Table of Contents




UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





Form
10-K




(Mark
One)


x
            ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
fiscal year ended December 31, 2008


OR


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


For the
transition period from_______to_______





Commission
file number 001-33449





TOWERSTREAM
CORPORATION


(Exact
name of registrant as specified in its charter)




Delaware
              (State
      or other jurisdiction of incorporation or organization)
            
            20-8259086
              (I.R.S.
      Employer Identification No.)55
      Hammarlund Way
              Middletown,
      Rhode Island
              (Address
      of principal executive offices)
            
            02842
              (Zip
      Code)





Registrant’s
telephone number, including area code (401) 848-5848





Securities
registered pursuant to Section 12(b) of the Act:


Title of each class
              
              Name of each exchange on which
      registeredCommon
      Stock, par value $0.001 per share
              
              The
      NASDAQ Capital Market





Securities
registered pursuant to Section 12(g) of the Act: None





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act. Yes oNo x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Act. Yes oNo x





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days. Yes xNo
o





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not
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-K
or any amendment to this Form 10-K. o





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Exchange Act.





Large accelerated filer o
                
                Accelerated filer  oNon-accelerated filer  o
                (Do not check if a smaller reporting company)
                Smaller reporting company  x





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Act). Yes oNo x





The
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common stock was
last sold as of the last business day of the registrant’s most recently
completed second fiscal quarter was $33,531,615.





As of
March 13, 2009, there were 34,587,854 shares of Common Stock, par value $0.001
per share, outstanding.





DOCUMENTS INCORPORATED BY
REFERENCE




Portions
of the definitive Proxy Statement for our 2009 Annual Meeting of Stockholders to
be filed with the SEC within 120 days after the close of the fiscal year ended
December 31, 2008 are incorporated by reference into Part III of this
Report.


Table of Contents


TOWERSTREAM
CORPORATION AND SUBISIDIARIES





Table of Contents




PagePART
      IItem 1.
                                                            
                                                            Business.
                                                            1Item 1A.
                                                            
                                                            Risk Factors.
                                                            6Item 1B.
                                                            
                                                            Unresolved Staff Comments.
                                                            16Item 2.
                                                            
                                                            Properties.
                                                            16Item 3.
                                                            
                                                            Legal Proceedings.
                                                            16Item 4.
                                                            
                                                            Submission of Matters to a Vote of Security
      Holders.
                                                            16PART
      IIItem 5.
                                                            
                                                            Market for Registrant’s Common Equity, Related Stockholder
      Matters and Issuer Purchases of Equity Securities.
                                                            17Item 6.
                                                            
                                                            Selected Financial Data.
                                                            18Item 7.
                                                            
                                                            Management’s Discussion and Analysis of Financial Condition
      and Results of Operations.
                                                            18Item 7A.
                                                            
                                                            Quantitative and Qualitative Disclosures About Market
      Risk.
                                                            23Item 8.
                                                            
                                                            Financial Statements and Supplementary
    Data.
                                                            24Item 9.
                                                            
                                                            Changes in and Disagreements With Accountants on Accounting
      and Financial Disclosure.
                                                            46Item 9A(T).
                                                            
                                                            Controls and Procedures.
                                                            46Item 9B.
                                                            
                                                            Other Information.
                                                            47PART
      IIIItem 10.
                                                            
                                                            Directors, Executive Officers and Corporate
      Governance.
                                                            48Item 11.
                                                            
                                                            Executive Compensation.
                                                            48Item 12.
                                                            
                                                            Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters.
                                                            48Item 13.
                                                            
                                                            Certain Relationships and Related Transactions, and
      Director Independence.
                                                            48Item 14.
                                                            
                                                            Principal Accountant Fees and Services.
                                                            48PART
      IVItem 15.
                                                            
                                                            Exhibits and Financial Statement
    Schedules.
                                                            49


Table of Contents
 
 PART
I





Forward-Looking
Statements




Forward-looking
statements in this report, including without limitation, statements related to
Towerstream Corporation’s plans, strategies, objectives, expectations,
intentions and adequacy of resources, are made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Investors
are cautioned that such forward-looking statements involve risks and
uncertainties including without limitation the following: (i) Towerstream
Corporation’s plans, strategies, objectives, expectations and intentions are
subject to change at any time at the discretion of Towerstream Corporation; (ii)
Towerstream Corporation’s plans and results of operations will be affected by
Towerstream Corporation’s ability to manage growth; and (iii) other risks and
uncertainties indicated from time to time in Towerstream Corporation’s filings
with the Securities and Exchange Commission.




In some
cases, you can identify forward-looking statements by terminology such as
‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘could,’’ ‘‘expects,’’ ‘‘plans,’’ ‘‘intends,’’
‘‘anticipates,’’ ‘‘believes,’’ ‘‘estimates,’’ ‘‘predicts,’’ ‘‘potential,’’ or
‘‘continue’’ or the negative of such terms or other comparable terminology.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements. Moreover, neither we nor any other person
assumes responsibility for the accuracy and completeness of such statements.
Readers are cautioned not to place undue reliance on these forward-looking
statements, which speak only as of the date hereof. We are under no duty to
update any of the forward-looking statements after the date of this
report.





Factors
that might affect our forward-looking statements include, among other
things:





●
            overall
      economic and business conditions;





●
            the
      demand for our goods and services;





●
            competitive
      factors in the industries in which we
compete;





●
            changes in tax requirements
      (including tax rate changes, new tax laws and revised tax law
      interpretations);





●
            the outcome of litigation and
      governmental proceedings;





●
            interest rate fluctuations and
      other changes in borrowing
costs;





●
            other capital market conditions,
      including availability of funding
  sources;





●
            potential
      further impairment of our indefinite-lived intangible assets and/or our
      long-lived assets; and





●
            changes
      in government regulations related to the broadband and Internet protocol
      industries.





Item 1. Business.





Towerstream
Corporation (“Towerstream”, “we”, “us”, “our” or the “Company”) provides fixed
wireless broadband services to commercial customers based on a monthly
recurring revenue model. We provide customers high speed Internet access over a
fixed wireless network transmitting over both regulated and unregulated radio
spectrum.  Our service supports bandwidth on demand, wireless
redundancy, virtual private networks (“VPNs”), disaster recovery, bundled data
and video services. We provide service to approximately 1,400business customers in
New York City, Boston, Chicago, Los Angeles, San Francisco, Seattle, Miami,
Dallas-Fort Worth, Providence and Newport, Rhode Island.





We tailor
our service offerings to satisfy customer needs based principally upon size. We
offer customers bandwidth connections ranging from 0.5 megabits per second up to
1 gigabit per second. As companies grow, they can increase their bandwidth at
any time in a variety of bits per second increments, usually without additional
installation or equipment charges. Furthermore, regardless of business size and
connection package, we guarantee uptime, latency and throughput by offering
customers technical credits against their bill for periods of down
time.


Table of Contents





The
Company maintains a website at http://www.towerstream.com. 
Information contained on the Company’s website is not incorporated into this
annual report on Form 10-K.  Annual reports on Form 10-K,
quarterly reports on Form 10-Q, current reports on Form 8-K, and all
amendments to those reports are available free of charge through the Securities
and Exchange Commission (“SEC”) Web site at http://idea.sec.gov as soon
as reasonably practicable after those reports are electronically filed with or
furnished to the SEC.





Our
Networks





We
establish proprietary wireless networks in each of the markets we serve by
installing antennae on towers, building rooftops or other structures to send and
receive wireless signals. We connect the customer to our Wireless Ring in the
Sky, which has no single point of failure. This ring is fed by multiple lead
Internet providers located at opposite ends of our service cities. We believe
that we are the only wireless broadband provider that offers true separate
egress for true redundancy. For new markets we enter, after installing our
wireless base stations and establishing our wireless ring, we generally can
activate new customers within two to seven business days of receiving an order.
Our coverage area can be accessed by customers within approximately 10 miles of
our installed base stations, depending upon location and line of sight
access.




Market
Coverage





We intend
to grow our business by deploying our service more broadly and seeking to
rapidly increase our customer base. We intend to deploy our wireless broadband
network broadly both in terms of geography and categories of commercial and
business customers. We intend to increase the number of geographic markets we
serve, taking advantage of a staged roll-out model to deploy our services
throughout major additional United States markets. We also plan to service a
wide range of commercial customers, from small businesses to large
enterprises.




We
determine which geographic markets to enter by assessing a number of criteria in
four broad categories. First, we evaluate our ability to deploy our service in a
given market, taking into consideration our spectrum position, the availability
of towers and zoning constraints. Second, we assess the market by evaluating the
number of competitors, existing price points, demographic characteristics and
distribution channels. Third, we evaluate the economic potential of the market,
focusing on our forecasts of revenue growth opportunities and capital
requirements. Finally, we look at market clustering opportunities and other cost
efficiencies that
might be realized. Based on this approach, as of December 31, 2008, we
offered wireless broadband connectivity in nine markets covering over 50% of
small and medium business (5 to 249 employees) in the top 20 metropolitan
statistical areas.





We
believe there are significant market opportunities beyond the nine markets in
which we are currently offering our services.  Our long term plan is to
expand nationally into other top metropolitan markets in the United
States.  However, given the difficult economic environment existing at the
end of 2008, we have determined that for the foreseeable future, we intend to
focus our resources on strengthening our market coverage in our existing markets
rather than expanding into new markets.  We believe there are significant
opportunities in our existing markets.  We plan to continue to monitor
the broader economic environment, and based on future changes, as well as our
future operating performance, will determine the appropriate time to enter new
markets.





Sales
and Marketing





We hire
salespeople to sell our services directly to business customers. As of December
31, 2008, we employed 97 direct salespeople. We generally compensate these
employees on a salary plus commission basis.





Our
indirect sales channels include a variety of authorized representatives, such as
integrators, resellers, and online operators. Authorized representatives assist
in developing awareness of and demand for our service by promoting our services
and brand as part of their own advertising and direct marketing
campaigns.





Competition





The
market for broadband services is highly competitive, and includes companies that
offer a variety of services using a number of distinctly different technological
platforms, such as cable networks, digital subscriber lines (“DSL”),
third-generation cellular, satellite, wireless Internet service and other
emerging technologies. We compete with these companies on the basis of the
portability, ease of use, speed and price of our respective services.
Competitors to our wireless broadband services include:


2
 Table of Contents




Incumbent
Local Exchange Carriers and Common Local Exchange Carriers





We face
competition from traditional wireline operators in terms of price, performance,
discounted rates for bundles of services, breadth of service, reliability,
network security, and ease of access and use. In particular, we face competition
from traditional wireline companies like Verizon Communications Inc., Qwest
Corporation and AT&T Inc., all of which are referred to as ‘‘incumbent local
exchange carriers,’’ or (“ILECS”), as well as Covad Communications Group, Inc.,
Speakeasy, Inc., MegaPath Networks Inc., and One Communications Corporation, all
of which are referred to as ‘‘common local exchange carriers,’’ or
(“CLECS”).





Cable
Modem and DSL Services





We
compete with companies that provide Internet connectivity through cable modems
or DSL. Principal competitors include cable companies, such as Comcast
Corporation, and incumbent telephone companies, such as AT&T Inc. or Verizon
Communications Inc. Both the cable and telephone companies deploy their services
over wired networks initially designed for voice and one-way data transmission
that have subsequently been upgraded to provide for additional
services.





Cellular
and PCS Services





Cellular
and personal communications service (“PCS”) carriers are seeking to expand their
capacity to provide data and voice services that are superior to ours. These
providers have substantially broader geographic coverage than we have and, for
the foreseeable future, than we expect to have. If one or more of these
providers can deploy technologies that compete effectively with our services,
the mobility and coverage offered by these carriers will provide even greater
competition than we currently face. Moreover, more advanced cellular and PCS
technologies, such as third generation mobile technologies, currently offer
broadband service with packet data transfer speeds of up to 2,000,000 bits per
second for fixed applications, and slower speeds for mobile applications. We
expect that third generation technology will be improved to increase
connectivity speeds to make it more suitable for a range of advanced
applications.




Wireless
Broadband Service Providers





We also
face competition from other wireless broadband service providers that use
licensed and unlicensed spectrum. In addition to these commercial operators,
many local governments, universities and other governmental or
quasi-governmental entities are providing or subsidizing ‘‘WiFi’’ networks over
unlicensed spectrum, in some cases at no cost to the user. There exist numerous
small local urban and rural wireless operations offering local services that
could compete with us in certain of our present or planned geographic
markets.  In addition, in 2008, Sprint, Google, Comcast, Time
Warner, Intel and Brighthouse provided Clearwire with over $3 billion in new
capital to build out a nationwide WiMAX network for consumers.





Satellite





Satellite
providers, such as WildBlue Communications, Inc. and Hughes Network Systems,
LLC, offer broadband data services that address a niche market, mainly less
densely populated areas that are unserved or underserved by competing service
providers. Although satellite offers service to a large geographic area, latency
caused by the time it takes for the signal to travel to and from the satellite
may challenge a satellite provider's ability to provide some services, such as
Voice over Internet Protocol (“VoIP”), which reduces the size of the addressable
market.





Other





We
believe other emerging technologies may also seek to enter the broadband
services market. For example, we are aware that several power generation and
distribution companies are seeking to develop or have already offered commercial
broadband Internet services over existing electric power lines.


3
 Table of Contents




Competitive
Strengths





Even
though we face substantial existing and prospective competition, we believe that
we have a number of competitive advantages that will allow us to retain existing
customers and attract new customers over time.





Reliability





As
compared to cellular, cable and DSL networks that generally rely on
infrastructure originally designed for non-broadband purposes, our network was
designed specifically to support wireless broadband services. We also connect
the customer to our Wireless Ring in the Sky, which has no single point of
failure. This ring is fed by multiple lead Internet providers located at
opposite ends of our service cities and connected to our national ring which is
fed by multiple leading carriers. We believe that we are the only wireless
broadband provider that offers true separate egress for true redundancy. With
DSL and cable offerings, all wires are rendered dead by one backhoe swipe or
switch failure. Our Wireless Ring in the Sky is backhoe-proof and weather-proof.
As a result of these factors, our network has historically experienced
reliability rates of approximately 99%.





Value





We own
our entire network, which enables us to price our services lower than most of
our competitors. Specifically, we are able to offer competitive prices because
we do not have to buy a local loop charge from the telephone
company.





Efficient
Economic Model





Our
economic model is characterized by low fixed capital and operating expenditures
relative to other wireless and wireline broadband service providers. We own our
entire network, thereby dispensing with the costs involved in using lines owned
by telephone or cable companies. Our system is expandable and covers an area up
to several miles away from each tower which will enable us to realize
incremental savings in our build-out costs as our customer base
grows.





Experienced Management
Team





We have an experienced executive
management team with more than 80 years combined experience as company
leaders.  Our President and Chief Executive Officer, Jeffrey M.
Thompson, is a founder of the Company and has more than 20 years experience in
the data communications industry.  Our Chief Financial Officer, Joseph
P. Hernon, has been the chief financial officer for three publicly traded
companies. Our Chief Revenue Officer, Mel Yarbrough, has more than 20 years
experience leading internal sales organizations. Our Chief Operations Officer,
Bruce E. Grinnell, has more than 20 years of experience improving operational
processes.





Corporate
History





We were
organized in the State of Nevada in June 2005, and subsequently became a
public shell company, as defined by the Securities and Exchange Commission. In
January 2007, we merged with and into a wholly-owned Delaware subsidiary,
for the sole purpose of changing our state of incorporation to Delaware. In
January 2007, a wholly-owned subsidiary of ours merged with and into a
private company, Towerstream Corporation, with Towerstream Corporation being the
surviving company. Upon closing of the merger, we discontinued our former
business and succeeded to the business of Towerstream Corporation as our sole
line of business. At the same time, we also changed our name to Towerstream
Corporation and, our subsidiary, Towerstream Corporation, changed its name to
Towerstream I, Inc.





Regulatory
Matters





Wireless
broadband services are subject to regulation by the Federal Communications
Commission (“FCC”). At the federal level, the FCC has jurisdiction over wireless
transmissions over the electromagnetic spectrum and all interstate
telecommunications services. State regulatory commissions have jurisdiction over
intrastate communications. Municipalities may regulate limited aspects of our
business by, for example, imposing zoning requirements and requiring
installation permits.


4
 Table of Contents




Telecommunications
Regulation





Our
wireless broadband systems can be used to provide Internet access service and
VPNs. In a March 2007 decision, the FCC classified wireless broadband Internet
access service as an interstate information service that is regulated under
Title I of the Communications Act of 1934, as amended. Accordingly, most
regulations that apply to telephone companies and other common carriers do not
apply to our wireless broadband Internet access service. For example, we are not
currently required to contribute a percentage of gross revenues from our
Internet access services to universal service funds used to support local
telephone service and advanced telecommunications services for schools,
libraries and rural health care facilities (‘‘USF Fees’’).





We are
not required to file tariffs with the FCC, setting forth the rates, terms, and
conditions of our Internet access service. The FCC, however, is currently
considering whether to impose various consumer protection obligations, similar
to Title II obligations, on wireless broadband Internet access providers. These
requirements may include obligations related to truth-in-billing, slamming,
discontinuing service, customer proprietary network information and federal
universal service funds mechanisms. Internet access providers are currently
subject to applicable state consumer protection laws enforced by each state’s
Attorney General and general Federal Trade Commission consumer protection
rules.




On
August 5, 2005, the FCC adopted an Order finding that facilities-based
broadband Internet access providers are subject to the Communications Assistance
for Law Enforcement Act (“CALEA”), which requires service providers covered by
that statute to build certain law enforcement surveillance assistance
capabilities into their communications networks. The FCC required
facilities-based broadband Internet access providers to comply with CALEA
requirements by May 14, 2007. We have complied with such CALEA
requirements.





On
May 3, 2006, the FCC adopted an additional Order addressing CALEA
compliance obligations of these providers. In that order, the FCC: (i) affirmed
the May 14, 2007 compliance deadline; (ii) indicated compliance
standards are to be developed by the industry within the telecommunications
standards-setting bodies working together with law enforcement; (iii) permitted
the use of certain third parties to satisfy CALEA compliance obligations; (iv)
restricted the availability of compliance extensions; (v) concluded that
facilities-based broadband Internet access providers are responsible for any
CALEA development and implementation costs; (vi) declared that the FCC may
pursue enforcement action, in addition to remedies available through the courts,
against any non-compliant provider; and (vii) adopted interim progress report
filing requirements.





Broadband
Internet-related and Internet protocol-services regulatory policies are
continuing to develop, and it is possible that our broadband Internet access
could be subject to additional regulations in the future. The extent of the
regulations that will ultimately be applicable to these services and the impact
of such regulations on the ability of providers to compete are currently
unknown.





Spectrum
Regulation





The FCC
routinely reviews its spectrum policies and may change its position on spectrum
allocations from time to time. We believe that the FCC is committed to
allocating spectrum to support wireless broadband deployment throughout the
United States and will continue to modify its regulations to foster such
deployment, which will help us implement our existing and future business
plans.




Internet
Taxation





The
Internet Tax Freedom Act, which was signed into law in October 2007, extended a
moratorium on taxes on Internet access and multiple, discriminatory taxes on
electric commerce. This moratorium had previously expired in November 2007,
and as with the preceding Internet Tax Freedom Act, ‘‘grandfathered’’ states
that taxed Internet access prior to October 1998 to allow them to continue
to do so. Certain states have enacted various taxes on Internet access or
electronic commerce, and selected states’ taxes are being contested on a variety
of bases. However, state tax laws may not be successfully contested, and future
state and federal laws imposing taxes or other regulations on Internet access
and electronic commerce may arise, any of which could increase the cost of
providing Internet services, which could, in turn, materially adversely affect
our business.





Employees





As of
December 31, 2008, we had 170 employees, all of whom are full-time employees. As
of February 28, 2009, we had 168 employees, of whom 166 are full-time employees
and 2 are part-time employees. We believe our employee relations are
good.  Of such employees, four are considered members of executive
management.


5
 Table of Contents




Item 1A.  Risk Factors.




Investing
in our common stock involves a high degree of risk. Prospective investors should
carefully consider the risks described below and other information contained in
this annual report, including our financial statements and related notes before
purchasing shares of our common stock. There are numerous and varied risks,
known and unknown, that may prevent us from achieving our goals. If any of these
risks actually occurs, our business, financial condition or results of
operations may be materially adversely affected. In that case, the trading price
of our common stock could decline and investors in our common stock could lose
all or part of their investment.




Risks
Relating to Our Business




We
may be unable to successfully execute any of our identified business
opportunities or other business opportunities that we determine to
pursue.




In order
to pursue business opportunities, we will need to continue to build our
infrastructure and operational capabilities. Our ability to do any of these
successfully could be affected by any one or more of the following
factors:




·
            the
      ability of our equipment, our equipment suppliers or our service providers
      to perform as we expect;





·
            the
      ability of our services to achieve market
  acceptance;





·
            our
      ability to execute our business strategy, which could be affected by our
      limited experience in providing fixed, high-speed wireless broadband
      services;





·
            our ability to manage our third
      party relationships
effectively;





·
            our ability to negotiate
      acceptable agreements to secure suitable locations for our equipment, such
      as desirable rooftop antenna lease
  locations;





·
            our ability to manage the
      expansion of our operations and any acquisitions we may make, which could
      result in increased costs, high employee turnover or damage to customer
      relationships;





·
            our ability to attract and retain
      qualified personnel, which may be affected by the significant competition
      in our industry for persons experienced in network operations and
      engineering;





·
            equipment failure or interruption
      of service, which could adversely affect our reputation and our relations
      with our customers;





·
            our ability to accurately predict
      and respond to the rapid technological changes in our industry and the
      evolving demands of the markets we serve;
  and





·
            our ability to raise substantial
      additional capital to fund our
growth.





Our
failure to adequately address any one or more of the above factors could have a
significant impact on our ability to implement our business plan and our ability
to pursue other opportunities that arise, which might negatively affect our
business.




We
depend on the continued availability of leases or licenses for our
communications equipment.




We have
constructed proprietary networks in each of the markets we serve by installing
antennae on rooftops, cellular towers and other structures pursuant to lease or
license agreements to send and receive wireless signals necessary for our
network. We typically seek five year initial terms for our leases with three to
five year renewal options. Such renewal options are generally exercisable at our
discretion before the expiration of the current term. If these leases are
terminated or if the owners of these structures are unwilling to continue to
enter into leases or licenses with us in the future, we would be forced to seek
alternative arrangements with other providers. If we are unable to continue to
obtain or renew such leases on satisfactory terms, our business would be
harmed.


6
 Table of Contents




Our
business depends on a strong brand, and if we do not maintain and enhance our
brand, our ability to attract and retain customers may be impaired and our
business and operating results may be harmed.




We
believe that our brand is a critical part of our business. Maintaining and
enhancing our brand may require us to make substantial investments with no
assurance that these investments will be successful. If we fail to promote and
maintain the “Towerstream” brand, or if we incur significant expenses in this
effort, our business, prospects, operating results and financial condition may
be harmed. We anticipate that maintaining and enhancing our brand will become
increasingly important, difficult and expensive.




We
may pursue acquisitions that we believe complement our existing operations but
which involve risks that could adversely affect our business.




Acquisitions
involve risks that could adversely affect our business, including the diversion
of management time from operations, and difficulties integrating the operations
and personnel of acquired companies. In addition, any future acquisitions could
result in significant costs, the incurrence of additional debt or the
issuance of equity securities to fund the acquisition, and the assumption of
contingent or undisclosed liabilities, all of which could materially adversely
affect our business, financial condition and results of operations.




In
connection with any future acquisition, we generally will seek to minimize the
impact of contingent and undisclosed liabilities by obtaining indemnities and
warranties from the seller. However, these indemnities and warranties, if
obtained, may not fully cover the liabilities due to their limited scope, amount
or duration, the financial limitations of the indemnitor or warrantor, or for
other reasons.




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




Our
current business was launched in 1999 and has incurred losses in each year of
operation. Prior to our merger in January 2007, Towerstream operated as an S
corporation. The accumulated deficit of the S corporation as of December 31,
2006 was $8,213,002. Concurrently with our merger, we elected to operate as a C
corporation, and reported a net loss of $8,501,725 in 2007. As of
December 31, 2007, our accumulated deficit was $8,501,725, which
included a recapitalization adjustment to eliminate the S corporation deficit.
In 2008, we recorded a net loss of $13,377,419.  We cannot anticipate
when, if ever, our operations will become profitable. We expect to incur
significant net losses as we expand our sales force, develop our network, expand
our markets, undertake acquisitions, acquire spectrum and pursue our business
strategy. We intend to invest significantly in our business before we expect
cash flow from operations to be adequate to cover our operating
expenses.




If we are
unable to execute our business strategy and grow our business, either as a
result of the risks identified in this section or for any other reason, our
business, prospects, financial condition and results of operations will be
adversely affected.





We
have a large cash and cash equivalent position and in light of the recent
market turmoil among financial institutions and related liquidity issues, we may
be at risk of being uninsured for a large portion of such assets or having
timing problems accessing such assets.




The
recent market turmoil, including the failure or insolvency of several large
financial institutions and the credit crunch affecting the short term debt
markets, has caused liquidity problems for companies and institutions across the
country.  As of December 31, 2008, we had approximately $25,000,000 in cash
and cash equivalents with one large financial banking institution. Although the
present regulatory response in the United States for when a large
institution becomes insolvent generally has been to have the failing
institution merge or transfer assets to more solvent entities, thereby avoiding
failures, it is possible that any financial institution could become insolvent
or fail.  At times, our cash and cash equivalents may be uninsured or
in deposit accounts that exceed the Federal Deposit Insurance Corporation
(“FDIC”) insurance limits. If the institution at which we have placed our funds
were to become insolvent or fail, we could be at risk for losing a substantial
portion of our cash deposits, or incur significant time delays in obtaining
access to such funds. In light of the limited amount of federal insurance
for deposits, even if we were to spread our cash assets among several
institutions, we would remain at risk for the amount not covered by
insurance.


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The
global economic crisis could have a material adverse effect on our liquidity and
capital resources.





The
recent distress in the financial markets has resulted in extreme volatility in
security prices and diminished liquidity and credit availability, and there can
be no assurance that our liquidity will not be affected by changes in the
financial markets and the global economy or that our capital resources will at
all times be sufficient to satisfy our liquidity needs. Although we believe that
cash provided by operations and our cash and cash equivalents currently on hand
will provide us with sufficient liquidity through the current credit crisis,
tightening of the credit markets could make it more difficult for us to access
funds, refinance our existing debt, enter into agreements for new debt or obtain
funding through the issuance of our securities.




In
addition, the current credit crisis is having a significant negative impact on
businesses around the world, and the impact of this crisis on our major
suppliers cannot be predicted. The inability of key suppliers to access
liquidity, or the insolvency of key suppliers, could lead to delivery delays or
failures.





Our
business may require additional capital for continued growth, and our growth may
be slowed if we do not have sufficient capital.




The
continued growth and operation of our business may require additional funding
for working capital, debt service, the enhancement and upgrade of our network,
the build-out of infrastructure to expand our coverage, possible acquisitions,
and possible bids to acquire spectrum licenses. In addition, we must use a
portion of our cash flows from operations and other available cash to make
payments of principal and interest on our debt, thereby reducing funds that
could be available for other purposes, such as working capital, the enhancement
and upgrade of our network, the build-out of infrastructure to expand our
coverage, possible acquisitions and possible bids to acquire spectrum licenses.
We may be unable to secure such funding when needed in adequate amounts or on
acceptable terms, if at all. To execute our business strategy, we may issue
additional equity securities in public or private offerings, potentially at a
price lower than the market price at the time of such issuance. Similarly, we
may seek additional debt financing, and may be forced to incur significant
interest expense. If we cannot secure sufficient funding, we may be forced to
forego strategic opportunities or delay, scale back or eliminate network
deployments, operations, acquisitions, spectrum bids and other
investments.




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




In
January 2007, we issued 8% senior convertible debentures, due
December 31, 2009, in an aggregate principal amount of $3,500,000. On
January 4, 2008, a debenture holder converted $750,000 of senior convertible
debentures into common stock at a conversion price of $2.75 per share resulting
in the issuance of 272,727 shares of common stock. As of December 31, 2008,
$2,750,000 of principal remains outstanding under the 8% senior convertible
debentures. The terms of our debt could have negative consequences to the
holders of our common stock.




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




·
            pay cash dividends to our
      stockholders;





·
            incur additional
      debt;





·
            permit liens on or conduct sales
      of assets; and





·
            engage in transactions with
      affiliates.





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


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Many of our competitors are better
established and have resources significantly greater than we have, which may
make it difficult to attract and retain customers.




The
market for broadband and related services is highly competitive, and we compete
with several other companies within each of our markets. Many of our competitors
are well established with larger and better developed networks and support
systems, longer-standing relationships with customers and suppliers, greater
name recognition and greater financial, technical and marketing resources than
we have. Our competitors may subsidize competing services with revenue from
other sources and, thus, may offer their products and services at prices lower
than ours. Our competitors may also reduce the prices of their services
significantly or may offer broadband connectivity packaged with other products
or services. We may not be able to reduce our prices or otherwise combine our
services with other products or services, which may make it more difficult to
attract and retain customers. In addition, new competitors may emerge for our
primarily commercial and business customer base from businesses primarily
engaged in providing residential services to consumers.





We expect existing and prospective
competitors to adopt technologies or business plans similar to ours, or seek
other means to develop services competitive with ours, particularly if our
services prove to be attractive in our target markets. This competition may make
it difficult to attract and retain customers.




We
may experience difficulties in constructing, upgrading and maintaining our
network, which could adversely affect customer satisfaction, increase customer
turnover and reduce our revenues.




Our
success depends on developing and providing products and services that give
customers high quality Internet connectivity. If the number of customers using
our network and the complexity of our products and services increase, we will
require more infrastructure and network resources to maintain the quality of our
services. Consequently, we may be required to make substantial investments to
construct and improve our facilities and equipment, and to upgrade our
technology and network infrastructure. If we do not implement these developments
successfully, or if we experience inefficiencies, operational failures or
unforeseen costs during implementation, the quality of our products and services
could decline.




We may
experience quality deficiencies, cost overruns and delays in implementing our
network improvements and expansion, in maintenance and upgrade projects,
including the portions of those projects not within our control or the control
of our contractors. Our network requires the receipt of permits and approvals
from numerous governmental bodies, including municipalities and zoning boards.
Such bodies often limit the expansion of transmission towers and other
construction necessary for our business. Failure to receive approvals in a
timely fashion can delay system rollouts and raise the cost of completing
projects. In addition, we typically are required to obtain rights from land,
building or tower owners to install our antennae and other equipment to provide
service to our customers. We may not be able to obtain, on terms acceptable to
us, or at all, the rights necessary to construct our network and expand our
services.




We also
face challenges in managing and operating our network. These challenges include
operating, maintaining and upgrading network and customer premise equipment to
accommodate increased traffic or technological advances, and managing the sales,
advertising, customer support, billing and collection functions of our business
while providing reliable network service at expected speeds and quality. Our
failure in any of these areas could adversely affect customer satisfaction,
increase customer turnover or churn, increase our costs and decrease our
revenues.




If
we do not obtain and maintain rights to use licensed spectrum in one or more
markets, we may be unable to operate in these markets which could negatively
impact our ability to execute our business strategy. To the extent we secure
licensed spectrum, we face increased operational costs, greater regulatory
scrutiny and may become subject to arbitrary government decision
making.




Since we
provide our services in some markets by using licensed spectrum, we must secure
and maintain sufficient rights to use licensed spectrum by obtaining licenses or
long-term leases in those markets. Obtaining licensed spectrum can be a long and
difficult process that can be costly and require a disproportionate amount of
our management resources, and may require us to incur significant debt or secure
additional capital. We may not be successful in our efforts to secure financing
and may not be deemed a qualified bidder due to our small size or our
creditworthiness, or be able to acquire, lease or maintain the spectrum
necessary to execute our strategy.


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Licensed
spectrum, whether owned or leased, poses additional risks,
including:





·
            inability to satisfy build-out or
      service deployment requirements upon which spectrum licenses or leases
      are, or may be, conditioned;





·
            increases in spectrum acquisition
      costs or complexity;





·
            competitive bids, pre-bid
      qualifications and post-bid requirements for spectrum acquisitions, in
      which we may not be successful leading to, among other things, increased
      competition;





·
            adverse changes to regulations
      governing spectrum rights;





·
            the risk that acquired or leased
      spectrum will not be commercially usable or free of damaging interference
      from licensed or unlicensed operators in our or adjacent
      bands;





·
            contractual disputes with, or the
      bankruptcy or other reorganization of, the license holders, which could
      adversely affect control over the spectrum subject to such
      licenses;





·
            failure of the FCC or other
      regulators to renew spectrum licenses as they expire;
      and





·
            invalidation of authorization to
      use all or a significant portion of our
  spectrum.




In
a number of markets we utilize unlicensed spectrum which is subject to intense
competition, low barriers of entry and slowdowns due to multiple
users.




We
presently utilize unlicensed spectrum in connection with our service offerings.
Unlicensed or “free” spectrum is available to multiple users and may suffer
bandwidth limitations, interference and slowdowns if the number of users exceeds
traffic capacity. The availability of unlicensed spectrum is not unlimited and
others do not need to obtain permits or licenses to utilize the same unlicensed
spectrum that we currently or may in the future utilize, threatening our ability
to reliably deliver our services. Moreover, the prevalence of unlicensed
spectrum creates low barriers of entry in our business, creating the potential
for heightened competition.




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




Our
services depend on the continuing operation of our information technology and
communications systems. We have experienced service interruptions in the past
and may experience service interruptions or system failures in the future. Any
unscheduled service interruption adversely affects our ability to operate our
business and could result in an immediate loss of revenues. If we experience
frequent or persistent system or network failures, our reputation could be
permanently harmed. We may need to make significant capital expenditures to
increase the reliability of our systems, however, these capital expenditures may
not achieve the results we expect.


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Excessive
customer churn may adversely affect our financial performance by slowing
customer growth, increasing costs and reducing revenues.





The
successful implementation of our business plan depends upon controlling customer
churn. Customer churn is a measure of customers who stop using our services.
Customer churn could increase as a result of:





·
            billing errors and/or general
      reduction in the quality of our customer
  service;





·
            interruptions to the delivery of
      services to customers over our
network;





·
            the
      availability of competing technology, such as cable modems, DSL,
      third-generation cellular, satellite, wireless internet service and other
      emerging technologies, some of which may be less expensive or
      technologically superior to those offered by us;
  and





·
            new
      competitors entering the markets in which we offer
  service.





An
increase in customer churn can lead to slower customer growth, increased costs
and a reduction in revenues.




If
our strategy is unsuccessful, we will not be profitable and our stockholders
could lose their investment.




There is
no track record for companies pursuing our strategy. Many fixed wireless
companies have failed and there is no guarantee that our strategy will be
successful or profitable. If our strategy is unsuccessful, the value of our
company may decrease and our stockholders could lose their
investment.




We
may not be able to effectively control and manage our growth which would
negatively impact our operations.




If our
business and markets continue to grow and develop, it will be necessary for us
to finance and manage expansion in an orderly fashion. In addition, we may face
challenges in managing expanding product and service offerings, and in
integrating acquired businesses. Such events would increase demands on our
existing management, workforce and facilities. Failure to satisfy increased
demands could interrupt or adversely affect our operations and cause backlogs
and administrative inefficiencies.




The
success of our business depends on the continuing contributions of key personnel
and our ability to attract, train and retain highly qualified
personnel.




We are
highly dependent on the continued services of our Chairman, Philip Urso, and our
President and Chief Executive Officer, Jeffrey M. Thompson. On December 21,
2007, we entered into a two-year employment agreement with Jeffrey M. Thompson
which includes renewal options. We cannot guarantee that any of these persons
will stay with us for any definite period. Loss of the services of any of these
individuals could adversely impact our operations. We do not maintain policies
of “key man” insurance on our executives.




In
addition, we must be able to attract, train, motivate and retain highly skilled
and experienced technical employees in order to successfully introduce our
services in new markets and grow our business in existing markets. Qualified
technical employees often are in great demand and may be unavailable in the time
frame required to satisfy our business requirements. We may not be able to
attract and retain sufficient numbers of highly skilled technical employees in
the future. The loss of technical personnel or our inability to hire or retain
sufficient technical personnel at competitive rates of compensation could impair
our ability to successfully grow our business and retain our existing customer
base.




Any
acquisitions we make could result in integration difficulties that could lead to
substantial costs, delays or other operational or financial
difficulties.




We may
seek to expand by acquiring competing businesses, including those operating in
our current business markets or those operating in other geographic markets. We
cannot accurately predict the timing, size and success of our acquisition
efforts and the associated capital commitments that might be required. We expect
to encounter competition for acquisitions which may limit the number of
potential acquisition opportunities and may lead to higher acquisition prices.
We may not be able to identify, acquire or profitably manage additional
businesses or successfully integrate acquired businesses, if any, without
substantial costs, delays or other operational or financial
difficulties.


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In
addition, such acquisitions involve a number of other risks,
including:




·
            failure of the acquired
      businesses to achieve expected
results;





·
            diversion of management’s
      attention and resources to
acquisitions;





·
            failure to retain key customers
      or personnel of the acquired
businesses;





·
            disappointing quality or
      functionality of acquired equipment and personnel;
    and





·
            risks associated with
      unanticipated events, liabilities or
  contingencies.





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




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




The
extent to which we will be able or willing to use shares of our common stock to
consummate acquisitions will depend on (i) the market value of our securities
which will vary, (ii) liquidity, which is presently limited, and (iii) the
willingness of potential sellers to accept shares of our common stock as full or
partial payment for their business. Using shares of our common stock for this
purpose may result in significant dilution to existing stockholders. To the
extent that we are unable to use common stock to make future acquisitions, our
ability to grow through acquisitions may be limited by the extent to which we
are able to raise capital through debt or equity financings. We may not be able
to obtain the necessary capital to finance any acquisitions. If we are unable to
obtain additional capital on acceptable terms, we may be required to reduce the
scope of expansion or redirect resources committed to internal purposes. Our
failure to use shares of our common stock to make future acquisitions may hinder
our ability to actively pursue our acquisition program.




We
rely on a limited number of third party suppliers that manufacture network
equipment, and install and maintain our network sites. If these companies fail
to perform or experience delays, shortages or increased demand for their
products or services, we may face shortage of components, increased costs, and
may be required to suspend our network deployment and our product and service
introduction.




We depend
on a limited number of third party suppliers to produce and deliver products
required for our networks. We also depend on a limited number of third parties
to install and maintain our network facilities. We do not maintain any long term
supply contracts with these manufacturers. If a manufacturer or other provider
does not satisfy our requirements, or if we lose a manufacturer or any other
significant provider, we may have insufficient network equipment for delivery to
customers and for installation or maintenance of our infrastructure, and we may
be forced to suspend the deployment of our network and enrollment of new
customers, thus impairing future growth.




If
our data security measures are breached, customers may perceive our network and
services as not secure, which may adversely affect our ability to attract and
retain customers and expose us to liability.




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


12
 Table of Contents




In
providing our services we could infringe on the intellectual property rights of
others, which may cause us to engage in costly litigation and, if we do not
prevail, could also cause us to pay substantial damages and prohibit us from
selling our services.




Third
parties may assert infringement or other intellectual property claims against
us. We may have to pay substantial damages, including damages for past
infringement if it is ultimately determined that our services infringe a third
party’s proprietary rights. Further, we may be prohibited from selling or
providing some of our services before we obtain additional licenses, which, if
available at all, may require us to pay substantial royalties or licensing fees.
Even if claims are without merit, defending a lawsuit takes significant time,
may be expensive and may divert management’s attention from our other business
concerns. Any public announcements related to litigation or interference
proceedings initiated or threatened against us could cause our business to be
harmed and our stock price to decline.




Risks
Relating to Our Industry




An
economic or industry slowdown may materially and adversely affect our
business.




Slowdowns
in the economy or in the wireless or broadband industry may impact demand for
wireless or broadband services, thereby reducing demand for our services, or
negatively impact other businesses or industries, thereby reducing demand for
our services by causing others to delay or abandon implementation of new systems
and technologies, including wireless broadband services. Further, the war on
terrorism, the threat of additional terrorist attacks, the political and
economic uncertainties resulting therefrom and other unforeseen events may
impose additional risks upon and adversely affect the wireless or broadband
industry, and our business.




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




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




·
            competition from service
      providers using more traditional and commercially proven means to deliver
      similar or alternative
services;





·
            competition from new service
      providers using more efficient, less expensive technologies, including
      products not yet invented or
developed;





·
            uncertain customer
      acceptance;





·
            realizing economies of
      scale;





·
            responding successfully to
      advances in competing technologies in a timely and cost-effective
      manner;





·
            migration toward standards-based
      technology, requiring substantial capital expenditures;
      and





·
            existing, proposed or undeveloped
      technologies that may render our wireless broadband services less
      profitable or obsolete.


13
 Table of Contents




As the
services offered by us and our competitors develop, businesses and consumers may
not accept our services as a commercially viable alternative to other means of
delivering wireless broadband services. As a result, our services may become
obsolete and we may be unable to develop competitive products or services on a
timely basis, or at all.




We
are subject to extensive regulation that could limit or restrict our activities.
If we fail to comply with these regulations, we may be subject to penalties,
including fines and suspensions, and past due fees and interest which may
adversely affect our financial condition and results of operations.




Our
business, including the acquisition, lease, maintenance, and use of spectrum
licenses, is extensively regulated by federal, state and local governmental
authorities. A number of federal, state and local privacy, security, and
consumer laws also apply to our business. These regulations and their
application are subject to continual change as new legislation, regulations or
amendments to existing regulations are adopted from time to time by governmental
or regulatory authorities, including as a result of judicial interpretations of
such laws and regulations. Current regulations directly affect the breadth of
services we are able to offer and may impact the rates, terms and conditions of
our services. Regulation of companies that offer competing services such as
cable and DSL providers, and telecommunications carriers also affects our
business.




We
believe that we are not required to register with the Universal Service
Administrative Company (“USAC”) as a seller of telecommunications, nor are we
required to collect USF Fees from our customers or to pay USF Fees directly. It
is possible, however, that the FCC may assert that we are a seller of
telecommunications and that we are required to register and pay USF Fees on some
or all of our gross revenues. Although we would contest any such assertion, we
could become obligated to pay USF Fees, interest and penalties to USAC with
respect to our gross revenues, past and/or future, from providing
telecommunications services, and we may be unable to retroactively bill our
customers for past USF Fees.




In
addition, the FCC or other regulatory authorities may in the future restrict our
ability to manage customers’ use of our network, thereby limiting our ability to
prevent or address customers’ excessive bandwidth demands. To maintain the
quality of our network and user experience, we may manage the bandwidth used by
our customers’ applications, in part by restricting the types of applications
that may be used over our network. If the FCC or other regulatory authorities
were to adopt regulations that constrain our ability to employ bandwidth
management practices, excessive use of bandwidth-intensive applications would
likely reduce the quality of our services for all customers. Such decline in the
quality of our services could harm our business.




The
breach of a license or applicable law, even if inadvertent, can result in the
revocation, suspension, cancellation or reduction in the term of a license or
the imposition of fines. In addition, regulatory authorities may grant new
licenses to third parties, resulting in greater competition in territories where
we already have rights to licensed spectrum. In order to promote competition,
licenses may also require that third parties be granted access to our bandwidth,
frequency capacity, facilities or services. We may not be able to obtain or
retain any required license, and we may not be able to renew a license on
favorable terms, or at all.




Wireless
broadband services may become subject to greater state or federal regulation in
the future. The scope of the regulations that may apply to companies like us and
the impact of such regulations on our competitive position are presently unknown
and could be detrimental to our business and prospects.




Risks
Relating to Our Organization




Our
certificate of incorporation allows for our board to create new series of
preferred stock without further approval by our stockholders which could
adversely affect the rights of the holders of our common stock.




Our board
of directors has the authority to fix and determine the relative rights and
preferences of preferred stock. Our board of directors also has the authority to
issue preferred stock without further stockholder approval. As a result, our
board of directors could authorize the issuance of a series of preferred stock
that would grant to holders the preferred right to our assets upon liquidation,
the right to receive dividend payments before dividends are distributed to the
holders of common stock and the right to the redemption of the shares, together
with a premium, prior to the redemption of our common stock. In addition, our
board of directors could authorize the issuance of a series of preferred stock
that has greater voting power than our common stock or that is convertible into
our common stock, which could decrease the relative voting power of our common
stock or result in dilution to our existing stockholders.


14
 Table of Contents




Our
officers and directors own a substantial amount of our common stock and,
therefore, exercise significant control over our corporate governance and
affairs which may result in their taking actions with which other shareholders
do not agree.




Our
executive officers and directors, and entities affiliated with them, control
approximately 25% of our outstanding common stock (including exercisable stock
options held by them). These shareholders, if they act together, may be able to
exercise substantial influence over the outcome of all corporate actions
requiring approval of our shareholders, including the election of directors and
approval of significant corporate transactions, which may result in corporate
action with which other shareholders do not agree. This concentration of
ownership may also have the effect of delaying or preventing a change in control
which might be in other shareholders’ best interest but which might negatively
affect the market price of our common stock.




We
are subject to financial reporting and other requirements for which our
accounting, internal audit and other management systems and resources may not be
adequately prepared.




On
January 12, 2007, we became subject to reporting and other obligations
under the Securities Exchange Act of 1934, as amended, including the
requirements of Section 404 of the Sarbanes-Oxley Act. Section 404 requires us
to conduct an annual management assessment of the effectiveness of our internal
controls over financial reporting for the fiscal year ended December 31, 2007
and thereafter, and to obtain a report by our independent auditors addressing
these assessments for the fiscal year ending December 31, 2009 and thereafter.
These reporting and other obligations will place significant demands on our
management, administrative, operational, internal audit and accounting
resources. We anticipate that we may need to (i) upgrade our systems, (ii)
implement additional financial and management controls, reporting systems and
procedures, (iii) implement an internal audit function, and (iv) hire additional
accounting, internal audit and finance staff. If we are unable to accomplish
these objectives in a timely and effective fashion, our ability to comply with
our financial reporting requirements and other rules that apply to reporting
companies could be impaired. Any failure to maintain effective internal controls
could have a negative impact on our ability to manage our business and on our
stock price.




Risks
Relating to Our Common Stock





We
may fail to qualify for continued listing on NASDAQ which could make it more
difficult for investors to sell their shares.




In May
2007, our common stock was approved for listing on The NASDAQ Capital Market and
our common stock continues to be listed on the Capital Market. There can be no
assurance that trading of our common stock on such market will be sustained or
that we can meet NASDAQ’s continued listing standards. In the event that our
common stock fails to qualify for continued inclusion, our common stock could
thereafter only be quoted on the OTC Bulletin Board which is commonly referred
to as the “pink sheets.” Under such circumstances, shareholders may find it more
difficult to dispose of, or to obtain accurate quotations, for our common stock,
and our common stock would become substantially less attractive to certain
purchasers such as financial institutions, hedge funds and other similar
investors.





Our
common stock may be affected by limited trading volume and price fluctuations,
each of which could adversely impact the value of our common stock.




There has
been limited trading in our common stock and there can be no assurance that an
active trading market in our common stock will either develop or be maintained.
Our common stock has experienced, and is likely to experience in the future,
significant price and volume fluctuations, which could adversely affect the
market price of our common stock without regard to our operating performance. In
addition, we believe that factors such as quarterly fluctuations in our
financial results and changes in the overall economy or the condition of the
financial markets could cause the price of our common stock to fluctuate
substantially. These fluctuations may also cause short sellers to periodically
enter the market in the belief that we will have poor results in the future. We
cannot predict the actions of market participants and, therefore, can offer no
assurances that the market for our stock will be stable or appreciate over
time.





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




We have
never paid cash dividends on our common stock and do not anticipate doing so in
the foreseeable future. The payment of dividends on our common stock will depend
on our earnings, financial condition and other business and economic factors as
our board of directors may consider relevant. If we do not pay dividends, our
common stock may be less valuable because a return on a shareholder’s investment
will only occur if our stock price appreciates.


15
 Table of Contents




Although
the NASDAQ Capital Market has temporarily suspended its continued listing
requirement of a minimum bid price, we could be at risk of a delisting in the
future.




Under the
rules of the NASDAQ Capital Market, we must maintain a minimum bid price of
$1.00 for our common stock.  If a company's stock trades for 30 consecutive
business days below the $1.00 minimum closing bid price requirement, NASDAQ will
send a deficiency notice to the company, advising that it has been granted a
"compliance period" of 180 calendar days to regain compliance with the
applicable requirements.  Given the current extraordinary market
conditions, NASDAQ has suspended the bid price and market value requirements
through Monday, April 20, 2009 for all of its listed
companies.




Our stock
price as of December 31, 2008 had a closing price of $0.69 per share.  As
of March 13, 2009, our stock price had a closing price of $0.81.  Although
the $1.00 minimum bid rule has been temporarily suspended, it is possible
that we could receive notice of possible delisting if our stock trades at less
than $1.00 when the rule is reinstated. If we receive a delisting notice and are
unable to increase our stock price above $1.00, our shares could be delisted
from trading on the NASDAQ Capital Market.





Item 1B.  Unresolved Staff Comments.





Not
applicable.





Item 2. Properties.





Our
executive offices are currently located in Middletown, Rhode Island, where we
lease approximately 42,137 square feet of space, consisting of a 17,137 square
feet building at 55 Hammarlund Way for our administrative, engineering,
information technology and customer care offices and a 25,000 square feet
building at 88 Silva Lane for our sales call center. Our annual rent payments
totaled approximately $527,000 in 2008 and will remain at that level through
February 2010, before increasing to approximately $558,000 through
May 2012, and approximately $590,000 through the end of the lease. Our
lease expires on October 1, 2013 with an option to renew for an additional
five-year term. We do not own any real property.





Item 3. Legal Proceedings.





There are
no legal proceedings pending, and we are not aware of any proceeding
contemplated by a governmental authority, to which we are a party or any of our
property is subject.





Item 4. Submission of Matters to a Vote of Security
Holders.





No matter
was submitted during the fourth quarter of the fiscal year ended December 31,
2008 to a vote of security holders through the solicitation of proxies or
otherwise.


16
 Table of Contents




PART
II





Item 5. Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities.





Market
Information





Our
common stock was quoted on the OTC Bulletin Board from January 12, 2007 through
May 30, 2007 under the symbol TWER.OB. Since May 31, 2007, our common stock has
been listed on The NASDAQ Capital Market under the symbol TWER. Prior to January
12, 2007, there was no active market for our common stock. The following table
sets forth the high and low bid prices for our common stock for the periods
indicated, as reported by the OTC Bulletin Board, and the high and low sales
prices as reported on The NASDAQ Capital Market. The quotations reflect
inter-dealer prices, without retail mark-up, mark-down or commission, and may
not represent actual transactions.





FISCAL
      YEAR 2008
                    
                    HIGH
                    
                    
                    LOWFirst
      Quarter
                    
                    $
                    3.65
                    
                    
                    $
                    1.01Second
      Quarter
                    
                    $
                    1.59
                    
                    
                    $
                    1.07Third
      Quarter
                    
                    $
                    1.84
                    
                    
                    $
                    0.87Fourth
      Quarter
                    
                    $
                    1.10
                    
                    
                    $
                    0.53





FISCAL
      YEAR 2007
                    
                    HIGH
                    
                    
                    LOWJanuary
      12, 2007 to March 31, 2007
                    
                    $
                    11.00
                    
                    
                    $
                    0.66April
      1, 2007 to May 30, 2007
                    
                    $
                    7.72
                    
                    
                    $
                    6.60May
      31, 2007 to June 30, 2007
                    
                    $
                    7.75
                    
                    
                    $
                    3.31Third
      Quarter
                    
                    $
                    3.80
                    
                    
                    $
                    2.38Fourth
      Quarter
                    
                    $
                    3.20
                    
                    
                    $
                    1.89





The last
reported sales price of our common stock on The NASDAQ Capital Market on
December 31, 2008 was $0.69 and on March 13, 2009, the last reported sales price
was $0.81. According to the records of our transfer agent, as of March 13, 2009,
there were approximately 63 holders of record of our common
stock.





Dividend
Policy





We have
never declared or paid cash dividends on our common stock, and we do not intend
to pay any cash dividends on our common stock in the foreseeable future. Rather,
we expect to retain future earnings (if any) to fund the operation and expansion
of our business and for general corporate purposes. In addition, our agreements
with debenture holders and other investors restrict us from paying any cash
dividends.


17
 Table of Contents




Securities
Authorized for Issuance Under Equity Compensation Plans





As of
December 31, 2008, securities issued and securities available for future
issuance under our 2008 Non-Employee Directors Compensation Plan, our 2007
Equity Compensation Plan and our 2007 Incentive Stock Plan were as
follows:





Equity
Compensation Plan Information





Number of securities to be
                                                issued upon exercise of
                                                outstanding options, warrants
                                                and rights
                                              
                                              Weighted
      average exercise
                                                price of outstanding
                                                options, warrants and rights
                                              
                                              Number of securities remaining
                                                available for future issuance
                                                under equity compensation plansEquity
      compensation plans approved
                                                by
      security holders
                                              
                                              3,335,793
                                              
                                              $
                                              1.82
                                              
                                              2,513,321Equity
      compensation plans not approved by security holders
                                              
                                              -
                                              
                                              
                                              -
                                              
                                              -Total
                                              
                                              3,335,793
                                              
                                              $
                                              1.82
                                              
                                              2,513,321





Recent
Sales of Unregistered Securities





None.





Item 6.  Selected Financial Data.





Not
applicable.





Item 7. Management’s Discussion and Analysis of Financial Condition
and Results of Operations.





Prior to
January 12, 2007, we were a public shell company, as defined by the
Securities and Exchange Commission (“SEC”), without material assets or
activities. On January 12, 2007, we completed a reverse merger (the
“Merger”), pursuant to which a wholly-owned subsidiary of ours merged with and
into a private company, Towerstream Corporation, with such private company being
the surviving company. In connection with the Merger, we discontinued our former
business and commenced operating the business of Towerstream as our sole line of
business. The former private company, our subsidiary, changed its name to
Towerstream I, Inc.  For financial reporting purposes, Towerstream,
and not the public shell company, is considered the acquiror.  All
costs associated with the Merger (other than financing related costs in
connection with the simultaneous sale of $3,500,000 of 8% senior convertible
debentures due 2009 and warrants, and approximately $11,500,000 of units
consisting of common stock and warrants) were expensed as incurred.




Overview




We
provide fixed wireless broadband services to commercial customers based on
a monthly recurring revenue model.  We provide customers
high speed Internet access over a fixed wireless network transmitting over both
regulated and unregulated radio spectrum. Our service supports bandwidth on
demand, wireless redundancy, virtual private networks (“VPNs”), disaster
recovery, bundled data and video services. We provide service to approximately
1,400 business customers in New York City, Boston, Chicago, Los Angeles, San
Francisco, Seattle, Miami, Dallas-Fort Worth, Providence and Newport, Rhode
Island.




Characteristics
of our Revenues and Expenses




We offer
our services under agreements having terms of one, two or three years. Pursuant
to these agreements, we bill customers on a monthly basis, in advance, for each
month of service. Payments received in advance of services performed are
recorded as deferred revenues.




Costs of
revenues consists of expenses that are directly related to providing services to
our customers, including the costs to establish points of presence in new
markets, and to strengthen or expand our presence in existing
markets.  These costs include bandwidth purchases, tower and roof rent
and utilities, site work visits, equipment support and network supplies
(collectively “Network Operating Expenses”).  Our gross margins can
fluctuate from period to period due to the timing of when we add network
capacity to existing markets or expand into new markets.  This
variability in gross margin occurs, in part, because we are required to incur
these costs prior to generating new customer revenues.


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 Table of Contents




Sales and
marketing expenses primarily consist of the salaries, benefits, travel and other
costs of our sales and marketing teams, as well as marketing initiatives and
business development expenses.





Customer
support services includes salaries and related payroll costs associated with our
customer support services, customer care, and installation and operations
staff.





General
and administrative expenses include costs attributable to corporate overhead and
the overall support of our operations.  Salaries and other related
payroll costs for executive management, finance, administration and information
systems personnel are included in this category.  Other costs include
rent, utilities and other facilities costs, accounting, legal and other
professional services, and other general operating expenses.





Year
Ended December 31, 2008 Compared to Year Ended December
31, 2007





Revenues.    Revenues
for the year ended December 31, 2008 totaled $10,656,081 compared to
$6,883,343 for the year ended December 31, 2007, representing an increase
of $3,772,738, or 55%. This increase was driven by a 51% increase in our
customer base during 2008.





Sequential
growth for the year ended December 31, 2008 was 55% compared to 9% for the year
ended December 31, 2007.  The higher sequential growth during 2008 was
driven by a 51% increase in customers and a 13% increase in monthly average
revenue per user (“ARPU”).  ARPU as of December 31, 2008 totaled $828
compared to $730 as of December 31, 2007, representing an increase of $98, or
13%.  This increase was primarily related to higher relative sales of
our midrange service offering which is priced at $999 per
month.  Customer churn, calculated as a percent of revenue lost on a
monthly basis from customers terminating service, totaled 1.24% for the year
ended December 31, 2008 compared to 1.60% for the year ended December 31, 2007,
representing a 23% decrease on a percentage basis.  During 2008, we
invested approximately $3,773,000 to strengthen our network in existing markets
and establish a network presence in new markets.  In addition, we
added personnel in our customer care and engineering
departments.  These efforts resulted in higher levels of customer
satisfaction and reduced churn.





Cost of
Revenues.    Cost of revenues for the year ended
December 31, 2008 totaled $4,076,100 compared to $2,469,065 for the year ended
December 31, 2007, representing an increase of $1,607,035, or
65%.  The dollar increase was consistent with the growth in
revenues.  Gross margins decreased to 62% during 2008 compared to 64%
during 2007.  We launched service in Miami at the end of the first
quarter of 2007 and in Dallas-Fort Worth in the second quarter of
2008.  Over the past twelve months, we have also expanded our presence
in existing markets including Chicago, Los Angeles, New York and San
Francisco.  These activities increased Network Operating Expenses by
approximately $1,276,000 in 2008 compared to 2007.  In addition,
network personnel costs increased by approximately $331,000 as additional
employees were hired to support our continued growth and expansion.





Depreciation.    Depreciation
for the year ended December 31, 2008 totaled $3,222,716 compared to $1,879,515
for the year ended December 31, 2007, representing an increase of
$1,343,201, or 71%. This increase was primarily related to the continued
investment in our network, base station and customer premise equipment
(collectively, our “Network”) which was required to support the growth in our
customer base and our expansion into new markets.  Gross fixed assets
at December 31, 2008 totaled $21,805,582 compared to $14,309,212 at December 31,
2007, representing an increase of $7,496,370, or 52%.




Customer Support
Services.    Customer support services for the year
ended December 31, 2008 totaled $1,820,101 compared to $931,785 for the year
ended December 31, 2007, representing an increase of $888,316, or 95%. This
increase was primarily related to the costs of additional personnel hired to
support our growing customer base.  Average headcount increased from
23 to 35 in 2008.




Sales and
Marketing.Sales and marketing expenses for the year ended
December 31, 2008 totaled $7,692,268 compared to $3,588,111 for the year ended
December 31, 2007, representing an increase of $4,104,157, or 114%.
Approximately $3,641,000, or 89%, related to higher payroll costs associated
with the expansion of our sales and marketing team, which includes direct sales,
sales support and marketing personnel.  The average number of
personnel totaled 123 in 2008 compared to 54 in 2007.  Approximately
$430,000, or 10%, of the increase related to higher advertising expenses,
primarily related to internet based advertising programs.


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 Table of Contents




General and
Administrative.    General and administrative
expenses for the year ended December 31, 2008 totaled $7,208,801 compared to
$6,827,036 for the year ended December 31, 2007, representing an increase
of $381,765, or 6%.  Payroll costs in 2008 increased by approximately
$700,000 related to higher employee headcount.  Rent and utilities
increased by approximately $313,000 as additional space was leased due to the
increase in headcount which also caused an increase of approximately $158,000 in
software user fees and approximately $247,000 in other employee based
expenses.  Insurance costs increased by approximately
$78,000.  These increases were offset by a decrease in stock-based
compensation of approximately $146,000 in 2008.  Professional services
fees decreased by approximately $976,000 in 2008 compared to 2007 which included
the extensive use of third party advisers related to the Merger and financing
transactions completed during 2007.





Interest
Income.Interest income for the year ended December 31, 2008
totaled $578,373 compared to $1,460,825 for the year ended December 31, 2007,
representing a decrease of $882,452, or 60%. In March 2008, we transferred our
cash balances into four separate U.S. Treasury based money market
funds.  These funds have lower yields but are higher quality
instruments than the funds in which we previously
invested.   Cash balances decreased from approximately
$41,000,000 to approximately $25,000,000 during 2008.  We used
approximately $7,873,000 to support operating activities and approximately
$7,684,000 to acquire property and equipment, primarily related to our
Network.




Interest
Expense.    Interest expense for the year ended
December 31, 2008 totaled $509,593 compared to $974,774 for the year ended
December 31, 2007, representing a decrease of $465,181, or 48%. The
decrease was attributable to certain non-recurring transactions related to our
Merger in January 2007.  During 2007, we agreed to convert certain
notes payable into common stock at a discounted rate.  We recognized
approximately $314,000 of non-cash interest expense, representing the discounted
amount, in connection with this transaction.  In addition, we
recognized non-cash interest expense of approximately $75,000 in connection with
an agreement to increase the outstanding balance of certain promissory notes by
the same amount.  These promissory notes were subsequently converted
into common stock in connection with the Merger.




Other Expense,
Net.   Other expense, net for the year ended December 31,
2008 totaled $82,294 compared to $175,607 for the year ended December 31, 2007,
representing a decrease of $93,313, or 53%. In April 2007, we entered into a
two-year services agreement with a third party monitoring firm to help us comply
with the Communications Assistance for Law Enforcement Act
(“CALEA”).  In the fourth quarter of 2008, we terminated the contract
and entered into a new agreement with another third party that was more cost
beneficial.  We recognized an expense of $56,365 representing the net
book value of equipment capitalized under the original agreement that is no
longer being used.  In 2007, we recognized a charge of approximately
$150,000 for failing to get a registration statement declared effective by a
certain date.




Net
Loss.    Net loss for the year ended December 31,
2008 totaled $13,377,419 compared to $8,501,725 for the year ended December
31, 2007, representing an increase of $4,875,694, or
57%.   Approximately $4,104,000, or 84%, of the increase related
to higher sales and marketing expenses primarily associated with the expansion
of our sales and marketing team.   The average number of sales
and marketing personnel totaled 123 in 2008 compared to 54 in 2007.





Liquidity
and Capital Resources




We have
historically met our liquidity and capital requirements primarily through the
public sale and private placement of equity securities and debt financing. Cash
and cash equivalents totaled $24,740,268 and $40,756,865 at December 31, 2008
and December 31, 2007, respectively. The decrease in cash and cash equivalents
related to our operating, investing and financing activities during the year
ended December 31, 2008, each of which is described below.  At
February 28, 2009, we had cash and cash equivalents totaling approximately
$22,500,000.




Net Cash Used in Operating
Activities.    Net cash used in operating activities
for the year ended December 31, 2008 totaled $7,873,237 compared to $3,973,760
for the year ended December 31, 2007, representing an increase of
$3,899,477, or 98%. This increase was primarily due to higher payroll and
related costs associated with increased headcount across all areas of
operations, most significantly in sales and marketing.




Net Cash Used in Investing
Activities.    Net cash used in investing activities
for the year ended December 31, 2008 totaled $8,095,870 compared to $6,895,114
for the year ended December 31, 2007, representing an increase of
$1,200,756, or 17%.  Acquisitions of property and equipment
represented $973,938, or 81%, of the increase.  This increase related
to both our expansion into new markets as well as the strengthening of our
Network in existing markets.    We entered the Miami market
in March 2007 and the Dallas-Fort Worth market in April 2008 and incurred higher
capital expenditures in 2008 for both of these new markets.  Our
Network includes equipment located on buildings at the customer location
(commonly known as customer premise equipment (“CPE”)) as well as on buildings
in which we maintain points of presence (“POPs”), which are used to transmit
data to multiple customers.  Our customer count increased from
approximately 900 to approximately 1,350 in 2008.  Spending on CPE
totaled approximately $2,996,000 and spending on POPs totaled approximately
$3,773,000 during 2008.  In addition, we used $400,000 to purchase FCC
licenses in 2008 compared to $125,000 in 2007.


20
 Table of Contents




Net Cash Used in/Provided by
Financing Activities.   Net cash used in financing activities
for the year ended December 31, 2008 totaled $47,490 compared to net cash
provided by financing activities of $51,465,376 for the year ended December
31, 2007, representing a decrease of $51,512,866 or 100%. The decrease is
directly related to financing transactions completed in 2007 including two
equity transactions which raised net proceeds of $48,251,237 and a debt
financing transaction which raised $3,360,000.  No financing
transactions were completed in 2008.




Working
Capital.As of December
31, 2008, we had working capital of $19,412,428. Based on our current operating
activities and plans, we believe our existing working capital will enable us to
meet our anticipated cash requirements for at least the next twelve
months.





Private
Placement




In
connection with the Merger in January 2007, we completed a private
placement pursuant to which we issued 5,110,056 shares of common stock at a
price of $2.25 per share and five-year warrants to purchase 2,555,030 shares of
common stock at an exercise price of $4.50 per share resulting in aggregate
gross proceeds of $11,497,625. In connection with this transaction, we incurred
placement agent fees of approximately $446,400, and issued to the placement
agent a five-year warrant to purchase an aggregate of 140,916 shares of common
stock at an exercise price of $4.50 per share. In addition, we incurred other
professional fees and expenses totaling approximately $186,000 in connection
with the Merger and private placement.




Senior
Convertible Debentures




In
conjunction with our Merger in January 2007, we also sold $3,500,000 of
senior convertible debentures. These debentures require quarterly interest
payments of 8% per annum and mature on December 31, 2009. The debentures
are convertible into shares of common stock at a conversion price of $2.75 per
share, subject to certain limitations. In addition, holders of the debentures
received five-year warrants to purchase an aggregate of 636,364 shares of common
stock at an exercise price of $4.00 per share and five-year warrants to purchase
an aggregate of 636,364 shares of common stock at an exercise price of $6.00 per
share.




In
connection with the issuance of the debentures, we incurred placement agent fees
totaling approximately $140,000, and issued to the placement agent a five-year
warrant to purchase 63,636 shares of common stock at an exercise price of
$4.50 per share. This warrant had an estimated fair value of
$34,750.





In
January 2008, a debenture holder converted $750,000 of debentures into common
stock at a conversion price of $2.75 per share resulting in the issuance of
272,727 shares of common stock.  The carrying value of the debentures
on the date of the conversion was $676,607.  Accordingly, we
recognized the remaining debt discount of $73,393 as non-cash interest expense
in connection with the conversion.  The principal amount of debentures
outstanding as of December 31, 2008 totaled $2,750,000.




Registered
Offering




In
June 2007, we issued 10,000,000 shares of common stock in connection with a
registered direct offering at $4.00 per share, resulting in gross proceeds of
$40,000,000. In connection with the registered offering, we incurred placement
agent fees of $2,800,000 and issued to the placement agents five-year warrants
to purchase 300,000 shares of common stock at an exercise price of $4.00 per
share.




Critical
Accounting Policies




The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities, the disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenues and expenses
during the reporting period. Critical accounting policies are those that require
the application of management’s most difficult, subjective or complex judgments,
often because of the need to make estimates about the effect of matters that are
inherently uncertain and that may change in subsequent periods. In preparing the
financial statements, we utilized available information, including our past
history, industry standards and the current economic environment, among other
factors, in forming our estimates and judgments, giving due consideration to
materiality. Actual results may differ from these estimates. In addition, other
companies may utilize different estimates, which may impact the comparability of
our results of operations to other companies in our industry. We believe that of
our significant accounting policies, the following may involve a higher degree
of judgment and estimation.


21
 Table of Contents




Revenue
Recognition.    We normally enter into contractual
agreements with our customers for periods ranging between one to three
years.  We recognize the total revenue provided under a contract
ratably over the contract period, including any periods under which we have
agreed to provide services at no cost.  Deferred revenues are
recognized as a liability when billings are received in advance of the date when
revenues are earned.  We apply the revenue recognition principles set
forth under SEC Staff Accounting Bulletin 104, (“SAB 104”) which provides for
revenue to be recognized when (i) persuasive evidence of an arrangement exists,
(ii) delivery or installation has been completed, (iii) the customer accepts and
verifies receipt, and (iv) collectability is reasonably assured.




Long-Lived Assets.Long-lived
assets consist primarily of property and equipment, and FCC licenses. Long-lived
assets are reviewed annually for impairment or whenever events or circumstances
indicate their carrying value may not be recoverable. Conditions that would
result in an impairment charge include a significant decline in the market value
of an asset, a significant change in the extent or manner in which an asset is
used, or a significant adverse change that would indicate that the carrying
amount of an asset or group of assets is not recoverable. When such events or
circumstances arise, an estimate of the future undiscounted cash flows produced
by the asset, or the appropriate grouping of assets, is compared to the asset’s
carrying value to determine if impairment exists pursuant to the requirements of
Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for
the Impairment or Disposal of Long-Lived Assets”. If the asset is determined to
be impaired, the impairment loss is measured based on the excess of its carrying
value over its fair value. Assets to be disposed of are reported at the lower of
their carrying value or net realizable value.





Asset Retirement
Obligations.   SFAS No. 143, “Accounting for Asset
Retirement Obligations,” (“FAS 143”) addresses financial accounting and
reporting for obligations associated with the retirement of tangible long-lived
assets and the associated asset retirement costs.  FAS 143 requires the
recognition of an asset retirement obligation and an associated asset retirement
cost when there is a legal obligation in connection with the retirement of
tangible long-lived assets.  Our network equipment is installed on
both buildings in which we have a lease agreement (“Company Locations”) and at
customer locations.  In both instances, the installation and removal of our
equipment is not complicated and does not require structural changes to the
building where the equipment is installed.  Costs associated with the
removal of our equipment at company or customer locations are not material, and
accordingly, we have determined that we do not presently have asset retirement
obligations under FAS 143.




Off-Balance Sheet
Arrangements.    We have no off-balance sheet
arrangements, financings, or other relationships with unconsolidated entities
known as ‘‘Special Purposes Entities’’.




Recent
Accounting Pronouncements





In
September 2006, the Financial Accounting Standards Board (“FASB”) issued
SFAS No. 157, ‘‘Fair Value Measurements’’, (“FAS 157”) which is effective for
fiscal years beginning after November 15, 2007 and for interim periods within
those years. This statement defines fair value, establishes a framework for
measuring fair value and expands the related disclosure requirements. This
statement applies under other accounting pronouncements that require or permit
fair value measurements.  The statement indicates, among other things,
that a fair value measurement assumes that the transaction to sell an asset or
transfer a liability occurs in the principal market for the asset or liability
or, in the absence of a principal market, the most advantageous market for the
asset or liability.  FAS 157 defines fair value based upon an exit
price model.  Relative to FAS 157, the FASB issued FASB Staff
Positions (“FSP”) 157-1, FSP 157-2, and proposed FSP 157-c.  FSP 157-1
amends FAS 157 to exclude SFAS No. 13, “Accounting for Leases”, (“FAS 13”) and
its related interpretive accounting pronouncements that address leasing
transactions, while FSP 157-2 delays the effective date of FAS 157 for all
nonfinancial assets and nonfinancial liabilities, except those that are
recognized or disclosed at fair value in the financial statements on a recurring
basis.  FSP 157-c clarifies the principles in FAS 157 on the fair
value measurement of liabilities.  We adopted FAS 157 as of January 1,
2008, with the exception of the application of the statement to nonrecurring
nonfinancial assets and nonfinancial liabilities.  While we are
currently evaluating the impact of the application of the statement to
nonrecurring nonfinancial assets and nonfinancial liabilities on our
consolidated financial statements upon adoption, we do not anticipate a material
impact on our consolidated financial position and results of
operations.


22
 Table of Contents




In
February 2007, the FASB issued SFAS No. 159, “The Fair Value
Option for Financial Assets and Financial Liabilities -including an amendment of
FASB Statement No. 115”, (“FAS 159”) which permits entities to choose to
measure many financial instruments and certain other items at fair value. The
fair value option permits entities to choose to measure eligible items at fair
value at specified election dates. A business entity shall report unrealized
gains and losses on items for which the fair value option has been elected in
earnings at each subsequent reporting date. Adoption is required for fiscal
years beginning after November 15, 2007. We adopted FAS 159 on January 1,
2008, but elected not to apply the fair value option to any of our eligible
financial assets or liabilities at that date. Therefore, the provisions of FAS
159 had no impact on our consolidated financial position and results of
operations for the year ended December 31, 2008.





In
December 2007, the FASB issued SFAS No. 141(R), "Business Combinations", (“FAS
141(R)”) which replaces SFAS No. 141, “Business Combinations”.  FAS
141(R) establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent consideration and certain acquired contingencies. FAS 141(R) also
requires that acquisition-related transaction expenses and restructuring costs
be expensed as incurred rather than capitalized as a component of the business
combination.  FAS 141(R) will be applicable prospectively beginning January
1, 2009.




In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of ARB No. 51", (“FAS 160”). FAS
160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary (previously referred to as minority interests). FAS 160
also requires that a retained noncontrolling interest upon the deconsolidation
of a subsidiary be initially measured at its fair value. Upon adoption of FAS
160, we will be required to report any noncontrolling interests as a separate
component of consolidated stockholders’ equity. We will also be required to
present any net income allocable to noncontrolling interests and net income
attributable to our stockholders separately in our consolidated statements
ofoperations. FAS
160 is effective prospectively beginning January 1, 2009.





In
May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally
Accepted Accounting Principles”,(“FAS 162”). FAS 162
identifies the sources of accounting principles and the framework for selecting
the principles to be used in the preparation of financial statements of
nongovernmental entities that are presented in conformity with United States
Generally Accepted Accounting Principles (“GAAP”). FAS 162 directs the GAAP
hierarchy to the entity, not the independent auditors, as the entity is
responsible for selecting accounting principles for the financial statements
that are presented in conformity with GAAP.  FAS 162 is effective
November 15, 2008.  The adoption of this pronouncement did not have
any impact on our consolidated financial position, results of operations or cash
flows.





In
April 2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3,
“Determination of the Useful Life of Intangible Assets.” This FSP amends
the factors that should be considered in developing renewal or extension
assumptions used to determine the useful life of a recognized intangible asset
under FASB Statement No. 142, “Goodwill and Other IntangibleAssets”, (“FAS
142”).  The objective of this FSP is to improve the consistency
between the useful life of a recognized intangible asset under FAS 142 and the
period of expected cash flows used to measure the fair value of the asset under
FAS 141(R) and other United States GAAP principles. This FSP is effective
beginning January 1, 2009. We are in the process of evaluating the impact
of this provision on our consolidated financial position and results of
operations.





In May
2008, the FASB issued FASB Staff Position APB 14-1, “Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial
Cash Settlement)”, (“FSP APB 14-1”).  FSP APB 14-1 specifies that for
convertible debt instruments that may be settled in cash upon conversion,
issuers of such instruments should separately account for the liability and
equity components in the statement of financial condition. The excess of the
initial proceeds of the convertible debt instrument over the amount allocated to
the liability component creates a debt discount which should be amortized as
interest expense over the expected life of the liability. FSP APB 14-1 is
effective beginning January 1, 2009 and is to be applied retrospectively. We are
currently evaluating the impact of adopting FSP APB 14-1 on our financial
position and results of operations.





Item 7A. Quantitative and Qualitative Disclosures About Market
Risk.





Not
applicable.


23
 Table of Contents




Item 8. Financial Statements and Supplementary Data.




TOWERSTREAM
CORPORATION


Index
to Consolidated Financial Statements





PageReport of Independent Registered Public Accounting
      Firm
                  
                  
                  25Consolidated Balance Sheets
                  
                  
                  26Consolidated Statements of
    Operations
                  
                  
                  27Consolidated Statements of Stockholders’
      Equity
                  
                  
                  28Consolidated Statements of Cash Flows
                  
                  
                  29Notes to Consolidated Financial
    Statements
                  
                  
                  31


24
 Table of Contents




Report of Independent Registered Public Accounting
Firm




To the
Audit Committee of the


Board of
Directors and Shareholders of


Towerstream
Corporation





We have
audited the accompanying consolidated balance sheets of Towerstream Corporation
and Subsidiaries (the “Company”) as of December 31, 2008 and December 31, 2007,
and the related consolidated statements of operations, stockholders’ equity and
cash flows for the years then ended.  These financial statements are
the responsibility of the Company’s management. Our responsibility is to express
an opinion on these financial statements based on our audits.





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 audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement.  The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audits included consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company’s internal control over financial
reporting. Accordingly, we express no such opinion.  An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, 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, the financial statements referred to above present fairly, in all
material respects, the consolidated financial position of Towerstream
Corporation, as of December 31, 2008 and 2007, and the consolidated results of
its operations and its cash flows for the years then ended, in conformity with
accounting principles generally accepted in the United States of
America.




/s/
Marcum & Kliegman LLP


New York,
New York


March 16, 2009


25
 Table of Contents




TOWERSTREAM CORPORATION


CONSOLIDATED
BALANCE SHEETS





As of December 31,2008
                      
                      
                      2007AssetsCurrent
      AssetsCash
      and cash equivalents
                      
                      $
                      24,740,268
                      
                      
                      $
                      40,756,865Accounts
      receivable, net of allowance for doubtful accounts of $66,649 and
      $77,615,respectively
                      
                      
                      279,399
                      
                      
                      
                      184,621Prepaid
      expenses and other current assets
                      
                      
                      319,325
                      
                      
                      
                      736,156Total
      Current Assets
                      
                      
                      25,338,992
                      
                      
                      
                      41,677,642Property
      and equipment, net
                      
                      
                      12,890,779
                      
                      
                      
                      8,518,750Security
      deposits and other assets
                      
                      
                      183,063
                      
                      
                      
                      283,790FCC
      licenses
                      
                      
                      875,000
                      
                      
                      
                      475,000Total
      Assets
                      
                      $
                      39,287,834
                      
                      
                      $
                      50,955,182Liabilities and Stockholders’
      EquityCurrent
      LiabilitiesCurrent
      maturities of capital lease obligations
                      
                      $
                      25,346
                      
                      
                      $
                      47,486Accounts
      payable
                      
                      
                      1,394,476
                      
                      
                      
                      1,413,970Accrued
      expenses
                      
                      
                      861,390
                      
                      
                      
                      685,576Deferred
      revenues
                      
                      
                      985,403
                      
                      
                      
                      631,506Short-term
      debt, net of discount of $142,605
                      
                      
                      2,607,395
                      
                      
                      
                      -Deferred
      rent
                      
                      
                      52,554
                      
                      
                      
                      -Total
      Current Liabilities
                      
                      
                      5,926,564
                      
                      
                      
                      2,778,538Other
      LiabilitiesLong-term
      debt, net of discount of $357,139
                      
                      
                      -
                      
                      
                      
                      3,142,861Capital
      lease obligations, net of current maturities
                      
                      
                      -
                      
                      
                      
                      25,341Deferred
      rent
                      
                      
                      354,071
                      
                      
                      
                      273,154Total
      Other Liabilities
                      
                      
                      354,071
                      
                      
                      
                      3,441,356Total
      Liabilities
                      
                      
                      6,280,635
                      
                      
                      
                      6,219,894Commitments
      (Note 14)Stockholders'
      EquityPreferred
      stock, par value $0.001; 5,000,000 authorized, none
      outstanding
                      
                      
                      -
                      
                      
                      
                      -Common
      stock, par value $0.001; 70,000,000 shares authorized; 34,587,854 and34,080,053
      issued and outstanding, respectively
                      
                      
                      34,588
                      
                      
                      
                      34,080Additional
      paid-in-capital
                      
                      
                      54,851,755
                      
                      
                      
                      53,223,033Deferred
      consulting costs
                      
                      
                      -
                      
                      
                      
                      (20,100
                      )Accumulated
      deficit
                      
                      
                      (21,879,144
                      )
                      
                      
                      (8,501,725
                      )Total
      Stockholders’ Equity
                      
                      
                      33,007,199
                      
                      
                      
                      44,735,288Total
      Liabilities and Stockholders' Equity
                      
                      $
                      39,287,834
                      
                      
                      $
                      50,955,182





The
accompanying notes are an integral part of these consolidated financial
statements.




26
 Table of Contents




TOWERSTREAM CORPORATION


CONSOLIDATED
STATEMENTS OF OPERATIONS





For the Years Ended
                                          December 31,2008
                                        
                                        
                                        2007Revenues
                                        
                                        $
                                        10,656,081
                                        
                                        
                                        $
                                        6,883,343Operating
      ExpensesCost
      of revenues (exclusive of depreciation)
                                        
                                        
                                        4,076,100
                                        
                                        
                                        
                                        2,469,065Depreciation
                                        
                                        
                                        3,222,716
                                        
                                        
                                        
                                        1,879,515Customer
      support services
                                        
                                        
                                        1,820,101
                                        
                                        
                                        
                                        931,785Sales
      and marketing
                                        
                                        
                                        7,692,268
                                        
                                        
                                        
                                        3,588,111General
      and administrative
                                        
                                        
                                        7,208,801
                                        
                                        
                                        
                                        6,827,036Total
      Operating Expenses
                                        
                                        
                                        24,019,986
                                        
                                        
                                        
                                        15,695,512Operating
      Loss
                                        
                                        
                                        (13,363,905
                                        )
                                        
                                        
                                        (8,812,169
                                        )Other
      (Expense) IncomeInterest
      income
                                        
                                        
                                        578,373
                                        
                                        
                                        
                                        1,460,825Interest
      expense
                                        
                                        
                                        (509,593
                                        )
                                        
                                        
                                        (974,774
                                        )Other
      expense, net
                                        
                                        
                                        (82,294
                                        )
                                        
                                        
                                        (175,607
                                        )Total
      Other (Expense) Income
                                        
                                        
                                        (13,514
                                        )
                                        
                                        
                                        310,444Net
      Loss
                                        
                                        $
                                        (13,377,419
                                        )
                                        
                                        $
                                        (8,501,725
                                        )Net
      loss per common share - basic and diluted
                                        
                                        $
                                        (0.39
                                        )
                                        
                                        $
                                        (0.29
                                        )Weighted
      average common shares outstanding – basic and diluted
                                        
                                        
                                        34,543,972
                                        
                                        
                                        
                                        29,243,802




The
accompanying notes are an integral part of these consolidated financial
statements.




27
 Table of Contents




TOWERSTREAM CORPORATION


CONSOLIDATED
STATEMENT OF STOCKHOLDERS’ EQUITY


For
the Years Ended December 31, 2008 and 2007




Common Stock
                            
                            
                            Additional
                              Paid-In-
                            
                            
                            Deferred
                              Consulting
                            
                            
                            AccumulatedShares
                            
                            
                            Amount
                            
                            
                            Capital
                            
                            
                            Costs
                            
                            
                            Deficit
                            
                            
                            TotalBalance
      at January 1, 2007 (see Note 1)
                            
                            
                            15,000,000
                            
                            
                            $
                            15,000
                            
                            
                            $
                            8,896,803
                            
                            
                            $
                            -
                            
                            
                            $
                            (8,213,002
                            )
                            
                            $
                            698,801University
      Girls Calendar,  Ltd. upon mergeron
      January 12, 2007
                            
                            
                            1,900,000
                            
                            
                            
                            1,900
                            
                            
                            
                            (18,652
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (16,752
                            )Recapitalization
      of accumulated deficit at thetime
      of S corporation revocation
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (8,213,002
                            )
                            
                            
                            
                            
                            
                            
                            8,213,002
                            
                            
                            
                            -Net
      proceeds from issuance of common stock –January
      12, 2007
                            
                            
                            5,110,056
                            
                            
                            
                            5,110
                            
                            
                            
                            11,046,127
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            11,051,237Net
      proceeds from issuance of common stock –June
      11, 2007
                            
                            
                            10,000,000
                            
                            
                            
                            10,000
                            
                            
                            
                            37,190,000
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            37,200,000Conversion
      of stockholder’s notes payable
                            
                            
                            1,302,582
                            
                            
                            
                            1,303
                            
                            
                            
                            1,940,333
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            1,941,636Conversion
      of notes payable
                            
                            
                            156,250
                            
                            
                            
                            156
                            
                            
                            
                            249,844
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            250,000Beneficial
      conversion feature upon conversionof
      stockholder’s notes payable into commonstock
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            378,055
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            378,055Issuance
      of common stock for consultingservices
                            
                            
                            200,000
                            
                            
                            
                            200
                            
                            
                            
                            401,800
                            
                            
                            
                            (402,000
                            )
                            
                            
                            
                            
                            
                            
                            -Exercise
      of warrants
                            
                            
                            56,062
                            
                            
                            
                            56
                            
                            
                            
                            119,917
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            119,973Exercise
      of options
                            
                            
                            4,672
                            
                            
                            
                            5
                            
                            
                            
                            6,676
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            6,681Fair
      value of warrants issued in connectionwith
      issuance of debentures
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            526,927
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            526,927Issuance
      of warrants to placement agent inconnection
      with issuance of debentures
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            34,750
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            34,750Cashless
      exercise of warrants
                            
                            
                            350,431
                            
                            
                            
                            350
                            
                            
                            
                            (350
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Stock-based
      compensation
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            663,805
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            663,805Amortization
      of deferred consulting costs
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            381,900
                            
                            
                            
                            
                            
                            
                            
                            381,900Net
      loss
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (8,501,725
                            )
                            
                            
                            (8,501,725
                            )Balance
      at December 31, 2007
                            
                            
                            34,080,053
                            
                            
                            
                            34,080
                            
                            
                            
                            53,223,033
                            
                            
                            
                            (20,100
                            )
                            
                            
                            (8,501,725
                            )
                            
                            
                            44,735,288Conversion
      of long-term debt
                            
                            
                            272,727
                            
                            
                            
                            273
                            
                            
                            
                            749,727
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            750,000Issuance
      of common stock for bonuses
                            
                            
                            31,099
                            
                            
                            
                            31
                            
                            
                            
                            21,116
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            21,147Cashless
      exercise of warrants
                            
                            
                            184,938
                            
                            
                            
                            185
                            
                            
                            
                            (185
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Cashless
      exercise of options
                            
                            
                            19,037
                            
                            
                            
                            19
                            
                            
                            
                            (19
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            -Payment
      for fractional shares upon cashlessexercise
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (9
                            )
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (9
                            )Stock-based
      compensation
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            858,092
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            858,092Amortization
      of deferred consulting costs
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            20,100
                            
                            
                            
                            
                            
                            
                            
                            20,100Net
      loss
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            
                            (13,377,419
                            )
                            
                            
                            (13,377,419
                            )Balance
      at December 31, 2008
                            
                            
                            34,587,854
                            
                            
                            $
                            34,588
                            
                            
                            $
                            54,851,755
                            
                            
                            $
                            -
                            
                            
                            $
                            (21,879,144
                            )
                            
                            $
                            33,007,199





The
accompanying notes are an integral part of these consolidated financial
statements.




28
 Table of Contents




TOWERSTREAM CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS





For the Years Ended December 31,2008
                                            
                                            
                                            2007Cash Flows From Operating
      ActivitiesNet
      loss
                                            
                                            $
                                            (13,377,419
                                            )
                                            
                                            $
                                            (8,501,725
                                            )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Provision
      for doubtful accounts
                                            
                                            
                                            65,000
                                            
                                            
                                            
                                            90,000Depreciation
                                            
                                            
                                            3,222,716
                                            
                                            
                                            
                                            1,879,515Stock-based
      compensation
                                            
                                            
                                            899,339
                                            
                                            
                                            
                                            1,045,705Non-cash
      interest on notes payable
                                            
                                            
                                            73,393
                                            
                                            
                                            
                                            74,882Amortization
      of beneficial conversion feature
                                            
                                            
                                            -
                                            
                                            
                                            
                                            378,055Accretion
      of debt discount
                                            
                                            
                                            141,141
                                            
                                            
                                            
                                            169,788Amortization
      of financing costs
                                            
                                            
                                            58,250
                                            
                                            
                                            
                                            56,308Deferred
      rent
                                            
                                            
                                            133,471
                                            
                                            
                                            
                                            273,153Loss
      on sale and disposition of property and equipment
                                            
                                            
                                            83,409
                                            
                                            
                                            
                                            25,631Other
                                            
                                            
                                            -
                                            
                                            
                                            
                                            1,139Changes
      in operating assets and liabilities:Accounts
      receivable
                                            
                                            
                                            (159,778
                                            )
                                            
                                            
                                            (117,178
                                            )Prepaid
      expenses and other current assets
                                            
                                            
                                            477,024
                                            
                                            
                                            
                                            (710,955
                                            )Accounts
      payable
                                            
                                            
                                            (19,493
                                            )
                                            
                                            
                                            579,025Accrued
      expenses
                                            
                                            
                                            175,813
                                            
                                            
                                            
                                            562,157Deferred
      compensation
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (10,000
                                            )Deferred
      revenues
                                            
                                            
                                            353,897
                                            
                                            
                                            
                                            230,740Total
      Adjustments
                                            
                                            
                                            5,504,182
                                            
                                            
                                            
                                            4,527,965Net
      Cash Used In Operating Activities
                                            
                                            
                                            (7,873,237
                                            )
                                            
                                            
                                            (3,973,760
                                            )Cash Flows From Investing
      ActivitiesAcquisitions
      of property and equipment
                                            
                                            
                                            (7,683,855
                                            )
                                            
                                            
                                            (6,709,917
                                            )Proceeds
      from sale of property and equipment
                                            
                                            
                                            5,700
                                            
                                            
                                            
                                            44,600Acquisition
      of FCC licenses
                                            
                                            
                                            (400,000
                                            )
                                            
                                            
                                            (125,000
                                            )Change
      in security deposits
                                            
                                            
                                            (17,715
                                            )
                                            
                                            
                                            (104,797
                                            )Net
      Cash Used In Investing Activities
                                            
                                            
                                            (8,095,870
                                            )
                                            
                                            
                                            (6,895,114
                                            )Cash Flows From Financing
      ActivitiesNet
      proceeds from sale of debentures
                                            
                                            
                                            -
                                            
                                            
                                            
                                            3,360,000Repayment
      of stockholder notes
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (200,000
                                            )Repayment
      of equipment note
                                            
                                            
                                            -
                                            
                                            
                                            
                                            (9,341
                                            )Payment
      for fractional shares issuable upon cashless exercise of
      warrants
                                            
                                            
                                            (9
                                            )
                                            
                                            
                                            -Repayment
      of capital leases
                                            
                                            
                                            (47,481
                                            )
                                            
                                            
                                            (63,174
                                            )Proceeds
      from exercise of warrants
                                            
                                            
                                            -
                                            
                                            
                                            
                                            119,973Proceeds
      from exercise of options
                                            
                                            
                                            -
                                            
                                            
                                            
                                            6,681Net
      proceeds from sale of common stock
                                            
                                            
                                            -
                                            
                                            
                                            
                                            48,251,237Net
      Cash (Used In) Provided By Financing Activities
                                            
                                            
                                            (47,490
                                            )
                                            
                                            
                                            51,465,376Net
      (Decrease) Increase In Cash and Cash Equivalents
                                            
                                            
                                            (16,016,597
                                            )
                                            
                                            
                                            40,596,502Cash and Cash Equivalents –
      Beginning
                                            
                                            
                                            40,756,865
                                            
                                            
                                            
                                            160,363Cash and Cash Equivalents –
      Ending
                                            
                                            $
                                            24,740,268
                                            
                                            
                                            $
                                            40,756,865





The
accompanying notes are an integral part of these consolidated financial
statements.




29
 Table of Contents




TOWERSTREAM
CORPORATION


CONSOLIDATED
STATEMENTS OF CASH FLOWS - CONTINUED





For the Years Ended
                                December 31,2008
                              
                              2007Supplemental Disclosures of Cash Flow
      InformationCash
      paid for:Interest
                              
                              $
                              172,427
                              
                              
                              $
                              321,694Non-cash
      investing and financing activities:Conversion
      of principal and interest on notes payable into shares of common
      stock
                              
                              $
                              −
                              
                              
                              $
                              2,191,636Conversion
      of long-term debt into shares of common stock
                              
                              $
                              750,000
                              
                              
                              $
                              −Assumption
      of accounts payable in reverse merger transaction
                              
                              $
                              −
                              
                              
                              $
                              16,752





The
accompanying notes are an integral part of these consolidated financial
statements.




30
 Table of Contents




TOWERSTREAM CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Note
1.    Organization and Nature of Business




Towerstream
Corporation (herein after referred to as ‘‘Towerstream’’ or the ‘‘Company’’) was
formed on December 17, 1999 and was incorporated in Delaware. In January 2007,
the Company terminated its Sub S tax status and elected to operate as a C
corporation with its corporate headquarters located in Rhode
Island.




In
January 2007, Towerstream merged with a newly formed subsidiary of University
Girls Calendar Ltd. (‘‘UGC’’), a publicly traded shell company. In connection
with the merger, all outstanding shares of UGC were cancelled, except for
1,900,000 shares of common stock. Also, in connection with the merger, UGC
issued 15,000,000 shares of its common stock for all the outstanding common
stock of Towerstream. As a result of the transaction, the former owners of
Towerstream became the controlling stockholders of UGC which also changed its
name to Towerstream Corporation. The previously private company, Towerstream
Corporation, changed its name to Towerstream I, Inc., and became a wholly-owned
subsidiary of the publicly traded company. The merger of Towerstream and UGC was
a reverse merger that was accounted for as a recapitalization of
Towerstream.




The
Company provides fixed wireless broadband services to commercial customers
based on a monthly recurring revenue model. The Company provides
customers high speed Internet access over a fixed wireless network transmitting
over both regulated and unregulated radio spectrum. The Company’s service
supports bandwidth on demand, wireless redundancy, virtual private networks
(“VPNs”), disaster recovery, bundled data and video services. The Company
provides service to business customers in New York City, Boston, Chicago, Los
Angeles, San Francisco, Seattle, Miami, Dallas-Fort Worth, Providence and
Newport, Rhode Island.




Note
2.    Summary of Significant Accounting
Policies




Basis of Presentation. The
consolidated financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America for
annual financial statements and with Form 10-K and Article 8 of Regulation S-X
of the Securities and Exchange Commission (“SEC”). The consolidated financial
statements include the accounts of the Company and its wholly owned
subsidiaries. All significant intercompany balances and transactions have been
eliminated in consolidation. In the opinion of the Company’s management, the
accompanying consolidated financial statements contain all the adjustments
necessary (consisting only of normal recurring accruals) to present the
financial position of the Company as of December 31, 2008 and 2007, and the
results of operations and cash flows for the years ended December 31, 2008 and
2007 not misleading.




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





Cash and Cash Equivalents.
The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.




Concentration of Credit Risk.
Financial instruments that potentially subject the Company to significant
concentrations of credit risk consist of cash and cash equivalents.




At times,
our cash and cash equivalents may be uninsured or in deposit accounts that
exceed the Federal Deposit Insurance Corporation (“FDIC”) insurance
limits.





The
Company also had approximately $23,683,000 invested in four institutional money
market funds. These funds are protected under the Securities Investor Protection
Corporation (‘‘SIPC’’), a nonprofit membership corporation which provides
limited coverage up to $500,000.




Accounts Receivable. Accounts
receivable are stated at cost less an allowance for doubtful accounts. The
allowance for doubtful accounts reflects the Company’s estimate of accounts
receivable that will be not collected. The allowance is based on the history of
past write-offs, the aging of balances, collections experience and current
credit conditions. Amounts determined to be uncollectible are written-off
against the allowance for doubtful accounts. Additions to the allowance for
doubtful accounts, e.g. bad debt expense, totaled
$65,000 and $90,000 for 2008 and 2007, respectively. Deductions to the allowance
for doubtful accounts, e.g. customer write-offs, totaled $75,966 and $119,630
for 2008 and 2007, respectively.




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NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED




Property and
Equipment.Property and
equipment are stated at cost and include equipment, installation costs and
materials. Depreciation is calculated on a straight-line basis over the
estimated useful lives of the assets. Leasehold improvements are amortized over
the lesser of the useful lives or the term of the respective lease. Network,
base station and customer premise equipment are depreciated over estimated
useful lives ranging from 5 to 7 years; furniture, fixtures and office equipment
from 5 to 7 years; computer equipment of 3 to 5 years; and system software of 3
years.




Expenditures
for maintenance and repairs, which do not generally extend the useful life of
the assets, are charged to expense as incurred. Gains or losses on disposal of
property and equipment are reflected in the statement of operations in the
period of disposal.




FCC Licenses. Federal
Communication Commission (“FCC”) licenses are initially recorded at cost and are
considered to be intangible assets with an indefinite life because the Company
is able to maintain the license indefinitely as long as it complies with certain
FCC requirements. The Company intends to maintain compliance with such
requirements. Statement of Financial Accounting Standards (“SFAS”) No. 142,
“Goodwill and Other Intangible Assets”, (“FAS 142”) provides that an asset with
an indefinite useful life is not amortized. However, as further described in the
next paragraph, these assets are reviewed annually for impairment.




Long-Lived Assets.Long-lived
assets consist primarily of property and equipment, and FCC licenses. Long-lived
assets are reviewed annually for impairment, or whenever events or circumstances
indicate their carrying value may not be recoverable. Conditions that would
result in an impairment charge include a significant decline in the market value
of an asset, a significant change in the extent or manner in which an asset is
used, or a significant adverse change that would indicate that the carrying
amount of an asset or group of assets is not recoverable. When such events or
circumstances arise, an estimate of the future undiscounted cash flows produced
by the asset, or the appropriate grouping of assets, is compared to the asset’s
carrying value to determine if impairment exists pursuant to the requirements of
SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets”.
If the asset is determined to be impaired, the impairment loss is measured based
on the excess of its carrying value over its fair value. Assets to be disposed
of are reported at the lower of their carrying value or net realizable
value.





The
Company has determined that there were no impairments of its property and
equipment or its FCC licenses during the years ended December 31, 2008 and
2007.





SFAS No.
143, “Accounting for Asset Retirement Obligations”, (“FAS 143”) addresses
financial accounting and reporting for obligations associated with the
retirement of tangible long-lived assets and the associated asset retirement
costs. FAS 143 requires the recognition of an asset retirement obligation and an
associated asset retirement cost when there is a legal obligation in connection
with the retirement of tangible long-lived assets. The Company’s network
equipment is installed on both buildings in which the Company has a lease
agreement (“Company Locations”) and at customer locations. In both instances,
the installation and removal of the Company’s equipment is not complicated and
does not require structural changes to the building where the equipment is
installed. Costs associated with the removal of the Company’s equipment at
company or customer locations are not material, and accordingly, the Company has
determined that it does not presently have asset retirement obligations under
FAS 143.





Fair Value of Financial
Instruments. In January 2008, the Company adopted the provisions of SFAS
No. 157, “Fair Value Measurements”, (“FAS 157”) which defines fair value for
accounting purposes, establishes a framework for measuring fair value and
expands disclosure requirements regarding fair value measurements. The Company’s
adoption of FAS 157 did not have a material impact on its consolidated financial
statements. Fair value is defined as an exit price, which is the price that
would be received upon sale of an asset or paid upon transfer of a liability in
an orderly transaction between market participants at the measurement date. The
degree of judgment utilized in measuring the fair value of assets and
liabilities generally correlates to the level of pricing observability.
Financial assets and liabilities with readily available, actively quoted prices
or for which fair value can be measured from actively quoted prices in active
markets generally have more pricing observability and require less judgment in
measuring fair value. Conversely, financial assets and liabilities that are
rarely traded or not quoted have less price observability and are generally
measured at fair value using valuation models that require more judgment. These
valuation techniques involve some level of management estimation and judgment,
the degree of which is dependent on the price transparency of the asset,
liability or market and the nature of the asset or liability. The Company has
categorized its financial assets and liabilities measured at fair value into a
three-level
hierarchy in accordance with FAS 157. See Note 13 for a further discussion
regarding the Company’s measurement of financial assets and liabilities at fair
value.





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CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





Income Taxes. Income taxes
are accounted for under the asset and liability method. Deferred tax assets and
liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases, and operating loss and tax
credit carryforwards. Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect
on deferred tax assets and liabilities of a change in tax rates is recognized in
operations in the period that includes the enactment date. A valuation allowance
is provided when it is more likely than not that some portion or all of a
deferred tax asset will not be realized. The ultimate realization of deferred
tax assets is dependent upon the generation of future taxable income and the
reversal of deferred tax liabilities during the period in which related
temporary differences become deductible. The benefit of tax positions taken or
expected to be taken in the Company’s income tax returns are recognized in the
consolidated financial statements if such positions are more likely than not of
being sustained.





Segment Information.SFAS No.
131, “Disclosures about Segments of an Enterprise and Related Information”,
(“FAS 131”) establishes standards for reporting information on operating
segments in interim and annual financial statements. The Company operates in one
segment which is the business of fixed wireless broadband services. The
Company’s chief operating decision-maker reviews the Company’s operating results
on an aggregate basis and manages the Company’s operations as a single operating
segment.





Revenue Recognition. The
Company normally enters into contractual agreements with its customers for
periods ranging between one to three years. The Company recognizes the total
revenue provided under a contract ratably over the contract period, including
any periods under which the Company has agreed to provide services at no cost.
Deferred revenues are recognized as a liability when billings are received in
advance of the date when revenues are earned. The Company applies the revenue
recognition principles set forth under SEC Staff Accounting Bulletin 104, (“SAB
104”) which provides for revenue to be recognized when (i) persuasive evidence
of an arrangement exists, (ii) delivery or installation has been completed,
(iii) the customer accepts and verifies receipt, and (iv) collectability is
reasonably assured.





Deferred Revenues. Deferred
revenues consist of either prepayment of future service periods or payments
received for current services which overlap monthly reporting
periods.




Advertising Costs.The
Company charges advertising costs to expense as incurred. Advertising costs for
the years ended December 31, 2008 and 2007 were approximately $1,024,000 and
$594,000, respectively, and are included in sales and marketing expenses in the
accompanying consolidated statements of operations.





Stock-Based
Compensation.The Company
accounts for share-based awards exchanged for employee services in accordance
with SFAS No. 123(R), “Share-Based Payment”, (“FAS 123(R)”). Under FAS 123(R),
share-based compensation expense is measured at the grant date, based on the
estimated fair value of the award, and is recognized as expense, net of
estimated forfeitures, over the employee’s requisite service period.
Compensation expense is amortized on a straight-line basis over the requisite
service period for the entire award, which is generally the maximum vesting
period of the award.





Basic and Diluted Loss Per
Share. Net loss per share is computed in accordance with SFAS No. 128,
‘‘Earnings Per Share’’, (‘‘FAS 128’’) which requires the presentation of both
basic and diluted earnings per share.




Basic and
diluted net loss per share has been calculated by dividing net loss by the
weighted average number of common shares outstanding during the period. All
potentially dilutive common shares have been excluded since their inclusion
would be antidilutive.


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CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED


The
following common stock equivalents were excluded from the computation of diluted
net loss per common share because they were antidilutive. The exercise of these
common stock equivalents outstanding could potentially dilute earnings per
shares in the future. The exercise of the outstanding stock options and warrants
could generate proceeds up to approximately $26,067,000.




Years Ended December 31,2008
                              
                              
                              2007Stock
      options
                              
                              
                              3,335,793
                              
                              
                              
                              2,328,067Warrants
                              
                              
                              4,332,310
                              
                              
                              
                              4,672,325Convertible
      debt
                              
                              
                              1,000,001
                              
                              
                              
                              1,272,728Total
                              
                              
                              8,668,104
                              
                              
                              
                              8,273,120




Reclassifications.Certain accounts in the prior year
consolidated financial statements have been reclassified for comparative
purposes to conform to the presentation in the current year consolidated
financial statements. These reclassifications have no effect on the previously
reported net loss.





Recent Accounting Pronouncements.In September 2006, the Financial Accounting Standards Board (“FASB”)
issued FAS 157, which is effective for fiscal years beginning after November 15,
2007 and for interim periods within those years. This statement defines fair
value, establishes a framework for measuring fair value and expands the related
disclosure requirements. This statement applies under other accounting
pronouncements that require or permit fair value measurements. The statement
indicates, among other things, that a fair value measurement assumes that the
transaction to sell an asset or transfer a liability occurs in the principal
market for the asset or liability or, in the absence of a principal market, the
most advantageous market for the asset or liability. FAS 157 defines fair value
based upon an exit price model. Relative to FAS 157, the FASB issued FASB Staff
Positions (“FSP”) 157-1, FSP 157-2, and proposed FSP 157-c. FSP 157-1 amends FAS
157 to exclude SFAS No. 13, “Accounting for Leases”, (“FAS 13”), and its related
interpretive accounting pronouncements that address leasing transactions, while
FSP 157-2 delays the effective date of FAS 157 for all nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair
value in the financial statements on a recurring basis. FSP 157-c clarifies the
principles in FAS 157 on the fair value measurement of liabilities. The Company
adopted FAS 157 as of January 1, 2008, with the exception of the application of
the statement to nonrecurring nonfinancial assets and nonfinancial liabilities.
While the Company is currently evaluating the impact of the application of the
statement to nonrecurring nonfinancial assets and nonfinancial liabilities on
its consolidated financial statements upon adoption, the Company does not
anticipate a material impact on its consolidated financial position and results
of operations. Refer to Note 13 for additional discussion on fair value
measurements.





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities -including an amendment of FASB
Statement No. 115”, (“FAS 159”) which permits entities to choose to measure many
financial instruments and certain other items at fair value. The fair value
option permits entities to choose to measure eligible items at fair value at
specified election dates. A business entity shall report unrealized gains and
losses on items for which the fair value option has been elected in earnings at
each subsequent reporting date. Adoption is required for fiscal years beginning
after November 15, 2007. The Company adopted FAS 159 on January 1, 2008, but
elected not to apply the fair value option to any of its eligible financial
assets or liabilities at that date. Therefore, the provisions of FAS 159 had no
impact on the Company’s consolidated financial position and results of
operations for the year ended December 31, 2008.





In
December 2007, the FASB issued SFAS No. 141(R), "Business Combinations", (“FAS
141(R)”) which replaces SFAS No. 141, “Business Combinations”. FAS 141(R)
establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent consideration and certain acquired contingencies. FAS 141(R) also
requires that acquisition-related transaction expenses and restructuring costs
be expensed as incurred rather than capitalized as a component of the business
combination. FAS 141(R) will be applicable prospectively beginning January 1,
2009.





In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements, an Amendment of ARB No. 51", (“FAS 160”). FAS
160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary (previously referred to as minority interests). FAS 160
also requires that a retained noncontrolling interest upon the deconsolidation
of a subsidiary be initially measured at its fair value. Upon adoption of FAS
160, the Company will be required to report any noncontrolling interests as a
separate component of consolidated stockholders’ equity. The Company will also
be required to
present any net income allocable to noncontrolling interests and net income
attributable to the stockholders of the Company separately in its consolidated
statements ofoperations. FAS 160 is effective prospectively beginning January 1,
2009.




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NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





In May
2008, FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting
Principles”,(“FAS
162”). FAS 162 identifies the sources of accounting principles and the framework
for selecting the principles to be used in the preparation of financial
statements of nongovernmental entities that are presented in conformity with
United States Generally Accepted Accounting Principles (“GAAP”). FAS 162 directs
the GAAP hierarchy to the entity, not the independent auditors, as the entity is
responsible for selecting accounting principles for the financial statements
that are presented in conformity with GAAP. FAS 162 is effective November 15,
2008. The adoption of this pronouncement did not have any impact on the
Company’s consolidated financial position, results of operations or cash
flows.





In April
2008, the FASB issued FASB Staff Position (“FSP”) FAS 142-3, “Determination of
the Useful Life of Intangible Assets.” This FSP amends the factors that should
be considered in developing renewal or extension assumptions used to determine
the useful life of a recognized intangible asset under FAS 142. The objective of
this FSP is to improve the consistency between the useful life of a recognized
intangible asset under FAS 142 and the period of expected cash flows used to
measure the fair value of the asset under FAS 141(R) and other United States
GAAP principles. This FSP is effective beginning January 1, 2009. The Company is
in the process of evaluating the impact of this provision on its consolidated
financial position and results of operations.





In May
2008, the FASB issued FASB APB Staff Position 14-1, “Accounting for Convertible
Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial
Cash Settlement)”, (“FSP APB 14-1”). FSP APB 14-1 specifies that for convertible
debt instruments that may be settled in cash upon conversion, issuers of such
instruments should separately account for the liability and equity components in
the statement of financial condition. The excess of the initial proceeds of the
convertible debt instrument over the amount allocated to the liability component
creates a debt discount which should be amortized as interest expense over the
expected life of the liability. FSP APB 14-1 is effective beginning January 1,
2009 and is to be applied retrospectively. The Company is currently evaluating
the impact of adopting FSP APB 14-1 on its financial position and results of
operations.





Note
3.    Property and Equipment, net




The Company’s property and equipment,
net is comprised of:





December 31,2008
                            
                            
                            2007Network
      and base station equipment
                            
                            $
                            11,075,631
                            
                            
                            $
                            7,448,258Customer
      premise equipment
                            
                            
                            7,079,096
                            
                            
                            
                            4,120,647Furniture,
      fixtures and equipment
                            
                            
                            1,525,980
                            
                            
                            
                            1,294,472Computer
      equipment
                            
                            
                            559,645
                            
                            
                            
                            476,206System
      software
                            
                            
                            789,810
                            
                            
                            
                            473,261Leasehold
      improvements
                            
                            
                            775,420
                            
                            
                            
                            496,36821,805,582
                            
                            
                            
                            14,309,212Less:
      accumulated depreciation
                            
                            
                            8,914,803
                            
                            
                            
                            5,790,462$
                            12,890,779
                            
                            
                            $
                            8,518,750




Depreciation
expense for the years ended December 31, 2008 and 2007 was $3,222,716 and
$1,879,515, respectively. The Company sold or wrote-off property and equipment
with $187,485 of cost and $98,375 of accumulated depreciation for the year ended
December 31, 2008.  The Company sold or wrote-off property and
equipment with $142,907 of cost and $72,670 of accumulated depreciation for the
year ended December 31, 2007.




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CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





Property
held under capital leases included within the Company’s property and equipment
consists of the following:





December 31,2008
                  
                  
                  2007Network
      and base station equipment
                  
                  $
                  168,441
                  
                  
                  $
                  194,702Less:
      accumulated depreciation
                  
                  
                  106,099
                  
                  
                  
                  93,419$
                  62,342
                  
                  
                  $
                  101,283




The
Company wrote-off property and equipment under capital leases with $26,261 of
cost and $25,386 of accumulated deprecation during the year ended December 31,
2008.





Note
4.    Accrued Expenses





Accrued expenses consist of the
following:





December
      31,2008
                
                
                2007Payroll
      and related
                
                $
                510,608
                
                
                $
                376,318Penalties
                
                
                149,976
                
                
                
                149,976Interest
                
                
                55,000
                
                
                
                -Rent
                
                
                50,149
                
                
                
                -Advertising
                
                
                -
                
                
                
                45,950Other
                
                
                95,657
                
                
                
                113,332Total
                
                $
                861,390
                
                
                $
                685,576





Note
5.    Debt




In
January 2007, the Company issued $3,500,000 of 8% senior convertible debentures
(the ‘‘Debentures’’). These Debentures mature on December 31, 2009, and are
convertible, in whole or in part, into shares of common stock at an initial
conversion price of $2.75 per share. In addition, holders of the Debentures
received warrants to purchase an aggregate of 636,364 shares of common stock at
an exercise price of $4.00 per share and warrants to purchase an aggregate of
636,364 shares of common stock at an exercise price of $6.00 per share. These
warrants are exercisable until January 2012 and were calculated using the
Black-Scholes option pricing model. The proceeds were allocated between the
warrants ($526,927) and the Debentures ($2,973,073) based on their relative fair
values. The initial, discounted carrying value of the Debentures of $2,973,073
is being accreted to the maturity value over the term of the Debentures. The
amount of accretion recorded in each period is recognized as non-cash interest
expense. Interest expense totaled $361,689 during 2008 and included $220,548
associated with the 8% coupon and $141,141 associated with the accretion of the
discount. Interest expense totaled $437,962 during 2007 and included $268,174
associated with the 8% coupon and $169,788 associated with the accretion of the
discount.





In
January 2008, a Debenture holder converted $750,000 of Debentures into common
stock at a conversion price of $2.75 per share resulting in the issuance of
272,727 shares of common stock. The carrying value of the Debentures on the date
of conversion was $676,607. Accordingly, the Company recognized the remaining
debt discount of $73,393 as non-cash interest expense in connection with the
conversion.




Should
the Company, at any time while the Debentures are outstanding, sell or grant any
option to purchase or sell or grant any right to reprice, or otherwise dispose
of or issue any common stock entitling any party to acquire shares of the
Company’s common stock at a per share price less than $2.75, the conversion
price of the Debentures shall be reduced to equal that lower price.




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CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





The terms
of the Debentures provide for interest on the outstanding principal at the rate
of 8% per annum, payable quarterly commencing January 1, 2008. So long as a
resale registration statement is in effect with respect to the shares of common
stock underlying the Debentures and the debenture holders are not subject to any
market standoff provisions, as described below, interest is payable in either
cash or common stock, at the Company’s option. If interest is paid in common
stock, however, the shares shall be




As part
of the debenture agreement, the Company may not pledge or grant a lien on any of
its assets without the debenture holders’ consent.




In
connection with the Debentures, the Company incurred placement agent fees
totaling approximately $140,000 and issued placement agent warrants to purchase
up to 63,636 shares of common stock at an exercise price of $4.50 per share. The
warrants are exercisable for five years and were valued at $34,750 using the
Black-Scholes pricing model. These financing costs are being amortized over the
term of the debenture agreement.




Note
6.    Capital Lease Obligations





The
Company leases certain equipment under various capital leases expiring in 2009.
Lease obligations at December 31, 2008 total $26,670, of which $25,346
represents principal and $1,324 represents deferred interest expense. The assets
are depreciated over the lease term, which approximates their useful lives,
using the straight-line method. Depreciation expense of assets under capital
leases in 2008 and 2007 was approximately $38,000 and $39,000
respectively.





Note
7.    Capital Stock




The Company is authorized to issue
5,000,000 shares of preferred stock at a par value of $0.001. There were no
issuances of preferred stock as of December 31, 2008 and 2007,
respectively.





The
Company is authorized to issue 70,000,000 shares of common stock at a par value
of $0.001. The holders of common stock are entitled to one vote per share. The
holders of the Company’s common stock are entitled to receive ratably such
dividends, if any, as may be declared by the board of directors out of legally
available funds. Upon liquidation, dissolution or winding-up, the holders of the
Company’s common stock are entitled to share ratably in all assets that are
legally available for distribution. The holders of the Company’s common stock
have no preemptive, subscription, redemption or conversion rights. The rights,
preferences and privileges of holders of the Company’s common stock are subject
to, and may be adversely affected by, the rights of the holders of any series of
preferred stock, which may be designated solely by action of the board of
directors and issued in the future.





During
2008, two former employees exercised options to purchase a total of 185,705
shares. The options were exercised on a cashless exercise basis resulting in the
issuance of 19,037 shares. Also in 2008, two former employees exercised warrants
to purchase a total of 251,717 shares. The warrants were exercised on a cashless
exercise basis resulting in the issuance of 184,938 shares. Under a cashless
exercise, the holder uses a portion of the shares that would otherwise be
issuable upon exercise, rather than cash, as consideration for the exercise. The
amount of net shares issuable in connection with a cashless exercise will vary
based on the exercise price of the option or warrant compared to the current
market price of the Company’s common stock on the date of exercise.





In
December 2008, 31,099 shares of common stock were issued to certain executive
officers as part of their quarterly bonuses. The Company recognized compensation
expense totaling $21,147 which represented the fair value of the shares on the
date of issuance.





During
2007, two former employees exercised options to purchase a total of 4,672 shares
at an exercise price of $1.43 per share.




In June
2007, the Company issued 10,000,000 shares of common stock in connection with a
registered direct offering (the ‘‘Registered Offering’’) at $4.00 per share,
resulting in gross proceeds of $40,000,000. In connection with the Registered
Offering, the Company
incurred placement agent fees of $2,800,000 and issued warrants to purchase
300,000 shares of common stock to the placement agents at an exercise price of
$4.00 per share for a period of five years.




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CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED




In June
2007, stockholders exercised warrants to purchase 325,000 and 75,000 shares,
respectively. Both transactions were cashless exercises. Accordingly, 288,976
shares were issued in exchange for the 325,000 warrants exercised and 61,455
shares were issued in exchange for the 75,000 warrants exercised.




In
connection with each of its January 2007 unit and debenture private placements,
the Company entered into a registration rights agreement, pursuant to which it
agreed to file a registration statement with the SEC to register the resale of
the shares of common stock issued as part of the units together with the common
stock underlying the unit warrants, the debentures and the debenture warrants,
and to cause such registration statement to be declared effective by the SEC on
or before May 28, 2007. This registration statement was not declared effective
until July 18, 2007. Accordingly, the Company recognized a liability of
approximately $150,000 representing liquidated damages equal to 1% of the
purchase price of the affected investors.





In
February 2007, warrants to purchase 56,062 shares of common stock were exercised
for $119,973.





In January 2007, concurrent with the
Merger, UGC sold 5,110,056 shares of common stock for gross proceeds of
$11,497,625 (at $2.25 per share) through a private placement (the ‘‘Private
Placement’’). In addition, investors received warrants to purchase 2,555,030
shares of common stock for a period of five years at an exercise price of $4.50
per share. In connection
with the Private Placement, UGC incurred placement agent fees totaling
approximately $446,400, and issued warrants to purchase up to 140,916 shares of
common stock to the placement agent at an exercise price of $4.50 per share for
a period of five years.




In
January 2007, certain stockholders collectively transferred an aggregate of
$1,616,754 in outstanding promissory notes and other payables due from
Towerstream to a group of third party investors. In connection with these
transfers, Towerstream issued new promissory notes to these investors with an
aggregate principal sum of $1,691,636 and cancelled the previous obligations.
The increase in the notes payable of approximately $75,000 was recorded as
additional interest expense by the Company. These notes were automatically
converted into 1,127,757 shares of common stock of UGC at a discounted
conversion price as a result of the Merger. The Company recognized non-cash
interest expense of approximately $314,000, representing the discounted
amount.




In
January 2007, concurrent with the Merger, a stockholder converted a $250,000
note exercised into 174,825 shares of common stock at $1.43 per
share.




In
January 2007, concurrent with the Merger, a $250,000 promissory note was
converted into 156,250 shares of common stock at a discounted conversion price
as a result of the Merger. The Company recognized non-cash interest expense of
approximately $64,000, representing the discounted amount.




In
January 2007, the Company entered into a one year consulting agreement for
investor relations services. The agreement provides for monthly payments of
$7,500 plus expenses and the issuance of 200,000 shares of common stock. The
fair value of the common shares was $402,000 which was amortized over the one
year consulting term. For the years ended December 31, 2008 and 2007, the
Company recognized $20,100 and $381,900, respectively, which were included in
general and administrative expenses.




Note
8.    Share-Based Compensation





The
Company uses the Black-Scholes valuation model to value options granted to
employees, directors and consultants. Compensation expense, including the effect
of forfeitures, is recognized over the period of service, generally the vesting
period. Stock-based compensation for the amortization of stock options granted
under the Company’s stock option plans totaled $858,092 and $663,805 for the
years ended December 31, 2008 and 2007, respectively. Stock-based compensation
for the amortization of stock-based consulting fees totaled $20,100 and $381,900
for the years ended December 31, 2008 and 2007, respectively. Stock-based
compensation is included in general and administrative expenses in the
accompanying consolidated statements of operations.




The
unamortized amount of stock options expense was $1,194,372 as of December 31,
2008, which will be recognized over a weighted-average period of 2.47 years.
There were no unamortized stock-based consulting fees as of December 31,
2008.




38
 Table of Contents




TOWERSTREAM
CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





The fair
values of stock option grants were calculated on the dates of grant using the
Black-Scholes option valuation model and the following weighted average
assumptions:





Years
      Ended December 31,2008
                      
                      
                      2007Risk-free
      interest rate
                      
                      
                      1.7%
      - 3.4
                      %
                      
                      
                      3.3%
      - 5.0
                      %Expected
      volatility
                      
                      
                      74%
      - 98
                      %
                      
                      
                      57%
      - 60
                      %Expected
      life (in years)
                      
                      
                      5 –
      6.5
                      
                      
                      
                      7Expected
      dividend yield
                      
                      
                      0
                      %
                      
                      
                      0
                      %




The
risk-free interest rate is based on rates established by the Federal Reserve. In
2008, the Company’s expected volatility was based upon the historical volatility
for its common stock. In 2007, the Company’s expected volatility was based on
the volatility of publicly-traded peers. In 2008, the expected life of the
Company’s options was determined using the simplified method under Staff
Accounting Bulletin No. 110 whereas in 2007, the expected life was based on the
period of time that options were expected to be outstanding. The dividend yield
is based upon the fact that the Company has not historically paid dividends, and
does not expect to pay dividends in the future.


For the
year ended December 31, 2008, the Company recorded $21,147 of additional
stock-based compensation related to the issuance of 31,099 shares of common
stock to certain executive officers as part of their 2008 bonus
program.





Note
9.    Employee Benefit Plan




The
Company has established a 401(k) retirement plan (“401(k) plan”) which covers
all eligible employees who have attained the age of twenty-one and have
completed 30 days of employment with the Company. The Company can elect to match
up to a certain amount of employees’ contributions to the 401(k) plan. No
employer contributions were made during the years ended December 31, 2008 and
2007.





Note
10. Income Taxes





The
provision for income taxes using the statutory Federal tax rate as compared to
the Company’s effective tax rate is summarized as follows:





For
      the Years Ended December 31,2008
                  
                  
                  2007Federal
      statutory rate
                  
                  
                  (34.0
                  )
      %
                  
                  
                  (34.0
                  )
      %State
      taxes
                  
                  
                  (6.0
                  )
      %
                  
                  
                  (6.0
                  )
      %Permanent
      differences
                  
                  
                  0.0
                  %
                  
                  
                  7.0
                  %Valuation
      allowance
                  
                  
                  40.0
                  %
                  
                  
                  33.0
                  %Effective
      tax rate
                  
                  
                  0.0
                  %
                  
                  
                  0.0
                  %





Income
tax benefit consists of the following:





For
      the Years Ended December 31,2008
                
                
                2007Income
      tax benefit at federal statutory rate
                
                $
                (4,548,394
                )
                
                $
                (2,387,218
                )State
      income taxes, net of federal benefit
                
                
                (802,658
                )
                
                
                (421,274
                )Other
                
                
                307,230
                
                
                
                236,590Change
      in valuation allowance
                
                
                5,043,822
                
                
                
                2,571,902Total
      income tax benefit
                
                $
                -
                
                
                $
                -




39
 Table of Contents




TOWERSTREAM
CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





As a
result of the Company’s significant net operating loss (“NOL”) and the
corresponding valuation allowance, no income tax benefit has been recorded at
December 31, 2008 and 2007.





Deferred
tax assets (liabilities) consist of the following:





For
      the Years Ended December 31,2008
                
                
                2007Net
      operating loss carryforward
                
                $
                7,939,891
                
                
                $
                2,612,914Stock-based
      compensation
                
                
                608,559
                
                
                
                418,082Allowance
      for doubtful accounts
                
                
                26,660
                
                
                
                31,046Other
                
                
                16,764
                
                
                
                6,667Deferred
      tax assets
                
                
                8,591,874
                
                
                
                3,068,709Depreciation
                
                
                (947,372
                )
                
                
                (485,918
                )FCC
      licenses
                
                
                (28,778
                )
                
                
                (10,889
                )Deferred
      tax liabilities
                
                
                (976,150
                )
                
                
                (496,807
                )Valuation
      allowance
                
                
                (7,615,724
                )
                
                
                (2,571,902
                )Net
                
                $
                -
                
                
                $
                -




FIN 48





Effective
January 1, 2007, the Company adopted FASB Interpretation 48, “Accounting for
Uncertainty in Income Taxes - an Interpretation of FASB Statement No. 109”,
(“FIN 48”). This interpretation establishes a minimum threshold for financial
statement recognition of the benefit of tax positions, and requires certain
expanded disclosures. Additionally, FIN 48 provides guidance on measurement,
derecognition, classification, interest and penalties, accounting for income
taxes in interim periods, as well as the required disclosures and transition.
The adoption of FIN 48 did not have a material impact on the Company’s
consolidated financial position and results of operations.




FIN 48
prescribes a recognition threshold and a measurement attribute for the financial
statement recognition and measurement of tax positions taken or expected to be
taken in a tax return. For those benefits to be recognized, a tax position must
be more likely than not to be sustained upon examination by taxing authorities.
Differences between tax positions taken and or expected to be taken in a tax
return and the benefit recognized and measured pursuant to the interpretation
are referred to as “unrecognized benefits”. A liability is recognized (or amount
of NOL carryforward or amount of tax refundable is reduced) for an unrecognized
tax benefit because it represents an enterprise’s potential future obligation to
the taxing authority for a tax position that was not recognized as a result of
applying provisions of FIN 48.





In
accordance with FIN 48, interest costs related to unrecognized tax benefits are
required to be calculated (if applicable) and would be classified within
interest expense in the consolidated statements of operations. Penalties would
be recognized as a component of general and administrative expenses. No interest
and penalties were recorded during the years ended December 31, 2008 and 2007,
respectively. As of December 31, 2008 and 2007, no liability for unrecognized
tax benefits was required to be recorded.





NOL
Limitations





The
Company’s utilization of NOL carryforwards is subject to an annual limitation
due to ownership changes that have occurred previously or that could occur in
the future as provided in Section 382 of the Internal Revenue Code of 1986, as
well as similar state and foreign provisions. In general, an ownership change,
as defined by Section 382, results from transactions increasing the ownership of
certain stockholders or public group in the stock of a corporation by more than
fifty percentage points over a three-year period. Since its formation, the
Company has raised capital through the issuance of capital stock and various
convertible instruments which, combined with the purchasing shareholders’
subsequent disposition of these shares, has resulted in an ownership change as
defined by Section 382, and also could result in an ownership change in the
future upon subsequent disposition.




40
 Table of Contents




TOWERSTREAM
CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





The
annual NOL limitation is determined by first multiplying the value of the
Company’s stock at the time of ownership change by the applicable long-term tax
exempt rate, and could then be subject to additional adjustments, as required.
Any limitation may result in expiration of a portion of the NOL carryforwards
before utilization.





The
Company has not utilized any of its NOL carryforwards as it has never reported
taxable income. The Company has applied a full valuation allowance against
deferred tax assets related to its NOL carryforwards. Federal NOLs will begin
expiring in 2027. State NOLs will begin expiring in 2012.





Valuation
Allowance





In
assessing the realizability of deferred tax assets, the Company has considered
whether it is more likely than not that some portion or all of the deferred tax
assets will not be realized. The ultimate realization of deferred tax assets is
dependent upon the generation of future taxable income during the periods in
which those temporary differences become deductible. In making this
determination, under the applicable financial reporting standards, the Company
is allowed to consider the scheduled reversal of deferred tax liabilities,
projected future taxable income, and tax planning strategies. A full valuation
allowance has been recorded for the deferred tax asset balance as of December
31, 2008 and 2007. A valuation allowance will be maintained until sufficient
positive evidence exists to support the reversal of any portion or all of the
valuation allowance, net of appropriate reserves.





Note
11. Stock Option Plans




In
conjunction with the Merger on January 12, 2007, Towerstream reserved a total of
3,200,000 shares for the issuance of options and warrants. Also, in conjunction
with the Merger, the Company adopted the 2007 Equity Compensation Plan (the
‘‘2007 Plan’’). The 2007 Plan provides for the issuance of options, stock
appreciation rights, restricted stock, restricted stock units, bonus shares and
dividend equivalents to officers and other employees, consultants and directors
of the Company. Under the Merger agreement, all options and certain warrants
were transferred into the 2007 Plan, including 350,386 warrants, which were
exchanged for 350,386 options. The total number of shares of common stock
issuable under the 2007 Plan is 2,403,922. A total of 2,366,494 stock options or
common stock have been issued under the 2007 Plan as of December 31,
2008.





In May
2007, the Board of Directors approved the adoption of the 2007 Incentive Stock
Plan which provides for the issuance of up to 2,500,000 shares of common stock
in the form of options or restricted stock (the ‘‘2007 Incentive Stock Plan’’).
The 2007 Incentive Stock Plan was approved by the Company’s stockholders in May
2007. A total of 1,024,107 stock options have been issued under the 2007
Incentive Stock Plan as of December 31, 2008.





Options
granted under both the 2007 Plan and the 2007 Incentive Plan have terms up to
ten years and are exercisable at a price per share not less than the fair market
value of the underlying common stock on the date of grant. The total number of
shares of common stock that remain available for issuance as of December 31,
2008 under the 2007 Plan and the 2007 Incentive Stock Plan combined is 1,513,321
shares.




In August
2008, the Company’s stockholders approved the adoption of the 2008 Non-Employee
Directors Compensation Plan (the “2008 Directors Plan”).  Under the 2008
Directors Plan, an aggregate of 1,000,000 shares have been reserved for
issuance.  As of December 31, 2008, no shares have been issued under
this plan.  Options granted under the 2008 Directors Plan have terms
of up to five years and are exercisable at a price per share equal to the fair
market value of the underlying common stock on the date of grant.





41
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TOWERSTREAM
CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





Transactions
under the stock option plans during the years ended December 31, 2008 and 2007
were as follows:





Number of
                            Options
                          
                          
                          Weighted
                            Average
                            Exercise PriceOutstanding
      as of January 1, 2007
                          
                          
                          1,504,564
                          
                          
                          $
                          1.31Granted
      during 2007
                          
                          
                          523,340
                          
                          
                          
                          4.83Warrants
      exchanged for options
                          
                          
                          350,386
                          
                          
                          
                          1.14Exercised
                          
                          
                          (4,672
                          )
                          
                          
                          1.43Forfeited
      /expired
                          
                          
                          (45,551
                          )
                          
                          
                          1.43Outstanding
      as of December 31, 2007
                          
                          
                          2,328,067
                          
                          
                          
                          2.08Granted
      during 2008
                          
                          
                          1,261,032
                          
                          
                          
                          1.26Exercised
                          
                          
                          (185,705
                          )
                          
                          
                          1.43Forfeited
      /expired
                          
                          
                          (67,601
                          )
                          
                          
                          1.70Outstanding
      as of December 31, 2008
                          
                          
                          3,335,793
                          
                          
                          $
                          1.82





The
weighted average fair value of the options granted during 2008 and 2007 were
$0.92 and $2.89, respectively.





The
following table summarizes information concerning outstanding and exercisable
stock options as of December 31, 2008:





Options Outstanding
                
                
                Options ExercisableRange of
                  Exercise
                  Prices
                
                Number
                  Outstanding
                
                
                Weighted
                  Average
                  Remaining
                  Contractual
                  Life (years)
                
                
                Weighted
                  Average
                  Exercise
                  Price
                
                
                Proceeds
                  Upon
                  Exercise
                
                
                Intrinsic
                  Value
                
                
                Number
                  Exercisable
                
                
                Weighted
                  Average
                  Exercise
                  Price
                
                
                Weighted
                  Average
                  Remaining
                  Contractual
                  Life (years)$0.68
      - $0.78
                
                
                645,309
                
                
                
                7.45
                
                
                $
                0.73
                
                
                $
                470,700
                
                
                $
                1,150
                
                
                
                280,309
                
                
                $
                0.78
                
                
                
                4.16$1.14
      - $1.22
                
                
                550,386
                
                
                
                7.24
                
                
                $
                1.17
                
                
                $
                643,440
                
                
                
                -
                
                
                
                550,386
                
                
                $
                1.17
                
                
                
                7.24$1.32
      - $1.45
                
                
                1,432,487
                
                
                
                6.75
                
                
                $
                1.41
                
                
                $
                2,025,257
                
                
                
                -
                
                
                
                948,966
                
                
                $
                1.43
                
                
                
                5.40$2.00
      - $2.25
                
                
                362,611
                
                
                
                8.67
                
                
                $
                2.11
                
                
                $
                763,597
                
                
                
                -
                
                
                
                135,910
                
                
                $
                2.22
                
                
                
                8.15$3.70
                
                
                135,000
                
                
                
                8.49
                
                
                $
                3.70
                
                
                $
                499,500
                
                
                
                -
                
                
                
                45,000
                
                
                $
                3.70
                
                
                
                8.49$7.05
                
                
                135,000
                
                
                
                8.35
                
                
                $
                7.05
                
                
                $
                951,750
                
                
                
                -
                
                
                
                45,000
                
                
                $
                7.05
                
                
                
                8.35$9.74
                
                
                75,000
                
                
                
                3.12
                
                
                $
                9.74
                
                
                $
                730,500
                
                
                
                -
                
                
                
                65,625
                
                
                $
                9.74
                
                
                
                3.123,335,793
                
                
                
                7.23
                
                
                $
                1.82
                
                
                $
                6,084,744
                
                
                $
                1,150
                
                
                
                2,071,196
                
                
                $
                1.76
                
                
                
                5.96





The intrinsic value is
calculated as the difference between the closing price of the Company’s common
stock at December 31, 2008, which was $0.69 per share, and the exercise price of
the options.  There was no intrinsic value associated with options
exercisable as of December 31, 2008.





The
number of shares issuable upon the exercise of outstanding options, and the
proceeds upon the exercise of such options, will be lower if an option holder
elects to exercise on a cashless basis.





Note
12.    Stock Warrants




The
Company has issued warrants to purchase shares of common stock which expire at
various dates through June 2012. Under the Merger agreement, 350,386
warrants were exchanged for 350,386 options under the 2007 Plan.




42
 Table of Contents




TOWERSTREAM
CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





Changes
in warrants outstanding for the years ended December 31, 2008 and 2007 were as
follows:





Number of
                                  Warrants
                                
                                Weighted
                                  Average
                                  Exercise priceWarrants
      outstanding as of January 1, 2007
                                
                                
                                1,146,462
                                
                                
                                $
                                0.97Granted
      (weighted average fair value of $0.92)
                                
                                
                                4,332,311
                                
                                
                                
                                4.61Warrants
      exchanged for options
                                
                                
                                (350,386)
                                
                                
                                
                                1.14Exercised
                                
                                
                                (456,062)
                                
                                
                                
                                0.89Warrants
      outstanding as of December 31, 2007
                                
                                
                                4,672,325
                                
                                
                                
                                4.34Exercised
      during 2008
                                
                                
                                (251,717)
                                
                                
                                
                                0.75Forfeited/expired
                                
                                
                                (88,298)
                                
                                
                                
                                1.27Warrants
      outstanding as of December 31, 2008
                                
                                
                                4,332,310
                                
                                
                                $
                                4.61





The
following table summarizes information concerning outstanding and exercisable
warrants as of December 31, 2008:





Warrants Outstanding
                
                
                Warrants ExercisableRange of Exercise
                  Prices
                
                Number
                  Outstanding
                
                
                Weighted
                  Average
                  Remaining
                  Contractual
                  Life (years)
                
                
                Weighted
                  Average
                  Exercise
                  Price
                
                
                ProceedsUponExercise
                
                
                Number
                  Exercisable
                
                
                Weighted
                  Average
                  Exercise
                  Price
                
                
                Weighted
                  Average
                  Remaining
                  Contractual
                  Life (years)$4.00
                
                
                936,364
                
                
                
                3.17
                
                
                $
                4.00
                
                
                $
                3,745,456
                
                
                
                936,364
                
                
                $
                4.00
                
                
                
                3.17$4.50
                
                
                2,759,582
                
                
                
                3.03
                
                
                $
                4.50
                
                
                $
                12,418,119
                
                
                
                2,759,582
                
                
                $
                4.50
                
                
                
                3.03$6.00
                
                
                636,364
                
                
                
                3.03
                
                
                $
                6.00
                
                
                $
                3,818,184
                
                
                
                636,364
                
                
                $
                6.00
                
                
                
                3.034,332,310
                
                
                
                3.06
                
                
                $
                4.61
                
                
                $
                19,981,759
                
                
                
                4,332,310
                
                
                $
                4.61
                
                
                
                3.06





This is
no intrinsic value associated with the Company’s warrants outstanding or
exercisable as of December 31, 2008.





The
number of shares issuable upon the exercise of outstanding warrants, and the
proceeds upon the exercise of such warrants, will be lower if a warrant holder
elects to exercise on a cashless basis.





Note
13.    Fair Value Measurement





In
September 2006, the FASB issued FAS 157, which is effective for fiscal
years beginning after November 15, 2007 and for interim periods within those
years. This statement defines fair value, establishes a framework for measuring
fair value and expands the related disclosure requirements. This statement
applies under other accounting pronouncements that require or permit fair value
measurements.  The statement indicates, among other things, that a
fair value measurement assumes that the transaction to sell an asset or transfer
a liability occurs in the principal market for the asset or liability or, in the
absence of a principal market, the most advantageous market for the asset or
liability.  FAS 157 defines fair value based upon an exit price
model.





FSP 157-1
amends FAS 157 to exclude FAS 13 and its related interpretive accounting
pronouncements that address leasing transactions, while FSP 157-2 delays the
effective date of the application of FAS 157 to fiscal years beginning after
November 15, 2008 for all nonfinancial assets and nonfinancial liabilities that
are recognized or disclosed at fair value in the financial statements on a
nonrecurring basis.





In
October 2008, the FASB issued FSP FAS No. 157-3, “Determining the Fair Value of
a Financial Asset When the Market for That Asset is not Active”.  The
FSP clarifies the application of FAS 157 when the market for a financial asset
is not active.  The FSP was effective upon issuance, including
reporting for prior periods for which financial statements have not been
issued.  The adoption of the FSP for reporting as of September 30,
2008 did not have a material impact on the Company’s consolidated financial
statements.




43
 Table of Contents




TOWERSTREAM
CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED





Valuation
Hierarchy





FAS 157
establishes a valuation hierarchy for disclosure of the inputs to valuation used
to measure fair value.  This hierarchy prioritizes the inputs into
three broad levels as follows.  Level 1 inputs are quoted prices
(unadjusted) in active markets for identical assets or
liabilities.  Level 2 inputs are quoted prices for similar assets and
liabilities in active markets or inputs that are observable for the asset or
liability, either directly or indirectly through market corroboration, for
substantially the full term of the financial instrument.  Level 3
inputs are unobservable inputs based on the Company’s own assumptions used to
measure assets and liabilities at fair value.  A financial asset or
liability’s classification within the hierarchy is determined based on the
lowest level input that is significant to the fair value
measurement.





The
following table provides the assets and liabilities carried at fair value
measured on a recurring basis as of December 31, 2008:





Fair Value Measurements at December 31, 2008Total Carrying
                  Value at December
                  31, 2008
                
                
                Quoted prices
                  in active
                  markets
                  (Level 1)
                
                
                Significant
                  other
                  observable
                  inputs (Level 2)
                
                
                Significant
                  unobservable
                  inputs (Level 3)Cash
      equivalents (money market funds)
                
                $
                23,683,454
                
                
                $
                23,683,454
                
                
                $
                -
                
                
                $
                -Total
                
                $
                23,683,454
                
                
                $
                23,683,454
                
                
                $
                -
                
                
                $
                -





Cash equivalents are measured at fair
value using quoted market prices and are classified within Level 1 of the
valuation hierarchy.  The carrying amounts of cash, accounts
receivable, accounts payable, accrued liabilities and debt approximate their
fair value due to their short maturities.  There were no changes in
the valuation techniques during the year ended December 31, 2008.





Note
14.    Commitments and Contingencies




Lease
Obligations.    The Company has entered into
operating leases related to roof rights, cellular towers, office space, and
equipment leases under various non-cancelable agreements expiring through
March 2019. As of December 31, 2008, total future lease commitments
were as follows:





Year
      Ending December 31,2009
                        
                        $
                        2,301,0242010
                        
                        
                        2,216,8822011
                        
                        
                        1,849,2282012
                        
                        
                        1,638,6412013
                        
                        
                        919,391Thereafter
                        
                        
                        965,497$
                        9,890,663




Rent
expense for the years ended December 31, 2008 and 2007 totaled
approximately $2,055,000 and $1,276,000, respectively.




In March
2007, the Company entered into a lease agreement for its corporate offices (the
“Original Space”). In August 2007, the Company signed a lease amendment
adding approximately 25,000 square feet (the “Additional Space”) and extending
the lease term. The new lease term commenced in October 2007 and terminates
six years from the date of commencement with an option to renew for an
additional five-year term.  The Company’s annual rent payments totaled
approximately $527,000 in 2008 and will remain at that level through
February 2010, before increasing to approximately $558,000 through
May 2012, and approximately $590,000 through the end of the
lease.





The
landlord provided the Company with certain incentives as an inducement to enter
the lease agreements.  These incentives included (i) an allowance of
$163,330 for leasehold improvements on the Original Space, (ii) an allowance of
$200,000 for leasehold improvements on the Additional Space, and (iii) an
initial six-month rent-free period on half of the Additional
Space.  Leasehold improvements funded by the landlord have been (i)
capitalized and are being amortized over the remaining lease term and (ii)
recognized as deferred rent and amortized over the term of the
lease.   The economic value of the rent-free period is being
amortized ratably over the term of the lease.




44
 Table of Contents




TOWERSTREAM
CORPORATION


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS- CONTINUED




Other Commitments and
Contingencies.  One of the purchase agreements related to FCC
licenses includes contingent payments of up to $375,000, depending on the status
of the license with the FCC, and whether the Company has obtained approval to
broadcast terrestrially in the 3650 to 3700 MHz band.  The contingent
payments include a $100,000 cash payment (due in May 2009) and the issuance of
common stock with a value of $275,000 (due in May 2011).


45
 Table of Contents




Item 9. Changes in and Disagreements With Accountants on Accounting
and Financial Disclosure.





None.





Item 9A(T). Controls and Procedures.




Controls and
Procedures




We
carried out an evaluation, under the supervision and with the participation of
our management, including our chief executive officer and chief financial
officer, of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the
Securities Exchange Act of 1934, as amended (the ‘‘Exchange Act’’). Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by an issuer in the
reports that it files or submits under the Exchange Act is accumulated and
communicated to the issuer’s management, including its principal executive and
principal financial officers, or persons performing similar functions, as
appropriate to allow timely decisions regarding required disclosure. Based upon
our evaluation, our chief executive officer and chief financial officer
concluded that our disclosure controls and procedures are effective, as of
December 31, 2008, in ensuring that material information that we are required to
disclose in reports that we file or submit under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission rules and forms.




Changes in Internal Control
over Financial Reporting




There
were no changes in our internal control over financial reporting during the
fourth quarter of the year ended December 31, 2008 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.




Management’s Annual Report
on Internal Control over Financial Reporting




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




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




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




Our
management assessed the effectiveness of our internal control over financial
reporting as of December 31, 2008. In making this assessment, management
used the criteria set forth by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO) in Internal Control — Integrated
Framework.





Based on
our assessment, our management has concluded that, as of December 31, 2008,
our internal control over financial reporting is effective based on those
criteria.




46
 Table of Contents




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





Item 9B. Other Information.





None.


47
 Table of Contents




PART
III





Item 10. Directors, Executive Officers and Corporate
Governance.





The
information required by this item will be set forth in the proxy statement for
our 2009 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission not later then 120 days after the end of the fiscal year
covered by this report on Form 10-K, and is incorporated by reference from our
proxy statement.





Item 11. Executive Compensation.





The
information required by this item will be set forth in the proxy statement for
our 2009 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission not later then 120 days after the end of the fiscal year
covered by this report on Form 10-K, and is incorporated by reference from our
proxy statement.





Item 12. Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters.





The
information required by this item will be set forth in the proxy statement for
our 2009 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission not later then 120 days after the end of the fiscal year
covered by this report on Form 10-K, and is incorporated by reference from our
proxy statement.




Item 13. Certain Relationships and Related Transactions, and
Director Independence.





The
information required by this item will be set forth in the proxy statement for
our 2009 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission not later then 120 days after the end of the fiscal year
covered by this report on Form 10-K, and is incorporated by reference from our
proxy statement.





Item 14. Principal Accountant Fees and Services.





The
information required by this item will be set forth in the proxy statement for
our 2009 Annual Meeting of Stockholders to be filed with the Securities and
Exchange Commission not later then 120 days after the end of the fiscal year
covered by this report on Form 10-K, and is incorporated by reference from our
proxy statement.


48
 Table of Contents




PART
IV





Item 15. Exhibits and Financial Statement
Schedules.





Exhibit No.
                  
                  Description2.1
                  
                  Agreement
      of Merger and Plan of Reorganization, dated January 12, 2007, by
      and among University Girls Calendar, Ltd., Towerstream Acquisition, Inc.
      and Towerstream Corporation (Incorporated by reference to Exhibit 2.1 to
      the Current Report on Form 8-K of Towerstream Corporation filed with
      the Securities and Exchange Commission on
      January 19, 2007).3.1
                  
                  Certificate
      of Incorporation of University Girls Calendar, Ltd. (Incorporated by
      reference to Exhibit 3.1 to the Current Report on Form 8-K of University
      Girls Calendar, Ltd. filed with the Securities and Exchange Commission on
      January 5, 2007).3.2
                  
                  Certificate
      of Amendment to Certificate of Incorporation of University Girls Calendar,
      Ltd., changing the Company’s name to Towerstream Corporation (Incorporated
      by reference to Exhibit 3.3 to the Current Report on Form 8-K of
      Towerstream Corporation filed with the Securities and Exchange Commission
      on January 19, 2007).3.3
                  
                  By-Laws
      of Towerstream Corporation (Incorporated by reference to Exhibit 3.2 to
      the Current Report on Form 8-K of Towerstream Corporation filed with the
      Securities and Exchange Commission on
      January 19, 2007).3.4
                  
                  Amendment
      No. 1 to the By-Laws of Towerstream Corporation (Incorporated by reference
      to Exhibit 3.1 to the Current Report on Form 8-K of Towerstream
      Corporation filed with the Securities and Exchange Commission on August
      30, 2007).10.1*
                  
                  Towerstream
      Corporation 2007 Equity Compensation Plan (Incorporated by reference to
      Exhibit 4.1 to the Current Report on Form 8-K of Towerstream Corporation
      filed with the Securities and Exchange Commission on
      January 19, 2007).10.2*
                  
                  Form
      of 2007 Equity Compensation Plan Incentive Stock Option Agreement
      (Incorporated by reference to Exhibit 10.18 to the Current Report on Form
      8-K of Towerstream Corporation filed with the Securities and Exchange
      Commission on January 19, 2007).10.3*
                  
                  Form
      of 2007 Equity Compensation Plan Non-Qualified Stock Option Agreement
      (Incorporated by reference to Exhibit 10.19 to the Current Report on Form
      8-K of Towerstream Corporation filed with the Securities and Exchange
      Commission on January 19, 2007).10.4
                  
                  Form
      of Directors and Officers Indemnification Agreement (Incorporated by
      reference to Exhibit 10.17 to the Current Report on Form 8-K of
      Towerstream Corporation filed with the Securities and Exchange Commission
      on January 19, 2007).10.5*
                  
                  Towerstream
      Corporation 2007 Incentive Stock Plan (incorporated by reference to
      Exhibit 10.12 to the Registration Statement on Form SB-2 (File No.
      333-142032) of Towerstream Corporation initially filed with the Securities
      and Exchange Commission on April 11, 2007).10.6
                  
                  Form
      of Placement Agent Agreement for June 2007 Offering (Incorporated by
      reference to Exhibit 10.10 to the Registration Statement on Form SB-2
      (333-142032) of Towerstream Corporation filed with the Securities and
      Exchange Commission on April 11, 2007).10.7
                  
                  Form
      of Subscription Agreement (Incorporated by reference to Exhibit 10.11 to
      the Registration Statement on Form SB-2 (333-142032) of Towerstream
      Corporation filed with the Securities and Exchange Commission on April 11,
      2007).10.8**
                  
                  Employment
      Agreement, dated December 21, 2007, between Towerstream Corporation and
      Jeffrey M. Thompson (Incorporated by reference to Exhibit 10.1 to the
      Current Report on Form 8-K of Towerstream Corporation filed with the
      Securities and Exchange Commission on December 31,
  2007).10.9
                  
                  Office
      Lease Agreement dated March 21, 2007 between Tech 2, 3, & 4 LLC
      (Landlord) and Towerstream Corporation (Tenant).10.10
                  
                  First
      Amendment to Office Lease dated August 8, 2007, amending Office Lease
      Agreement dated March, 21 2007.21.1
                  
                  List
      of Subsidiaries.23.1
                  
                  Consent
      of Marcum & Kliegman LLP31.1
                  
                  Section
      302 Certification of Principal Executive Officer31.2
                  
                  Section
      302 Certification of Principal Financial Officer32.1
                  
                  Section
      906 Certification of Principal Executive Officer32.2
                  
                  Section
      906 Certification of Principal Financial
Officer







*
                Management
      compensatory plan**
                Management
      contract




49
 Table of Contents




SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.





TOWERSTREAM
      CORPORATIONDate: March
      18, 2009
                By:
                /s/
      Jeffrey M. ThompsonJeffrey
      M. ThompsonPresident
      and Chief Executive
Officer




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





Name
                          
                          Capacity
                          
                          Date/s/ Jeffrey M.
      Thompson
                          
                          Director
      and Chief Executive Officer
                          
                          March
      18, 2009Jeffrey
      M. Thompson
                          
                          (President
      and Principal Executive Officer)/s/
      Joseph P. Hernon
                          
                          Chief
      Financial Officer
                          
                          March
      18, 2009Joseph
      P. Hernon
                          
                          (Principal
      Financial Officer andPrincipal
      Accounting Officer)/s/
      Philip Urso
                          
                          Director
      - Chairman of the Board of Directors
                          
                          March
      18, 2009Philip
      Urso/s/
      Howard L. Haronian, M.D.
                          
                          Director
                          
                          March
      18, 2009Howard
      L. Haronian, M.D./s/
      William J. Bush
                          
                          Director
                          
                          March
      18, 2009William
      J. Bush/s/
      Paul Koehler
                          
                          Director
                          
                          March
      18, 2009Paul
      Koehler




50
 Table of Contents




EXHIBIT
INDEX




Exhibit
      No.
                  
                  Description2.1
                  
                  Agreement
      of Merger and Plan of Reorganization, dated January 12, 2007, by
      and among University Girls Calendar, Ltd., Towerstream Acquisition, Inc.
      and Towerstream Corporation (Incorporated by reference to Exhibit 2.1 to
      the Current Report on Form 8-K of Towerstream Corporation filed with
      the Securities and Exchange Commission on
      January 19, 2007).3.1
                  
                  Certificate
      of Incorporation of University Girls Calendar, Ltd. (Incorporated by
      reference to Exhibit 3.1 to the Current Report on Form 8-K of University
      Girls Calendar, Ltd. filed with the Securities and Exchange Commission on
      January 5, 2007).3.2
                  
                  Certificate
      of Amendment to Certificate of Incorporation of University Girls Calendar,
      Ltd., changing the Company’s name to Towerstream Corporation (Incorporated
      by reference to Exhibit 3.3 to the Current Report on Form 8-K of
      Towerstream Corporation filed with the Securities and Exchange Commission
      on January 19, 2007).3.3
                  
                  By-Laws
      of Towerstream Corporation (Incorporated by reference to Exhibit 3.2 to
      the Current Report on Form 8-K of Towerstream Corporation filed with the
      Securities and Exchange Commission on
      January 19, 2007).3.4
                  
                  Amendment
      No. 1 to the By-Laws of Towerstream Corporation (Incorporated by reference
      to Exhibit 3.1 to the Current Report on Form 8-K of Towerstream
      Corporation filed with the Securities and Exchange Commission on August
      30, 2007).10.1*
                  
                  Towerstream
      Corporation 2007 Equity Compensation Plan (Incorporated by reference to
      Exhibit 4.1 to the Current Report on Form 8-K of Towerstream Corporation
      filed with the Securities and Exchange Commission on
      January 19, 2007).10.2*
                  
                  Form
      of 2007 Equity Compensation Plan Incentive Stock Option Agreement
      (Incorporated by reference to Exhibit 10.18 to the Current Report on Form
      8-K of Towerstream Corporation filed with the Securities and Exchange
      Commission on January 19, 2007).10.3*
                  
                  Form
      of 2007 Equity Compensation Plan Non-Qualified Stock Option Agreement
      (Incorporated by reference to Exhibit 10.19 to the Current Report on Form
      8-K of Towerstream Corporation filed with the Securities and Exchange
      Commission on January 19, 2007).10.4
                  
                  Form
      of Directors and Officers Indemnification Agreement (Incorporated by
      reference to Exhibit 10.17 to the Current Report on Form 8-K of
      Towerstream Corporation filed with the Securities and Exchange Commission
      on January 19, 2007).10.5*
                  
                  Towerstream
      Corporation 2007 Incentive Stock Plan (incorporated by reference to
      Exhibit 10.12 to the Registration Statement on Form SB-2 (File No.
      333-142032) of Towerstream Corporation initially filed with the Securities
      and Exchange Commission on April 11, 2007).10.6
                  
                  Form
      of Placement Agent Agreement for June 2007 Offering (Incorporated by
      reference to Exhibit 10.10 to the Registration Statement on Form SB-2
      (333-142032) of Towerstream Corporation filed with the Securities and
      Exchange Commission on April 11, 2007).10.7
                  
                  Form
      of Subscription Agreement (Incorporated by reference to Exhibit 10.11 to
      the Registration Statement on Form SB-2 (333-142032) of Towerstream
      Corporation filed with the Securities and Exchange Commission on April 11,
      2007).10.8**
                  
                  Employment
      Agreement, dated December 21, 2007, between Towerstream Corporation and
      Jeffrey M. Thompson (Incorporated by reference to Exhibit 10.1 to the
      Current Report on Form 8-K of Towerstream Corporation filed with the
      Securities and Exchange Commission on December 31,
  2007).10.9
                  
                  Office
      Lease Agreement dated March 21, 2007 between Tech 2, 3, & 4 LLC
      (Landlord) and Towerstream Corporation (Tenant).10.10
                  
                  First
      Amendment to Office Lease dated August 8, 2007, amending Office Lease
      Agreement dated March, 21 2007.21.1
                  
                  List
      of Subsidiaries.23.1
                  
                  Consent
      of Marcum & Kliegman LLP31.1
                  
                  Section 302
      Certification of Principal Executive Officer31.2
                  
                  Section 302 Certification of
      Principal Financial Officer32.1
                  
                  Section 906 Certification of
      Principal Executive Officer32.2
                  
                  Section 906 Certification of
      Principal Financial
Officer







*
                Management
      compensatory plan**
                Management
      contract