions
        in
        the Asset Purchase Agreement the Company issued on March 20, 2007 an additional
        20,026 restricted shares of its common stock and 14,364 warrants exercisable
        at
        $2.98 per share for a period of five years to the shareholders of
        Canufly.net.
 
 -46-
 The
        acquisition was not significant from an accounting perspective.
 
 **Consulting
        Agreements / Employment Agreements with Abraham Keinan and Guy
        Nissenson**
 
 **Background**
 
 As
        previously disclosed on Current Report on Form 8-K filed December 28, 2006,
        o n
        December 25, 2006, the Board of Directors of the Company approved, effective
        as
        of January 1, 2007, an annual compensation of £168,000 ($329,112) to the President and Chief Executive Officer of the Company, Mr. Guy Nissenson;
        and an annual compensation of £168,000 ($329,112) to
        the Chairman of the Board of Directors of the Company, Mr. Abraham
        Keinan.
 
 The
        Board of Directors further resolved that the Company and its wholly-owned
        U.K.
        based subsidiary, Swiftnet Limited will enter into appropriate written
        agreements with Messrs Nissenson and Keinan to reflect the above-mentioned
        resolution. These new agreements will supersede prior compensation agreements
        and Board of Directors resolutions regarding Mr. Nissenson, Campbeltown Business
        Ltd., and Mr. Keinan.
 
 It
        was further resolved by the Board of Directors that bonuses and success fees
        to
        Messrs Nissenson and Keinan will be discussed separately, taking into account
        revenues and profit growth in 2007.
 
 The
        above-mentioned resolutions (the “December 25, 2006 Board Resolutions”) were
        approved by all non-interested members of the Board of Directors, following
        a
        review and discussion by the Company’s Audit Committee.
 
 **Keinan
        Employment Agreement with Swiftnet**
 
 Pursuant
        to the December 25, 2006 Board Resolutions, on March 28, 2007, Swiftnet and
        Mr.
        Keinan entered into an employment agreement, to be effective as of January
        1,
        2007 (the “Keinan Employment Agreement”).
 
 The
        Keinan Employment Agreement provides that Mr. Keinan shall be employed as
        the
        Chairman of the Board of Directors of Swiftnet. Keinan Employment Agreement
        shall be in effect for an initial fixed term of five years, beginning on
        January
        1, 2007, (the "Initial Effective Term"), and thereafter shall automatically
        be
        renewed for additional terms of three years (each, an "Additional Effective
        Term"). Notwithstanding the foregoing, each of Swiftnet and Mr. Keinan shall
        have the right to terminate the automatic renewal of Keinan Employment
        Agreement, for any reason whatsoever, by a termination notice in writing,
        to be
        provided to the other party not less than six months prior to: (i) the
        expiration of the Initial Effective Term, or (ii) the expiration of any
        Additional Effective Term (the "Notice Period"). Notwithstanding the foregoing,
        Mr. Keinan shall have the right to terminate the Keinan Employment Agreement,
        for any reason whatsoever, and at any time, including during the Initial
        Effective Term ("Early Termination"). In the event of Early Termination,
        the
        Notice Period shall be of not less than eight months.
 
 Under
        the
        Keinan Employment Agreement, Swiftnet shall pay to Mr. Keinan during the
        term of
        his engagement a salary at the rate of Forty Eight Thousand British Pounds
        (£48,000) ($94,032) per annum, such salary to be paid in equal monthly
        installments in arrears on the last Friday of each month. Swiftnet shall
        provide
        Mr. Keinan with an appropriate executive car or car allowance with an effective
        annual cost to Swiftnet of up to Fifteen Thousand British Pounds (£15,000)
        ($29,385).
 
 -47-
 Swiftnet
        shall pay Mr. Keinan contributions to the following schemes: (i) Health care
        for
        him and his immediate family; (ii) Permanent health; (iii) Life insurance
        arrangements (up to a maximum of four times salary); (iv) Pension rights
        -
        Swiftnet shall contribute a monthly sum equal to 7.5% of his salary. (v)
        Travel
        insurance.
 
 Swiftnet
        shall reimburse to Mr. Keinan all traveling, hotel, restaurant and other
        expenses incurred by him in the proper performance of his duties under his
        engagement.
 
 If
        during
        the period of the employment under the Keinan Employment Agreement Mr. Keinan
        shall cease to be a director of Swiftnet, his employment shall continue and
        the
        terms of the Keinan Employment Agreement (other than those relating to the
        holding of office of director / chairman) shall continue in full
        force.
 
 The
        Keinan Employment Agreement also contains special arrangements for sickness
        benefits, holiday entitlement and provisions regarding non-competition;
        intellectual property; confidentiality; conflict of interests and other standard
        terms and conditions.
 
 The
        Keinan Employment Agreement was approved by all non-interested members of
        the
        Board of Directors, following a review and discussion by the Company’s Audit
        Committee.
 
 A
        copy of
        the Keinan Employment Agreement is attached hereto as Exhibit 10.97 and
        incorporated herein by reference.
 
 **Keinan
        Consulting Agreement**
 
 Pursuant
        to the December 25, 2006 Board Resolutions, on March 28, 2007, the Company
        and
        Mr. Keinan entered into a consulting agreement, to be effective as of January
        1,
        2007 (the “Keinan Consulting Agreement”).
 
 The
        Keinan Consulting Agreement provides that Mr. Keinan shall render the Company
        advisory, consulting and other services in relation to the business and
        operations of the Company (excluding its business and operations in the United
        Kingdom).
 
 In
        consideration of the performance of the Services pursuant to the Keinan
        Consulting Agreement, the Company shall pay Mr. Keinan a monthly fee of Ten
        Thousand British Pounds (£10,000) ($19,590) (the "Fee"). Mr. Keinan shall
        invoice the Company at the end of each calendar month and the Company shall
        make
        the monthly payment immediately upon receiving such invoice. Once a calendar
        year, and no later than December 15, the Company’s Board shall consider
        approving an increase to the Fee. Such Board approval shall be subject to
        the
        prior review, oversight and recommendation to the Board of both the Audit
        Committee and the Compensation Committee of the Company (the "Compensation
        Committee"). However, in the event the Company has not established a
        Compensation Committee, the review, oversight and recommendation to the Board
        of
        the Audit Committee shall suffice. In connection with the performance of
        this
        provision, the Audit Committee, the Compensation Committee and the Board
        shall
        take into account, among other factors, growth in the Company’s revenues and/or
        profits.
  -48-
 The
        Company’s Board shall, from time to time, and not less than once a calendar
        year, consider approving a grant of success bonus to Mr. Keinan (the "Bonus").
        Such Board approval shall be subject to the prior review, oversight and
        recommendation to the Board of both the Audit Committee and the Compensation
        Committee. However, in the event the Company has not established a Compensation
        Committee, the review, oversight and recommendation to the Board of the Audit
        Committee shall suffice. In connection with the performance of this provision,
        the Audit Committee, the Compensation Committee and the Board shall take
        into
        account, among other factors, growth in the Company’s revenues and/or profits
        and/or successful completion of transactions or activities by the Company
        (such
        as, but not limited to, reorganization, mergers, acquisitions, capital raisings
        and cost cuts). Any Board member, except Mr. Keinan, may, at any time and
        from
        time to time, initiate a Bonus grant to Mr. Keinan, and in such an event
        the
        approving process shall be set in motion.
 
 Immediately
        upon the establishment by the Company of any new stock option or purchase
        plan
        or other equity compensation arrangement pursuant to which options or stock
        may
        be acquired by officers, directors, employees, or consultants of the Company
        (collectively, "Plan"), the Company’s Board shall consider approving a grant of
        an appropriate amount of options (or any other applicable rights) under the
        Plan
        to Mr. Keinan. Such Board approval shall be subject to the prior review,
        oversight and recommendation to the Board of both the Audit Committee and
        the
        Compensation Committee. However, in the event the Company has not established
        a
        Compensation Committee, the review, oversight and recommendation to the Board
        of
        the Audit Committee shall suffice.
 
 In
        addition to the Fee and the Bonus, the Company shall pay directly and/or
        reimburse Mr. Keinan for his Expenses. For the purposes of the Keinan Consulting
        Agreement, the term "Expenses" shall mean any and all amounts actually paid
        by
        the Company and/or by Mr. Keinan, and/or to be paid by Mr. Keinan at his
        direction, including, without limitation (i) costs associated with
        telecommunication services and products, and (ii) costs associated with
        transportation and/or travel (including, but not limited to, by plane, train,
        rented car and taxi) and/or accommodation (including, but not limited to,
        at
        rented flats and hotels) and/or any other board and lodging expenses (including,
        but not limited to, food, restaurants and entertainment) which were and/or
        will
        be incurred in connection with the performance of the Services pursuant to
        the
        Keinan Consulting Agreement.
 
 The
        Company acknowledges that in order to render the Services pursuant to the
        Keinan
        Consulting Agreement, Mr. Keinan may be required to travel frequently around
        the
        world. Therefore, in order to enable Mr. Keinan a normal family life the
        Company
        shall bear Expenses which are related to Mr. Keinan's spouse.
 
 Mr.
        Keinan shall hold and use, in his sole discretion, credit cards in the name
        of
        the Company (the "Credit Cards"). Due to Mr. Keinan's position with the Company
        (i.e. Chairman of the Board) he may from time to time use the Credit Cards
        to
        make certain Company payments and pay certain Company expenses.
 
 This
        Keinan Consulting Agreement shall be in effect for an initial fixed term
        of five
        years, beginning on January 1, 2007 (the "Initial Effective Term"), and
        thereafter, unless terminated as provided below, shall automatically be renewed
        for additional terms of three years (each, an "Additional Effective Term").
        Notwithstanding the foregoing, each of the Company and Mr. Keinan shall have
        the
        right to terminate the automatic renewal of the Keinan Consulting Agreement,
        for
        any reason whatsoever, by a termination notice in writing, to be provided
        to the
        other party not less than six months prior to: (i) the expiration of the
        Initial
        Effective Term, or (ii) the expiration of any Additional Effective Term (the
        "Notice Period"). Notwithstanding the foregoing, as long as Mr. Keinan shall
        command and/or control, directly and/or indirectly, including together with
        others (as well as pursuant to that certain Voting Agreement dated September
        28,
        2004, by and among Mr. Keinan, Guy Nissenson and Campbeltown Business Ltd.)
        and/or by proxies, fifteen percent (15%) or more of the voting rights of
        the
        Company, if the Company shall choose to exercise its right to terminate the
        automatic renewal of the Keinan Consulting Agreement, the Notice Period shall
        be
        of not less than twelve months. Notwithstanding the foregoing, Mr. Keinan
        shall
        have the right to terminate the Keinan Consulting Agreement, for any reason
        whatsoever, and at any time, including during the Initial Effective Term
        ("Early
        Termination by Mr. Keinan "). In the event of Early Termination by Mr. Keinan,
        the Notice Period shall be of not less than eight months.
 
 -49-
 The
        Keinan Consulting Agreement further provides that no later than June 30,
        2007,
        the Company and Mr. Keinan shall enter into a severance agreement providing
        for
        an appropriate severance package for Mr. Keinan (the "Severance Agreement").
        The
        Severance Agreement shall, inter alia, cover events of termination of the
        automatic renewal of the Keinan Consulting Agreement by the Company or Mr.
        Keinan, termination of the Keinan Consulting Agreement by Mr. Keinan, and
        scheduled retirement by Mr. Keinan.
 
 The
        Keinan Consulting Agreement also contains provisions regarding non-competition;
        intellectual property; confidentiality; conflict of interests and other standard
        terms and conditions.
 
 The
        Keinan Consulting Agreement was approved by all non-interested members of
        the
        Board of Directors, following a review and discussion by the Company’s Audit
        Committee.
 
 A
        copy of
        the Keinan Consulting Agreement is attached hereto as Exhibit 10.98 and
        incorporated herein by reference.
 
 **Nissenson
        Employment Agreements with Swiftnet**
 
 Pursuant
        to the December 25, 2006 Board Resolutions, on March 28, 2007, Swiftnet and
        Mr.
        Nissenson entered into an employment agreement, to be effective as of January
        1,
        2007 (the “Nissenson Employment Agreement”).
 
 The
        Nissenson Employment Agreement provides that Mr. Nissenson shall be employed
        as
        Director of Business Development of Swiftnet. Nissenson Employment Agreement
        shall be in effect for an initial fixed term of five years, beginning on
        January
        1, 2007, (the "Initial Effective Term"), and thereafter shall automatically
        be
        renewed for additional terms of three years (each, an "Additional Effective
        Term"). Notwithstanding the foregoing, each of Swiftnet and Mr. Nissenson
        shall
        have the right to terminate the automatic renewal of Nissenson Employment
        Agreement, for any reason whatsoever, by a termination notice in writing,
        to be
        provided to the other party not less than six months prior to: (i) the
        expiration of the Initial Effective Term, or (ii) the expiration of any
        Additional Effective Term (the "Notice Period"). Notwithstanding the foregoing,
        Mr. Nissenson shall have the right to terminate the Nissenson Employment
        Agreement, for any reason whatsoever, and at any time, including during the
        Initial Effective Term ("Early Termination"). In the event of Early Termination,
        the Notice Period shall be of not less than eight months.
 
 Under
        the
        Nissenson Employment Agreement, Swiftnet shall pay to Mr. Nissenson during
        the
        term of his engagement a salary at the rate of Forty Eight Thousand British
        Pounds (£48,000) ($94,032) per annum, such salary to be paid in equal monthly
        installments in arrears on the last Friday of each month. Swiftnet shall
        provide
        Mr. Nissenson with an appropriate executive car or car allowance with an
        effective annual cost to Swiftnet of up to Fifteen Thousand British Pounds
        (£15,000) ($29,385).
 
 Swiftnet
        shall pay Mr. Nissenson contributions to the following schemes: (i) Health
        care
        for him and his immediate family; (ii) Permanent health; (iii) Life insurance
        arrangements (up to a maximum of four times salary); (iv) Pension rights
        -
        Swiftnet shall contribute a monthly sum equal to 7.5% of his salary. (v)
        Travel
        insurance.
 
 Swiftnet
        shall reimburse to Mr. Nissenson all traveling, hotel, restaurant and other
        expenses incurred by him in the proper performance of his duties under his
        engagement.
 
 -50-
 If
        during
        the period of the employment under the Nissenson Employment Agreement Mr.
        Nissenson shall cease to be a director of Swiftnet, his employment shall
        continue and the terms of the Nissenson Employment Agreement (other than
        those
        relating to the holding of office of director) shall continue in full
        force.
 
 The
        Nissenson Employment Agreement also contains special arrangements for sickness
        benefits, holiday entitlement and provisions regarding non-competition;
        intellectual property; confidentiality; conflict of interests and other standard
        terms and conditions.
 
 The
        Nissenson Employment Agreement supersedes his May 11, 2000 Employment
        Agreement.
 
 The
        Nissenson Employment Agreement was approved by all non-interested members
        of the
        Board of Directors, following a review and discussion by the Company’s Audit
        Committee.
 
 A
        copy of
        the Nissenson Employment Agreement is attached hereto as Exhibit 10.99 and
        incorporated herein by reference.
 
 **Nissenson
        Consulting Agreement**
 
 Pursuant
        to the December 25, 2006 Resolutions, on March 28, 2007, the Company and
        Mr.
        Nissenson entered into a consulting agreement, to be effective as of January
        1,
        2007 (the “Nissenson Consulting Agreement”).
 
 The
        Nissenson Consulting Agreement provides that Mr. Nissenson shall render the
        Company advisory, consulting and other services in relation to the business
        and
        operations of the Company (excluding its business and operations in the United
        Kingdom).
 
 In
        consideration of the performance of the Services pursuant to the Nissenson
        Consulting Agreement, the Company shall pay Mr. Nissenson a monthly fee of
        Ten
        Thousand British Pounds (£10,000) ($19,590) (the "Fee"). Mr. Nissenson shall
        invoice the Company at the end of each calendar month and the Company shall
        make
        the monthly payment immediately upon receiving such invoice. Once a calendar
        year, and no later than December 15, the Company’s Board shall consider
        approving an increase to the Fee. Such Board approval shall be subject to
        the
        prior review, oversight and recommendation to the Board of both the Audit
        Committee and the Compensation Committee of the Company (the "Compensation
        Committee"). However, in the event the Company has not established a
        Compensation Committee, the review, oversight and recommendation to the Board
        of
        the Audit Committee shall suffice. In connection with the performance of
        this
        provision, the Audit Committee, the Compensation Committee and the Board
        shall
        take into account, among other factors, growth in the Company’s revenues and/or
        profits.
  -51-
 The
        Company’s Board shall, from time to time, and not less than once a calendar
        year, consider approving a grant of success bonus to Mr. Nissenson (the
        "Bonus"). Such Board approval shall be subject to the prior review, oversight
        and recommendation to the Board of both the Audit Committee and the Compensation
        Committee. However, in the event the Company has not established a Compensation
        Committee, the review, oversight and recommendation to the Board of the Audit
        Committee shall suffice. In connection with the performance of this provision,
        the Audit Committee, the Compensation Committee and the Board shall take
        into
        account, among other factors, growth in the Company’s revenues and/or profits
        and/or successful completion of transactions or activities by the Company
        (such
        as, but not limited to, reorganization, mergers, acquisitions, capital raisings
        and cost cuts). Any Board member, except Mr. Nissenson, may, at any time
        and
        from time to time, initiate a Bonus grant to Mr. Nissenson, and in such an
        event
        the approving process shall be set in motion.
 
 Immediately
        upon the establishment by the Company of any new stock option or purchase
        plan
        or other equity compensation arrangement pursuant to which options or stock
        may
        be acquired by officers, directors, employees, or consultants of the Company
        (collectively, "Plan"), the Company’s Board shall consider approving a grant of
        an appropriate amount of options (or any other applicable rights) under the
        Plan
        to Mr. Nissenson. Such Board approval shall be subject to the prior review,
        oversight and recommendation to the Board of both the Audit Committee and
        the
        Compensation Committee. However, in the event the Company has not established
        a
        Compensation Committee, the review, oversight and recommendation to the Board
        of
        the Audit Committee shall suffice.
 
 In
        addition to the Fee and the Bonus, the Company shall pay directly and/or
        reimburse Mr. Nissenson for his Expenses. For the purposes of the Nissenson
        Consulting Agreement, the term "Expenses" shall mean any and all amounts
        actually paid by the Company and/or by Mr. Nissenson, and/or to be paid by
        Mr.
        Nissenson at his direction, including, without limitation (i) costs associated
        with telecommunication services and products, and (ii) costs associated with
        transportation and/or travel (including, but not limited to, by plane, train,
        rented car and taxi) and/or accommodation (including, but not limited to,
        at
        rented flats and hotels) and/or any other board and lodging expenses (including,
        but not limited to, food, restaurants and entertainment) which were and/or
        will
        be incurred in connection with the performance of the Services pursuant to
        the
        Nissenson Consulting Agreement.
 
 The
        Company acknowledges that in order to render the Services pursuant to the
        Nissenson Consulting Agreement, Mr. Nissenson may be required to travel
        frequently around the world. Therefore, in order to enable Mr. Nissenson
        a
        normal family life the Company shall bear Expenses which are related to Mr.
        Nissenson's spouse.
 
 Mr.
        Nissenson shall hold and use, in his sole discretion, credit cards in the
        name
        of the Company (the "Credit Cards"). Due to Mr. Nissenson's position with
        the
        Company (i.e. President and CEO) he may from time to time use the Credit
        Cards
        to make certain Company payments and pay certain Company expenses.
 
 This
        Nissenson Consulting Agreement shall be in effect for an initial fixed term
        of
        five years, beginning on January 1, 2007 (the "Initial Effective Term"),
        and
        thereafter, unless terminated as provided below, shall automatically be renewed
        for additional terms of three years (each, an "Additional Effective Term").
        Notwithstanding the foregoing, each of the Company and Mr. Nissenson shall
        have
        the right to terminate the automatic renewal of the Nissenson Consulting
        Agreement, for any reason whatsoever, by a termination notice in writing,
        to be
        provided to the other party not less than six months prior to: (i) the
        expiration of the Initial Effective Term, or (ii) the expiration of any
        Additional Effective Term (the "Notice Period"). Notwithstanding the foregoing,
        as long as Mr. Nissenson shall command and/or control, directly and/or
        indirectly, including together with others (as well as pursuant to that certain
        Voting Agreement dated September 28, 2004, by and among Mr. Nissenson, Abraham
        Keinan and Campbeltown Business Ltd.) and/or by proxies, fifteen percent
        (15%)
        or more of the voting rights of the Company, if the Company shall choose
        to
        exercise its right to terminate the automatic renewal of the Nissenson
        Consulting Agreement, the Notice Period shall be of not less than twelve
        months.
        Notwithstanding the foregoing, Mr. Nissenson shall have the right to terminate
        the Nissenson Consulting Agreement, for any reason whatsoever, and at any
        time,
        including during the Initial Effective Term ("Early Termination by Mr. Nissenson
        "). In the event of Early Termination by Mr. Nissenson, the Notice Period
        shall
        be of not less than eight months.
 
 -52-
 The
        Nissenson Consulting Agreement further provides that no later than June 30,
        2007, the Company and Mr. Nissenson shall enter into a severance agreement
        providing for an appropriate severance package for Mr. Nissenson (the "Severance
        Agreement"). The Severance Agreement shall, inter alia, cover events of
        termination of the automatic renewal of the Nissenson Consulting Agreement
        by
        the Company or Mr. Nissenson, termination of the Nissenson Consulting Agreement
        by Mr. Nissenson, and scheduled retirement by Mr. Nissenson.
 
 The
        Nissenson Consulting Agreement also contains provisions regarding
        non-competition; intellectual property; confidentiality; conflict of interests
        and other standard terms and conditions.
 
 The
        Nissenson Consulting Agreement was approved by all non-interested members
        of the
        Board of Directors, following a review and discussion by the Company’s Audit
        Committee.
 
 A
        copy of
        the Nissenson Consulting Agreement is attached hereto as Exhibit 10.100 and
        incorporated herein by reference.
 
 **Election
        of Guy Nissenson as the Company’s Treasurer, Chief Financial Officer and
        Principal Accounting Officer**
 
 On
        March
        28, 2007, the Board filled the vacancy caused by the termination of the
        employment of Gilad Amozeg by the election of Guy Nissenson, our President,
        Chief Executive Officer and Director, as the Company’s Treasurer, Chief
        Financial Officer and Principal Accounting Officer.
 
 -53-
 PART
        III
  ITEM 9. DIRECTORS, EXECUTIVE OFFICERS, PROMOTERS ANDCONTROL PERSONS
        AND CORPORATE GOVERNANCE; COMPLIANCE WITH SECTION 16 (a) OF THE EXCHANGE
        ACT
 
 **Directors
        and Executive Officers**
 
 Our
        bylaws provide that we have at least two directors. Each director shall be
        elected and/or removed by the shareholders at any meeting and shall hold
        office
        until the next meeting of shareholders scheduling such a discussion with
        such a
        specific purpose or until that director's successor shall have been elected
        and
        qualified. Vacancies in the Board, whether caused by removal, death, mental
        or
        physical incapacitation or any other reason, including vacancies caused by
        an
        increase in the number of directors, may be filled by the affirmative vote
        of a
        majority of the remaining Directors, even though less than a quorum of the
        Board, or by a sole remaining director. Our Board of Directors elects our
        executive officers. Our directors
 and
        executive officers are as follows:
 
 **Name**
              **Age**
              **Director
                  / Officer**Abraham
                  Keinan
              
              
              57
              
              
              Chairman
                  of the Board of Directors, since our inceptionGuy
                  Nissenson
              
              
              32
              
              
              Director,
                  President and CEO since our inception; Treasurer, Chief Financial
                  Officer
                  and Principal Accounting Officer since March 28, 2007Eyal
                  J. Harish
              
              
              54
              
              
              Director,
                  since December 19, 2002Shemer
                  S. Schwartz
              
              
              32
              
              
              Director,
                  since December 19, 2002, and is an independent director and a member
                  of
                  the Audit CommitteeItzhak
                  Almog
              
              
              68
              
              
              Director,
                  since May 18, 2006, and is an independent director and Chairman
                  of the
                  Audit CommitteeAviu
                  Ben-Horrin
              
              
              58
              
              
              Director,
                  since November 23, 2004, and is an independent director.Israel
                  Singer
              
              
              58
              
              
              Director,
                  since December 28, 2006, and is an independent director and a member
                  of
                  the Audit Committee.Morris
                  Mansour
              
              
              59
              
              
              Director,
                  since December 28, 2006, and is an independent
                  director.Alon
                  Mualem
              
              
              39
              
              
              Had
                  been our Treasurer, Chief Financial Officer and Principal Accounting
                  Officer since June 8, 2005 and until March 1,
                  2007.
 
 -54-
 Mr.
        Abraham Keinan has been our Chairman of the Board of Directors since our
        inception. Abraham Keinan founded Swiftnet in February 1990. Mr. Keinan has
        been
        the Chairman of the Board of Directors of Swiftnet since its inception. From
        1991 to October 2003, Mr. Keinan was Swiftnet’s Managing Director. In or about
        January 2002, Mr. Keinan became a Director of Auracall Limited, our UK based
        affiliated entity. Mr. Keinan has been a Director of Xfone 018 since its
        inception in April 2004. In March 2005, Mr. Keinan became the Chairman of
        the
        Board of Directors of Xfone 018. Mr. Keinan has been a Director of Xfone
        USA,
        since its inception in May 2004. Mr. Keinan has been a Director of Story
        Telecom
        since May 2006. In July 2006, Mr. Keinan became a Director of Equitalk.co.uk.
        In
        1975, Mr. Keinan received a Bachelor of Science Degree in Mechanical Engineering
        from Ben-Gurion University, Beer-Sheeva - Israel.
 
 Mr.
        Guy
        Nissenson has been our President, Chief Executive Officer and a Director
        since
        our inception. On March 28, 2007, Mr. Nissenson was elected as our Treasurer,
        Chief Financial Officer and Principal Accounting Officer. Mr. Nissenson joined
        Swiftnet in October 1999 and became a Director of Swiftnet in May 2000. He
        had
        been the Managing Director of Swiftnet from October 2003 until July 2006.
        In
        October 2002, Mr. Nissenson became a Director of Story Telecom. In or about
        January 2002, Mr. Nissenson became a Director of Auracall Limited. Mr. Nissenson
        has been a Director of Xfone 018 since its inception in April 2004. Mr.
        Nissenson has been a Director of Xfone USA since its inception in May 2004.
        In
        March 2005, Mr. Nissenson became the Chairman of the Board of Directors of
        Xfone
        USA. In July 2006, Mr. Nissenson became a Director of Equitalk.co.uk. Mr.
        Nissenson was a marketing manager of RADA Electronic Industries Ltd. in Israel
        from May 1997 to October 1998. Mr. Nissenson was an audit and control officer
        with the rank of Lieutenant of the Israeli Defense Forces - Central Drafting
        Base and other posts from March 1993 to May 1997. In July 2000, Mr. Nissenson
        received a Bachelor of Science Degree in Business Management from Kings College
        - University of London. In September 2001, Mr. Nissenson received a Master
        of
        Business Administration in International Business from Royal Holloway at
        the
        University of London in London, United Kingdom.
 
 Dr.
        Eyal
        J. Harish has been a member of our Board of Directors since December 19,
        2002.
        Dr. Harish has been a Director of Xfone 018 since its inception in April
        2004.
        Dr. Harish has been a Director of Xfone USA since March 2005. From 1980 to
        present, Dr. Harish has been in his own private practice in Israel as a dentist.
        Prior to becoming a dentist, from 1974 to 1980, Dr. Harish was an Administration
        Manager with Consortium Holdings, an Israel based communication company.
        Dr.
        Harish is the brother-in-law of Mr. Keinan, our Chairman of the Board.
 
 Mr.
        Shemer S. Schwartz has been a member of our Board of Directors since December
        19, 2002, and is an independent director and a member of the Audit Committee.
        Mr. Schwartz has been a Director of Xfone 018 since its inception in April
        2004.
        Mr. Schwartz has been a Director of Xfone USA since March 2005. From March
        2003
        to present, Mr. Schwartz has been the co-founder and research and development
        expert of XIV Ltd., a data storage start up company located in Tel-Aviv,
        Israel.
        From November 2001 to March 2003, Mr. Schwartz has been an Application Team
        Leader of RF Waves, an Israel based high technology company in the field
        of
        wireless communication. From 1996 to 2001, Mr. Schwartz was a Captain in
        the
        Research and Development Center of the Israeli Defense Forces Intelligence.
        In
        July 1995, Mr. Schwartz received a BS degree in Physics and Mathematics from
        the
        Hebrew University in Jerusalem. In September 2003, Mr. Schwartz received
        an MS
        degree in Computer science from the Tel-Aviv University in Tel-Aviv, Israel.
 
 Mr.
        Itzhak Almog has been a member of our Board of Directors since May 18, 2006,
        and
        is an independent director and Chairman of the Audit Committee. From 2002
        to
        present, Mr. Almog is an independent business consultant, specializing in
        international marketing and management. From 1993 to 2002, Mr. Almog was
        the
        President and CEO of Comverge Control Systems Ltd., an Israel based start
        up
        company, which developed innovative solutions for Electric Utilities. From
        1990
        to 1993, Mr. Almog was the President of Tasco Electronic Services, Inc.,
        a US
        based Hi-Tech company, specializing in Automatic Test machines for commercial
        and military Aviation. Mr. Almog was an officer with the rank of Rear Admiral
        in
        the Israel Defense Forces and served in various commanding posts in the Israeli
        Navy. In 1980 Mr. Almog received a BA in Modern Middle East History and
        Economics from the Tel Aviv University in Tel Aviv. In 1984 Mr. Almog received
        a
        Master of Business Administration from the Tel Aviv University in Tel
        Aviv.
 
 -55-
 Mr.
        Aviu
        Ben-Horrin has been a member of our Board of Directors since November 23,
        2004,
        and is an independent director. Mr. Ben-Hurrin had been a member of our Audit
        Committee from November 24, 2004 until January 17, 2007. From 2001 to present,
        Mr. Ben-Horrin directs, controls and manages various real estate projects
        together with Bonei RMAG Ltd. and MPK Ltd. From 1996 to 2001, Mr. Ben-Horrin
        managed real estate projects for Lear Or Ltd. and was an engineering consultant
        for Orik Ltd., a construction company. From 1994 to 1996, Mr. Ben-Horrin
        worked
        for the Ministry of Construction and Housing of the state of Israel as a
        manager
        of various projects. From 1975 to 1992, Mr. Ben-Horrin was an officer with
        the
        rank of Colonel in the Israel Defense Forces and served in various engineering
        and commanding posts. In 1975, Mr. Ben-Horrin received a BS in Mechanical
        Engineering from the Technion University in Haifa. In 1987, Mr. Ben-Horrin
        received a BA in Economics from the Bar-Ilan University in Ramat Gan.
 
 Mr.
        Israel Singer has been a member of our Board of Directors since December
        28,
        2006, and is an independent director and a member of the Audit Committee
        since
        January 17, 2007. Mr. Singer is an elected member of the Ramat Gan
        City council. During 2006 Mr. Singer had been the managing director of the
        academic center "Raanana College" in Israel. During the years
        2004-2005 Mr. Singer was a consultant to the Education Committee of the "Israeli
        Knesset" (the Israeli Parliament). From 1985 to 2003, Mr. Singer was the
        principal of the "Blich High School" in Ramat Gan. From 1992 to 1998 Mr.
        Singer
        was a member of the board of directors of Rada Electronic Industries Ltd.
        In
        1973, Mr. Singer received a B.Sc in Physics from the Tel Aviv University
        in Tel
        Aviv, Israel. In 1978, Mr. Singer received an M.Sc in High - Energy Physics
        from
        the Tel Aviv University in Tel Aviv, Israel.
 
 Mr.
        Morris Mansour has been
        a member of our Board of Directors since December 28, 2006. Mr. Mansour  has
        been a Director of Superderivatives, Inc., a leading company in developing
        and marketing options and derivatives pricing systems in forex, interest
        rates, commodities etc, since 2001. Since 2000 he has been a Director of
        Soffair Financial Services, a company engaged in investment, property and
        finance. From 1995 to 1999 Mr. Mansour was a financial advisor for several
        private companies which invested in hi-tech start-up companies, and property.
        From 1986 to 1988 and from 1993 to 1994, Mr. Mansour was Director and General
        Manager of "Le Shark Ltd.", a major clothing brand in the United Kingdom.
        From
        1980 to 1985, Mr. Mansour was the Credit Manager of Bank Hapoalim B.M. in
        the
        United Kingdom and a senior member of its Management Committee. In 1972,
        Mr.
        Mansour received a B.A. in Economics and International Relations from the
        Hebrew
        University in Jerusalem, Israel.
 
 Mr.
        Alon
        Mualem had been our Treasurer, Chief Financial Officer and Principal Accounting
        Officer since June 8, 2005. On January 30, 2007, Mr. Alon Mualem submitted
        his
        resignation to be effective as of March 1, 2007. The resignation of Mr. Mualem
        was not the result of any disagreement on any matter relating to the Company’s
        operations, policies, practices or historical financial statements.
 
 Except
        as set forth herein, no officer or director of the Company has, during the
        last
        five years: (i) been convicted in or is currently subject to a pending criminal
        proceeding ( excluding
        traffic violations and other minor offenses )
        ; (ii) been a party to a civil proceeding of a judicial or administrative
        body
        of competent jurisdiction and as a result of such proceeding was or is subject
        to a judgment, decree or final order enjoining future violations of, or
        prohibiting or mandating activities subject to any federal or state securities
        or banking laws including, without limitation, in any way limiting involvement
        in any business activity, or finding any violation with respect to such law,
        nor
        (iii) has any bankruptcy petition been filed by or against the business of
        which
        such person was an executive officer or a general partner, whether at the
        time
        of the bankruptcy of for the two years prior thereto.
 
 **Vacancies
        in Board of Directors**
 
 On
        May
        17, 2006, Mr. Arie Czertok, a former independent director and Chairman of
        the
        Audit Committee of the Board of Directors of the Company announced his
        resignation to the Chairman of the Board. The resignation of Mr. Czertok
        was not
        the result of any disagreement on any matter relating to our operations,
        policies or practices.
 
 -56-
 On
        May
        18, 2006, the Board filled the vacancy caused by the resignation of Mr. Czertok
        by the election of Itzhak Almog as independent director to the Board and
        appointed him as the Chairman of the Audit Committee. The election of Mr.
        Almog
        was by way of unanimous written consent in lieu of a meeting pursuant to
        Section
        78.315 of the Nevada Revised Statutes and Article 3.6 of the Company’s Bylaws.
        On December 28, 2006, Mr. Almog was elected as a director at the Company’s
        Annual Meeting, and on January 17, 2007 he was reappointed by the Board as
        Chairman of the Audit Committee.
 
 **Significant
        Employees**
 
 Mr.
        Wade
        Spooner, 49 years of age, has been Chief Executive Officer and President of
        Xfone USA since the consummation of the WS Telecom/Xfone USA merger on March
        10,
        2005. Prior to this he founded WS TeleCom, Inc, d/b/a eXpeTel
        Communications in February 2001 and served as Chairman, CEO and President.
        Prior
        to founding eXpeTel Communications, Mr. Spooner was the President and Chief
        Operating Officer of LSCI Telecommunications, Inc., an integrated Regional
        Local
        Exchange Carrier with operations in Mississippi and Louisiana. Prior to joining
        LSCI, Mr. Spooner worked with competitive telecommunications service providers,
        most recently serving as Director of Technical Operations for ITC DeltaCom,
        Inc.
        (NASDAQ: ITCD), a publicly traded Competitive Local Exchange Carrier (CLEC)
        and
        fiber optic network provider, and served as Chairman and CEO for I.T. GROUP
        Communications, a regional, facilities-based, voice and data communications
        company operating out of Jackson, Mississippi. I.T.GROUP Communications was
        subsequently acquired by ITC DeltaCom. Mr. Spooner received a B.S. Degree
        in
        Petroleum Engineering from Mississippi State University.
 
 Mr.
        John
        Mark Burton, 42 years of age, was appointed as the Managing Director of Swiftnet
        at the completion of the acquisition of Equitalk on July 3, 2006. He founded
        Equitalk.co.uk, the UK’s first fully automated e-telco, in 2000 and has been
        serving as its Managing Director since then. On
        August
        3, 2006, Mr. Burton was appointed to the Board of Directors of Swiftnet.
        On
        August 7, 2006, Mr. Burton was elected as a Chairman to the Board of Directors
        of Story Telecom, Inc. and Story Telecom Limited. Prior to
        founding Equitalk, Mr. Burton founded Nexus Telecom Limited in 1995. Under
        his
        leadership as Managing Director, Nexus designed an award-winning server-based
        soft switch that gained UK Regulatory and IBM Approval. Prior to Nexus, Mr.
        Burton worked as Business Development Manager for Griffin International (a
        telecom messaging company). He has also served as R&D Manager at Nortel
        Networks with responsibility for engineers in the UK, US and Far East designing
        a next generation, open architecture PBX. Mr. Burton is a graduate of the
        University of Liverpool where he earned a BEng degree in Electronic Engineering.
        He also holds an MBA from the Cranfield School of Management and a CEng MIEE
        designation from the Institute of Electrical Engineers.
 
 Mr.
        Rafael Dick, 52 years of age, has been the Managing Director of Xfone 018
        since
        its inception. From October 2001 to April 2004, Mr. Dick was employed as
        a
        Director of Sales and Marketing with “Hertz” - Kesher Rent a Car Ltd., a rental
        and leasing firm located in Israel. From December 2000 to September 2001,
        Mr.
        Dick was employed as a Director of Sales and Customers Relations with Artnet
        Ltd., an Outsourcing Services firm located in Israel. From October 1996 to
        November 2000, Mr. Dick was employed as a Director of Sales and Customers
        Relations with 012 Golden Lines Ltd., an international telecommunication
        firm
        located in Israel.
 
 Mr.
        Nir
        Davison, 36 years of age, Managing Director of Story Telecom, Inc. and Story
        Telecom Limited, is a telecom entrepreneur with over 10 years experience.
        From
        May 1995 to May 1998, Mr. Davison was the Marketing Director of America First,
        which was sold to Centrica. Subsequently, from June 1998 to December 1999,
        Mr.
        Davison founded a security software company together with Integration Group
        which later became public. A joint venture with Primus Telecommunication
        from
        January 2000 till December 2002 was his last venture before launching Story
        Telecom together with the Company. Mr. Davison received a BA Degree from
        the
        American University in London in addition to a qualified diploma in Finance
        and
        Marketing.
 
 -57-
 Mrs.
        Bosmat Houston, 42 years of age, has been our Research and Development Manager
        since our inception. She joined Swiftnet in September 1991 as its Research
        and
        Development Manager. Mrs. Houston received a Bachelor of Science Degree in
        Computer Science from the Technion - Institution of Technology, Haifa Israel
        in
        1986.
 
 **Family
        Relationships**
 
 Dr.
        Eyal
        J. Harish, one of our directors, is the brother-in-law of Mr. Abraham Keinan,
        our Chairman of the Board.
 
 Mr.
        Iddo
        Keinan, son of Mr. Abraham Keinan, our Chairman of the Board, has been employed
        by our wholly-owned UK based subsidiary, Swiftnet Limited since
        1998.
 
 Mr.
        Guy
        Nissenson, our President, Chief Executive Officer, Treasurer, Chief Financial
        Officer, Principle Accounting Officer and Director, and other members of
        the
        Nissenson family own and control Campbeltown Business Ltd., our major
        shareholder and a former consultant.
 
 Mr.
        Haim
        Nissenson, father of Mr. Guy Nissenson, our President and Chief Executive
        Officer, is the Managing Director of Dionysos Investments (1999) Ltd., our
        consultant. Dionysos Investments is owned and controlled by certain members
        of
        the Nissenson family, other than Guy Nissenson.
 
 **Involvement
        in certain legal proceedings**
 
 No
        director, person nominated to become a director, executive officer, promoter
        or
        control person of the Company has, during the last five years: (i) been
        convicted in or is currently subject to a pending a criminal proceeding
        (excluding traffic violations and other minor offenses); (ii) been a party
        to a
        civil proceeding of a judicial or administrative body of competent jurisdiction
        and as a result of such proceeding was or is subject to a judgment, decree
        or
        final order enjoining future violations of, or prohibiting or mandating
        activities subject to any Federal or state securities or banking or commodities
        laws including, without limitation, in any way limiting involvement in any
        business activity, or finding any violation with respect to such law, nor
        (iii)
        any bankruptcy petition been filed by or against the business of which such
        person was an executive officer or a general partner, whether at the time
        of the
        bankruptcy or for the two years prior thereto.
 
 **Committee
        of the Board of Directors**
 
 We
        have
        an Audit Committee that was formed in a November 24, 2004 Board of Directors
        meeting. The Audit Committee is composed of three directors: Messrs. Almog,
        Schwartz and Singer (all 3 are considered independent directors). Mr. Almog who
        satisfies the “financial sophistication” requirement was appointed as the
        Chairman of the Audit Committee. The Audit Committee makes decisions regarding
        compensation, our audit, the appointment of auditors, and the inclusion of
        financial statements in our periodic reports. Issues regarding our 2004 Stock
        Option Plan are decided by the entire Board of Directors, including the members
        of the Audit Committee.
 
 -58-
 **Audit
        Committee financial expert**
 
 Mr.
        Itzhak Almog who satisfies the “financial sophistication” requirement is the
        Audit Committee financial expert as defined by Item 401(e)(2) of Regulation
        S-B
        of the Securities exchange Act of 1934 and the Chairman of the Audit
        Committee.
 
 **Section
        16(a) Beneficial Ownership Reporting Compliance**
 
 Under
        the
        securities laws of the United States, our directors, executive (and certain
        other) officers, and any persons holding ten percent or more of our common
        stock
        must report on their ownership of the common stock and any changes in that
        ownership to the Commission. Specific due dates for these reports have been
        established. During the fiscal year ended December 31, 2006, we believe that
        all
        reports required to be filed by Section 16(a) were filed on a timely
        basis.
 
 **Code
        of Conduct and Ethics**
 
 The
        Audit
        Committee of the Board of Directors of the Company has adopted and approved
        a
        Code of Conduct and Ethics (the “Code”) to apply to all the directors, officers
        and employees of the Company. The Code which was ratified by the Board of
        Directors of the Company is intended to promote ethical conduct and compliance
        with laws and regulations, to provide guidance with respect to the handling
        of
        ethical issues, to implement mechanisms to report unethical conduct, to foster
        a
        culture of honesty and accountability, to deter wrongdoing and to ensure
        fair
        and accurate financial reporting. The Code became effective on August 15,
        2006.
 
 Our
        Code
        of Conduct and Ethics was previously filed on form 8-K filed on August 15,
        2006,
        and is also available on our website at www.xfone.com.
  -59-
 ITEM 10. EXECUTIVE COMPENSATION
 
 **Executives
        and Directors compensation**
  The
        following table sets forth summary information concerning the compensation
        received for services rendered to the Company during the year ended December
        31,
        2006 by our Chairman of the Board, Abraham Keinan, our President, Chief
        Executive Officer, Treasurer, Chief Financial Officer, Principle Accounting
        Officer and Director, Guy Nissenson, and our former Treasurer, Chief Financial
        Officer and Principle Accounting Officer, Alon Mualem.
  **Summary
        Compensation Table**
  **Annual
                  Compensation**
              **Long
                  Term Compensation****Name
                  &**
                **Position**
              **Year**
              **Salary
                  ($)**
              **Bonus
                  ($)**
              **Other
                  ($)**
              **Restricted**
                **Stock
                  Awards**
              **Options**
              **L/Tip($)**
              **All**
                **Other****Abraham
                  Keinan**
                Chairman
                  of the Board
              2006
              $94,032
                  (1)
                (£48,000)
              -
              $100,710
                  (2)
                (£51,409)
              -
              -
              -
              -**Guy
                  Nissenson**
                President,
                  Chief
                Executive
                  Officer
                and
                  Chief Financial
                Officer
              2006
              $94,032
                  (3)
                (£48,000)
              -
              $163,381
                  (4)
                (£83,400)
              -
              -
              -
              -**Alon
                  Mualem**
                Treasurer,
                  Chief Financial Officer and Principal Accounting Officer
                **(**until
                  March 1, 2007**)**
              2006
              $137,274
                (£70,073)
              -
              -
              -
              -
                (5)
              -
              -
 
 (1)
        Salary paid to Mr. Keinan by our U.K. based wholly-owned subsidiary, Swiftnet,
        in connection with his employment as Chairman of the Board. Mr. Keinan has
        been
        the Chairman of the Board of Directors of Swiftnet since its inception in
        1990.
 
 -60-
 (2)
        On
        April 2, 2002, our Board of Directors approved a bonus and success fee whereby
        if we receive monthly revenues in excess of $485,000 then Mr. Keinan and
        our
        former consultant, Campbeltown Business Ltd. shall receive 1% of such monthly
        revenues, up to a maximum of one million dollars (the “Bonus and Success Fee”).
        On April 10, 2003, Mr. Keinan and Campbeltown Business waived their right
        to
        receive 1% of the revenues generated by Story Telecom. On February 8, 2007,
        an
        Agreement was entered by and between the Company, Swiftnet, Campbeltown
        Business, and Mr. Keinan (the “February 8, 2007 Agreement”). The February 8,
        2007 Agreement provides that effective as of January 1, 2007, the Bonus and
        Success Fee is cancelled, and that Mr. Keinan and Campbeltown Business shall
        have no further right to any percentage of our revenues. Mr. Keinan agreed
        to
        receive a total amount of only $100,710 (£51,409) as Bonus and Success Fee for
        2006, and waived the remainder.
 
 (3)
        Salary paid to Mr. Nissenson by our U.K. based wholly-owned subsidiary,
        Swiftnet, in connection with his employment as Director of Business Development.
        Mr. Nissenson joined Swiftnet in October 1999 and became a member of its
        Board
        of Directors in May 2000. Mr. Nissenson had been the Managing Director of
        Swiftnet from October 2003 until July 2006.
 
 (4)
        Campbeltown Business Ltd., a private company incorporated in the British
        Virgin
        Islands, is owned and controlled by Guy Nissenson and other members of the
        Nissenson family. On May 11, 2000, Swiftnet and Mr. Keinan entered into a
        consulting agreement with Campbeltown Business that provided that Swiftnet
        will
        hire Campbeltown Business as its financial and business development consultant
        and will pay Campbeltown Business £2,000 per month together with an additional
        monthly performance bonus based upon Swiftnet attaining certain revenue levels
        (the “Consulting Agreement”). On April 2, 2002, our Board of Directors approved
        a bonus and success fee whereby if we receive monthly revenues in excess
        of
        $485,000 then Mr. Keinan and Campbeltown Business shall receive 1% of such
        monthly revenues, up to a maximum of one million dollars (the “Bonus and Success
        Fee”). On April 10, 2003, Mr. Keinan and Campbeltown Business waived their right
        to receive 1% of the revenues generated by Story Telecom. On February 8,
        2007,
        an Agreement was entered by and between the Company, Swiftnet, Campbeltown
        Business, and Mr. Keinan (the “February 8, 2007 Agreement”). The February 8,
        2007 Agreement provides that effective as of January 1, 2007, the Bonus and
        Success Fee is cancelled, and that Mr. Keinan and Campbeltown Business shall
        have no further right to any percentage of our revenues. The February 8,
        2007
        Agreement further provides that effective as of January 1, 2007, the Consulting
        Agreement is terminated. Campbeltown Business agreed to receive a total amount
        of only $163,381 (£83,400) as compensation under the Consulting Agreement and
        Bonus and Success Fee for 2006, and waived the remainder. Guy Nissenson owns
        20%
        of Campbeltown Business. The compensation is shown in the table above as
        paid to
        Guy Nissenson due to his 20% ownership of Campbeltown Business.
 
 (5)
        On
        June 8, 2005, our Board of Directors granted to Mr. Mualem 300,000 options
        under
        and subject to the Company's 2004 Stock Option Plan. On January 30, 2007,
        Mr.
        Mualem submitted his resignation as Treasurer, Chief Financial Officer and
        Principal Accounting Officer of the Company, effective March 1, 2007. On
        March
        1, 2007, due to Mr. Mualem's resignation, 187,500 of his aforementioned options
        were terminated.
 
 -61-
 **Options/SAR
        Grants Table**
 
 **Name
                  and**
                **Principle**
                **Position**
              **Number**
                **Securities**
                **Underlying**
                **Options**
              **%
                  of Total**
                **Options**
                **Granted
                  To**
                **Employees**
                **in
                  2004**
              **%
                  of Total**
                **Options**
                **Granted
                  To**
                **Employees**
                **in
                  2005**
              **%
                  of Total**
                **Options**
                **Granted
                  To**
                **Employees**
                **in
                  2006**
              **Exercise**
                **Price**
              **Expiration**
                **Date****Abraham
                  Keinan**(1)
                Chairman
                of
                  the Board
              (2)
                  1,500,000
                Common
                  stock
                shares
              46.88%
              
              
              $3.50
              November
                  24, 2010**Guy
                  Nissenson**(3)
                President,
                  Chief Executive Officer, Treasurer, Chief Financial Officer and
                  Principal
                  Accounting Officer
              (2)
                  1,500,000
                Common
                  stock
                Shares
              46.88%
              
              
              $3.50
              November
                  24, 2010**Eyal
                  J. Harish**
                Director
              (2)
                  75,000
                Common
                  stock
                Shares
              2.34%
              
              
              $3.50
              November
                  24, 2010**Shemer
                  S. Schwartz**
                Director
              (2)
                  75,000
                Common
                  stock
                shares
              2.34%
              
              
              $3.50
              November
                  24, 2010**Arie
                  Czertok**
                Former
                  Director and Chairman of the Audit Committee
                (until
                  May 17, 2006)
              (2),
                  (4) 25,000
                Common
                  stock
                Shares
              0.78%
              
              
              $3.50
              November
                  24, 2010**Aviu
                  Ben-Horrin**
                Director
              (2)
                  25,000
                Common
                  stock
                shares
              0.78%
              
              
              $3.50
              November
                  24, 2010**Itzhak
                  Almog**
                Director
                  and Chairman of the Audit Committee
              (5)
                  25,000 Common stock
                Shares
              
              
              7.7%
              $3.50
              October
                  30, 2012**Alon
                  Mualem**
                Treasurer,
                  Chief Financial Officer and Principal Accounting Officer (until
                  March 1,
                  2007)
              (6)
                  300,000
                Common
                  stock
                shares
              
              15.5%
              
              $3.50
              December
                  8, 2010Total
              
              100%
              15.5%
              7.7%
 
 -62-
 (1)
        On
        August 21, 2003, we issued 400,000 options to acquire shares of our restricted
        common stock to Abraham Keinan. These options were issued to Abraham Keinan
        for
        services rendered by Mr. Keinan as the Chairman of our Board of Directors.
        These
        options were exercisable at a price of $0.475 per share for a period of five
        years, and vested immediately. On March 1, 2004, our Board of Directors canceled
        these options.
 
 (2)
        On
        November 24, 2004, our board of directors approved and adopted the principal
        items forming our 2004 Stock Option Plan (the “2004 SOP Plan”) which is
        designated for the benefit of employees, officers, directors, consultants
        and
        subcontractors of the Company including its subsidiaries. On November 1,
        2005,
        the 2004 SOP Plan was approved by our board of directors, and on March 13,
        2006
        by our shareholders, at a Special Meeting. The purpose of the 2004 SOP Plan
        is
        to enable the Company to attract and retain the best available personnel
        for
        positions of substantial responsibility, to provide an incentive to such
        persons
        presently engaged with the Company, and to promote the success of our business.
        These options were granted under the following terms: exercise price - $3.5,
        vesting date - 12 month from the date of grant, expiration date - five years
        from the vesting date.
 
 (3)
        On
        August 21, 2003, we issued 200,000 options to acquire shares of our restricted
        common stock to Guy Nissenson. These options were issued to Guy Nissenson
        for
        services rendered by Mr. Nissenson as our President and Chief Executive Officer.
        These options were exercisable at a price of $0.475 per share for a period
        of
        five years, and vested immediately. On March 1, 2004, our Board of Directors
        canceled these options.
 
 (4) These
        options were terminated on August 17, 2006, following the resignation of
        Mr.
        Czertok.
 
 (5) 
        On October 30, 2006, the Company’s Board of Directors approved a grant of 25,000
        options to Mr. Itzhak Almog under and subject to the Company’s 2004 Stock Option
        Plan of the Company according to the following terms: Option exercise price
        -
        $3.50, vesting Date - 12 months from the Date of Grant, expiration Date -
        5
        years from the Vesting Date.
 
 (6) On
        June 8, 2005, the Company’s board of directors approved a grant to Mr. Alon
        Mualem, the Company's former Treasurer, Chief Financial Officer and Principal
        Accounting Officer, of 300,000 options under and subject to the 2004 Stock
        Option Plan of the Company according to the following terms: Option exercise
        price of $3.50; Vesting Date **-** the
        vesting of the options will be over a period of 4 years as follows: 25% of
        the
        options are vested after a year from the Date of Grant. Thereafter, 1/16
        of the
        options are vested every 3 months for the following 3 years; Expiration
        Date **-** 5.5
        years
        from the grant date. On January 30, 2007, Mr. Mualem submitted his resignation
        as Treasurer, Chief Financial Officer and Principal Accounting Officer of
        the
        Company, effective March 1, 2007.  On
        March
        1, 2007, due to Mr. Mualem's resignation, 187,500 of his aforementioned options
        were terminated.
 
 -63-
 **Aggregated
        Option/SAR Exercises in 2004 and Fiscal Year End Option/SAR
        Value**  **Table**
 
 **Name**
              **Shares**
                **Acquired
                  on**
                **Exercise
                  (#)**
              **Value**
                **Realized
                  ($)**
              **Number
                  of Securities Underlying**
                **Unexercised
                  Options/SARs at FY-End**
                **(#)**
                **Exercisable/Unexercisable**
              **Value
                  of Unexercised In-the**
                **Money
                  Options/SARs at FY-End**
                **($)**
                **Exercisable/Unexercisable****Guy
                  Nissenson**
              Not
                  Applicable
              Not
                  Applicable
              500,000
                  / 0 (1)
              $1,200,000
                  / $0 (2)President,
                Chief
                  Executive Officer, Treasurer, Chief Financial Officer and Principal
                  Accounting Officer
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  1,500,000 (3)
              $0
                  / Negative Value**Abraham
                  Keinan**
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  1,500,000 (3)
              $0
                  / Negative ValueChairman
                  ofThe
                  Board**Eyal
                  J. Harish**
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  75,000 (4)
              $0
                  / Negative ValueDirector**Shemer
                  S. Schwartz**
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  75,000 (5)
              $0
                  / Negative ValueDirector**Arie
                  Czertok**
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  25,000 (6)
              $0
                  / Negative ValueDirector
                (until
                  May 17, 2006)**Aviu
                  Ben-Horrin**
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  25,000 (7)
              $0
                  / Negative ValueDirector
 
 -64-
 **Aggregated
        Option/SAR Exercises in 2005 and Fiscal Year End Option/SAR
        Value**  **Table**
 
 **Name**
              **Shares**
                **Acquired
                  on**
                **Exercise(#)**
              **Value**
                **Realized**
                **($)**
              **Number
                  of Securities Underlying**
                **Unexercised
                  Options/SARs at FY-End**
                **(#)**
                **Exercisable/Unexercisable**
              **Value
                  of Unexercised In-the**
                **Money
                  Options/SARs at FY-End**
                **($)**
                **Exercisable/Unexercisable****Guy
                  Nissenson**
              500,000
              1,175,000
                  (2)
              0
                  /
                  0
              $0
                  / $0President,
              Not
                  Applicable
              Not
                  Applicable
              1,500,000/0
                  (3)
              Negative
                  Value / $0Chief
                  Executive Officer, Treasurer, Chief Financial Officer and Principal
                  Accounting Officer**Abraham
                  Keinan**
              Not
                  Applicable
              Not
                  Applicable
              1,500,000/0
                  (3)
              Negative
                  Value / $0Chairman
                  ofThe
                  Board**Eyal
                  J. Harish**
              Not
                  Applicable
              Not
                  Applicable
              75,000
                  / 0 (4)
              Negative
                  Value / $0Director**Shemer
                  S. Schwartz**
              Not
                  Applicable
              Not
                  Applicable
              75,000
                  / 0 (5)
              Negative
                  Value / $0Director**Arie
                  Czertok**
              Not
                  Applicable
              Not
                  Applicable
              25,000
                  / 0 (6)
              Negative
                  Value / $0Director
                (until
                  May 17, 2006)**Aviu
                  Ben-Horrin**
              Not
                  Applicable
              Not
                  Applicable
              25,000
                  / 0 (7)
              Negative
                  Value / $0Director**Alon
                  Mualem**
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  300,000 (8)
              $0
                  / Negative ValueTreasurer,
                  Chief Financial Officer and Principal Accounting Officer
                (until
                  March 1, 2007)
 
 -65-
 **Aggregated
        Option/SAR Exercises in 2006 and Fiscal Year End Option/SAR
        Value**  **Table**
 
 **Name**
              **Shares**
                **Acquired
                  on**
                **Exercise(#)**
              **Value**
                **Realized**
                **($)**
              **Number
                  of Securities Underlying**
                **Unexercised
                  Options/SARs at FY-End**
                **(#)**
                **Exercisable/Unexercisable**
              **Value
                  of Unexercised In-the**
                **Money
                  Options/SARs at FY-End**
                **($)**
                **Exercisable/Unexercisable****Guy
                  Nissenson**
              Not
                  Applicable
              Not
                  Applicable
              1,500,000/0
                  (3)
              Negative
                  Value / $0President,
                  Chief Executive Officer, Treasurer, Chief Financial Officer and
                  Principal
                  Accounting Officer**Abraham
                  Keinan**
              Not
                  Applicable
              Not
                  Applicable
              1,500,000/0
                  (3)
              Negative
                  Value / $0Chairman
                  of The Board**Eyal
                  J. Harish**
              Not
                  Applicable
              Not
                  Applicable
              75,000
                  / 0 (4)
              Negative
                  Value / $0Director**Shemer
                  S. Schwartz**
              Not
                  Applicable
              Not
                  Applicable
              75,000
                  / 0 (5)
              Negative
                  Value / $0Director**Arie
                  Czertok**
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  0 (6)
              N/A
                  / $0Director
                (until
                  May 17, 2006)**Aviu
                  Ben-Horrin**
              Not
                  Applicable
              Not
                  Applicable
              25,000
                  / 0 (7)
              Negative
                  Value / $0Director**Itzhak
                  Almog**
              Not
                  Applicable
              Not
                  Applicable
              0
                  /
                  25,000 (9)
              $0
                  / Negative ValueDirector
                  and Chairman of the Audit Committee**Alon
                  Mualem**
              Not
                  Applicable
              Not
                  Applicable
              112,500
                  / 187,500 (8)
              Negative
                  Value /
                Negative
                  ValueTreasurer,
                  Chief Financial Officer and Principal Accounting Officer
                (until
                  March 1, 2007)
 
 -66-
 (1)
        Campbeltown Business Ltd., a private company incorporated in the British
        Virgin
        Islands which is owned and controlled by Guy Nissenson and other members
        of the
        Nissenson family, owned options to purchase 500,000 shares of our common
        stock
        for $0.40 per share or an aggregate of $200,000. Said options were exercised
        on
        December 29, 2005. Guy Nissenson owns 20% of Campbeltown Business. Options
        to
        purchase shares of our common stock are shown in the table above as owned
        by Guy
        Nissenson due to his 20% ownership of Campbeltown Business.
 
 (2)
        Based
        on the closing price of $2.80 and $2.75 per share as of December 30, 2004
        and
        December 29, 2005, respectively, and an exercise price $0.40 per share for
        500,000 share options.
 
 (3)
        Based
        on the closing price of $2.80, $2.76 and $2.89 per share as of December 30,
        2004, December 30, 2005 and December 29, 2006, respectively, and an exercise
        price of $3.50 per share.
 
 (4)
        Based
        on the closing price of $2.80, $2.76 and $2.89 per share as of December 30,
        2004, December 30, 2005 and December 29, 2006, respectively, and an exercise
        price of $3.50 per share.
 
 (5)
        Based
        on the closing price of $2.80, $2.76 and $2.89 per share as of December 30,
        2004, December 30, 2005 and December 29, 2006, respectively, and an exercise
        price of $3.50 per share.
 
 (6)
        Based
        on the closing price of $2.80 and $2.76 per share as of December 30, 2004
        and
        December 30, 2005, respectively, and an exercise price of $3.50 per share.
        These
        25,000 options were terminated on August 17, 2006, following the resignation
        of
        Mr. Czertok.
 
 (7)
        Based
        on the closing price of $2.80, $2.76 and $2.89 per share as of December 30,
        2004, December 30, 2005 and December 29, 2006, respectively, and an exercise
        price of $3.50 per share.
 
 (8)
        Based
        on the closing price of $2.76 and $2.89 per share as of December 30, 2005
        and
        December 29, 2006, respectively, and an exercise price of $3.50 per share.
        On
        March 1, 2007, due to Mr. Mualem's resignation, 187,500 of his options were
        terminated.
 
 (9)
        Based
        on the closing price of $2.89 per share as of December 29, 2006, and an exercise
        price of $3.50 per share.
 
 **Employment
        Arrangements - Directors**
 
 The
        employment arrangements of Mr. Abraham Keinan, our Chairman of the Board,
        and
        Mr. Guy Nissenson, our President, Chief Executive Officer, Treasurer, Chief
        Financial Officer and Principal Accounting Officer, are described in detail
        under Item 12 (“Certain Relationships And Related Transactions And Director
        Independence”) of this Annual Report.
 
 -67-
 **Compensation
        for Board Services and Reimbursement of Expenses**
 
 Pursuant
        to a Company’s Board of Directors’ resolution dated October 30, 2006, the
        Company agreed to compensate all its non-employed Directors for participation
        at
        meetings of the Board and Committees of the Board. The compensation for Board
        services is as follows: (a) $200 - for physical participation at each meeting
        of
        the Board or Committee of the Board; (b) $50 - for participation via the
        telephone at each meeting of the Board or Committee of the Board. In addition,
        the Company agreed to reimburse its non-employed Directors for expenses incurred
        in connection with Board services. The expenses shall be reviewed and
        pre-approved by the President of the Company.
 
 The
        total
        compensation for Board Services amounted in 2006 to £1,940 ($3,800). This amount
        was not paid yet to the Directors.
 
 **Employment
        Arrangements - Executives and Key Employees**
 
 A
        March
        10, 2005 employment agreement between Xfone, USA, Inc. and Wade Spooner,
        its
        President and Chief Executive Officer, provides, that Mr. Spooner will be
        granted and issued options for 600,000 shares of our restricted common stock,
        of
        which: (a) 100,000 will be attributable to Employment Year 1; (b) 200,000
        will
        be attributable to Employment Year 2; and (c) 300,000 of which shall be
        attributable to Employment Year 3. The options will vest as follows: (a)
        options
        for 100,000 shares of the our restricted common Stock will vest 3 years from
        the
        grant date; (b) options for 200,000 shares of our restricted common stock
        will
        vest 4 years from the grant date; and (c) options for 300,000 shares of our
        common stock will vest 5 years from the grant date. The stock options will
        provide for a five (5) year term from the vesting date, a strike price that
        is
        10% above the closing price of the Company’s common stock on the date of issue
        of the options. In addition, under certain circumstances, Mr. Spooner will
        be
        entitled to receive warrants (See immediately below “Acquisition Bonus”).
 
 A
        March
        10, 2005 employment agreement between Xfone, USA and Ted Parsons, its Executive
        Vice President and Chief Marketing Officer, provides, that Mr. Parsons will
        be
        granted and issued options for 300,000 shares of our restricted common stock,
        of
        which: (a) 50,000 will be attributable to Employment Year 1; (b) 100,000
        will be
        attributable to Employment Year 2; and (c) 150,000 of which shall be
        attributable to Employment Year 3. The options will vest as follows: (a)
        options
        for 50,000 shares of the Our restricted common Stock will vest 3 years from
        the
        grant date; (b) options for 100,000 shares of our restricted common stock
        will
        vest 4 years from the grant date; and (c) options for 150,000 shares of our
        common stock will vest 5 years from the grant date. The stock options will
        provide for a five (5) year term from the vesting date, a strike price that
        is
        10% above the closing price of our common stock on the date of issue of the
        options. In addition, under certain circumstances, Mr. Parsons will be
        entitled to receive warrants (See immediately below “Acquisition Bonus”).
 
 On
        November 13, 2005, our Board of Directors ratified the grant of 600,000 options
        to Wade Spooner and 300,000 options to Ted Parsons, under our 2004 Stock
        Option Plan, pursuant to the terms described in the March 10, 2005
        employment agreements.
 
 On
        July
        11, 2006, and in conjunction with the March 10, 2005 employment agreements,
        we
        issued 32,390 warrants to Wade Spooner and 16,195 warrants to Ted Parsons,
        as “Acquisition Bonus”. These warrants do not necessarily constitute the entire
        Aggregate Transaction Consideration (as defined in the abovementioned employment
        agreements). We were advised by the American Stock Exchange that the approval
        of
        the shareholders of the Company is required in order to allow the issuance
        and
        listing of the shares underlying said warrants. The required approval was
        obtained on December 28, 2006. The warrants are convertible on a one to one
        basis into restricted shares of our common stock at an exercise price of
        $3.285,
        and have a term of five years.
 
 -68-
 Effective
        June 8, 2005, in accordance with a Board resolution dated June 8, 2005, the
        Company appointed Mr. Alon Mualem, as Treasurer, Chief Financial Officer
        and
        Principal Accounting Officer of the Company. Mr. Mualem also held the position
        of Chief Financial Officer of the Company’s majority owned subsidiary in Israel,
        Xfone 018. For holding the positions of Treasurer, Chief Financial Officer
        and
        Principal Accounting Officer of Xfone, Inc. and Chief Financial Officer of
        Xfone
        018, Mr. Mualem received an annual salary of approximately $105,000 use of
        a
        company car, and manager’s insurance that included health, pension, disability
        and an educational training fund. Mr. Mualem was granted on June 8, 2005,
        under
        the Company's 2004 Stock Option Plan, 300,000 options to purchase 300,000
        common
        shares of the Company at an exercise price of $3.5. The vesting of the options
        will be over a period of 4 years as follows: 25% of the options are vested
        after
        a year from the date of grant. Thereafter, 1/16 of the options are vested
        every
        3 months for the following 3 years. The agreement with Mr. Mualem was subject
        to
        termination by either party giving written notice to the other 30 days prior
        to
        the effective date of termination. On January 30, 2007, Mr. Alon Mualem
        submitted his resignation to be effective as of March 1, 2007. The resignation
        of Mr. Mualem was not the result of any disagreement on any matter relating
        to
        the Company’s operations, policies, practices or historical financial
        statements. On March 1, 2007, due to Mr. Mualem's resignation, 187,500 of
        his
        aforementioned options were terminated.
 
 On
        July
        11, 2006, and in conjunction with a July 3, 2006 Service Agreement between
        the
        Company, Swiftnet Limited and John Mark Burton, the Managing Director of
        our UK based subsidiaries, Swiftnet Limited and Equitalk.co.uk Limited, and
        the
        Chairman of the Board of Story Telecom, the Company’s Board of Directors
        approved the grant of 300,000 options, under and subject to our 2004 Stock
        Option Plan, to Mr. Burton. The options are convertible on a one to one basis
        into restricted shares of our common stock, at an exercise price of $3.50,
        and
        have a term of ten years. The vesting of the options will be over a period
        of 4
        years as follows: 75,000 options are vested on July 3, 2007. Thereafter,
        18,750
        options are vested every 3 months for the following 3 years.
 
 -69-
 ITEM
        11. SEC URITY
        OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER
        MATTERS
 
 **Security
        Ownership of Beneficial Owners and Management**
  **Title
                  of Class**
              **Name,
                  Title & Address of**
                **Beneficial
                  Owner**
              **Amount
                  of Beneficial Ownership**
              **Nature
                  of Ownership**
              **Percent
                  of Class**Common
              **Abraham
                  Keinan***/***
                Chairman
                  of the Board
                4
                  Wycombe Gardens
                London
                  NW11 8AL
                United
                  Kingdom
              4,878,000
              Direct
              37.47%Common
              **Guy
                  Nissenson****/***
                Chief
                  Executive Officer/ President/Director
                3A
                  Finchley Park
                London
                  N12 9JS
                United
                  Kingdom
              2,703,500
              Direct/Indirect
              20.77%Common
              **Eyal
                  J. Harish******
                Director
                3
                  Moshe Dayan Street, Raanana, Israel
              90,000
              Direct
              0.78%Common
              **Shemer
                  S. Schwartz*******
                Director
                5
                  Israel Galili, Kefar Saba, Israel
              75,000
              Direct
              0.65%Common
              **Aviu
                  Ben-Horrin********
                Director
                40
                  Jabotinski Street, Tel Aviv, Israel
              25,000
              Direct
              0.22%Common
              **MCG
                  Capital Corporation*********
                1100
                  Wilson Boulevard, Suite 3000, Arlington VA, 22209, USA
              1,022,591
              Direct/Indirect
              8.76%Common
              **Crestview
                  Capital**
                **Master
                  LLC**********
                95
                  Revere Drive, Suite F, Northbrook, Illinois 60062, USA
              1,367,838
              Direct
              11.19%Common
              **Mercantile
                  Discount - Provident Funds***********
                32
                  Yavne Street
                Tel-Aviv
                  65792, Israel
              718,500
              Direct
              6.11%Common
              **Alon
                  Mualem************
                15
                  Begin Blvd.
                Yahud,
                  Israel
              112,500
              Direct
              0.97%Common****
              **Directors
                  and Executive Officers as a group**
                **(6
                  persons)**
              7,884,000
              Direct
              53.25%
 
 -70-
 *
        Until
        June 23, 2004, Abraham Keinan indirectly held 1,302,331 shares of our common
        stock through Vision Consultants Limited, a Nassau, Bahamas incorporated
        company
        that is 100% owned by Mr. Keinan. On June 23, 2004, the shares held by Vision
        Consultants Limited were transferred to Mr. Keinan as an individual. In
        addition, certain stockholders provided Mr. Keinan and Mr. Nissenson with
        irrevocable proxies representing a total of 16.48% of our common stock. On
        November 24, 2004, our board of directors issued 1,500,000 options to Mr.
        Keinan
        on the following terms: Option exercise price - $3.5, vesting date - 12 month
        from the date of grant, expiration date - 5 years from the vesting date.
        Mr.
        Keinan’s 4,878,000 shares of common stock include 1,500,000 shares issuable upon
        the exercise of options, exercisable within 60 days from the date of this
        Annual
        Report.
 
 **
        Guy
        Nissenson, our President, Chief Executive Officer, Treasurer, Chief Financial
        Officer, Principal Accounting Officer and Director, has indirect beneficial
        ownership of 1,203,500 shares of our common stock and direct beneficial
        ownership of 1,500,000 shares issuable upon the exercise of options, exercisable
        within 60 days from the date of this Annual Report. In addition, certain
        stockholders provided Mr. Nissenson and Mr. Keinan with irrevocable proxies
        representing a total of 16.48% of our common stock. To the extent that we
        issue
        any shares to Abraham Keinan, Campbeltown Business Ltd. has the right to
        purchase or acquire such number of our shares on the same terms and conditions
        so that the relative percentage ownership of Abraham Keinan and Campbeltown
        Business Ltd. remains the same. On November 24, 2004, our board of directors
        issued 1,500,000 options to Mr. Nissenson on the following terms: Option
        exercise price - $3.5, vesting date - 12 month from the date of grant,
        expiration date - 5 years from the vesting date.
 
 ***
        Our
        Chairman of the Board, Abraham Keinan, and our President, Chief Executive
        Officer, Treasurer, Chief Financial Officer, Principal Accounting Officer
        and
        Director, Guy Nissenson, exercise significant control over stockholder matters
        through a September 28, 2004 Voting Agreement between Mr. Keinan, Mr. Nissenson
        and Campbeltown Business Ltd., an entity owned and controlled by Mr. Nissenson
        and his family. This agreement is for a term of 10 years and provides that:
        (a)
        Messrs. Keinan and Nissenson and Campbeltown Business, Ltd. agree to vote
        any
        shares of our common stock controlled by them only in such manner as previously
        agreed by all these parties; and (b) in the event of any disagreement regarding
        the manner of voting, a party to the agreement will not vote any shares,
        unless
        all the parties have settled the disagreement.
 
 ****
        Dr.
        Eyal J. Harish is the brother-in-law of Abraham Keinan, our Chairman of the
        Board. Dr. Harish holds 15,000 shares of our common stock and 75,000 shares
        issuable upon the exercise of options, exercisable within 60 days from the
        date
        of this Annual Report.
 
 *****
        Mr.
        Shemer S. Schwartz holds 75,000 shares issuable upon the exercise of options,
        exercisable within 60 days from the date of this Annual Report.
 
 ******
        Mr. Aviu Ben-Horrin holds 25,000 shares issuable upon the exercise of options,
        exercisable within 60 days from the date of this Annual Report.
 
 *******
        MCG Capital Corporation owns 868,946 shares of our common stock, 100,474
        of
        which are held by Trustmark National Bank as an Escrow Agent; and 153,645
        shares
        issuable upon the exercise of warrants, exercisable within 60 days from the
        date
        of this Annual Report, 76,822 of which held by Trustmark National Bank as
        an
        Escrow Agent. These shares and warrants were issued in conjunction with the
        consummation of the acquisition of I-55 Internet Services, Inc.
 
 ********
        Crestview Capital Master LLC owns 666,500 shares of our common stock and
        701,338
        shares issuable upon the exercise of warrants, exercisable within 60 days
        from
        the date of this Annual Report.
 
 -71-
 *********
        Mercantile Discount - Provident Funds owns 478,500 shares of our common stock
        and 240,000 shares issuable upon the exercise of warrants, exercisable within
        60
        days from the date of this Annual Report.
  **********
        On June 8, 2005, Mr. Alon Mualem, our former Treasurer, Chief Financial Officer
        and Principal Accounting Officer, was granted 300,000 options at an exercise
        price of $3.50. The vesting of the options will be over a period of 4 years
        as
        follows: 25% of the options are vested after a year from the date of grant.
        Thereafter, 1/16 of the options are vested every 3 months for the following
        3
        years. On January 30, 2007, Mr. Mualem submitted his resignation as Treasurer,
        Chief Financial Officer and Principal Accounting Officer of the Company,
        effective March 1, 2007. On March 1, 2007, due to Mr. Mualem's resignation,
        187,500 of his aforementioned options were terminated. Mr. Mualem holds 112,500
        shares issuable upon the exercise of options, exercisable within 60 days
        from
        the date of this Annual Report.
 
 Our
        Chairman of the Board, Abraham Keinan, beneficially owns 29.33% of our common
        stock. Our President, Chief Executive Officer, Treasurer, Chief Financial
        Officer, Principal Accounting Officer and Director, Guy Nissenson has
        significant influence over an additional 10.45% of our
        common stock, which is owned by Campbeltown Business Ltd., an entity owned
        and
        controlled by Mr. Nissenson and his family. In addition, certain stockholders
        provided Mr. Nissenson and Mr. Keinan with irrevocable proxies representing
        a
        total of 16.48% of our common stock. Eyal Harish, a director, beneficially
        owns 0.13% of our
        common stock. Swiftnet beneficially owns 1.13% of our
        common stock. Therefore, our management potentially may vote 57.52% of our
        common stock, without giving effect to the issuance of any shares upon the
        exercise of outstanding warrants or options. As such, our management controls
        the outcome of all matters submitted to a vote of the holders of our common
        stock, including the election of our directors, amendments to our articles
        of
        incorporation and approval of significant corporate transactions. Additionally,
        our management can delay, deter or prevent a change in our control that might
        be
        beneficial to our other stockholders.
 
 ITEM
        12 .
        CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONSAND
        DIRECTOR INDEPENDENCE
 
 SWIFTNET
        LIMITED
 
 **General
        Contract for Services**
 
 A
        General
        Contract for Services by and between the Company and its wholly-owned
        subsidiary, Swiftnet Limited, provides that as of January 1, 2005, the Company
        will provide Swiftnet the following services: Marketing, Finance and Operational
        Consultancy work related to customers and transactions that are based in
        and
        outside the United Kingdom. In return for these services, Swiftnet will pay
        the
        Company the following consideration: 5% of the total turnover of Swiftnet;
        5% on
        money raised from sources outside the United Kingdom; and expenses. The General
        Contract for Services may be terminated by either party upon 30 days prior
        written notice to the other party.
 
 On
        March
        14, 2007, the Company and Swiftnet entered into a First Amendment to the
        General
        Contract for Services (the "First Amendment") to be effective as of January
        1,
        2006. The First Amendment provides that the Company will render Swiftnet
        the
        following services; Day-to-day support to the Directors of Swiftnet in the
        general management of the business (to include Marketing, Finance and
        Operational advisory work), special projects (outside of the day-to-day
        management of the business) required to achieve specific business development
        goals (to include the new supplier relationships and the introduction of
        new
        products and processes) and activities to secure financing for Swiftnet (from
        outside the U.K.). In exchange for the services Swiftnet will pay the Company
        according to the following schedule; 2.5% of the total turnover of Swiftnet,
        in
        return for special projects: £750 per each Xfone executive per day, 5% of money
        raised from sources outside the U.K., and expenses.
 
 A
        copy of
        the First Amendment is attached hereto as Exhibit 10.96 and incorporated
        herein
        by reference.
 
 -72-
 XFONE
        018
        LTD.
 
 **August
        26, 2004 Investment Agreement**
 
 According
        to an August 26, 2004 Investment Agreement between us, Xfone 018 Ltd. and
        our
        26% minority interest partner in Xfone 018 (respectively, the "Investment
        Agreement", the "Minority Partner"), the Minority Partner provided in 2004
        a
        bank guarantee of 10,000,000 New Israeli Shekels ("NIS") (£1, 206,505) ($2,
        366,864) to the Ministry of Communications of the State of Israel which replaced
        an existing bank guarantee given by us in connection with Xfone 018’s license to
        provide international telecom services in Israel. As part of the Investment
        Agreement, we agreed to indemnify the Minority Partner for any damage caused
        to
        him due to the forfeiture of the bank guarantee with the Ministry of
        Communications on account of any act and/or omission of Xfone 018, provided
        that
        the said act or omission is performed against the opinion of the Minority
        Partner or without his knowledge. Further, we agreed that if at the end of
        the
        first two years of Xfone 018’s business activity, its revenues shall be less
        than $2,000,000 (£1, 021,000) or if it shall cease business activity (at
        any time), we shall secure the return of the bank guarantee to the Minority
        Partner.
 
 Pursuant
        to the Investment Agreement, the Minority Partner provided in the fourth
        quarter
        of year 2004, a shareholder loan of approximately $400,000 (£204,200) to Xfone
        018 (the "Minority Partner Loan"). The Minority Partner Loan is for four
        years
        with annual interest of 4% and linkage to the Israeli consumer price
        index.
 
 As
        of December 31, 2006, Xfone, Inc. provided to Xfone 018 a shareholder loan
        in an
        aggregate amount of $ 1,150,049 (£ 587,100 ).
 
 The
        Investment Agreement provides that we shall be entitled to receive from Xfone
        018 management fees equivalent to 5% of the operating profit of Xfone 018,
        in
        return for the management services provided by us to Xfone 018. As of Decenber
        31, 2006, no management fees were due or paid.
 
 **Giora
        Spigel Agreement**
 
 Pursuant
        to a verbal agreement between Mr. Giora Spigel and us, the Board of Directors
        of
        Xfone 018 approved on November 24, 2004, subject to the approval of the Ministry
        of Communications of the State of Israel, that shares held by us, representing
        5% ownership of Xfone 018, will be transferred to Margo Sport Ltd., a company
        owned by Mr. Spigel and his wife. Upon approval of the Ministry of
        Communications of the State of Israel, such verbal agreement was evidenced
        by a
        share transfer deed as required by the Israel Company Law - 1999.
 
 Xfone
        018
        is currently owned 69% by us, 26% by Newcall Ltd. (a company owned by the
        Minority Partner), and 5% by Margo Sport Ltd.
 
 -73-
 **October
        30, 2006, our Board of Directors Resolution**
 
 On
        October 30, 2006, our Board of Directors directed and authorized the President
        of the Company to execute a confirmation letter to be furnished to BKR Yarel
        +
        Partners (the independent auditors of Xfone 018), declaring that it is the
        intention of the Company, as the parent company of Xfone 018, to further
        invest
        funds which are required to finance the continuing operations of Xfone 018
        in
        the 12 months period ending on November 16, 2007. The confirmation letter
        was
        executed and furnished to BKR Yarel + Partners the same day.
 
 AURACALL
        LIMITED
  **Our
        interest in Auracall through Swiftnet**
  On
        October 16, 2001, our wholly owned UK based subsidiary, Swiftnet Limited
        entered
        into an agreement titled “Formation of Newco” (the “Newco Agreement”). The Newco
        Agreement provided that Dr. Nissim Levy and Swiftnet will establish a company,
        Newco (which later became Auracall Limited), for the purpose of developing
        telecommunication business based on non-geographic numbers. In May 2002,
        Swiftnet exercised its option pursuant to the Newco Agreement to receive
        50% of
        the shares of Auracall, and both Swiftnet and Dr. Levy agreed to give 5%
        of
        Auracall’s shares to Auracall’s Managing Director, Mr. Dan Kirschner. Therefore,
        the interest in Auracall was as follows: Swiftnet - 47.5%, Dr. Levy - 47.5%,
        and
        Mr. Kirschner - 5%. In practice, Dr. Levy and Swiftnet provided a loan to
        Auracall to the level of about £45,000 and £15,000, respectively. On August 21,
        2003, Swiftnet and Mr. Kirschner entered into an agreement (the “August 21, 2003
        Agreement”) which provided that Swiftnet will not object if Dr. Levy sells all
        of his interest in Auracall to Mr. Kirschner once the Newco Agreement provisions
        concerning the payout of profits to cover debt/investments and other conditions
        are fulfilled. Swiftnet and Mr. Kirschner further agreed to certain conditions
        which were affirmed by the Newco Agreement. The August 21, 2003 Agreement
        further provided that once the Newco Agreement provisions concerning the
        payout
        of profits to cover debt/investments are fulfilled, Mr. Kirschner’s salary will
        be reinstated to £50,000 and Swiftnet will receive £24,000 as
        management/consultancy fees. The August 21, 2003 Agreement further provided
        that
        Auracall will issue to Mr. Kirschner, as a bonus, further shares from treasury
        to the level that Mr. Kirschner will hold 67.5% of Auracall shares and Swiftnet
        will hold only 32.5% of Auracall shares. This bonus was subject to certain
        pre-conditions. The August 21, 2003 Agreement provided that it will take
        effect
        only after the arrangement between Dr. Levy and Mr. Kirschner will be finalized.
        In January 2004, Dr. Levy sold all of his interest in Auracall to Mr. Kirschner.
        Therefore, Mr. Kirschner owned 52.5% of Auracall shares and Swiftnet owned
        47.5%
        of Auracall shares. On January 1, 2006, Auracall issued to Mr. Kirschner
        further
        shares from treasury to the level that Swiftnet was diluted from 47.5% to
        32.5%
        holdings of Auracall. This issuance was a bonus in accordance with the August
        21, 2003 Agreement.
  **September
        27, 2006 Shareholders Loan Agreement**
 
 On
        September 27, 2006, a Shareholders Loan Agreement was entered by and between
        Auracall Limited, an affiliated company, Swiftnet Limited, our wholly owned
        U.K.
        subsidiary and the Managing Director of Auracall who holds 67.5% of Auracall.
        As
        part of this agreement, Swiftnet agreed to provide a loan of £24,000 ($47,016)
        to Auracall, free of interest, to be repaid within one year. The loan was
        funded
        on October 13, 2006.
 
 CRESTVIEW
        CAPITAL MASTER, LLC
 
 **November
        20, 2006 Consultancy Agreement with Crestview Capital
        Partners**
 
 -74-
 On
        November 20, 2006, the Company and Crestview Capital Partners, LLP (the
“Consultant”) entered into a one-year Consultancy Agreement (the "Consultancy
        Agreement"). During the term of the Consultancy Agreement, the Company will
        engage the Consultant as its strategic consultant on United States capital
        markets for micro-cap public companies. In return for its services pursuant
        to
        the Consultancy Agreement, the Consultant was granted 117,676 warrants to
        purchase restricted shares of the Company’s common stock, registered in the name
        of Crestview Capital Master, LLC (the "Warrants"). The Warrants are be
        exercisable pursuant to the following terms: Vesting - 29,419 warrants
        immediately, 29,419 warrants on February 10, 2007, 29,419 warrants on May
        10,
        2007, and 29,419 warrants on August 10, 2007; Exercise Price - $3.50; Term
        -
        five (5) years.
 
 Crestview
        Capital Master, LLC owns 666,500 shares of the Company’s common stock and a
        total of 760,176 warrants to purchase shares of the Company’s common stock.
 
 ABRAHAM
        KEINAN
 
 **Keinan
        Share Issuance**
 
 On
        September 1, 2000, we issued 1,730,000 shares of our common stock to our
        founder
        and Chairman of the Board, Abraham Keinan, for services rendered to us in
        our
        corporate formation. Mr. Keinan’s services consisted of the establishment of our
        business concept and providing us with technical expertise. We valued Mr.
        Keinan’s services at $247,390.
 
 **Keinan
        Stock Ownership through Vision Consultants**
 
 Until
        June 23, 2004, our Chairman of the Board, Mr. Abraham Keinan indirectly held
        1,302,331 shares of our common stock through Vision Consultants Limited,
        a
        Nassau, Bahamas incorporated company that is 100% owned by Mr. Keinan. On
        June
        23, 2004, the shares held by Vision Consultants Limited were transferred
        to Mr.
        Keinan as an individual.
 
 **Redemption
        of Keinan shares**
 
 On
        December 29, 2005, the Board of Directors of the Company entered into an
        oral
        stock purchase agreement with Mr. Keinan pursuant to which it repurchased
        100,000 restricted shares of its common stock at a price of $2.50 per share
        (market price at that day was $2.75 per share). The 100,000 shares were returned
        to us for cancellation. The Agreement was approved by a majority of the
        non-interested members of the Board of Directors.
 
 On
        December 25, 2006, the Board of Directors of the Company entered into an
        oral
        stock purchase agreement with Mr. Keinan, pursuant to which the Company
        repurchased from Mr. Keinan 100,000 restricted shares of its common stock
        at a
        price of $2.70 per share (market price at that day was $2.80 per share).
        The
        100,000 shares were returned to us for cancellation on December 26, 2006.
        The
        Agreement was approved by all non-interested members of the Board of Directors,
        following a review and discussion by the Company’s Audit Committee.
 
 -75-
 **Keinan
        Employment with Swiftnet**
 
 Our
        Chairman of the Board, Mr. Abraham Keinan, has been employed by our wholly-owned
        UK based subsidiary, Swiftnet Limited since its inception in 1990. In 2005,
        Mr.
        Keinan’s annual salary was £54,594 ($94,175). In 2006, Mr. Keinan’s annual
        salary was £48,000 ($94,032). Mr. Keinan received in addition to his monthly
        salary pension benefits and a company car. With respect to employment years
        1990-2006, Mr.
        Keinan had no written employment agreement with Swiftnet.
 
 **Keinan
        Employment Agreement with Swiftnet**
 
 Pursuant
        to a Company’s Board of Directors’ resolution dated December 25, 2006, on March
        28, 2007, Swiftnet and Mr. Keinan entered into an employment agreement, to
        be
        effective as of January 1, 2007 (the “Keinan Employment
        Agreement”).
 
 The
        Keinan Employment Agreement provides that Mr. Keinan shall be employed as
        the
        Chairman of the Board of Directors of Swiftnet. Keinan Employment Agreement
        shall be in effect for an initial fixed term of five years, beginning on
        January
        1, 2007, (the "Initial Effective Term"), and thereafter shall automatically
        be
        renewed for additional terms of three years (each, an "Additional Effective
        Term"). Notwithstanding the foregoing, each of Swiftnet and Mr. Keinan shall
        have the right to terminate the automatic renewal of Keinan Employment
        Agreement, for any reason whatsoever, by a termination notice in writing,
        to be
        provided to the other party not less than six months prior to: (i) the
        expiration of the Initial Effective Term, or (ii) the expiration of any
        Additional Effective Term (the "Notice Period"). Notwithstanding the foregoing,
        Mr. Keinan shall have the right to terminate the Keinan Employment Agreement,
        for any reason whatsoever, and at any time, including during the Initial
        Effective Term ("Early Termination"). In the event of Early Termination,
        the
        Notice Period shall be of not less than eight months.
 
 Under
        the
        Keinan Employment Agreement, Swiftnet shall pay to Mr. Keinan during the
        term of
        his engagement a salary at the rate of Forty Eight Thousand British Pounds
        (£48,000) ($94,032) per annum, such salary to be paid in equal monthly
        installments in arrears on the last Friday of each month. Swiftnet shall
        provide
        Mr. Keinan with an appropriate executive car or car allowance with an effective
        annual cost to Swiftnet of up to Fifteen Thousand British Pounds (£15,000)
        ($29,385).
 
 Swiftnet
        shall pay Mr. Keinan contributions to the following schemes: (i) Health care
        for
        him and his immediate family; (ii) Permanent health; (iii) Life insurance
        arrangements (up to a maximum of four times salary); (iv) Pension rights
        -
        Swiftnet shall contribute a monthly sum equal to 7.5% of his salary. (v)
        Travel
        insurance.
 
 Swiftnet
        shall reimburse to Mr. Keinan all traveling, hotel, restaurant and other
        expenses incurred by him in the proper performance of his duties under his
        engagement.
 
 If
        during
        the period of the employment under the Keinan Employment Agreement Mr. Keinan
        shall cease to be a director of Swiftnet, his employment shall continue and
        the
        terms of the Keinan Employment Agreement (other than those relating to the
        holding of office of director / chairman) shall continue in full
        force.
 
 -76-
 The
        Keinan Employment Agreement also contains special arrangements for sickness
        benefits, holiday entitlement and provisions regarding non-competition;
        intellectual property; confidentiality; conflict of interests and other standard
        terms and conditions.
 
 The
        Keinan Employment Agreement was approved by all non-interested members of
        the
        Board of Directors, following a review and discussion by the Company’s Audit
        Committee.
 
 A
        copy of
        the Keinan Employment Agreement is attached hereto as Exhibit 10.97 and
        incorporated herein by reference.
 
 **Keinan
        Consulting Agreement**
 
 Pursuant
        to a Company’s Board of Directors’ resolution dated December 25, 2006, on March
        28, 2007, the Company and Mr. Keinan entered into a consulting agreement,
        to be
        effective as of January 1, 2007 (the “Keinan Consulting
        Agreement”).
 
 The
        Keinan Consulting Agreement provides that Mr. Keinan shall render the Company
        advisory, consulting and other services in relation to the business and
        operations of the Company (excluding its business and operations in the United
        Kingdom).
 
 In
        consideration of the performance of the Services pursuant to the Keinan
        Consulting Agreement, the Company shall pay Mr. Keinan a monthly fee of Ten
        Thousand British Pounds (£10,000) ($19,590) (the "Fee"). Mr. Keinan shall
        invoice the Company at the end of each calendar month and the Company shall
        make
        the monthly payment immediately upon receiving such invoice. Once a calendar
        year, and no later than December 15, the Company’s Board shall consider
        approving an increase to the Fee. Such Board approval shall be subject to
        the
        prior review, oversight and recommendation to the Board of both the Audit
        Committee and the Compensation Committee of the Company (the "Compensation
        Committee"). However, in the event the Company has not established a
        Compensation Committee, the review, oversight and recommendation to the Board
        of
        the Audit Committee shall suffice. In connection with the performance of
        this
        provision, the Audit Committee, the Compensation Committee and the Board
        shall
        take into account, among other factors, growth in the Company’s revenues and/or
        profits.
  The
        Company’s Board shall, from time to time, and not less than once a calendar
        year, consider approving a grant of success bonus to Mr. Keinan (the "Bonus").
        Such Board approval shall be subject to the prior review, oversight and
        recommendation to the Board of both the Audit Committee and the Compensation
        Committee. However, in the event the Company has not established a Compensation
        Committee, the review, oversight and recommendation to the Board of the Audit
        Committee shall suffice. In connection with the performance of this provision,
        the Audit Committee, the Compensation Committee and the Board shall take
        into
        account, among other factors, growth in the Company’s revenues and/or profits
        and/or successful completion of transactions or activities by the Company
        (such
        as, but not limited to, reorganization, mergers, acquisitions, capital raisings
        and cost cuts). Any Board member, except Mr. Keinan, may, at any time and
        from
        time to time, initiate a Bonus grant to Mr. Keinan, and in such an event
        the
        approving process shall be set in motion.
 
 Immediately
        upon the establishment by the Company of any new stock option or purchase
        plan
        or other equity compensation arrangement pursuant to which options or stock
        may
        be acquired by officers, directors, employees, or consultants of the Company
        (collectively, "Plan"), the Company’s Board shall consider approving a grant of
        an appropriate amount of options (or any other applicable rights) under the
        Plan
        to Mr. Keinan. Such Board approval shall be subject to the prior review,
        oversight and recommendation to the Board of both the Audit Committee and
        the
        Compensation Committee. However, in the event the Company has not established
        a
        Compensation Committee, the review, oversight and recommendation to the Board
        of
        the Audit Committee shall suffice.
 -77-
 In
        addition to the Fee and the Bonus, the Company shall pay directly and/or
        reimburse Mr. Keinan for his Expenses. For the purposes of the Keinan Consulting
        Agreement, the term "Expenses" shall mean any and all amounts actually paid
        by
        the Company and/or by Mr. Keinan, and/or to be paid by Mr. Keinan at his
        direction, including, without limitation (i) costs associated with
        telecommunication services and products, and (ii) costs associated with
        transportation and/or travel (including, but not limited to, by plane, train,
        rented car and taxi) and/or accommodation (including, but not limited to,
        at
        rented flats and hotels) and/or any other board and lodging expenses (including,
        but not limited to, food, restaurants and entertainment) which were and/or
        will
        be incurred in connection with the performance of the Services pursuant to
        the
        Keinan Consulting Agreement.
 
 The
        Company acknowledges that in order to render the Services pursuant to the
        Keinan
        Consulting Agreement, Mr. Keinan may be required to travel frequently around
        the
        world. Therefore, in order to enable Mr. Keinan a normal family life the
        Company
        shall bear Expenses which are related to Mr. Keinan's spouse.
 
 Mr.
        Keinan shall hold and use, in his sole discretion, credit cards in the name
        of
        the Company (the "Credit Cards"). Due to Mr. Keinan's position with the Company
        (i.e. Chairman of the Board) he may from time to time use the Credit Cards
        to
        make certain Company payments and pay certain Company expenses.
 
 This
        Keinan Consulting Agreement shall be in effect for an initial fixed term
        of five
        years, beginning on January 1, 2007 (the "Initial Effective Term"), and
        thereafter, unless terminated as provided below, shall automatically be renewed
        for additional terms of three years (each, an "Additional Effective Term").
        Notwithstanding the foregoing, each of the Company and Mr. Keinan shall have
        the
        right to terminate the automatic renewal of the Keinan Consulting Agreement,
        for
        any reason whatsoever, by a termination notice in writing, to be provided
        to the
        other party not less than six months prior to: (i) the expiration of the
        Initial
        Effective Term, or (ii) the expiration of any Additional Effective Term (the
        "Notice Period"). Notwithstanding the foregoing, as long as Mr. Keinan shall
        command and/or control, directly and/or indirectly, including together with
        others (as well as pursuant to that certain Voting Agreement dated September
        28,
        2004, by and among Mr. Keinan, Guy Nissenson and Campbeltown Business Ltd.)
        and/or by proxies, fifteen percent (15%) or more of the voting rights of
        the
        Company, if the Company shall choose to exercise its right to terminate the
        automatic renewal of the Keinan Consulting Agreement, the Notice Period shall
        be
        of not less than twelve months. Notwithstanding the foregoing, Mr. Keinan
        shall
        have the right to terminate the Keinan Consulting Agreement, for any reason
        whatsoever, and at any time, including during the Initial Effective Term
        ("Early
        Termination by Mr. Keinan "). In the event of Early Termination by Mr. Keinan,
        the Notice Period shall be of not less than eight months.
 
 The
        Keinan Consulting Agreement further provides that no later than June 30,
        2007,
        the Company and Mr. Keinan shall enter into a severance agreement providing
        for
        an appropriate severance package for Mr. Keinan (the "Severance Agreement").
        The
        Severance Agreement shall, inter alia, cover events of termination of the
        automatic renewal of the Keinan Consulting Agreement by the Company or Mr.
        Keinan, termination of the Keinan Consulting Agreement by Mr. Keinan, and
        scheduled retirement by Mr. Keinan.
 
 The
        Keinan Consulting Agreement also contains provisions regarding non-competition;
        intellectual property; confidentiality; conflict of interests and other standard
        terms and conditions.
 
 The
        Keinan Consulting Agreement was approved by all non-interested members of
        the
        Board of Directors, following a review and discussion by the Company’s Audit
        Committee.
 
 A
        copy of
        the Keinan Consulting Agreement is attached hereto as Exhibit 10.98 and
        incorporated herein by reference.
 
 -78-
 **Keinan
        Bonus and Success Fee**
 
 On
        April
        2, 2002, our Board of Directors approved a bonus and success fee whereby
        if we
        receive monthly revenues in excess of $485,000 then Mr. Keinan and Campbeltown
        Business shall receive 1% of such monthly revenues, up to a maximum of one
        million dollars (the “Bonus and Success Fee”). On April 10, 2003, Mr. Keinan and
        Campbeltown Business waived their right to receive 1% of the revenues generated
        by Story Telecom. On February 8, 2007, an Agreement was entered by and between
        the Company, Swiftnet, Campbeltown Business, and Mr. Keinan (the “February 8,
        2007 Agreement”). The February 8, 2007 Agreement provides that effective as of
        January 1, 2007, the Bonus and Success Fee is cancelled, and that Mr. Keinan
        and
        Campbeltown Business shall have no further right to any percentage of our
        revenues.
 
 On
        June
        28, 2004, our Board of Directors approved a bonus of £5,000 ($9,795) to Mr.
        Keinan for his efforts in connection with obtaining the license to become
        an
        international telecom service provider in Israel by Xfone 018.
 
 **Keinan
        Loan**
 
 Since
        our
        inception in September 2000, through December 31, 2000, we along with our
        subsidiary, Swiftnet loaned Abraham Keinan, our Chairman of the Board. This
        loan
        originally was reflected in a September 29, 2000 promissory note payable
        in ten
        equal installments ending on January 1, 2011. This note is non-interest bearing.
        We provided the loan to Mr. Keinan to promote his loyalty and continued service
        as our Chairman of the Board of Directors. On December 29, 2005, Mr. Keinan
        repaid £123,966 ($242,849) which was due for the fiscal year ended December 31,
        2005.  On
        December 26, 2006 Mr. Abraham Keinan, repaid the final payment of £123,965
        ($242,847) under the terms of his loan.
 
 **Indemnification**
 
 Xfone
        018
        Ltd., Our Israeli subsidiary, has obtained certain credit facilities from
        Bank
        Hapoalim B.M. The credit facilities are secured, among others, with a personal
        guarantee by Abraham Keinan and Guy Nissenson, which includes a pledge on
        1,000,000 shares of common stock of the Company owned by Mr. Keinan, and
        an
        undertaking to provide Bank Hapoalim with an additional financial guarantee
        of
        up to $500,000 under certain circumstances. We agreed to indemnify Abraham
        Keinan and/or Guy Nissenson on account of any damage and/or loss and/or expense
        (including legal expenses) that they may incur in connection with the stock
        pledge and/or any other obligation made by them to Bank Hapoalim in connection
        with the collateral.
 
 GUY
        NISSENSON
 
 **Campbeltown
        Business Ltd.**
 
 Consulting
        Agreement
 
 -79-
 On
        May
        11, 2000, Swiftnet Limited, which is now our wholly owned subsidiary, and
        our
        Chairman of the Board of Directors, Abraham Keinan, entered into an 18-month
        renewable consulting agreement with Campbeltown Business Ltd., a private
        company
        incorporated in the British Virgin Island which is owned by Guy Nissenson,
        our
        President, Chief Executive Officer, Treasurer,
        Chief Financial Officer, Principal Accounting Officer and
        Director and other family members of Mr. Nissenson. This agreement provided
        that
        Swiftnet will hire Campbeltown Business as its financial and business
        development consultant and will pay Campbeltown Business £2,000 per month, along
        with an additional monthly performance bonus based upon Swiftnet attaining
        the
        following revenue levels, for consulting services in the area of business
        development and management activities:
 
 **TARGET
                  AMOUNT OF**
                **REVENUES
                  PER MONTH**
              **ADDITIONAL
                  MONTHLY BONUS**Less
                  than £125,000
              £0Between
                  £125,000 - £150,000
                (approximately
                  $244,875 - $293,850)
              £1,250
                (approximately
                  $2,449)Between
                  £150,000 - £175,000
                (approximately
                  $293,850 - $342,825)
              £2,500
                (approximately
                  $4,898)Over
                  £175,000
                (approximately
                  $342,825)
              £2,750
                (approximately
                  $5,387)
 
 The
        agreement with Campbeltown Business involving the aforementioned monthly
        payment
        of £2000, along with an additional monthly performance bonus, was separate from
        a bonus and success fee arrangement that was approved by our Board of Directors
        on April 2, 2002.
 
 The
        May
        11, 2000 agreement was for 18 months, but provided that it will be renewed
        by
        mutual agreement of Swiftnet and Campbeltown Business. On November 5, 2001,
        May
        11, 2003, November 10, 2004, and May 11, 2006 we renewed this agreement for
        additional 18 month periods. On February 8, 2007, an Agreement was entered
        by
        and between the Company, Swiftnet, Campbeltown Business, and Mr. Keinan (the
        “February 8, 2007 Agreement”). The February 8, 2007 Agreement provides that
        effective as of January 1, 2007, the aforementioned consulting agreement
        is
        terminated.
 
 -80-
 Stock
        Purchase Agreement
 
 On
        June
        19, 2000, Swiftnet Limited entered into a Stock Purchase Agreement with Abraham
        Keinan and Campbeltown Business Ltd. a company owned and controlled by Guy
        Nissenson and his family. This agreement provides that:
 ·
              Abraham
                  Keinan confirmed that all his businesses activities and initiatives
                  in the
                  field of telecommunications are conducted through Swiftnet, and
                  would
                  continue for at least 18 months after the conclusion of this
                  transaction.
 ·
              Campbeltown
                  Business declared that it is not involved in any business that
                  competes
                  with Swiftnet and would not be involved in such business at least
                  for 18
                  months after this transaction is concluded.
 ·
              Campbeltown
                  Business would invest $100,000 in Swiftnet, in exchange for 20%
                  of the
                  total issued shares of Swiftnet;
 ·
              Campbeltown
                  Business would also receive 5% of our issued and outstanding shares
                  following our acquisition with Swiftnet. In June 2000, Campbeltown
                  Business invested the $100,000 in Swiftnet. We acquired Swiftnet
                  and
                  Campbeltown received 720,336 shares of our common stock for its
                  20%
                  interest in Swiftnet.
 ·
              Swiftnet
                  and Abraham Keinan would guarantee that Campbeltown Business' 20%
                  interest
                  in the outstanding shares of Swiftnet would be exchanged for at
                  least 10%
                  of our outstanding shares and that Campbeltown Business would have
                  in
                  total at least 15% of our total issued shares after our acquisition
                  occurred.
 ·
              Campbeltown
                  Business would have the right to nominate 33% of the members of
                  our board
                  of directors and Swiftnet’s board of directors. When Campbeltown Business
                  ownership in our common stock was less than 7%, Campbeltown Business
                  would
                  have the right to nominate only 20% of our board members but always
                  at
                  least one member. In the case that Campbeltown Business ownership
                  in our
                  common stock was less than 2%, this right would
                  expire.
 ·
              Campbeltown
                  Business would have the right to nominate a vice president in Swiftnet.
                  Mr. Guy Nissenson was nominated as of the time of the June 19,
                  2000
                  agreement. If for any reason Guy Nissenson will leave his position,
                  Campbeltown Business and Abraham Keinan will agree on another nominee.
                  The
                  Vice President will be employed with suitable
                  conditions.
 ·
              Campbeltown
                  Business will have the right to participate under the same terms
                  and
                  conditions in any investment or transaction that involve equity
                  rights in
                  Swiftnet or us conducted by Abraham Keinan at the relative ownership
                  portion.
 ·
              Keinan
                  and Campbeltown Business have signed a right of first refusal agreement
                  for the sale of their shares.
 ·
              Until
                  we conduct a public offering or are traded on a stock market, we
                  are not
                  permitted to issue any additional shares or equity rights without
                  a
                  written agreement from Campbeltown Business. This right expires
                  when
                  Campbeltown no longer owns any equity interest or shares in our
                  company or
                  our subsidiary, Swiftnet.
 
 Bonus
        and
        Success Fee
 
 On
        April
        2, 2002, our Board of Directors approved a bonus and success fee whereby
        if we
        receive monthly revenues in excess of $485,000 then Mr. Keinan and Campbeltown
        Business shall receive 1% of such monthly revenues, up to a maximum of one
        million dollars (the “Bonus and Success Fee”). On April 10, 2003, Mr. Keinan and
        Campbeltown Business waived their right to receive 1% of the revenues generated
        by Story Telecom. This bonus and success fee was separate from our consulting
        agreement with Campbeltown Business, involving a monthly payment of £2000, along
        with an additional monthly performance bonus. On February 8, 2007, an Agreement
        was entered by and between the Company, Swiftnet, Campbeltown Business, and
        Mr.
        Keinan (the “February 8, 2007 Agreement”). The February 8, 2007 Agreement
        provides that effective as of January 1, 2007, the Bonus and Success Fee
        is
        cancelled, and that Mr. Keinan and Campbeltown Business shall have no further
        right to any percentage of our revenues.
 
 -81-
 **Nissenson
        Employment Agreements with Swiftnet**
 
 May
        11,
        2000 Employment Agreement
 
 On
        May
        11, 2000, Swiftnet Limited and our Chairman of the Board of Directors, Abraham
        Keinan, entered into an employment agreement with Guy Nissenson, our President,
        Chief Executive Officer, Treasurer,
        Chief Financial Officer, Principal Accounting Officer and Director (the
“ May
        11,
        2000 Employment Agreement”). Under the terms of the agreement, Swiftnet employed
        Mr. Nissenson to provide business development and sales and marketing services,
        at a base rate of £1000 per month (approximately $1,959). The May 11, 2000
        Employment Agreement provided that when Swiftnet reaches average sales of
        £175,000 per month for a consecutive three-month period, Mr. Nissenson’s salary
        will increase to £2,000 (approximately $3,918) per month. The May 11, 2000
        Employment Agreement further provided that Mr. Nissenson will receive an
        unspecified number of options to acquire our stock that is limited to 50%
        of the
        options that Mr. Keinan receives. As such, the agreement protected Mr.
        Nissenson’s rights to have at least 50% of the options rights that Mr. Keinan
        will have. Mr. Nissenson can transfer the right of these options to another
        company or person at his discretion. Swiftnet may only cancel these options
        if:
        (1) Mr. Nissenson no longer works with Swiftnet; or (2) if within twelve
        months
        of Mr. Nissenson’s employment with the company Swiftnet and any other companies
        that may buy or merge into Swiftnet in the future, do not reach average revenues
        (over a three consecutive month period) of at least £120,000. Because the
        average sales per month exceeded £120,000 within a twelve-month period of Mr.
        Nissenson’s employment, Swiftnet cannot cancel these options.
 
 March
        28,
        2007 Employment Agreement
 
 Pursuant
        to a Company’s Board of Directors’ resolution dated December 25, 2006, on March
        28, 2007, Swiftnet and Mr. Nissenson entered into an employment agreement,
        to be
        effective as of January 1, 2007 (the “Nissenson Employment
        Agreement”).
 
 The
        Nissenson Employment Agreement provides that Mr. Nissenson shall be employed
        as
        Director of Business Development of Swiftnet. Nissenson Employment Agreement
        shall be in effect for an initial fixed term of five years, beginning on
        January
        1, 2007, (the "Initial Effective Term"), and thereafter shall automatically
        be
        renewed for additional terms of three years (each, an "Additional Effective
        Term"). Notwithstanding the foregoing, each of Swiftnet and Mr. Nissenson
        shall
        have the right to terminate the automatic renewal of Nissenson Employment
        Agreement, for any reason whatsoever, by a termination notice in writing,
        to be
        provided to the other party not less than six months prior to: (i) the
        expiration of the Initial Effective Term, or (ii) the expiration of any
        Additional Effective Term (the "Notice Period"). Notwithstanding the foregoing,
        Mr. Nissenson shall have the right to terminate the Nissenson Employment
        Agreement, for any reason whatsoever, and at any time, including during the
        Initial Effective Term ("Early Termination"). In the event of Early Termination,
        the Notice Period shall be of not less than eight months.
 
 Under
        the
        Nissenson Employment Agreement, Swiftnet shall pay to Mr. Nissenson during
        the
        term of his engagement a salary at the rate of Forty Eight Thousand British
        Pounds (£48,000) ($94,032) per annum, such salary to be paid in equal monthly
        installments in arrears on the last Friday of each month. Swiftnet shall
        provide
        Mr. Nissenson with an appropriate executive car or car allowance with an
        effective annual cost to Swiftnet of up to Fifteen Thousand British Pounds
        (£15,000) ($29,385).
 
 -82-
 Swiftnet
        shall pay Mr. Nissenson contributions to the following schemes: (i) Health
        care
        for him and his immediate family; (ii) Permanent health; (iii) Life insurance
        arrangements (up to a maximum of four times salary); (iv) Pension rights
        -
        Swiftnet shall contribute a monthly sum equal to 7.5% of his salary. (v)
        Travel
        insurance.
 
 Swiftnet
        shall reimburse to Mr. Nissenson all traveling, hotel, restaurant and other
        expenses incurred by him in the proper performance of his duties under his
        engagement.
 
 If
        during
        the period of the employment under the Nissenson Employment Agreement Mr.
        Nissenson shall cease to be a director of Swiftnet, his employment shall
        continue and the terms of the Nissenson Employment Agreement (other than
        those
        relating to the holding of office of director) shall continue in full
        force.
 
 The
        Nissenson Employment Agreement also contains special arrangements for sickness
        benefits, holiday entitlement and provisions regarding non-competition;
        intellectual property; confidentiality; conflict of interests and other standard
        terms and conditions.
 
 The
        Nissenson Employment Agreement supersedes the May 11, 2000 Employment
        Agreement.
 
 The
        Nissenson Employment Agreement was approved by all non-interested members
        of the
        Board of Directors, following a review and discussion by the Company’s Audit
        Committee.
 
 A
        copy of
        the Nissenson Employment Agreement is attached hereto as Exhibit 10.99 and
        incorporated herein by reference.
 
 **Nissenson
        Consulting Agreement**
 
 Pursuant
        to a Company’s Board of Directors’ resolution dated December 25, 2006, on March
        28, 2007, the Company and Mr. Nissenson entered into a consulting agreement,
        to
        be effective as of January 1, 2007 (the “Nissenson Consulting
        Agreement”).
 
 The
        Nissenson Consulting Agreement provides that Mr. Nissenson shall render the
        Company advisory, consulting and other services in relation to the business
        and
        operations of the Company (excluding its business and operations in the United
        Kingdom).
 
 In
        consideration of the performance of the Services pursuant to the Nissenson
        Consulting Agreement, the Company shall pay Mr. Nissenson a monthly fee of
        Ten
        Thousand British Pounds (£10,000) ($19,590) (the "Fee"). Mr. Nissenson shall
        invoice the Company at the end of each calendar month and the Company shall
        make
        the monthly payment immediately upon receiving such invoice. Once a calendar
        year, and no later than December 15, the Company’s Board shall consider
        approving an increase to the Fee. Such Board approval shall be subject to
        the
        prior review, oversight and recommendation to the Board of both the Audit
        Committee and the Compensation Committee of the Company (the "Compensation
        Committee"). However, in the event the Company has not established a
        Compensation Committee, the review, oversight and recommendation to the Board
        of
        the Audit Committee shall suffice. In connection with the performance of
        this
        provision, the Audit Committee, the Compensation Committee and the Board
        shall
        take into account, among other factors, growth in the Company’s revenues and/or
        profits.
  -83-
 The
        Company’s Board shall, from time to time, and not less than once a calendar
        year, consider approving a grant of success bonus to Mr. Nissenson (the
        "Bonus"). Such Board approval shall be subject to the prior review, oversight
        and recommendation to the Board of both the Audit Committee and the Compensation
        Committee. However, in the event the Company has not established a Compensation
        Committee, the review, oversight and recommendation to the Board of the Audit
        Committee shall suffice. In connection with the performance of this provision,
        the Audit Committee, the Compensation Committee and the Board shall take
        into
        account, among other factors, growth in the Company’s revenues and/or profits
        and/or successful completion of transactions or activities by the Company
        (such
        as, but not limited to, reorganization, mergers, acquisitions, capital raisings
        and cost cuts). Any Board member, except Mr. Nissenson, may, at any time
        and
        from time to time, initiate a Bonus grant to Mr. Nissenson, and in such an
        event
        the approving process shall be set in motion.
 
 Immediately
        upon the establishment by the Company of any new stock option or purchase
        plan
        or other equity compensation arrangement pursuant to which options or stock
        may
        be acquired by officers, directors, employees, or consultants of the Company
        (collectively, "Plan"), the Company’s Board shall consider approving a grant of
        an appropriate amount of options (or any other applicable rights) under the
        Plan
        to Mr. Nissenson. Such Board approval shall be subject to the prior review,
        oversight and recommendation to the Board of both the Audit Committee and
        the
        Compensation Committee. However, in the event the Company has not established
        a
        Compensation Committee, the review, oversight and recommendation to the Board
        of
        the Audit Committee shall suffice.
 
 In
        addition to the Fee and the Bonus, the Company shall pay directly and/or
        reimburse Mr. Nissenson for his Expenses. For the purposes of the Nissenson
        Consulting Agreement, the term "Expenses" shall mean any and all amounts
        actually paid by the Company and/or by Mr. Nissenson, and/or to be paid by
        Mr.
        Nissenson at his direction, including, without limitation (i) costs associated
        with telecommunication services and products, and (ii) costs associated with
        transportation and/or travel (including, but not limited to, by plane, train,
        rented car and taxi) and/or accommodation (including, but not limited to,
        at
        rented flats and hotels) and/or any other board and lodging expenses (including,
        but not limited to, food, restaurants and entertainment) which were and/or
        will
        be incurred in connection with the performance of the Services pursuant to
        the
        Nissenson Consulting Agreement.
 
 The
        Company acknowledges that in order to render the Services pursuant to the
        Nissenson Consulting Agreement, Mr. Nissenson may be required to travel
        frequently around the world. Therefore, in order to enable Mr. Nissenson
        a
        normal family life the Company shall bear Expenses which are related to Mr.
        Nissenson's spouse.
 
 Mr.
        Nissenson shall hold and use, in his sole discretion, credit cards in the
        name
        of the Company (the "Credit Cards"). Due to Mr. Nissenson's position with
        the
        Company (i.e. President and CEO) he may from time to time use the Credit
        Cards
        to make certain Company payments and pay certain Company expenses.
 
 This
        Nissenson Consulting Agreement shall be in effect for an initial fixed term
        of
        five years, beginning on January 1, 2007 (the "Initial Effective Term"),
        and
        thereafter, unless terminated as provided below, shall automatically be renewed
        for additional terms of three years (each, an "Additional Effective Term").
        Notwithstanding the foregoing, each of the Company and Mr. Nissenson shall
        have
        the right to terminate the automatic renewal of the Nissenson Consulting
        Agreement, for any reason whatsoever, by a termination notice in writing,
        to be
        provided to the other party not less than six months prior to: (i) the
        expiration of the Initial Effective Term, or (ii) the expiration of any
        Additional Effective Term (the "Notice Period"). Notwithstanding the foregoing,
        as long as Mr. Nissenson shall command and/or control, directly and/or
        indirectly, including together with others (as well as pursuant to that certain
        Voting Agreement dated September 28, 2004, by and among Mr. Nissenson, Abraham
        Keinan and Campbeltown Business Ltd.) and/or by proxies, fifteen percent
        (15%)
        or more of the voting rights of the Company, if the Company shall choose
        to
        exercise its right to terminate the automatic renewal of the Nissenson
        Consulting Agreement, the Notice Period shall be of not less than twelve
        months.
        Notwithstanding the foregoing, Mr. Nissenson shall have the right to terminate
        the Nissenson Consulting Agreement, for any reason whatsoever, and at any
        time,
        including during the Initial Effective Term ("Early Termination by Mr. Nissenson
        "). In the event of Early Termination by Mr. Nissenson, the Notice Period
        shall
        be of not less than eight months.
 -84-
 
 The
        Nissenson Consulting Agreement further provides that no later than June 30,
        2007, the Company and Mr. Nissenson shall enter into a severance agreement
        providing for an appropriate severance package for Mr. Nissenson (the "Severance
        Agreement"). The Severance Agreement shall, inter alia, cover events of
        termination of the automatic renewal of the Nissenson Consulting Agreement
        by
        the Company or Mr. Nissenson, termination of the Nissenson Consulting Agreement
        by Mr. Nissenson, and scheduled retirement by Mr. Nissenson.
 
 The
        Nissenson Consulting Agreement also contains provisions regarding
        non-competition; intellectual property; confidentiality; conflict of interests
        and other standard terms and conditions.
 
 The
        Nissenson Consulting Agreement was approved by all non-interested members
        of the
        Board of Directors, following a review and discussion by the Company’s Audit
        Committee.
 
 A
        copy of
        the Nissenson Consulting Agreement is attached hereto as Exhibit 10.100 and
        incorporated herein by reference.
 
 **Nissenson
        Bonus and Success Fee**
 
 On
        December 29, 2005, the Company’s Board of Directors granted a bonus to Mr.
        Nissenson for an aggregate amount of $220,000 (the "Bonus"). The Company’s Board
        of Directors with the exception of Mr. Nissenson and Mr. Keinan who abstained
        from voting, resolved and granted the Bonus to Mr. Nissenson for his exceptional
        efforts and professional abilities to achieve the Company’s goals and determined
        that it was in the best interest of the Company, moreover, the Company believes
        that the Bonus was fair and proportionate to its President and Chief Executive
        Officer’s commitment and achievements.
 
 Mr.
        Nissenson waived $22,610 of the Bonus.
 
 **Dionysos
        Investments (1999) Ltd. financial services and business development consulting
        agreement**
 
 A
        Financial Services Consulting Agreement was entered into on November 18,
        2004,
        between Dionysos Investments (1999) Ltd., an Israeli company (“Dionysos
        Investments”) and the Company with respect to certain services (the “Dionysos
        Investments Consulting Agreement”). Mr. Haim Nissenson, father of Mr. Guy
        Nissenson, our President, Chief Executive Officer, Treasurer,
        Chief Financial Officer, Principal Accounting Officer and Director ,
        is the
        Managing Director of Dionysos Investments. Dionysos Investments is owned
        and
        controlled by certain members of the Nissenson family, other than Mr. Guy
        Nissenson.
 
 Under
        the
        Dionysos Investments Consulting Agreement, Dionysos Investments agrees to
        assist
        the Company in connection with services related to financial activities,
        financial reports, mergers & acquisitions and other business development
        work (the “Services”). In the event the Company requests additional services,
        the scope of such additional services shall be as agreed by the parties and
        shall be governed by the Dionysos Investments Consulting Agreement.
 
 -85-
 The
        Dionysos Investments Consulting Agreement provided that Dionysos Investments
        will be compensated by the Company for the Services provided to the Company
        in
        the amount of Three Thousand British Sterling Pounds (£3,000) per month
        beginning on the Effective Date of the Dionysos Investments Consulting Agreement
        (the “Fees”). In addition, the Company will reimburse Dionysos Investments,
        based on prior approval, for expenses incurred, which expenses include travel,
        hotel, meals, courier, report reproduction and other administrative costs
        when
        and where needed (the “Expenses”). Compensation for any additional services
        provided by Dionysos Investment for the Company shall be as agreed by the
        parties.
 
 The
        Effective Date of the Dionysos Investments Consulting Agreement is January
        1,
        2005 (the “Effective Date”). The term of the Dionysos Investments Consulting
        Agreement is two years (the “Term”). According to the Dionysos Investments
        Consulting Agreement, the Term will be automatically renewed for successive
        two-year periods, unless either party provides written notice at least ninety
        days prior to the end of the Term that such party does not wish to renew
        the
        Dionysos Investments Consulting Agreement.
 
 On
        February 8, 2007, pursuant to the recommendations of the Audit Committee
        of the
        Company and the resolutions of its Board of Directors dated December 25,
        2006,
        and February 4, 2007, the Company and Dionysos Investments entered into a
        First
        Amendment to the of the Dionysos Investments Consulting Agreement (the “First
        Amendment”).
 
 The
        First
        Amendment provides that Section 2 of the Dionysos Investments Consulting
        Agreement shall be amended in its entirety to provide as follows:
 
 (i)
        The
        parties agree that Dionysos Investments will be compensated by the Company
        for
        the Services provided to the Company in the amount of Eight Thousand British
        Sterling Pounds (£8,000) per month, beginning on January 1, 2007; (ii) In
        addition, the Company will pay Dionysos Investments a one time success fee
        in
        the amount of Ten Thousand British Sterling Pounds (£10,000), for initiating,
        establishing and developing the relationship between the Company and certain
        Israeli financial institutions during fiscal years 2005-2006, relationships
        which resulted in significant investments made by certain Israeli financial
        institutions; (iii) In addition, the Company will pay Dionysos Investments
        a
        success fee for any future investments in the Company made by Israeli investors
        during fiscal year 2007, provided such investments were a direct or indirect
        result of the Services provided to the Company. The success fee will be equal
        to
        0.5% (half percent) of the gross proceeds of such investments; (iv) In addition,
        the Company will reimburse Dionysos Investments, based on prior approval
        by the
        Audit Committee of the Company, for expenses incurred, which expenses will
        include travel, hotel, meals, courier, report reproduction and other
        administrative costs when and where needed. Compensation for any additional
        services provided by Dionysos Investments for the Company shall be as agreed
        by
        the parties.
 
 The
        parties agreed that the abovementioned compensation will only apply to fiscal
        year 2007, and then be reviewed and reconsidered by the Audit Committee and
        Board of Directors of the Company in December 2007. In the event the Board
        of
        Directors of the Company, exercising sole discretion, decides not to approve
        the
        abovementioned compensation for fiscal year 2008, Dionysos Investments will
        have
        the option, in its sole discretion, to terminate the Dionysos Investments
        Consulting Agreement, or continue and provide the Services in return for
        the
        same compensation which was paid to it in fiscal years 2005-2006 (i.e. fee
        of
£3,000 per month plus reimbursement of expenses)."
 
 The
        First
        Amendment further declares that the Audit Committee and Board of Directors
        of
        the Company approved the automatic renewal of the Term for an additional
        two-year period, ending on December 31, 2008.
 
 -86-
 VOTING
        AGREEMENT
 
 Our
        Chairman of the Board, Abraham Keinan, and our President, Chief Executive
        Officer, Treasurer,
        Chief Financial Officer , Principal Accounting Officer and
        Director, Guy Nissenson, exercise significant control over stockholder matters
        through a September 28, 2004 Voting Agreement between Mr. Keinan, Mr. Nissenson
        and Campbeltown Business Ltd, an entity owned and controlled by Mr. Nissenson
        and his family. This agreement, which is for a term of 10 years, provides
        that:
        (a) Messrs. Keinan and Nissenson and Campbeltown Business, Ltd. agree to
        vote
        any shares of our common stock controlled by them only in such manner as
        previously agreed by all these parties; and (b) in the event of any disagreement
        regarding the manner of voting, a party to the agreement will not vote any
        shares, unless all the parties have settled the disagreement.
 
 Section
        801 of the AMEX Company Guide provides that a listed company in which over
        50%
        of the voting power is held by an individual, a group or another company
        (a
        "Controlled Company") is not required to comply with Sections 802(a), 804
        or 805
        of the AMEX Company Guide, and that a Controlled Company that chooses to
        take
        advantage of any or all of these exceptions must disclose that it is a
        Controlled Company and the basis for that determination. In light of the
        abovementioned September 28, 2004 Voting Agreement the Company should be
        considered as a Controlled Company.
 
 IDDO
        KEINAN
 
 Mr.
        Iddo
        Keinan, son of Mr. Abraham Keinan, our Chairman of the Board, has been employed
        by our wholly-owned UK based subsidiary, Swiftnet limited since 1998. In
        2005
        and 2006 Mr. Iddo Keinan served as the Commercial Director of Swiftnet, and
        his
        annual salary was £29,989 ($58,748), and £54,459 ($106,692),
        respectively.
 
 On
        December 25, 2006, our Board of Directors approved the continuing employment
        of
        Mr. Iddo Keinan by Swiftnet Limited, at an annual salary of £36,000
        ($70,524).
 
 WADE
        SPOONER
 
 In
        connection with the acquisition of WS Telecom, Inc. we issued a promissory
        note
        to Wade Spooner, who was President, Chief Executive Officer and shareholder
        of
        WS Telecom; the promissory note replaced a $200,000 note issued by WS Telecom
        in
        favor of Mr. Spooner. This note was amended to provide for quarterly payment
        beginning in October 2004, provided that such payment shall not exceed 50%
        of
        the net profits of Xfone USA, Inc. Mr. Spooner is the President and Chief
        Executive Officer of our wholly owned subsidiary, Xfone USA, Inc. Final payment
        on the note was made to Mr. Spooner February 14, 2007.
 
 -87-
 ITEM 13. EXHIBITS
 
 **(a)**
              **Exhibits
                  and Index of Exhibits**
 
 Exhibit
        Number / Description
 2.
              Agreement
                  and plan of reorganization dated September 20, 2000, between the
                  Company
                  and Swiftnet Limited. (1)3.1
              Articles
                  of Incorporation of the Company. (1)3.2a
              Bylaws
                  of the Company. (1)3.2b
              Amended
                  Bylaws of the Company. (4)3.3
              Memorandum
                  of Association of Swiftnet Limited. (1)3.4
              Articles
                  of Association of Swiftnet Limited. (1)3.6
              Bylaws
                  of Xfone USA, Inc. (7)3.8.
              Amended
                  and Restated Bylaws of the Company dated March 12, 2006.
                  (22)3.9
              Reamended
                  and Restated Bylaws of the Company dated February 5, 2007.
                  (32)4.
              Specimen
                  Stock Certificate. (1)5.
              Opinion
                  of Gersten Savage LLP. (30) (21.1)10.1
              Agreement
                  dated May 11, 2000, between Swiftnet Limited and Guy Nissenson.
                  (1)10.2
              Employment
                  Agreement dated January 1, 2000 with Bosmat Houston.
                  (1)10.3
              Loan
                  Agreement dated August 5, 2000, with Swiftnet Limited, Guy Nissenson,
                  and
                  Nissim Levy (1)10.4
              Promissory
                  Note dated September 29, 2000, between the Company and Abraham
                  Keinan.
                  (1)10.5
              Stock
                  Purchase Agreement dated June 19, 2000, between Swiftnet Limited,
                  Abraham
                  Keinan, and Campbeltown Business Ltd. (1)10.6
              Consulting
                  Agreement dated May 11, 2000 between Swiftnet Limited and Campbeltown
                  Business Ltd. (1)10.7
              Agreement
                  dated July 30, 2001, with Campbeltown Business Ltd. (1)10.8
              Contract
                  dated June 20, 1998, with WorldCom International Ltd.
                  (1)10.9
              Contract
                  dated April 11, 2000, with VoiceNet Inc. (1)10.10
              Contract
                  dated April 25, 2000, with InTouchUK.com Ltd. (1)10.11
              Letter
                  of Understanding dated July 30, 2001, from Campbeltown Business
                  Ltd. to
                  the Company (2)10.12
              Agreement
                  dated April 6, 2000, between Adar International, Inc./Mr. Sidney
                  J. Golub
                  and Swiftnet Limited. (2)10.13
              Lease
                  Agreement dated December 4, 1991, between Elmtree Investments Ltd.
                  and
                  Swiftnet Limited. (2)10.14
              Lease
                  Agreement dated October 8, 2001, between Postwick Property Holdings
                  Limited and Swiftnet Limited.(2)10.15
              Agreement
                  dated September 30, 2002, between the Company, Swiftnet Limited.,
                  and Nir
                  Davison. (5)10.16
              As
                  to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy,
                  Warrant
                  A, Warrant B and Registration Rights Agreement of Selling Shareholders
                  Platinum Partners Value Arbitrage Fund LP, Countrywide Partners
                  LLC and
                  WEC Partners LLC. (6)
  -88-
 10.17
              As
                  to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy,
                  Warrant
                  A, Warrant B and Registration Rights Agreement of Selling Shareholders
                  Simon Langbart, Robert Langbart, Arik Ecker, Zwi Ecker, Michael
                  Derman,
                  Errol Derman,Yuval Haim Sobel, Zvi Sobel, Tenram Investment Ltd.,
                  Michael
                  Zinn, Michael Weiss. (6)10.18
              As
                  to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy,
                  Warrant
                  A, Warrant B and Registration Rights Agreement of Selling Shareholders
                  Southridge Partners LP and Southshore Capital Fund Ltd.
                  (6)10.19
              As
                  to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy,
                  Warrant
                  A, Warrant B and Registration Rights Agreement of Selling Shareholders
                  Crestview Capital Master LLC. (6)10.20
              As
                  to Form: Shares and Warrant Purchase Agreement, Irrevocable Proxy,
                  Warrant
                  A, Warrant B and Registration Rights Agreement of Selling Shareholders
                  Adam Breslawsky, Oded Levy, Michael Epstein, Steven Frank, Joshua
                  Lobel,
                  Joshua Kazan and The Oberon Group LLC. (6)10.21
              Newco
                  (Auracall Limited) Formation Agreement. (6)10.22
              Agreement
                  with ITXC Corporation. (6)10.23
              Agreement
                  with Teleglobe International. (6)10.23.1
              Amendment
                  to Agreement with Teleglobe International. (6)10.24
              Agreement
                  with British Telecommunications. (6)10.25
              Agreement
                  with Easyair Limited (OpenAir). (6)10.26
              Agreement
                  with Worldnet. (6)10.27
              Agreement
                  with Portfolio PR. (6)10.28
              Agreement
                  with Stern and Company. (6)10.29
              Letter
                  to the Company dated December 31, 2003, from Abraham Keinan.
                  (6)10.30
              Agreement
                  between Swiftnet Limited and Dan Kirschner. (8)10.31
              Agreement
                  and Plan of Merger. (7)10.32
              Escrow
                  Agreement. (7)10.33
              Release
                  Agreement. (7)10.34
              Employment
                  Agreement date March 10, 2005, between Xfone USA, Inc. and Wade
                  Spooner.
                  (7)10.35
              Employment
                  Agreement date March 10, 2005, between Xfone USA, Inc. and Ted
                  Parsons.
                  (7)10.36
              First
                  Amendment to Agreement and Plan of Merger (to acquire WS Telecom,
                  Inc.)
                  (11)10.37
              Finders
                  Agreement with The Oberon Group, LLC. (11)10.38
              Agreement
                  with The Oberon Group, LLC. (11)10.39
              Management
                  Agreement between WS Telecom, Inc. and Xfone USA, Inc.
                  (8)10.40
              Engagement
                  Letter to Tommy R. Ferguson, Confidentiality Agreement, and Executive
                  Inventions Agreement dated August 19, 2004 (11)10.41
              Voting
                  Agreement dated September 28, 2004. (11)10.42
              Novation
                  Agreement executed September 27, 2004. (11)10.43
              Novation
                  Agreement executed September 28, 2004. (11)10.44
              Investment
                  Agreement dated August 26, 2004, with Ilan Shoshani.
                  (12)10.44.1
              Addendum
                  and Clarification to the Investment Agreement with Ilan Shoshani
                  dated
                  September 13, 2004. (12)
  -89-
 10.45
              Agreement
                  dated November 16, 2004, with Elite Financial Communications
                  Group. (13)10.46
              Financial
                  Services and Business Development Consulting Agreement dated November
                  18,
                  2004, with Dionysos Investments (1999) Ltd. (13)10.47
              Agreement
                  and Plan of Merger to acquire I-55 Internet Services, Inc. dated
                  August
                  18, 2005. (14)10.48
              Agreement
                  and Plan of Merger to acquire I-55 Telecommunications, LLC dated
                  August
                  26, 2005 (15)10.49
              Securities
                  Purchase Agreement, dated September 27, 2005, by and between the
                  Company
                  and Laurus Master Fund, Ltd. (16)10.50
              Secured
                  Convertible Term Note, dated September 27, 2005, by the Company
                  in favor
                  of Laurus Master Fund, Ltd.; Adjustment Provision Waiver Agreement,
                  dated
                  September 27, 2005, by and between the Company and Laurus Fund,
                  Ltd. (16)10.51
              Common
                  Stock Purchase Warrant, dated September 27, 2005, by the Company
                  in favor
                  of Laurus Master Fund, Ltd. (16)10.52
              Registration
                  Rights Agreement, dated September 27, 2005, by and between the
                  Company and
                  Laurus Master Fund, Ltd. (16)10.53
              Master
                  Security Agreement, dated September 27, 2005, by and between the
                  Company,
                  Xfone USA, Inc., eXpeTel Communications, Inc., Gulf Coast Utilities,
                  Inc.,
                  and Laurus Master Fund, Ltd. (16)10.54
              Stock
                  Pledge Agreement, dated September 27, 2005, by and between the
                  Company,
                  Xfone USA, Inc., and Laurus Master Fund, Ltd. (16)10.55
              Subsidiary
                  Guarantee dated September 27, 2005, by Xfone USA, Inc., eXpeTel
                  Communications, Inc. and Gulf Coast Utilities, Inc. in favor of
                  Laurus
                  Master Fund, Ltd. (16)10.56
              Funds
                  Escrow Agreement, dated September 27, 2005, by and between the
                  Company,
                  Laurus Master Fund, Ltd. and Loeb & Loeb LLP; Disbursement Letter,
                  dated September 27, 2005 (16)10.57
              Incremental
                  Funding Side Letter, dated September 27, 2005, by and between the
                  Company
                  and Laurus Master Fund, Ltd. (16)10.58
              Securities
                  Purchase Agreement, dated September 28, 2005, by and between the
                  Company
                  and Crestview Capital Mater, LLC, Burlingame Equity Investors,
                  LP,
                  Burlingame Equity Investors II, LP, Burlingame Equity Investors
                  (Offshore), Ltd., and Mercantile Discount - Provident Funds.
                  (16)10.59
              Registration
                  Rights Agreement, dated September 28, 2005, by and between the
                  Company and
                  Crestview Capital Mater, LLC, Burlingame Equity Investors, LP,
                  Burlingame
                  Equity Investors II, LP, Burlingame Equity Investors (Offshore),
                  Ltd., and
                  Mercantile Discount - Provident Funds. (16)10.60
              Common
                  Stock Purchase Warrant, dated September 28, 2005, by the Company
                  in favor
                  of the Crestview Capital Mater, LLC, Burlingame Equity Investors,
                  LP,
                  Burlingame Equity Investors II, LP, Burlingame Equity Investors
                  (Offshore), Ltd., and Mercantile Discount - Provident
                  Funds.(16)10.61
              Escrow
                  Agreement, dated September 28, 2005, by and between the Company,
                  the
                  Purchasers and Feldman Weinstein LLP (16)10.62
              Management
                  Agreement dated October 11, 2005. (17)10.63
              First
                  Amendment to Agreement and Plan of Merger (to acquire I-55 Internet
                  Services, Inc.), dated October 10, 2005. (17)10.64
              Letter
                  Agreement with MCG Capital Corporation dated October 10, 2005.
                  (17)10.65
              Securities
                  Purchase Agreement, dated November 23, 2005, between the Company
                  and
                  Mercantile Discount - Provident Funds, Hadar Insurance Company
                  Ltd., The
                  Isreali Phoenix Assurance Company Ltd. and Gaon Gemel Ltd.
                  (18)10.66
              Registration
                  Rights Agreement, dated November 23, 2005, between the Company
                  and
                  Mercantile Discount - Provident Funds, Hadar Insurance Company
                  Ltd., The
                  Isreali Phoenix Assurance Company Ltd. and Gaon Gemel Ltd. 
                  (18)10.67
              Common
                  Stock Purchase Warrant, dated November 23, 2005, by the Company
                  in favor
                  of Mercantile Discount - Provident Funds, Hadar Insurance Company
                  Ltd.,
                  The Isreali Phoenix Assurance Company Ltd. and Gaon Gemel Ltd.
                  (18)
  -90-
 10.68
              Escrow
                  Agreement, dated November 23, 2005, between the Company, the Escrow
                  Agent,
                  and Mercantile Discount - Provident Funds, Hadar Insurance Company
                  Ltd.,
                  The Isreali Phoenix Assurance Company Ltd. and Gaon Gemel Ltd.
                  (18)10.69
              Management
                  Agreement with I-55 Telecommunications, LLC dated October 12, 2005.
                  (19)10.70
              Agreement
                  - General Terms and Conditions with EBI Comm, Inc., dated January
                  1, 2006.
                  (21)10.71
              Asset
                  Purchase Agreement with Canufly.net, Inc., dated January 10, 2006.
                  (21)10.72
              Stock
                  Purchase Agreement dated May 10, 2006, by and among the Company,
                  Story
                  Telecom, Inc., Story Telecom Limited, Story Telecom (Ireland) Limited,
                  Nir
                  Davison, and Trecastle Holdings Limited. (23)10.73
              Agreement
                  dated May 25, 2006, by and among the Company and the shareholders
                  of
                  Equitalk.co.uk Limited. (24)10.74
              Securities
                  Purchase Agreement, dated June 19, 2006, by and between the Company
                  and
                  the Purchasers. (25)10.75
              Registration
                  Rights Agreement, dated June 19, 2006, by and between the Company
                  and the
                  Purchasers. (25)10.76
              Common
                  Stock Purchase Warrant, dated June 19, 2006, by the Company in
                  favor of
                  the Purchasers. (25)10.77
              Escrow
                  Agreement, dated June 19, 2006, by and between the Company, the
                  Escrow
                  Agent, and the Purchasers. (25)10.78
              Form
                  of Indemnification Agreement between the Company and its Directors
                  and
                  Officers. (27)10.79
              Agreement
                  to Purchase Promissory Note dated October 31, 2005, with Randall
                  Wade
                  James Tricou. (27)10.80
              Agreement
                  to Purchase Promissory Note dated October 31, 2005, with Rene Tricou
                  -
                  Tricou Construction. (27)10.81
              Agreement
                  to Purchase Promissory Note dated October 31, 2005, with Rene Tricou
                  - Bon
                  Aire Estates. (27)10.82
              Agreement
                  to Purchase Promissory Note dated October 31, 2005, with Rene Tricou
                  - Bon
                  Aire Utility. (27)10.83
              Agreement
                  to Purchase Promissory Note dated February 3, 2006, with Danny
                  Acosta.
                  (27)10.84
              Letter
                  Agreement dated November 15, 2005, with Oberon Securities, LLC.
                  (27)10.85
              Letter
                  Agreement dated June 15, 2006, with Oberon Securities, LLC.
                  (27)10.86
              Second
                  Amendment to Agreement and Plan of Merger (to acquire WS Telecom,
                  Inc.),
                  dated June 28, 2006. (27)10.87
              General
                  Contract for Services dated January 1, 2005, by and between the
                  Company
                  and Swiftnet Limited. (27)10.88
              Service
                  Agreement dated December 6, 2005, by and between the Company and
                  Elite
                  Financial Communications Group, LLC. (27)10.89
              Agreement
                  for Market Making in Securities dated July 31, 2006, by and between
                  the
                  Company and Excellence Nessuah Stock Exchange Services Ltd.
                  (27)10.90
              Shareholders
                  Loan Agreement, dated September 27, 2006, by and between Auracall
                  Limited,
                  Swiftnet Limited, and Dan Kirschner. (28)10.91
              Service
                  Agreement, dated November 7, 2006, by and between the Company and
                  Institutional Marketing Services, Inc. (28)10.92
              Consultancy
                  Agreement, dated November 20, 2006, by and between the Company
                  and
                  Crestview Capital Partners, LLP. (29)10.93
              Agreement
                  dated December 24, 2006, by and between the Company, Halman-Aldubi
                  Provident Funds Ltd., and Halman-Aldubi Pension Funds Ltd. [translation
                  from Hebrew] (31)10.94
              First
                  Amendment to Financial Services and Business Development Consulting
                  Agreement dated February 8, 2007, by and between the Company and
                  Dionysos
                  Investments (1999) Ltd. (33)10.95
              Agreement
                  dated February 8, 2007, by and between the Company, Swiftnet Limited,
                  Campbeltown Business, Ltd., and Mr. Abraham Keinan.
                  (33)10.96
              First
                  amendment to General Contract for Services, dated
                  March 14, 2007, by and between the Company and Swiftnet Limited.10.97
              Employment
                  Agreement, dated March 28, 2007, between
                  Swiftnet Limited and Abraham Keinan.
  -91-
 10.98
              Consulting
                  Agreement, dated March 28, 2007, between the
                  Company and Abraham Keinan.10.99
              Employment
                  Agreement, dated March 28, 2007, between
                  Swiftnet Limited and Guy Nissenson.10.100
              Consulting
                  Agreement, dated March 28, 2007, between the
                  Company and Guy Nissenson.16.1
              Letter
                  dated January 31, 2006 from Chaifetz & Schreiber, P.C to the
                  Securities and Exchange Commission (20)21.1
              List
                  of Subsidiaries (Amended) (26)23
              Consent
                  of Stark, Winter, Scheinkein & Co.,
                  LLP23.1
              Consent
                  of Chaifetz & Schreiber, P.C. (30) (22.1)23.2
              Consent
                  of Gersten Savage LLP - incorporated in the legal opinion filed
                  as Exhibit
                  5.23.3
              Consent
                  of Postlethwaite & Netterville, APAC dated February 7, 2006.
                  (21.1)23.4
              Consent
                  of Postlethwaite & Netterville, APAC dated February 7, 2006.
                  (21.1)31
              Certification
                  pursuant to section 302 of the Sarbanes -
                  Oxley Act of 2002.32
              Certification
                  of Officer pursuant to section 906 of the
                  Sarbanes - Oxley Act of 2002.(1)
              Denotes
                  previously filed exhibits: filed on August 10, 2001 with Xfone,
                  Inc.'s
                  SB-2 registration statement.(2)
              Denotes
                  previously filed exhibits: filed on October 16, 2001 with Xfone,
                  Inc.'s
                  SB-2/Amendment 1 registration statement.(4)
              Denotes
                  previously filed exhibit: filed on December 5, 2002 with Xfone,
                  Inc.'s
                  Form 8-K.(5)
              Denotes
                  previously filed exhibit: filed on March 3, 2003 with Xfone, Inc.'s
                  SB-2/Post Effective Amendment 2 registration statement.(6)
              Denotes
                  previously filed exhibit: filed on April 15, 2004 with Xfone's,
                  Inc.SB-2
                  Amendment 1 Registration Statement.(7)
              Denotes
                  previously filed exhibit: filed on June 1, 2004 with Xfone, Inc.'s
                  Form
                  8-K.(8)
              Denotes
                  previously filed exhibit: filed on June 7, 2004 with Xfone, Inc.'s
                  SB-2/Amendment 2 Registration Statement.(9)
              Denotes
                  previously filed exhibit: filed on August 11, 2004 with Xfone's,
                  Inc. SB-2
                  Amendment 3 Registration Statement.(10)
              Denotes
                  previously filed exhibit: filed on September 13, 2004 with Xfone's,
                  Inc.SB-2 Amendment 4 Registration Statement.(11)
              Denotes
                  previously filed exhibits: filed on October 4, 2004 with Xfone,
                  Inc.‘s
                  Form 8-K(12)
              Denotes
                  previously filed exhibits: filed on November 29, 2004 with Xfone,
                  Inc.‘s
                  Form 8-K.(13)
              Denotes
                  previously filed exhibits; filed on March 31, 2005 with Xfone,
                  Inc.’s Form
                  10-KSB.(14)
              Denotes
                  previously filed exhibit: filed on August 22, 2005 with Xfone,
                  Inc.‘s Form
                  8-K.(15)
              Denotes
                  previously filed exhibit: filed on August 31, 2005 with Xfone,
                  Inc.‘s Form
                  8-K.(16)
              Denotes
                  previously filed exhibits: filed on October 3, 2005 with Xfone,
                  Inc.‘s
                  Form 8-K.(17)
              Denotes
                  previously filed exhibits: filed on October 11, 2005 with Xfone,
                  Inc.‘s
                  Form 8-K/A #1.(18)
              Denotes
                  previously filed exhibits: filed on November 29, 2005 with Xfone,
                  Inc.‘s
                  Form 8-K.(19)
              Denotes
                  previously filed exhibit: filed on January 23, 2006 with Xfone,
                  Inc.‘s
                  Form 8-K/A #3.
  -92-
 (20)
              Denotes
                  previously filed exhibit: filed on January 31, 2006 with Xfone,
                  Inc.‘s
                  Form 8-K/A #1.(21)
              Denotes
                  previously filed exhibit: filed on January 31, 2006 with Xfone,
                  Inc.‘s
                  Form 8-K.(21.1)
              Denotes
                  previously filed exhibits: filed on February 7, 2006 with Xfone,
                  Inc.‘s
                  Form SB-2 Amendment 3.(22)
              Denotes
                  previously filed exhibit: filed on March 15, 2006 with Xfone, Inc.‘s Form
                  8-K.(22.1)
              Denotes
                  previously filed exhibit: filed on March 31, 2006 with Xfone, Inc.‘s Form
                  10-KSB.(23)
              Denotes
                  previously filed exhibit: filed on May 16, 2006 with Xfone, Inc.‘s Form
                  8-K.(24)
              Denotes
                  previously filed exhibit: filed on May 30, 2006 with Xfone, Inc.‘s Form
                  8-K.(25)
              Denotes
                  previously filed exhibits: filed on June 20, 2006 with Xfone, Inc.‘s Form
                  8-K.(26)
              Denotes
                  previously filed exhibits: filed on July 5, 2006 with Xfone, Inc.‘s Form
                  8-K.(27)
              Denotes
                  previously filed exhibits: filed on July 31, 2006 with Xfone, Inc.‘s Form
                  8-K.(28)
              Denotes
                  previously filed exhibits: filed on November 14, 2006 with Xfone,
                  Inc.‘s
                  Form 10-QSB.(29)
              Denotes
                  previously filed exhibit: filed on November 22, 2006 with Xfone,
                  Inc.‘s
                  Form 8-K.(30)
              Denotes
                  previously filed exhibits: filed on November 30, 2006 with Xfone,
                  Inc.‘s
                  Form SB-2.(31)
              Denotes
                  previously filed exhibit: filed on December 28, 2006 with Xfone,
                  Inc.‘s
                  Form 8-K.(32)
              Denotes
                  previously filed exhibit: filed on February 5, 2007 with Xfone,
                  Inc.‘s
                  Form 8-K.(33)
              Denotes
                  previously filed exhibits: filed on February 8, 2007 with Xfone,
                  Inc.‘s
                  Form 8-K.
 
 ITEM
        14. P RICINPAL
        ACCOUNTANT FEES AND SERVICES
  Our
        Audit Committee pre-approved all audit and non-audit services provided to
        us and
        during the periods listed below. The Audit Committee approves discrete projects
        on a case-by-case basis that may have a material effect on our operations
        and
        also considers whether proposed services are compatible with the independence
        of
        the public accountants.
  **2006**
  **Audit
        Fees**
  The
        aggregate fees billed for the fiscal year ended December 31, 2006, for
        professional services rendered by the principal accountant for the audit
        of our
        annual financial statements and review of the financial statements included
        in
        our Form 10-KSB or services that are normally provided by the accountant
        in
        connection with statutory and regulatory filings or engagements for these
        fiscal
        periods were estimated as follows: we paid our accountant, Stark Winter
        Schenkein & Co., LLP $72,000.
  -93-
 **Audit-Related
        Fees**
  None
  **Tax
        Fees**
 
 None
  **All
        Other Fees**
  None
 
 **2005**
  **Audit
        Fees**
  The
        aggregate fees billed for the fiscal year ended December 31, 2005, for
        professional services rendered by the principal accountant for the audit
        of our
        annual financial statements and review of the financial statements included
        in
        our Form 10-KSB or services that are normally provided by the accountant
        in
        connection with statutory and regulatory filings or engagements for these
        fiscal
        periods were estimated as follows: we paid our accountant, Stark Winter
        Schenkein & Co., LLP $60,000.
  **Audit-Related
        Fees**
  None
  **Tax
        Fees**
  None
  **All
        Other Fees**
  None
 -94-
 **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.
 
 XFONE,
                  INC.Date: March
                  30, 2007
              By:
              /s/ Guy
                  NissensonGuy
                  Nissenson
                President,
                  Chief Executive Officer,
                Treasurer,
                  Chief Financial Officer,
                Principal
                  Accounting Officer and Director
 
  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**
              **Title**
              **Date**/s/
                  Abraham Keinan
              Chairman
                  of the Board
              March
                  30, 2007Abraham
                  Keinan/s/Guy
                  Nissenson
              President,
                  Chief Executive Officer, Treasurer, Chief Financial Officer, Principal
                  Accounting Officer and Director
              March
                  30, 2007Guy
                  Nissenson/s/
                  Israel Singer
              Director
              March
                  30, 2007Israel
                  Singer/s/Eyal
                  J. Harish
              Director
              March
                  30, 2007Eyal
                  J. Harish/s/
                  Itzhak Almog
              Director,
                Chairman
                  of the Audit Committee
              March
                  30, 2007Itzhak
                  Almog


-95-