** **

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,D.C.  20549**

**FORM10-KSB**

**ANNUALREPORT PURSUANT TO SECTION 13 OR 15(D)OF THE SECURITIES EXCHANGE ACT OF 1934**

**FOR THEFISCAL YEAR ENDED DECEMBER 31, 2006**

**COMMISSIONFILE NUMBER 0-2564**

**TELESOURCE INTERNATIONAL, INC.**

(EXACTNAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)

| **Delaware**                                                   |   | **6770**                                                 |   | **36-4025775**                      |
|----------------------------------------------------------------|--------|----------------------------------------------------------|--------|-------------------------------------|
| State or other  jurisdiction of  Incorporation or organization |   | PRIMARY STANDARD  INDUSTRIAL  CLASSIFICATION CODE NUMBER |   | I.R.S. Employer  Identification No. |

 

**860Parkview Blvd**

**Lombard, Illinois 60148**

REGISTRANT’S TELEPHONE NUMBER, INCLUDING AREA CODE

**(630)620-4787**

SECURITIES REGISTERED PURSUANTTO SECTION 12(G) OF THE ACT:

**COMMON STOCK, PAR VALUE $.01 PERSHARE**

(Title of each class)

SECURITIES REGISTERED PURSUANT TO SECTION 12(B) OF THE ACT:

**NONE**

Indicate by check mark if the registrant is awell-known seasoned issuer, as defined in Rule 405 of the Securities ActYes  o  No  x

Indicate by check mark if the registrant is notrequired to file reports pursuant to Section 13 or Section 15(d) of the Act.Yes  o  No  x

Indicate by check mark whether the Registrant (1) hasfiled all reports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the Registrant was required to file such reports) and (2) has been subjectto such filing requirements for the past 90 days. Yes  o    No  x

Indicate by check mark if disclosure of delinquentfilers pursuant to Item 405 of Regulation S-K is not contained herein, and willnot be contained, to the best of Registrant’s knowledge, in definitive proxy orinformation statements incorporated by reference in Part III of this Form 10-Kor any amendment to the Form 10-K. x

Indicate by check mark whether the registrant is ashell company (as defined in Rule12b-2 of the Act. Yes  o    No  x

Issuer’s revenues for the most recent fiscal year:$5,509,784

State the aggregate market value of the voting andnon-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was last sold, or the average bid and askedprice of such common equity, as of the last business day of the registrant’smost recently completed second fiscal quarter. The Registrant’s votingstock held by non-affiliates of the Registrant on December 31, 2006 wasapproximately $4,824,600.

Number of shares of $0.01 par value Common Stockoutstanding as of the close of business on December 31, 2006: 105,067,661shares.

**Documents Incorporated byReference**

None

 

 

----

# **TABLE OFCONTENTS**

|            | ** ** | ** **                                                                                                                             | ** ** | ** ** | ** ** |
|------------|------------|----------------------------------------------------------------------------------------------------------------------------------------|------------|------------|------------|
| ** ** | ** ** | **PART I**                                                                                                                             |       |       |       |
| Item 1.    |       | Description of Business                                                                                                                |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 2.    |       | Properties                                                                                                                             |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 3.    |       | Legal Proceedings                                                                                                                      |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 4.    |       | Submission of  Matters to a Vote of Security Holders                                                                                   |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
|       | ** ** | **PART II**                                                                                                                            |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 5.    |       | Market for the  Registrant’s Common Equity, Related Stockholder Matters, and Small Business  Issuer Purchase of Equity securities |       |       |       |
| ** ** |       |                                                                                                                                   |       |       |       |
| Item 6.    |       | Management’s  Discussion and Analysis                                                                                             |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 7.    |       | Financial  Statements                                                                                                                  |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 8     |       | Changes in and  Disagreements with Accountants on Accounting and Financial Disclosure                                                  |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 8A    |       | Controls and Procedures                                                                                                                |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 8B    |       | Other Information                                                                                                                      |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| ** ** | ** ** | **PART III**                                                                                                                           |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 9.    |       | Directors  Executive Officers, Promoters, Control Persons and Corporate Governance;  Compliance with section 16(a) of Exchange Act     |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 10.   |       | Executive  Compensation                                                                                                                |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 11.   |       | Security  Ownership of Certain Beneficial Owners and Management and Related matters                                                    |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 12.   |       | Certain  Relationships and Related Transactions, and Directors Independence                                                            |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 13.   |       | Exhibits                                                                                                                               |       |       |       |
|       |       |                                                                                                                                   |       |       |       |
| Item 14.   |       | Principal  Accountant Fees and Services                                                                                                |       |       |       |

 

2

----

**PART I**

**ITEM 1. BUSINESS**

The terms “Telesource,” “Company,” “our,” and“us,” as used in this annual report, refer to Telesource International Inc. Theterm “SHBC” refers to Sayed Hamid Behbehani and Sons Company.

You are cautioned that the Form 10-KSB contains“forward-looking statements” within the meaning of the Private SecuritiesLitigation Reform Act of 1995. When the words “believes,” “plans,” “anticipates,”“will likely result,” “will continue,” “projects,” “expects,” and similarexpressions are used in the Form 10-KSB, they are intended to identify “forward-lookingstatements,” and such statements are subject to certain risks and uncertaintieswhich could cause actual results to differ materially from those projected.Furthermore, the Company’s plans, strategies, objective, expectations andintentions are subject to change at any time at the discretion of managementand the Board. These forward-looking statements speak only as of the date thisreport is filed. The Company does not intend to update the forward-lookingstatements contained in this report, so as to reflect events or circumstancesafter the date hereof or to reflect the occurrence of unanticipated events,except as may occur as part of its ongoing periodic reports filed with the SEC.

**1a) GENERAL**

Telesource is an international company engaged primarily in theoperation of energy conversion power plants. During 2005 the Companyrestructured its construction business after it had completed all constructionprojects that existed at that time. In a strategic shift from priorconstruction contracts, the Company will seek new projects on a limited basisin coordination with other companies in possible joint venture partnerships.The primary partner in these projects would most likely be with SHBC. SHBC,together with certain of its affiliates, which owns in excess of 95% of theCompany’s outstanding shares. The Company has begun to bid on internationalengineering and construction projects in a joint venture arrangement with SHBC.One of these bids recently resulted in the award of a $42.6 million contractduring 2006 to build a United States Embassy in Fiji.  The Joint Venture (as explained below)received notice to proceed with construction in 2007.

The Company conducts its operations through the parent company and itsthree subsidiaries located in four geographic locations. Telesource, located inLombard, Illinois U.S.A,. is the Company’s headquarters where it also operatesa small service for the procurement, export and shipping of U.S. fabricatedproducts for use by the Company’s subsidiaries or for resale to customersoutside of the mainland.

The Company has a subsidiary located in Fiji, Telesource Fiji, Ltd., thatmaintains and operates diesel fired electric power generation plants for thesale of electricity in the country. Additionally, the Company also isattempting to develop future construction and other energy related businessactivities in Fiji. The Company’s Mariana subsidiary, Telesource CNMI, Inc., ison the island of Tinian, an island in the Commonwealth of Mariana Islands (U.S.Territory). The Company operates a diesel fired electric power generation plantfor the sale of electricity to the local power grid. In Saipan, the Companymaintains offices for coordinating marketing and development activities in theregion and is responsible for all operations including the development offuture construction projects and energy conversion opportunities in the region.

The Company’s construction joint venture with SHBC named TelesourceInternational, Inc./ Sayed Behbehani & Sons Company, Joint Venture, L.P. (“TSI/SHBCJV”) also operates from its Lombard office. TSI/SHBC JV is a limitedpartnership, with an equity split of 51% Telesource and 49% SHBC. The totalstart up equity of the joint venture is $2,245,000. Telesource InternationalInc., is the general partner of the TSI/SHBC JV and accordingly is authorizedto determine the appropriate allocation of profit and losses. It is the generalpartners’ intention to allocate profits and losses 99% Telesource and 1% SHBC. Thejoint venture company also has a wholly owned subsidiary in Fiji, namedTelesource SHBC Fiji (“TSF”)

The Company was previously engaged independently in the construction ofairports, correctional facilities, museum improvements, radio towers and singlefamily homes. The Company’s new strategy, effective in 2006, is to engage inconstruction activities through its joint-venture with SHBC.

3

----

Power Plant Operation and Maintenance

Our agreement with the governmental agency in theCommonwealth of the Northern Mariana Islands is for the management of one oftheir power plants. Under the terms of this agreement, Telesource designed,financed and built the power plant. Telesource obtained financing for theproject through a $25,000,000 line of credit from the Commercial Bank ofKuwait, New York branch. For the construction of the first phase of this powerplant, Telesource is paid $180,000 per month for ten years by the governmentalagency. Each monthly payment is secured by a promissory note in the amount of$180,000 issued by the Commonwealth Utilities Corporation.

Telesource has a 20-year lease on the land on whichthe power plant is built, plus title to the entire plant and a two-month escrowaccount of no less than $360,000 on which Telesource has a first lien. In theevent the governmental agency is unable to meet its obligations either to makepayments of monthly maintenance fees or on the promissory notes, Telesource maysell, lease, assign or transfer the power plant or any part of the plantequipment.

In the first phase of the project, the governmentalagency also pays Telesource a production fee based upon a fixed fee perkilowatt-hour for each kilowatt-hour produced on its behalf. In the secondphase, which added 10-megawatts of capacity, the governmental agency has agreedto pay Telesource an additional production fee per kilowatt-hour. In addition,the governmental agency pays Telesource a monthly service fee for operating andmaintaining the power plant.

In May 2001, the governmental agency and Telesourceexecuted Change Order No. 3 to the Tinian Power Plant Contract. Change OrderNo. 3 provides a suspension in the Escalator on the variable payments fromJanuary 1, 2001 to December 31, 2005. This Change Order extends the term of thecontract from an expiration of 10 years following commissioning of the lastconstructed phase (currently Phase II was commissioned in March 2000 andtherefore the contract was to have expired in March 2010) to an new expirationdate of March 31, 2020. Change Order No. 3 does not include an expansion of thepower generation capacity of the power plant. The power plant will continue tooperate at its current maximum generation capacity of 20 Mwh. Effectively, thecontract has been extended for an additional 10 years. Power rates agreed tounder the original contract and Change Order No. 1 remain unchanged. ChangeOrder No. 3 does provide the customer with an early termination option relatedto the extended agreement beginning on March 31, 2010 and available annuallythereafter; however, the customer is required to give a six-month notice and topay an early termination fee of $6,000,000. Change Order No. 3 prohibits thecustomer from purchasing power from any source other than Telesource for thefirst 30 MW. The expanded agreement executed under Change Order No. 3 onlyextends the power generation contract term and does not require additionalperformance by Telesource, with respect to building additional power generationcapacity.

Change Order No. 3 requires Telesource to upgrade thepower distribution system in certain areas of the Tinian Island. TheCompany is responsible for the costs of the upgrade which include labor andmaterial. The Company has incurred approximately $876,000 in costs associated withthis upgrade through December 31, 2006. The Company will be seekingcertification for the upgrade by the client. Such certification includescertain negotiating issues that may affect the remaining costs to complete theupgrade. The Company projects the completion of the upgrade in 2007 andestimates the additional costs to be approximately in the range of $48,000 to$125,000.

Potential Future Power Plant Construction and PowerSupply

Based on previous experience, management believesthere will be a growing demand for power around the world; however competitionand deregulation could eliminate the financial feasibility of these projectsand thereby prevent Telesource from taking advantage of the expected growth indemand. In the U.S., two-thirds of the country’s installed plants are 25 ormore years old and need to be replaced and re-powered, principally with newcombustion turbines. The world’s use of electricity is projected to increase bytwo-thirds over the forecast horizon, from 13 trillion kilowatt hours in 1999to 22 trillion kilowatt-hours in 2020. The strongest growth rates inelectricity consumption are projected for the developing world. The most rapidexpansion in electricity use is expected for developing Asia and Central andSouth America, with average annual growth rates exceeding 3.5 percent between1999 and 2020. In the industrialized world, electricity consumption isexpected to grow at a more modest pace. Slower population and economic growth,along with the market saturation of certain electronic appliances (such aswashers and dryers) and efficiency gains from electrical appliances help toexplain the expected slower growth of electricity use in the industrializednations, although growing computer usage and the introduction of new electronicdevices could modulate that trend in the future. Telesource also believes thatthose situations where the local governments lack the up-front funding to buildthe additional power plants will represent an opportunity for Telesource tofind alternative solutions up to and including having Telesource locate theneeded project financing. Without the additional energy, Telesource believesthat many of the infrastructure upgrades envisioned by local governments willbe unable to occur. In Telesource’s experience, in return for securing projectfinancing in a manner similar to that obtained for the project in theCommonwealth of the Northern Mariana Islands, local governments will be willingto enter into contracts which guarantee Telesource a minimum amount of powerconsumption, coupled with long-term operation and maintenance contracts.

4

----

Telesource anticipates that these contracts willgenerally be secured by governmental guarantees, promissory notes, liens andcollateral on the land and in the physical power plants.

Construction Services

As noted above, Telesource has implemented a newstrategy for the construction market. This new strategy combined the depth ofSHBC’s experienced personnel and success in the construction industry withTelesource’s experience and contacts. The strengths that each of theseCompanies contributes to the joint venture will be the foundation for theCompany’s future growth in this market segment.

The JV has been awarded the contract to build a UnitedStates Embassy in Suva, Fiji. The Company has extensive experience in Fiji,primarily from operating power plants. Through this experience it has developeda strong understanding of the economic and business climate and has developedstrong relations with local businesses. It is the Company’s intentions toobtain other opportunities in Fiji.

Similarly, the Company’s extensive constructionexperience in the Commonwealth of Northern Mariana Islands has resulted indeveloping strong relationships within the government units as well as thebusiness community. Additionally, the Company will rely heavily upon SHBC toprovide more effective personnel to manage new construction projects. This incombination with implementing strong financial systems to monitor constructionprojects will provide stronger controls over project management.

Active Construction Projects and Services

The TSI/SHBC JV was recently awarded the contract tobuild the new United States Embassy in Fiji. This contract is a design-buildcontract valued at $42.6 million.

Completed Construction Projects and Services

The Company completed the Adult Correctional Facilityin Saipan during 2005. This project has a warranty period of up to three yearsfor certain components, of which there have been no material claims. (SeeCommitments and Contingencies in the footnotes to the financial statements)

Power Generation Construction Projects

Telesource’s power generation business involvesbuilding power plants, operating power plants for a contracted period of time,selling wholesale power to the client to be distributed on their power grid andthe transfer of the ownership of the properties to the client at the end of thecontract.

In March 2003, Telesource was awarded a 20-year,multi-million dollar, energy conversion agreement with the Fiji ElectricAuthority for the operation and maintenance of three diesel power plants withgeneration capacity of 78 MW. The two power plants are located in Kinoya andVuda, Fiji. Telesource and the Fiji Electric Authority finalized negotiationsfor the management of the recently newly built power plant in Kinoya. TheCompany is responsible for managing the power plant and will receive additionalfees for providing these services.

5

----

Sales and Marketing Strategies

The company has determined that it will be very selectiveand enter into new construction projects in a joint venture with SHBC.Meanwhile, a significant focus of its marketing efforts will be in the powergeneration business. Telesource’s power generation projects are obtainedthrough a public bid process, and clients are either governments orgovernmental agencies. In obtaining contracts:

·Telesource reviews market trends in the geographic locations it presentlyoperates, specifically Fiji and Saipan. Telesource’s research also includesanalyzing numerous government documents and reviewing previous and currentrequests for management of power generation facility bids.

·Telesource is actively involved in public relations with the governments andagencies that might contract for Telesource’s services. Much of this effort isinformational, learning the specific needs of each governmental agency while atthe same time explaining what services Telesource has to offer.

·Telesource has created and provides to potential clients a survey to helpgovernmental agencies evaluate whether Telesource’s resources and servicesmight be more efficient and cost-effective than their current system.

## Competition

The independent power industry has grown rapidly overthe past twenty years. There are a large number of suppliers in the wholesalemarket and a surplus of capacity, which has led to intense competition in thismarket. The principal sources of competition in this market include traditionalregulated utilities that have excess capacity, unregulated subsidiaries ofregulated utilities, energy brokers and traders, energy service companies inthe development and operation of energy-producing projects and the marketing ofelectric energy, equipment suppliers and other non-utility generators likeTelesource. Competition in this industry is substantially based on price withcompetitors discovering lower cost alternatives for providing electricity. Theelectric industry is also characterized by rapid changes in regulations, whichTelesource expects could continue to increase competition. Telesource does notbelieve the Tinian power plant would be significantly impacted by competitionin the wholesale energy market since its revenues are subject to contractedrates which are substantially fixed for several years.

Telesource also competes in the market to develop andconstruct power generation and other facilities. The primary bases ofcompetition in this market are the quality of development plans, the ability ofthe developer to finance and complete the project and the price. In some cases,competitive bidding for a development opportunity is required. Competition forattractive development opportunities is expected to be intense as there are anumber of competitors in the industry interested in the limited number ofopportunities. Many of the companies competing in this market havesubstantially greater resources. Telesource believes its project developmentexperience and its experience in creating strategic alignments with otherdevelopment firms with greater financial and technical resources could enableTelesource to continue to compete effectively in the development market if andwhen opportunities arise. Presently, Telesource believes there are a number ofopportunities for project development worldwide for projects similar to thosepreviously developed by Telesource. However, Telesource is currently evaluatingwhether it should seek development opportunities in other areas outside of theSouth Pacific to diversify its activities.

Presently, there is significant merger and consolidationactivity occurring in the electric industry. From time to time, Telesource mayconsider merger and acquisition proposals when they appear to present anopportunity to enhance stockholder value. Telesource is not involved in any ofthese discussions or negotiations at this time and there can be no assurancethat any opportunities will develop.

Customer dependence

Telesource depends on twocustomers for power-generation revenues. The loss of either single customerwould have a material adverse impact on the company’s financial performance. Together,CUC and FEA represent 86.6% of Telesource’s 

6

----

total revenues of $5.5million. Revenues from CUC totaled $978,534 or 20.5% of combined powergeneration revenues whereas FEA totaled $3,790,477 or 79.5% of combined powergeneration revenues.

Since March 1999, Telesource began deriving a portionof its revenues from the sale of electric power. Under Telesource’s agreementwith a governmental agency, the electrical power generated at Telesource’spower generation facility is owned by the governmental agency. Telesource ispaid a fee to produce the electric power. The governmental agency in turn sellsthe electric power to the various users throughout the Island of Tinian. If theend-user customer defaults or increases in power use do not materialize asanticipated, Telesource’s revenue base may not grow to support otheroperations.

Telesource operates two additional power plants for aperiod of 20 years within Fiji for one customer, the Fiji Electric Authority.Telesource is to operate the two power plants in Fiji by converting fuelprovided by the customer into electricity for which Telesource receives a fee.The Fiji Electric Authority in turn sells the power produced to various usersin Fiji. If the end-user customer defaults or increases in power use do notmaterialize as anticipated, Telesource’s revenue base may not grow to supportother operations.

Energy Regulation

Telesource’s projects are subject to regulation underfederal and local energy laws and regulations. Telesource is subject to therequirements established by its permitting authorities, i.e. the Department ofEnvironmental Quality (“DEQ”) and the Environmental Protection Agency (“EPA”).

Presently, neither the Customer Choice Act norproposed legislation dealing with U.S. energy policy directly impactsTelesource because the legislation and restructuring plan pertain to the retailmarket or new contracts in the wholesale market. However, as discussed above,Telesource could be impacted in the future by, among other things, increases incompetition as a result of deregulation. Telesource is actively monitoringthese developments in energy proceedings in order to evaluate the impact onexisting projects and also to evaluate new business opportunities created bythe restructuring of the electric industry.

Environmental Regulation

Telesource’s projects are subject to regulation underfederal, foreign and local environmental laws and regulations and must alsocomply with the applicable laws pertaining to the protection of theenvironment, primarily in the areas of water and air pollution. These laws andregulations in many cases require a lengthy and complex process of obtainingand maintaining licenses, permits and approvals from federal and localagencies. As regulations are enacted or adopted in any of these jurisdictions,Telesource cannot predict the effect of compliance therewith on its business.Telesource’s failure to comply with all applicable requirements could result indelays in proceeding with any projects under development or requiremodifications to operating facilities. During periods of non-compliance,Telesource’s operating facilities may be forced to shutdown until the instancesof non-compliance are corrected. Telesource is responsible for ensuringcompliance of its facilities with applicable requirements and, accordingly,attempts to minimize these risks by dealing with reputable contractors andusing appropriate technology to measure compliance with the applicablestandards.

Insurance and Bonding

Telesource maintains general and excess liability,construction equipment, and workers’ compensation insurance; all in amountsconsistent with industry practices. Telesource believes its insurance programsare adequate subject to deductibles some of which are approximately $800,000.

TSI/SHBC JV was required to obtain two stand by letterof credits representing performance and payment bonds on its most recentconstruction project, the United States Embassy in Fiji. The Company was ableto obtain these stand by letter of credits with Al Ahli Bank of Kuwait andconfirmed by the Bank of New York. The total of these stand by letter ofcredits are $21.5 million.

Previously, Telesource was required to provide bondingfor the airport runway project on the island of Tinian. This project hadpartial funding from the U.S. Government (the Federal Aviation Administration “FAA”)and consequently, U.S. Treasury Listed Bonding was required. During 2002,Telesource was required to provide bonding for the prison project on 

7

----

the island of Saipan. In order to secure the requiredbonding, Telesource’s largest shareholder, SHBC, provided a letter of credit tothe surety equal to 100% of the contract value of $17 million. Telesource’sability to obtain additional surety bonding depends upon its capitalization,working capital, past performance, management expertise and other factors,which may change from time to time. During 2005, the Company was released fromthe bonding requirement and consequently, SHBC was also released from theletter of credit requirements.

Employees

Telesource, as of December 31, 2006, employed 132people, consisting of 14 employees in management, 22 engineers and technicalstaff members, 7 support staff members and 89 hourly employees. All ofTelesource’s employees are nonunion workers, although Telesource may employunion subcontractors from time to time.

Telesource’s non-engineering level employees arehourly workers, while its engineering and supervisory staffs are on monthlysalaries.

Sources and Availability of Raw Materials

Telesource relies on thirdparties for important raw materials and technical expertise. Telesource’sability to enter into new engagements or to conduct the business in aprofitable manner will be harmed if its access to these important resources islimited or becomes too costly.

Telesource relies on third-party suppliers for rawmaterials like wood, steel and concrete; for fabrication of technical equipmentsubsystems including diesel generation and technical expertise. Telesource’sability to obtain cost-effective raw materials, fabrication services andtechnical assistance is subject to a number of external factors which areoutside of its control, including:

·                  Third partiesmay increase the price of the raw materials, fabrication services or technicalassistance they provide.

·                  Third-party rawmaterial suppliers, fabricators or technical expertise providers may decide notto provide Telesource with materials or services.

·                  Telesource hasno long-term contracts with third-party suppliers of raw materials, fabricationservices or technical expertise providers.

·                  Telesource’sthird-party contracts are usually short term in duration and are cancelable bysuch third party.

Reports to Security Holders

The Company files various reports with Securities andExchange Commission as required. Currently, the Company selected to file underthe Small Business regulations and files 10-QSB Quarterly Reports and 10KSB’sAnnual Reports.

The public may read and copy any material the Companyfiles with the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E.,Washington, D.C. 20549 or by calling 1-800SEC-0330. In addition the Companyfiles electronically and their filings can be obtained at http://www.sec.gov.

**ITEM 2. PROPERTIES**

Telesource maintains leased office space and leasesland for storage of construction equipment. In the corporate offices inIllinois, Telesource has an office space leased through April 2007. Telesource’sMariana subsidiary’s head office in the Commonwealth of the Northern MarianaIslands is leased for a term which extended through December 2004 and iscurrently on a month-to-month renewal. The Company’s office in the Republic ofPalau was closed in August 2005. Management believes its existing arrangementsfor its office facilities are adequate.

8

----

**ITEM 3. LEGAL PROCEEDINGS**

In the ordinary course of its business Telesourcebecomes involved from time to time in legal proceedings and claims asserted byand against Telesource. It is the opinion of management that the ultimatedisposition of these routine pending matters will not have a materially adverseimpact on the Company.

The Company, in1999 was awarded a contract to build 45 housing units for the Northern MarinaHousing Agency, a government unit. The houses were built and subsequentlyoccupied. The Northern Marianas Housing Corporation has filed a lawsuit againstTelesource and two other parties for $3.0 million in damages related to thisproject. These claims involve allegations of various construction defects. TheCompany estimates that, if the plaintiff is successful, the Company may have anestimated liability in the range of $500,000 to $1,200,000. The Companyrecorded a $300,000 estimated loss during 2004 and additional $200,000 during2006. Telesource has denied any liability and will aggressively defend itselfto dismiss this claim

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

At thecompany’s Annual meeting of Shareholders on October 31, 2006, the Shareholdersvoted to retain the existing members of the Board of Directors. The followingdirectors were elected: Ralph Beck, Jeff Adams, Max Engler, Ibrahim Ibrahim andNidal Z. Zayed. The number of votes “for” the election of the directors was90,448,540, “against” were zero and 150 votes abstained. In addition, theShareholders approved to increase the number of authorized shares of commonstock from 100,000,000 to 200,000,000. The number of votes for the increase inthe number of authorized shares of common stock was 90,448,540, against werezero and 150 votes abstained. No other action was taken during this meeting.

9

----

**PARTII**

**ITEM 5.          MARKET FOR THE REGISTRANT’S COMMONEQUITY AND RELATED STOCKHOLDER MATTERS**

MARKET INFORMATION. On November 1, 2001, Telesource’scommon stock began trading on the Over-the-Counter Bulletin Board under thesymbol “TSCI” and currently is traded in the Pink Sheets. Prior to that time,Telesource’s common stock was not listed for trading.

The following table sets forth high and low salesprices for the common stock for the periods indicated as reported on PinkSheets:
|                | ** ** | **HIGH**   | ** ** | **LOW**    | ** ** |
|----------------|------------|------------|------------|------------|------------|
| 2006           |       |       |       |       |       |
| First Quarter  |       | 0.25       |       | 0.25       |       |
| Second Quarter |       | 0.25       |       | 0.25       |       |
| Third Quarter  |       | 0.25       |       | 0.25       |       |
| Fourth Quarter |       | 1.10       |       | 0.25       |       |
| ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2005           |       |       |       |       |       |
| First Quarter  |       | 0.02       |       | 0.02       |       |
| Second Quarter |       | 0.02       |       | 0.02       |       |
| Third Quarter  |       | 0.02       |       | 0.02       |       |
| Fourth Quarter |       | 0.02       |       | 0.02       |       |

 

On the most recent trade date of January 15, 2007, thestock traded at $1.05 per share for 1,500 shares.

HOLDERS. As of December 31, 2006, there were 184shareholders of record.

Equity Compensation Plans

**2000Non-Employee Director’s Stock Option Plan**

In January 2001, the Company’s board of directorsadopted the 2000 Non-Employee Director’s Stock Option Plan that provides forthe issuance of nonqualified stock options to outside directors. Under theterms of this plan, under which 285,000 shares of common stock were reservedfor issuance, options to purchase common stock are granted at not less thanfair market value, become exercisable over a 3 year period from the dateof grant (vesting occurs annually on the grant date at 33.3% of the grant), andexpire 10 years from the date of grant.
|                                                       | ** ** | **December 31, 2006** | ** ** | **December 31, 2005** | ** ** |
|-------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                            | ** ** | **Weighted  average  shares**   | ** ** | **Exercise  price**             | ** ** | **Weighted  average  shares** | ** ** | **Exercise  price** | ** ** |
| Options outstanding at  January 1                |       | 180,000                         |       | $                               | 1.25       |   | 225,000 |   | $ | 1.25 |   |
| Granted                                               |       | —                          |       |                            |       | — |   |   |   |
| Exercised                                             |       | —                          |       |                            |       | — |   |   |   |
| Cancelled                                             |       | —                          |       |                            |       | — |   |   |   |
| Options outstanding at  December 31              |       | 180,000                         |       | 1.25                            |       | 225,000 |   | 1.25 |   |
| Options exercisable at  December 31              |       | 180,000                         |       | 1.25                            |       | 225,000 |   | 1.25 |   |
| Shares available for future grant at December 31 |       | 100,000                         |       |                            |       | 60,000 |   |   |   |
|                                                       |            |                                 |            |                                 |            |  |  |  |  |  |  |

 

10

----

**2000Incentive Stock Option Plan**** **

In January 2001, the Company’s board of directorsadopted the 2000 Incentive Stock Option Plan that provides for the issuance ofqualified stock options to employees. Under the terms of this plan, under which888,000 shares of common stock were reserved for issuance, options to purchasecommon stock are granted at not less than fair market value, become exercisableover a 3 year period from the date of grant (vesting occurs annually onthe grant date at 33.3% of the grant), and expire 10 years from the date ofgrant. As of December 31, 2006, no options had been awarded under this plan.

**UNREGISTERED SALES OF SECURITIES**.

We issued unregistered securities to SHBC in thefollowing transactions during 2006:

·                  On December 12,2006 we issued 1,350,000 shares of common stock pursuant to an exemption underRegulation S of the Securities Act for $675,000.

·                  On December 13,2006 we issued  2,000,000 shares ofcommon stock pursuant to an exemption under Regulation S of the Securities Actfor $1,000,000.

·                  On December 22,2006 we issued  8,279,521 shares ofcommon stock pursuant to an exemption under Regulation S of the Securities Actfor $4,139,760. The shares issued represented the conversion of related partydebt with SHBC, to equity.  Loans in theamount of $3,992,000 with interest of $147,760 were converted into 8,279,521shares of common stock.

The funds received from these sales were used toreduce long-term debt, vendor payables and support on-going operations.

**ITEM 6.****                        MANAGEMENT’SDISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION**

** **

The following discussion of our financial conditionand plan of operation should be read in conjunction with our financialstatements and the related notes included elsewhere in this annual report onForm 10-KSB.

**HIGHLIGHTS**

Revenues for the year ended December 31, 2006 were $5.5 million compared to $5.9 million for the year ended December 31, 2005.  Net loss to common stockholders was $3.5million for 2006 compared to $5.4 million for 2005, a decrease of $1.9 millionor 35.2%.  Basic and diluted net loss to common stockholders per share was$0.04 for 2006 compared to $0.08 per share for 2005.

**Liquidity**

As of December 31, 2006, the Company’s totalliabilities exceeded total assets by $5.8 million.  This was a $2.4million improvement over 2005.  TheCompany continues to rely on equity sales to SHBC and bank financing to supportits operations.  The Company’s ability to refinance its existing bank debtis critical to provide funding to satisfy the Company’s obligations as theymature. As of December 31, 2006 the Company had total outstanding debt of $14.6million of which $2.5 million is due in 2007. As of December 31, 2006 theCompany had an accumulated deficit of $62.9 million and total stockholders’deficit of $5.8 million.

The Company incurred operating losses of $2.1 millionand $4.7 million for the years ended December 31, 2006 and 2005, respectively.The Company incurred net losses to common stockholders of $3.5 million and $5.4million for the years ended December 31, 2006 and 2005, respectively.

Cash used in operating activities was $1.3 million and$3.5 million for the years ended December 31, 2006 and 2005, respectively.Funds provided through financing activities representing either debt or commonstock issuance amounted to $3.0 million and $2.0 million for the years endedDecember 31, 2006 and 2005, respectively.

11

----

During 2006 management addressed operating and workingcapital deficits by working with its key investor, SHBC.  As reported in Item 5, herein, managementraised $5.7 million in 2006 and $9.0 million in 2005 through the combination ofshort term debt and issuance of common stock.   The short term debt was converted into equityin December of 2006 subsequent to shareholder approval to increase the numberof outstanding shares to 200,000,000. The sales of common stock were made through private, unregistered salesof the Company’s securities.  The additional equity raised during 2006 wasused to pay down debt and fund continuing operations.  Much of the debt obligations coming dueduring 2006 were project-financing-based and the Company repaid a portion ofthese obligations with cash generated from the collection of billings.  Thesecollections along with the additional equity and short term debt weresufficient to cover Telesource’s 2006 obligations.  Beyond the cashexpected to be generated by the U.S. Embassy Project in Fiji the Companyexpects to  seek support from its principalstockholder, SHBC, on an as-needed basis only.  SHBC has signed a Stock Purchase Agreement that provides  a guarantee of $2.6 million cash infusion in2007.  These funds would work tosupplement cash needs arising from operational working capital shortages, debtrepayment, and business expansion. SHBC has continued its support of theCompany and has agreed to guarantee or provide letters of credit covering allof the Company’s debt of $14.6 million.

During  2006 theCompany  received $4.0 million in loansfrom SHBC related companies.  On October31, 2006 at the annual general meeting, results of the shareholder proxy werereported.  Five incumbent members of theBoard of Directors were re-elected and a measure to increase the authorizednumber of common stock shares to 200,000,000 was passed.  Afterward, the entirety of the $4.0 millionin debt plus another $1.7 million of cash infusion were converted into11,629,521 shares of common stock.

**OPERATINGSEGMENTS**

Telesource’s business consists of the followingoperating segments: power generation and construction of power plants, trading,and construction services. Revenue of the power generation and construction ofpower plants segment includes sales-type lease revenues. The power generationactivities occurred in the Commonwealth of Northern Mariana Islands, a U.S.territory, (“CNMI”) and construction of power plants and U.S. Embassy occurredin Fiji. Construction services occurred in the CNMI and the Republic of Palauwhile trading activities occurred in the United States and the CNMI. Telesourceis responsible for certain warranty work associated with the Adult CorrectionalFacility located in Saipan. Telesource as noted earlier is changing itsconstruction strategy.   As a result ofimplementing this new strategy, TSI/SHBC JV has been awarded the contract tobuild the new United States Embassy in Fiji. This contract was awarded late in the fiscal year and therefore nomaterial transactions relating to this project occurred during 2006.

**OVERVIEW**

During 2006, total assets decreased from 2005 by$901,022 due primarily to reductions in construction receivables ($1.3million), which were partially offset by increases in power generationreceivables ($544,583).  Also contributingto the decrease were reductions in the net investment in sales type lease ($2.1million), partially offset by a $1.7 million increase in the cash balancerelated  to equity infusions, higherinventory and other asset balances ($340,379). The construction receivables decreased due to the collection from theDepartment of Public Works as well as payments received on retainage balancesfor the West Tinian Airport project.  The Company’s power generation receivables decreased solely due to TCNMI’s   collections on delinquent receivables fromthe Commonwealth Utility Corporation. Net investment in sales-type lease was reduced through the monthlycollection and normal amortization of the sale/leaseback amount related to theconstruction agreement of the Tinian power plant.

The Company’s vendor payable liabilities decreased by$0.6 million primarily due to payments made to construction related vendors inthe TCNMI subsidiary.  In addition, wealso reduced our total long term debt by $2.7 million from the proceeds ofequity sales.  The sales of thesecurities were primarily to SHBC and their affiliates.

Total revenues decreased in 2006 by $424,103 dueprimarily to less construction related activities ($1,202,079).  Partially offsetting this was a $927,645increase in power generation revenues.  Thecost of revenues declined as well from 2005 levels by $1,397,057 million, againrelated to the significant reduction in construction activity as well as tofewer engine overhauls.  These costreductions were partially offset by higher expenses in the TransmissionDistribution business.

Operating expenses decreased by $1.6 million in 2006from across the board reductions in salaries, occupancy, general andadministrative and asset impairment charges.

12

----

**RESULTS OF OPERATIONS**

**Comparison of the twelve months endedDecember 31, 2006 and 2005**

*Service Fees - Power GenerationPlant*. Service fees - power generation plant increased 24.1%to $4.8 million in 2006 from $3.8 million in 2005. The $927,645 increase inservice fees - power generation plant is attributed to an increase in dieselpower demand as Fiji experienced lower rainfall throughout the year, anegotiated reduction in the cap on foreign exchange conversion which had apositive impact on the revenue computation formula, and a 29.8 mega-wattincrease in production capacity as a result of the Company contracting with FEAto manage the new Caterpillar engines in the Kinoya plant.  Partially offsetting these increases waslower power generation revenue at the Tinian power plant in the amount of$142,000 as compared to 2005 revenue. This reduction in Tinian was due to engine overhauls and the operationof the new Caterpillar engines in Kinoya.

*ServiceFees -*Sales increased to $66,825 in 2006 from $0 in 2005 aresult of obtaining additional work in Fiji related to repair as well asinstalling new transmission lines and work related to the Butoni wind farm.

*Service Fees — related party -*Service fees increased $2,482 or 35.1% to $9,544 in 2006.  The increase was due to a higher demand forTSI’s purchasing services in locating products to be used by SHBC.

*Rental Income* -Rental income decreased 96.6% in 2006 to $956 from $28,420 in 2005. Thedecrease in rental income was attributed to the termination of two separateshort-term lease agreements with Fiji Electric Authority and the government ofGuam in which the Company was to provide temporary power generationequipment.  Additionally, this type ofbusiness does not complement Telesource’s longer-term strategic plan.

*Finance Lease Revenues*.Finance lease revenues decreased 25.0% to $0.6 million in 2006 from $0.8million in 2005. Finance lease revenue for the Tinian power plant will decreaseeach year until the investment in sales-type-lease is fully amortized in March,2009.

*Construction Revenues*- Construction revenues decreased 96.3% to $46,000 in 2006 from $1,248,079 in2005. The decrease in construction revenues is attributed to management’sefforts to complete existing contracts and implement its new joint-venturingstrategy under the name of TSI/SHBC JV on new projects. In late November, 2006TSI/SHBC JV was awarded a $42.6 construction project by the Department of Stateto build the United States Embassy in Fiji.

***Expenses***

*Operation and Maintenance Costs —Power Generation Plant* - Operation and maintenance costs —power generation plant decreased 10.0% to $3.7 million in 2006 from $4.1million in 2005.  The decrease was due tofewer engine overhauls in Fiji as well as a reduction in the amount of sparepart purchases required for these overhauls.

*Provision for UncollectibleAccounts-  *Provision for uncollectible accountsincreased to $36,168 in 2006 from $21,572 in 2005. The increase in the 2006expense was related to small accounts within TCNMI.

*Construction Costs*- Total construction costs decreased to $0 in 2006, down from $1,136,888 in2005. This decrease reflects the wind-down of construction contracts during2005 before initiating the new strategy of working in a joint venture withSHBC.

*Salaries and Employee Benefits*-   Salaries and employee benefits decreased by $431,440 due to exitingthe construction business in 2005 and management’s continuing efforts to reducecosts during 2006.

*Occupancy and Equipment*- Occupancy and equipment expenses decreased $146,231 to $220,726 in 2006 from$366,957 in 2005. The decrease was the result of closing an office in Saipan.

*General and Administrative Expenses*-   General and administrative expenses decreased 18.7% to $2.6 million in2006 from $3.2 million in 2005. The decrease is due to lower professional fees,depreciation, and travel and insurance costs during 2006.

13

----

*Impairment of long-lived assets de*creasedby 100.0% to $0 from $385,926 in 2005, due to the wind-down in the constructionsegment.  In 2005 the Company hadreviewed all fixed assets, particularly those that were construction related,and determined that certain items were impaired.   Based upon management’s review of assets, noimpairment charge was necessary in 2006.

*Otherincome/ (expense)* - Other expense increased to $870,153 in 2006 from $685,423 in 2005 due tohigher interest expense resulting from an increase in the interest rate onexisting loans and interest expense related to SHBC short term debt.

*Income Tax Expense*- Telesource recognized an income tax provision of $464,565 in 2006 and anincome tax credit of $12,932 in 2005. The large provision in 2006 derives from Fiji.  Telesource had net operating loss carryforwards for U.S. purposes at December 31, 2006 of approximately $13million.  The Company has approximately $41 million of net operating losscarry forwards for the Commonwealth of Northern Mariana Islands.

**SUBSEQUENT EVENTS**

The Company issuedunregistered securities to SHBC in the following transactions subsequent toDecember 31, 2006:

·                  On February 1,2007 we issued 310,000 shares of common stock of S for $155,000.

·                  On February 19,2007 we issued 730,000 shares of common stock S for $365,000.

 

14

----

**ITEM 7.          FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

Consolidated FinancialStatements

December 31, 2006 and2005

**Table ofContents**
|                                                                               | ** ** | ** ** |
|-------------------------------------------------------------------------------|------------|------------|
|                                                                          |       |       |
| Report of Independent Registered Public Accounting  Firm                      |       | 16         |
|                                                                          |       |       |
| Consolidated  Balance Sheets                                                  |       | 17         |
|                                                                          |       |       |
| Consolidated Statements of Operations                                         |       | 18         |
|                                                                          |       |       |
| Consolidated Statements of Stockholders’ Deficit and  Comprehensive Loss |       | 19         |
|                                                                          |       |       |
| Consolidated Statements of Cash Flows                                         |       | 20         |
|                                                                          |       |       |
| Notes to Consolidated Financial Statements                                    |       | 21         |

 

15

----

**REPORT OFINDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

To the Board of Directors and StockholdersTelesource International, Inc.Lombard, Illinois

We have audited the accompanying balance sheets ofTelesource International, Inc. as of December 31, 2006 and 2005, and therelated consolidated statements of operations, stockholders’ deficit,comprehensive loss, and cash flows for each of the years in the two-year periodended December 31, 2006. These financial statements are the responsibility ofthe company’s management. Our responsibility is to express an opinion on thesefinancial statements based on our audits.

We conducted our audits in accordance with thestandards of the Public Company Accounting Oversight Board (United States).Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The company is not required to have, nor were we engaged toperform, an audit of its internal control over financial reporting. Our auditincluded consideration of internal control over financial reporting as a basisfor designing audit procedures that are appropriate in the circumstances, butnot for the purpose of expressing an opinion on the effectiveness of the company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position ofTelesource International, Inc. as of December 31, 2006 and 2005, and theresults of its operations and its cash flows for each of the years in thetwo-year period ended December 31, 2006 in conformity with accountingprinciples generally accepted in the United States of America.

L J Soldinger Associates, LLC

Deer Park, IllinoisMarch 23, 2007

16

----

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**Consolidated Balance SheetsDecember 31, 2006 and 2005
| ** **                                                                                                                                                                         | ** ** | **December 31,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------|------------|-----------------------------|------------|
| **Assets**                                                                                                                                                                         |       |                        |       |                        |       |
| Current assets:                                                                                                                                                                    |       |                        |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                         |       | $                           | 2,194,207  |                        | $          | 477,944 |   |
| Accounts  receivable less allowance for doubful accounts of $62,345 and $26,177 at  December 31, 2006 and December 31, 2005, respectively                                          |       | 1,226,912                   |       | 2,021,136                   |       |
| Accounts  receivable - related party                                                                                                                                               |       | 2,582                       |       | 10,397                      |       |
| Current portion  of net investment in sales-type lease                                                                                                                             |       | 2,352,864                   |       | 2,142,552                   |       |
| Prepaid expenses  and other current assets                                                                                                                                         |       | 1,663,914                   |       | 1,320,511                   |       |
| Total current  assets                                                                                                                                                              |       | 7,440,479                   |       | 5,972,540                   |       |
| Net investment in  sales-type lease — long term                                                                                                                               |       | 3,038,470                   |       | 5,391,333                   |       |
| Property, plant, and  equipment, net                                                                                                                                               |       | 553,016                     |       | 566,090                     |       |
| Other assets                                                                                                                                                                       |       | 39,334                      |       | 42,358                      |       |
| Total assets                                                                                                                                                                       |       | $                           | 11,071,299 |                        | $          | 11,972,321 |   |
|                                                                                                                                                                               |       |                        |       |                        |       |
| **Liabilities  and Stockholders’ Deficit**                                                                                                                                    |       |                        |       |                        |       |
| Current liabilities:                                                                                                                                                               |       |                        |       |                        |       |
| Current portion  of long-term debt                                                                                                                                                 |       | $                           | 2,513,107  |                        | $          | 3,131,938 |   |
| Accounts payable                                                                                                                                                                   |       | 484,701                     |       | 1,005,656                   |       |
| Accounts payable  — related party                                                                                                                                             |       | 212,974                     |       | 179,255                     |       |
| Accrued expenses                                                                                                                                                                   |       | 1,544,082                   |       | 1,674,919                   |       |
| Other current  liabilities                                                                                                                                                         |       | 10,110                      |       | 22,739                      |       |
| Total current  liabilities                                                                                                                                                         |       | 4,764,974                   |       | 6,014,507                   |       |
|                                                                                                                                                                               |       |                        |       |                        |       |
| Long-term debt                                                                                                                                                                     |       | 12,117,289                  |       | 14,201,531                  |       |
|                                                                                                                                                                               |       |                        |       |                        |       |
| Total  liabilities                                                                                                                                                                 |       | 16,882,263                  |       | 20,216,038                  |       |
|                                                                                                                                                                               |       |                        |       |                        |       |
| Stockholders’ deficit:                                                                                                                                                        |       |                        |       |                        |       |
| Convertible  Preferred Stock, $0.01 par value authorized 50,000,000 shares, shares, none  issued and outstanding at September 30, 2006 and December 31, 2005                       |       |                        |       |                        |       |
| Common stock,  $0.01 par value. authorized 200,000,000 shares, 105,067,661 and 93,438,140  shares issued and outstanding at December 31, 2006 and December 31, 2005,  respectively |       | 1,050,677                   |       | 934,381                     |       |
| Additional  paid-in capital                                                                                                                                                        |       | 56,050,645                  |       | 50,352,181                  |       |
| Accumulated  deficit                                                                                                                                                               |       | (62,920,570                 | )          | (59,448,751                 | )          |
| Accumulated  comprehensive income (loss)                                                                                                                                           |       | 8,284                       |       | (81,528                     | )          |
|                                                                                                                                                                               |       |                        |       |                        |       |
| Total  stockholders’ deficit                                                                                                                                                  |       | $                           | (5,810,964 | )                           | (8,243,717 | ) |
|                                                                                                                                                                               |       |                        |       |                        |       |
| Total liabilities and  stockholders’ deficit                                                                                                                                  |       | $                           | 11,071,299 |                        | $          | 11,972,321 |   |

 

See accompanying notes toconsolidated financial statements.

17

----

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**Consolidated Statements of OperationsYears ended December 31, 2006 and 2005
| ** **                                                | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|-----------------------------------------------------------|------------|------------|------------|------------|------------|
| Revenues:                                                 |       |       |       |       |       |
| Service fees —  power generation plant               |       | $          | 4,769,011  |       | $          | 3,841,366 |   |
| Service Fees                                              |       | 66,825     |       | —     |       |
| Service Fees —  related party                        |       | 9,544      |       | 7,062      |       |
| Rental income                                             |       | 956        |       | 28,420     |       |
| Finance lease  revenue                                    |       | 617,448    |       | 808,960    |       |
| Construction  revenues                                    |       | 46,000     |       | 1,248,079  |       |
| Gross revenues                                            |       | 5,509,784  |       | 5,933,887  |       |
| Costs and expenses:                                       |       |       |       |       |       |
| Operation and  maintenance costs - power generation plant |       | 3,729,472  |       | 4,143,773  |       |
| Provision for  uncollectible accounts                     |       | 36,168     |       | 21,572     |       |
| Costs of service                                          |       | 151,518    |       | 89,594     |       |
| Construction  costs                                       |       | —     |       | 1,154,592  |       |
|                                                      |       |       |       |       |       |
| Cost of revenues                                          |       | 3,917,158  |       | 5,409,531  |       |
|                                                      |       |       |       |       |       |
| Gross profit                                              |       | 1,592,626  |       | 524,356    |       |
|                                                      |       |       |       |       |       |
| Operating expenses:                                       |       |       |       |       |       |
| Salaries and  employee benefits                           |       | 948,325    |       | 1,379,765  |       |
| Occupancy and  equipment                                  |       | 220,726    |       | 366,957    |       |
| General and  administrative                               |       | 2,560,676  |       | 3,085,828  |       |
| Impairment of  long-lived asset                           |       | —     |       | 385,925    |       |
|                                                      |       |       |       |       |       |
| Total operating  expenses                                 |       | 3,729,727  |       | 5,218,475  |       |
|                                                      |       |       |       |       |       |
| Operating loss                                            |       | (2,137,101 | )          | (4,694,119 | )          |
|                                                      |       |       |       |       |       |
| Other income/(expense):                                   |       |       |       |       |       |
| Interest  expense, net                                    |       | (1,304,840 | )          | (1,118,385 | )          |
| Other  income/(expense), net                              |       | 434,687    |       | 432,962    |       |
|                                                      |       |       |       |       |       |
| Total other  expense                                      |       | (870,153   | )          | (685,423   | )          |
|                                                      |       |       |       |       |       |
| Loss before  income taxes                                 |       | (3,007,254 | )          | (5,379,542 | )          |
|                                                      |       |       |       |       |       |
| Income tax expense  (benefit)                             |       | 464,565    |       | (12,932    | )          |
|                                                      |       |       |       |       |       |
| Net loss                                                  |       | (3,471,819 | )          | (5,366,610 | )          |
|                                                      |       |       |       |       |       |
| Net loss to  common stockholders                          |       | $          | (3,471,819 | )          | $          | (5,366,610 | ) |
|                                                      |       |       |       |       |       |
| Basic and diluted net  loss per share                     |       | (0.04      | )          | (0.08      | )          |
|                                                      |       |       |       |       |       |
| Weighted average shares outstanding                       |       | 93,501,812 |       | 64,350,919 |       |

 

See accompanying notes toconsolidated financial statements.

18

----

**TELESOURCE INTERNATIONAL, INC.**

**AND SUBSIDIARIES**

Consolidated Statements of Stockholders’ Deficit and Comprehensive Loss

Yearsended December 31, 2006 and 2005
| ** **                                                                 | ** ** | **Preferred Stock** | ** ** | **Common Stock** | ** ** | ** ** | ** **  | ** ** | ** ** | ** **     | ** ** | **Accu-**   | ** ** | ** **  | ** ** |
|----------------------------------------------------------------------------|------------|---------------------|------------|------------------|------------|------------|-------------|------------|------------|----------------|------------|-------------|------------|-------------|------------|
| ** **                                                                 | ** ** | ** **          | ** ** | ** **       | ** ** | ** ** | ** **  | ** ** | ** ** | ** **     | ** ** | **mulated** | ** ** | ** **  | ** ** |
| ** **                                                                 | ** ** | ** **          | ** ** | ** **       | ** ** | ** ** | ** **  | ** ** | ** ** | ** **     | ** ** | ** **  | ** ** | ** **  | ** ** | **compre-** | ** ** | ** ** | ** ** |
| ** **                                                                 | ** ** | ** **          | ** ** | ** **       | ** ** | ** ** | ** **  | ** ** | ** ** | **Additional** | ** ** | **Accu-**   | ** ** | **Compre-** | ** ** | **hensive** | ** ** | **Total** | ** ** |
| ** **                                                                 | ** ** | ** **          | ** ** | ** **       | ** ** | ** ** | ** **  | **Par**    | ** ** | **paid-in**    | ** ** | **mulated** | ** ** | **hensive** | ** ** | **income** | ** ** | **stockholders’** | ** ** |
| ** **                                                                 | ** ** | **Shares**          | ** ** | **Value**        | ** ** | **Shares** | ** **  | **value**  | ** ** | **capital**    | ** ** | **deficit** | ** ** | **loss**    | ** ** | **(loss)** | ** ** | **deficit** | ** ** |
| Balance at December 31, 2004                           |       | —              |       | $                | —     |       | 49,568,519  |       | $          | 495,685        |       | $           | 37,860,989 |        | $          | (54,082,141 | ) |   |   | $ | (15,331 | ) | $ | (15,740,798 | ) |
| ** **                                                                 | ** ** | ** **          | ** ** | ** **       | ** ** | ** ** | ** **  | ** ** | ** ** | ** **     | ** ** | ** **  | ** ** | ** **  | ** ** | ** ** | ** ** | ** ** | ** ** |
| Sale of common stock -  9,103,401 shares at $0.50 per share                |       | —              |       | —           |       | 12,186,543 |        | 121,865    |       | 5,971,407      |       | —      |       | —      |       | — |   | 6,093,272 |   |
| Sale of common stock -  2,500,000 shares at $0.40 per share                |       | —              |       | —           |       | 2,500,000  |        | 25,000     |       | 975,000        |       | —      |       | —      |       | — |   | 1,000,000 |   |
| Sale of common stock - 9,500,000  shares at $0.20 per share                |       | —              |       | —           |       | 9,500,000  |        | 95,000     |       | 1,805,000      |       | —      |       | —      |       | — |   | 1,900,000 |   |
| Conversion of debt into  common stock 19,683,078 shares at $0.20 per share |       | —              |       | —           |       | 19,683,078 |        | 196,831    |       | 3,739,785      |       | —      |       | —      |       | — |   | 3,936,616 |   |
| Net loss                                                                   |       | —              |       | —           |       | —     |        | —     |       | —         |       | (5,366,610  | )          | (5,366,610  | )          | — |   | (5,366,610 | ) |
| Dividend                                                                   |       | —              |       | —           |       | —     |        | —     |       | —         |       | —      |       | —      |       | — |   | — |   |
| Foreign currency  translation adjustment                                   |       | —              |       | —           |       | —     |        | —     |       | —         |       | —      |       | (66,197     | )          | (66,197 | ) | (66,197 | ) |
| Comprehensive loss                                                         |       | —              |       | —           |       |       |        |       |       |           |       |        |       | $           | (5,432,807 | ) |   |   |   |   |
| Balance at December 31,  2005                                              |       | —              |       | $                | —     |       | 93,438,140  |       | $          | 934,381        |       | $           | 50,352,181 |        | $          | (59,448,751 | ) |   |   | $ | (81,528 | ) | $ | (8,243,717 | ) |
|                                                                       |       |                |       |             |       |       |        |       |       |           |       |        |       |        |       |   |   |   |   |
| Sale of common stock -  3,350,000 shares at $0.50 per share                |       | —              |       | —           |       | 3,350,000  |        | 33,500     |       | 1,641,500      |       | —      |       | —      |       | — |   | 1,675,000 |   |
| Conversion of debt into  common stock 8,279,521 shares at $0.50 per share  |       | —              |       | —           |       | 8,279,521  |        | 82,796     |       | 4,056,964      |       | —      |       | —      |       | — |   | 4,139,760 |   |
| Net loss                                                                   |       | —              |       | —           |       | —     |        | —     |       | —         |       | (3,471,819  | )          | (3,471,819  | )          | — |   | (3,471,819 | ) |
| Dividend                                                                   |       | —              |       | —           |       | —     |        | —     |       | —         |       | —      |       | —      |       | — |   | — |   |
| Foreign currency  translation adjustment                                   |       | —              |       | —           |       | —     |        | —     |       | —         |       | —      |       | 89,812      |       | 89,812 |   | 89,812 |   |
| Comprehensive loss                                                         |       |                |       |             |       |       |        |       |       |           |       |        |       | $           | (3,382,007 | ) |   |   |   |   |
| Balance at December 31, 2006                                               |       | —              |       | $                | —     |       | 105,067,661 |       | $          | 1,050,677      |       | $           | 56,050,645 |        | $          | (62,920,570 | ) |   |   | $ | 8,284 |   | $ | (5,810,964 | ) |

 

See accompanying notes toconsolidated financial statements.

19

----

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**Consolidated Statements of Cash FlowsYears ended December 31, 2006 and 2005
| ** **                                                                   | ** ** | **2006**   | ** ** | **2005**    | ** ** |
|------------------------------------------------------------------------------|------------|------------|------------|-------------|------------|
| Cash flows from  operating activities:                                       |       |       |       |        |       |
| Net loss                                                                     |       | $          | (3,471,819 | )           | $          | (5,366,610 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |       |       |        |       |
| Depreciation                                                                 |       | 203,735    |       | 385,908     |       |
| (Gain)/Loss on  disposal of fixed assets                                     |       | (166,824   | )          | (23,097     | )          |
| Interest expense  paid through issuance of common stock                      |       | 147,760    |       | —      |       |
| Provision for  unbilled and uncollected accounts                             |       | 36,168     |       | 21,572      |       |
| Impairment of  long-lived assets                                             |       | —     |       | 385,926     |       |
| Changes in  assets and liabilities:                                          |       |       |       |        |       |
| Accounts  Receivable                                                         |       | 758,056    |       | 2,787,201   |       |
| Accounts  Receivable - related party                                         |       | 7,815      |       | —      |       |
| Prepaid expenses  and other current assets                                   |       | (343,403   | )          | 447,134     |       |
| Costs and  estimated earnings in excess of billings                          |       | —     |       | 1,375,689   |       |
| Net investment  in sales-type lease                                          |       | 2,142,553  |       | 1,951,040   |       |
| Other assets                                                                 |       | 3,022      |       | (17,601     | )          |
| Accounts payable                                                             |       | (565,872   | )          | (2,957,902  | )          |
| Accounts payable  - related party                                            |       | 78,636     |       | 390,957     |       |
| Accrued expenses                                                             |       | (130,837   | )          | (807,973    | )          |
| Billings in  excess of cost and estimated earnings                           |       | —     |       | (108,643    | )          |
| Accrued loss on  contracts in progress                                       |       | —     |       | (1,985,557  | )          |
| Other  liabilities                                                           |       | (12,629    | )          | 22,739      |       |
|                                                                         |       |       |       |        |       |
| Net cash used in  operating activities                                       |       | (1,313,639 | )          | (3,499,217  | )          |
|                                                                         |       |       |       |        |       |
| Cash flows from  investing activities:                                       |       |       |       |        |       |
| Proceeds from  sale of equipment                                             |       | 391,282    |       | 139,400     |       |
| Capital  expenditures                                                        |       | (288,646   | )          | (69,550     | )          |
| Net cash  provided by (used in) investing activities                         |       | 102,636    |       | 69,850      |       |
| Cash flows from  financing activities:                                       |       |       |       |        |       |
| Proceeds from  long-term debt                                                |       | —     |       | 7,500,000   |       |
| Proceeds from  borrowings - related party                                    |       | 3,992,000  |       | —      |       |
| Principal  payments on borrowings - related party                            |       | —     |       | (1,500,000  | )          |
| Payments of  long-term debt                                                  |       | (2,829,546 | )          | (12,992,493 | )          |
| Proceeds from  sale of common stock                                          |       | 1,675,000  |       | 8,993,272   |       |
| Net cash  provided by financing activities                                   |       | 2,837,454  |       | 2,000,779   |       |
|                                                                         |       |       |       |        |       |
| Effect of  exchange rate changes on cash                                     |       | 89,812     |       | (66,197     | )          |
| Net increase  (decrease) in cash and cash equivalents                        |       | 1,716,263  |       | (1,494,785  | )          |
| Cash and cash  equivalents at beginning of year                              |       | 477,944    |       | 1,972,729   |       |
| Cash and cash  equivalents at end of year                                    |       | $          | 2,194,207  |        | $          | 477,944 |   |
|                                                                         |       |       |       |        |       |
| Supplemental  disclosure:                                                    |       |       |       |        |       |
| Cash paid during  the year for interest                                      |       | $          | 1,268,610  |        | $          | 1,029,088 |   |
| Cash paid during the  year for income taxes                                  |       | 118,186    |       | —      |       |

 

See accompanying notes toconsolidated financial statements.

20

----

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes toConsolidated Financial Statements**

**(1)****                     Background**

Telesource International, Inc. (“Telesource” or the “Company”)was incorporated in Delaware in 1994. Telesource was formed to facilitatevarious intra-corporate activities and, until July 1999, was a wholly ownedsubsidiary of Sayed Hamid Behbehani & Sons Co. W.L.L. (‘SHBC”), aKuwait-based civil, electrical, and mechanical engineering and constructioncompany. Telesource entered into contracts as an international engineering andconstruction company for various projects including airport runways as well asmoving large radio broadcast towers. In addition, Telesource also constructedand manages the operation of energy conversion power plants. In Tinian, anisland in the Commonwealth of the Northern Mariana Islands (U.S. Territory),the Company operates a diesel fired electric power generation plant for thesale of electricity to the local power grid. In Fiji, the Company operates twodiesel fired electric power generation plants for the sale of electricity tothe local power grid. The Company’s facility in Lombard, Illinois, handles theprocurement, export, and shipping of U.S. fabricated products for use by theCompany’s subsidiaries or for resale to customers outside of the mainland. Inaddition, it bids on construction projects with its joint venture partner, SHBCunder the name, Telesource International, Inc./Sayed Hamid Behbehani &Sons, Co., Joint Venture, LP (“TSI/SHBC JV”) TSI/SHBC JV recently won a $42.6million contract to build a United States Embassy in Suva, Fiji.

The Company conducts its operations through the parentand its three subsidiaries. The Company’s Telesource International divisionincludes its trading business. The Company’s TSI/SHBC JV bids constructionprojects. The Company’s Mariana subsidiary, Telesource CNMI, Inc., handles themanagement of the Company’s energy conversion facilities in the Commonwealth ofthe Northern Mariana Islands. The Company’s other subsidiary, Telesource Fiji,Ltd., handles the Company’s power generation activities in Fiji.

Telesource has three main operating segments: powergeneration , trading and construction services. The power generation activitiescommenced in March 1999.

**(2)****                     Summary of Significant AccountingPolicies**

***(a)******                      Principlesof Consolidation***

The consolidated financial statements include theaccounts of the Company and its wholly owned subsidiaries: TelesourceInternational ,Telesource CNMI Inc., and Telesource Fiji, Ltd. In addition, theconsolidated financial statements will also include 51% of the initial equitycontributions and 99% of the operating income or loss of the joint ventureTSI/SHBC JV. As of December 31, 2006 no material transactions related toTSI/SHBC JV occurred. All significant intercompany transactions and accountshave been eliminated.

***(b)******                      Liquidity***

Although the Company has been experiencing a networking capital deficiency, as well as recurring losses and negative cash flowsfrom operations, the Company plans to raise approximately $2.6 million offunding from its principal shareholder, SHBC in 2007 to cover planned operatingdeficits in 2007. SHBC related companies have signed a Stock Purchase Agreementthat commits to purchasing $2.6 million of equity shares during 2007. In 2006the Company received $4.0 million in equity infusion from SHBC relatedcompanies. During the latter part of 2005, a new management team was promotedand hired to develop a plan to improve operations. The new management team hasbegun to assess each of the business segments and is developing a strategy toimprove the financial condition of the Company. Management plans to improveprofitability and cash flow by reducing costs and securing additional projects.However, no assurance can be given that such increased revenues will beachieved. The Company has and expects to continue to seek support from itsprincipal stockholder, SHBC, for its operations, and for working

21

----

capital needs, debt repayment, and business expansionas may be required. SHBC has continued its support of the Company.

The company entered into a Joint Venture Agreementwith SHBC during 2006. Telesource International Inc. is the General Partner isexpected to allocate profits/losses to the Company and SHBC on a 99% to 1% basis,respectively. SHBC has provided a stand by letter of credit in the amount of$21.5 million for the performance bond requirements of the $42 million embassyproject in Fiji. The $2.6 million to be received through the Stock purchasePlan, noted above is not anticipated to be used by the joint venture.

As of December 31, 2006, the Company’s totalliabilities exceeded its total assets by $5.8 million. The Company reliesheavily on financing from banks as well as its principal investors, SHBC tosupport its operations. As of December 31, 2006 the Company had totaloutstanding debt of $14.6 million of which $2.5 million is due in 2007 and$12.1 million is due in 2008. As of December 31, 2006 the Company had anaccumulated deficit of $62.9 million and total stockholders’ deficit of $5.8million.

The Company incurred a net loss to common stockholdersof $3,471,819 and $5,366,610 for the years ended December 31, 2006 and 2005,respectively.

**Net cashprovided by financing activities was $2,837,454 and $2,000,779 for the yearsended December 31, 2006 and 2005, respectively.**

***(c)******                       CashEquivalents***

Telesource records as cash equivalents all highlyliquid short-term investments with original maturities of three months or less.

***(d)******                      ForeignCurrency***

All assets and liabilities denominated in foreigncurrencies are translated at the exchange rate on the balance sheet date.Revenues, costs, and expenses are translated at average rates of exchangeprevailing during the period. Translation adjustments are deferred as aseparate component of stockholders’ equity. Gains and losses resulting fromforeign currency transactions are included in the consolidated statements ofoperations.

***(e)******                       Deposits inExcess of Federal Deposit Insurance Corporation Insurance***

The Company maintains its cash accounts at numerous financialinstitutions. Certain of these financial institutions are located in foreigncountries which do not have Federal Deposit Insurance Corporation, “FDIC”insurance. Those accounts covered by the FDIC are insured up to $100,000 perinstitution. As of December 31, 2006, the amount of bank deposits that exceededor are not covered by the FDIC insurance was $1,809,703.

***(f)******                         RevenueRecognition***

The Company receives variable monthly payments ascompensation for its production of power. The variable payments are recognizedbased upon power produced and billed to the customer as earned during eachaccounting period.

22

----

Revenue from construction contracts and constructionrevenues on power plants, with the exception of the power plant constructed onTinian which is accounted for using the sales-type lease method of accountingas discussed below, is recognized using the percentage-of-completion method of accounting,based upon costs incurred and estimated total projected costs. Cost of revenueconsists of direct costs on contracts, including labor and materials, amountspayable to subcontractors, direct overhead costs, equipment expense (primarilydepreciation, maintenance, and repairs), and interest associated withconstruction projects, and insurance costs. Contracts frequently extend over aperiod of more than one year and revisions in cost and profit estimates duringconstruction are recognized in the accounting period in which the facts thatrequire the revision become known. Losses on contracts are provided for intotal when determined, regardless of the degree of project completion. Claimsfor additional contract revenue are recognized in the period when it isprobable that the claim will result in additional revenue and the amount can bereasonably estimated.

The Company accounts for its leasing activities inaccordance with the requirements of Statement of Financial Accounting StandardsNo. 13, *Accounting for Leases*.Revenue associated with the sale of the Tinian power plant constructed and soldunder a sales-type lease, measured as the present value of noncancelable rents,was recognized in connection with recording the loss on sale in 1997 and 1998.The Company recognizes finance lease revenue on the resulting sales-type leasereceivable at a constant rate using the interest method. Service revenuesreceived from operating and maintaining the Tinian power plant for the durationof the lease are recognized as earned based on actual kilowatt hours ofelectricity produced and delivered to the lessee’s customers. To the extentthat variable payments based on kilowatt-hours of production exceed the fairvalue of operation and maintenance services provided, the Company recognizessuch contingent payments as additional finance lease revenue as they areearned.

Revenue from the Company’s brokering of U.S.fabricated goods is recognized at the time of shipment. The sales revenues forU.S. fabricated goods are recognized net of costs of goods sold due to titletransferring from the manufacturer directly to the Company’s customer, with therisk of loss borne by the customer at the time of transfer. The Companyrecognizes management fees and energy sales revenue in the period in which thecommodity is delivered or at the time the work is performed. Telesourcerecognizes rental revenue on the accrual basis pursuant to contractualarrangements between the Company and its customers.

***(g)******                      Property,Plant, and Equipment***

Property, plant, andequipment are stated at cost less accumulated depreciation. Depreciation iscomputed using the straight-line method at rates sufficient to depreciate thecost over the estimated economic lives of the assets. Depreciable lives usedfor financial reporting purposes are as follows:
| **Asset description**            | ** ** | **Estimated  useful life**  | ** ** |
|---------------------------------------|------------|----------------------------------|------------|
| Leasehold  improvements               |       | Lesser of lease term or  7 years |       |
| Automobiles                           |       | 5 years                          |       |
| Construction  machinery and equipment |       | 10 years                         |       |
| Office furniture  and fixtures        |       | 5 years                          |       |
| Computer and  communication equipment |       | 3-5 years                        |       |
| Other Assets                          |       | 1 year                           |       |

 

** **

23

----

Cost and accumulated depreciation are eliminated fromthe accounts when assets are sold or retired and any resulting gain or loss isreflected in operations in the year of disposition.

***(h)******                      Impairmentof Long-lived Assets***

The Company accounts for long-lived assets inaccordance with the provisions of Statement of Financial Accounting StandardsNo. 144, *Accounting for the Impairmentof Long-Lived Assets*. This statement requires that long-lived assetsand certain identifiable intangibles be reviewed for impairment whenever eventsor changes in circumstances indicate that the carrying amount of an asset maynot be recoverable. Recoverability of assets to be held and used is measured bya comparison of the carrying amount of an asset to future net cash flowsexpected to be generated by the asset. If such assets are considered to beimpaired, the impairment to be recognized is measured by the amount by whichthe carrying amount of the assets exceeds the fair value of the assets. Assetsto be disposed of are reported at the lower of the carrying amount or fairvalue less costs to sell. Fair values are determined based on quoted marketvalue, discounted cash flows or internal and external appraisals, asapplicable. During 2006 and 2005 Telesource recognized asset impairment chargesof $0 and $385,926, respectively, related to certain construction equipmentheld by Telesource. See Note 6.

***(i)******                         IncomeTaxes***

Telesource International, Inc., Telesource CNMI, Inc.,and Telesource Fiji, Ltd. file separate corporation income tax returns.Telesource International, Inc. is a U.S. corporation that files a separate U.S.corporate income tax return. Telesource CNMI, Inc. is a Commonwealth ofNorthern Mariana Islands corporation and files a corporation tax return forthis commonwealth. Telesource Fiji, Ltd. is a Fijian corporation and files aFijian corporation tax return.

Deferred income taxes are accounted for under theasset and liability method. Deferred tax assets and liabilities are recognizedfor the estimated future tax consequences attributable to differences betweenthe financial statement carrying amounts of existing assets and liabilities andtheir respective income tax bases. Deferred tax assets and liabilities aremeasured using enacted tax rates expected to apply to taxable income in theyears in which those temporary differences are expected to be recovered orsettled. The effect on deferred tax assets and liabilities of a change in taxrates is recognized in income in the period that includes the enactment date.

A valuation reserve is recorded to offset a portion ofthe deferred tax benefit if management has determined it is more likely thannot that the deferred tax assets will not be realized.

The Company’s subsidiary, Telesource CNMI, Inc., inthe Commonwealth of the Northern Mariana Islands (CNMI) prepares its corporateincome tax returns based on the local tax code. The tax code used is outlinedin the “Covenant to Establish a Commonwealth of the Northern Mariana Islands inPolitical Union with the United States,” which adopted the Internal RevenueCode as the local territorial income tax regime. Beginning January 1,1985, 95% of any income tax due on the CNMI source income is rebated to the extentthat it exceeds local business gross receipts taxes. In 1995, the rebatepercent was decreased and currently ranges from 90% decreasing to 50% dependingupon the amount of taxable income. The amounts paid for the gross receipts taxamounted to $163,566 and $302,405 in 2006 and 2005, respectively, and areincluded in general and administrative expenses on the accompanyingconsolidated statements of operations.

24

----

***(j)******                         Use ofEstimates***

The preparation of financial statements in conformitywith accounting principles generally accepted in the United States of Americarequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period. Actual results could bedifferent from those estimates.

Significant estimates used in preparing thesefinancial statements include those assumed in computing profit percentagesunder the percentage-of-completion revenue recognition method.

***(k)******                      Fair Valueof Financial Instruments***

The Company’s financial instruments include cash andcash equivalents, receivables, short-term debt, accounts payable, and long-termdebt. The gross carrying amount of the notes receivable related to thesales-type lease approximates fair value as the notes have been discounted at arate approximating the Company’s borrowing rate. The carrying amount of thelong-term debt approximates fair value due to the variable interest rates. Thecarrying amounts of other financial assets and liabilities approximate fairvalue because of the short maturities of those instruments.

***(l)******                         StockBased Compensation***

The Company has stock incentive plans that provide forstock-based employee compensation, including the granting of stock options tocertain key employees. The plans are more fully described in note 12. In yearsprior to 2006, the Company accounted for the stock incentive plans inaccordance with the recognition and measurement principles of APB Opinion No.25, *Accounting for Stock Issued to Employees*,and related Interpretations. Under this method, compensation expense isrecorded on the date of grant only if the current market price of theunderlying stock exceeds the exercise price. Under the Company’s stockincentive plans, stock options are granted at exercise prices that equal themarket value of the underlying common stock on the date of grant. Therefore, nocompensation expense related to stock options is recorded in the ConsolidatedStatements of Operations.

The Companyadopted SFAS No. 123R, “Share-Based Payment,” as of January 1, 2006, using themodified prospective application. Under this method, all equity-basedcompensation awarded after the adoption date will be determined under the fairvalue provision of SFAS No. 123R. Additionally, for all equity-basedcompensation awarded prior to the adoption date, compensation for the portionof awards for which the requisite service is performed after the adoption dateis recognized as service is rendered.

There was no stock basedcompensation granted in 2006 or 2005.

***(m)******                   Maintenance ofPower Generation Equipment***

The Company’s power generation equipment has requiredmaintenance schedules based upon hours of service and capacity. The Companyaccounts for this maintenance as costs are incurred.

***(n)******                     ******RecentAccounting Pronouncements***

In July 2006, the FASB issued Interpretation No. 48(“FIN 48”), “Accounting for Uncertainty in Income Taxes, an interpretation ofFASB Statement No. 109,” which seeks to reduce the diversity in practiceassociated with the accounting and reporting for uncertainty in income taxpositions. This Interpretation prescribes a comprehensive model for thefinancial statement recognition, measurement, presentation and disclosure ofuncertain tax positions taken or expected to be taken in income tax returns.FIN 48 is effective for fiscal years beginning after December 15, 2006 and theCompany will adopt the new requirements in its fiscal first quarter of 2007.The Company does not expect the adoption of this statement in fiscal year 2007to have a material impact on the Company’s financial position or results ofoperations.

In September 2006, the FASB issued Statement ofFinancial Accounting Standards (“SFAS”) 157, “Fair Value Measurements” (“SFAS157”), which provides guidanceon measuring the fair value of assets and liabilities. SFAS 157 will apply toother accounting pronouncements that require or permit assets or liabilities tobe measured at fair value but does not expand the use of fair value to any newcircumstances. This standard will also require additional disclosures in bothannual and quarterly reports. SFAS 157 will be effective for financialstatements issued for fiscal years beginning after November 15, 2007. TheCompany is currently determining the effect, if any, the adoption of SFAS 157will have on its financial statements.

In September 2006, the SEC staff issued StaffAccounting Bulletin No. 108, “Considering the Effects of Prior YearMisstatements when Quantifying Misstatements in Current Year FinancialStatements” (“SAB 108”). The intent of SAB 108 is to reduce diversity inpractice for the method companies use to quantify financial statementmisstatements, including the effect of prior year uncorrected errors. SAB 108establishes an approach that requires quantification of financial statementerrors using both an income statement and a cumulative balance sheet approach.SAB 108 is effective for fiscal years beginning after November 15, 2006, andthe Company will adopt the new requirements in 2007. The adoption of SAB 108 isnot currently expected to have a significant impact on the Company’sconsolidated financial statements.

25

----

***(o)******                      Reclassifications***

Certain amounts for the year ended December 31, 2005have been reclassified in the comparative financial statements to be comparableto the presentation for the year ended December 31, 2006. Thesereclassifications had no effect on net income.

**(3)****                     CustomerConcentrations**

The Company has a concentration of risk with twosignificant customers. The Company was contracted by the Commonwealth UtilitiesCorporation (CUC) to construct and operate a power generation facility. InMarch 1999, the power generation plant became operational. Power revenues fromthis plant began in March 1999 and are earned under the terms of a long-termpower energy conversion agreement with this customer. Revenues from the CUCwere approximately $1.0 million and $1.1 million for 2006 and 2005,respectively.

Upon commissioning of the Company’s power plant on theisland of Tinian for Phase I in March 1999, the Company received 120 promissorynotes each in the amount of $180,000 representing the guaranteed payment duefrom CUC over the term of the agreement. The par value balance of promissorynotes outstanding was $4.7 million and $6.8 million as of December 31, 2006 and2005, respectively. The discounted value of the promissory notes was $4.2million and $5.9 million at December 31, 2006 and 2005, respectively. Under theagreement the Company also receives a monthly operation and maintenance fee of$50,000 for 120 months. The discounted value of the operation and maintenancefee was $1.2 million and $1.6 million at December 31, 2006 and 2005,respectively. The promissory notes have been included in the original netinvestment in sales-type lease as discussed in note 7. Revenues from theTinian power plant were 29.0% and 32.5% of the Company’s revenues for 2006 and2005, respectively. Gross receivables for the investment in sales-type leasewere $6.0 million and $8.7 million at December 31, 2006 and 2005, respectively.

The second significant customer is the Fiji ElectricAuthority (FEA). The Company signed a 20-year operations and maintenanceagreement with the FEA in April 2003 and recognized revenues under the contractof $3.8 million and $2.7 million in 2006 and 2005, respectively. Revenues fromFEA were 69% and 46% of the Company’s total revenues for 2006 and 2005,respectively.

The Company previously had several constructioncontracts for projects that were completed in Saipan, Tinian, Palau and Guam.These projects have all been completed and the Company began to bid on newcontracts under the TSI/SHBC JV company during 2006. As noted earlier, theCompany was awarded a $42.6 million contract to build a United States Embassyin Suva, Fiji. This project began in 2007

**(4)****                     Accounts Receivable**

Accounts receivableconsist of the following at December 31, 2006 and 2005:
| ** **                                        | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2006**              | ** ** | **2005** | ** ** |
| Construction  contracts completed and in progress |       | $                     | 0          |   | $ | 801,071 |   |
| Retainages                                        |       | 0                     |       | 486,547 |   |
| Trade and Other                                   |       | 1,289,257             |       | 759,695 |   |
|                                              |       | 1,289,257             |       | 2,047,313 |   |
| Less allowance  for doubtful accounts             |       | 62,345                |       | 26,177 |   |
| Net accounts  receivable                          |       | $                     | 1,226,912  |   | $ | 2,021,136 |   |

 

26

----

The allowance for doubtful accounts at December 31,2006 and 2005 were $62,345 and $26,177, respectively. Direct write-offs ofuncollectible accounts were $0 and $16,074 in 2006 and 2005, respectively..

During the Twelve month period ended December 31, 2006the accounts receivable balance of Commonwealth Utilities Corporation (CUC),the major power production customer of TCNMI, increased $384,615 or 83.5% to$845,230 from $460,615. The accounts receivable balance represents the totalamount billed for variable and fixed service fees related to power productionthat had not been collected from the CUC during this period. During the year,CUC had become delinquent in their payments to TCNMI . However CUC has beenreducing the outstanding delinquent amount through payments in accordance withan agreed upon payment plan. CUC had made payments of $442,000 against theoutstanding delinquent balance as of December 31, 2006. Furthermore, CUChad made additional payments of approximately $447,000 during the first threemonths of 2007 against the delinquent amount.

**(5)****                     Costs andEstimated Earnings in Excess of Billings on Uncompleted Contracts**

Long-term construction contracts in progress areaccounted for using the percentage-of-completion method. In 2006 and 2005, respectively,balances for costs and estimated earnings in excess of billings were $0 and$3,670.

**(6)****                     Property,Plant, and Equipment**
|                                                 | ** ** | **2006**  | ** ** | **2005**  | ** ** |
|-------------------------------------------------|------------|-----------|------------|-----------|------------|
| Buildings/Leasehold  improvements               |       | $         | 84,570     |      | $          | 2,730 |   |
| Transportation  equipment                       |       | 412,375   |       | 286,778   |       |
| Construction machinery  and equipment           |       | 275,557   |       | 1,091,843 |       |
| Office furniture and  equipment                 |       | 322,218   |       | 194,169   |       |
| Computer and  communication equipment           |       | 141,065   |       | 102,764   |       |
|                                            |       | 1,235,785 |       | 1,678,284 |       |
| Less accumulated  depreciation and amortization |       | 682,769   |       | 1,112,194 |       |
| Net property, plant, and equipment              |       | $         | 553,016    |      | $          | 566,090 |   |

 

Total depreciation expense was $203,735 and $385,908,in 2006 and 2005, respectively. Depreciation for construction machinery andequipment is recognized as a project expense when appropriate.

The Company recognized an asset impairment charge of$385,926 in 2005 attributable to construction equipment to be sold during 2005and 2006. The charge included abandoned assets. The Company had reported theentire amount of this impairment in operating expenses in 2005. The Company didnot require an impairment charge in 2006.

**(7)****                     Investment inSales-type Lease**

The Company’s contract with Commonwealth UtilitiesCorporation (CUC) for the construction and operation of a power plant on the islandof Tinian is accounted for as a sales-type lease. The minimum lease paymentsdue under the agreement began upon commissioning of the first phase of thepower plant and are comprised of a guaranteed monthly payment of $180,000 forone hundred and twenty (120) months, and an operation and maintenance fee of$50,000 due monthly for one hundred and twenty (120) months. These minimumlease payments were discounted at an interest rate of 6.74%, which was theten-year U.S. Treasury note rate in June 1997, the time of contract execution.Amortization of the minimum lease payments began in March 1999 when the plantwas commissioned and the Company began collecting payments on the promissorynotes and service fees for operating the plant. The Company also receivesvariable monthly production fee payments based upon the Kwh produced plus anadditional fee for Kwh produced in excess of the first 5,140,000 Kwh producedeach month. The variable payments are recognized based upon power

27

----

produced and delivered to the customer as earnedduring each accounting period. Service fees earned in 2006 and 2005 were not inexcess of the estimated fair value of the services performed.

The original net investment in sales-type lease wasrecognized in June 1997, the date the contract was executed. The components ofthe net investment in sales-type lease are as follows:
|                                         | ** ** | **December 31** | ** ** | **June 20, 1997** | ** ** |
|-----------------------------------------|------------|-----------------|------------|-------------------|------------|
| ** **                              | ** ** | **2006**        | ** ** | **2005**          | ** ** | **inception** | ** ** |
| Guaranteed  monthly payment             |       | $               | 4,680,000  |              | $          | 6,840,000 |   | $ | 21,600,000 |   |
| Minimum  operation and maintenance fee  |       | 1,300,000       |       | 1,900,000         |       | 6,000,000 |   |
| Total minimum lease payments receivable |       | 5,980,000       |       | 8,740,000         |       | 27,600,000 |   |
| Less unearned  income                   |       | 588,666         |       | 1,206,115         |       | 9,750,000 |   |
| Net investment in sales-type lease      |       | $               | 5,391,334  |              | $          | 7,533,885 |   | $ | 17,850,000 |   |
|                                    |       |            |       |              |       |   |   |
| Current portion                         |       | $               | 2,352,864  |              | $          | 2,142,552 |   |   |   |
| Long-term  portion                      |       | 3,038,470       |       | 5,391,333         |       |   |   |
|                                    |       |            |       |              |       |   |   |
|                                    |       | $               | 5,391,334  |              | $          | 7,533,885 |   |   |   |

 

The future minimum lease payments to be collected bythe Company are $2,760,000 each year through 2008 and $460,000 in 2009.

Phase I of the power plant was commissioned in March of1999. Phase II was commissioned in March of 2000. The Company recognized powergeneration revenues from billings on the Tinian power plant of $978,534 and$1,120,560 for the years ended December 31, 2006 and 2005, respectively.

28

----

**(8)****                     Long-termDebt and Credit Arrangements**

Long-term debt consists of the following at December31, 2006 and 2005: 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | **2006**         | ** ** | **2005**         | ** ** |
| Bank of Hawaii  loan, due in quarterly principal installments of $118,750 and interest  payable monthly at prime with the loan maturing on June 3, 2007, secured by  an irrevocable standby letter of Credit for $625,000 issued by the Bank of  New York on behalf of SHBC.                                                                                                                                                                                      |       | $                | 235,967    |             | $          | 710,967 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Bank of Hawaii  loan, due in quarterly principal installments of $37,491 and interest payable  monthly at prime with the loan maturing on June 3, 2007, secured by an  irrevocable standby letter of credit for $625,000 issued by Bank of New York  on behalf of SHBC.                                                                                                                                                                                           |       | 74,983           |       | 224,948          |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Commercial Bank  of Kuwait loan, restructured during 2003, due in monthly installments of  $180,000 plus interest, from February 4, 2004 through January 4, 2009, with a  final payment of $2.2 million on February 4, 2009. The note bears interest at  LIBOR plus 3%. The loan is guaranteed by SHBC and two shareholders of SHBC.  In the event the Company defaults on one installment payment, the entire loan  and accrued interest become due and payable. |       | 6,700,000        |       | 8,860,000        |       |
| Arab Banking  Corporation Loan Facility with interest payments due in six month periods,  and principal balance due June 30, 2008. Interest is charged at 1.25% plus  Libor. Guaranteed by Al Ahli Bank of Kuwait.                                                                                                                                                                                                                                                |       | 7,500,000        |       | 7,500,000        |       |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |   |
| ANZ Motor  Vehicle Principal. Consists of three leases each running 36 months from  November 22, 2006 through October 31, 2009, total monthly payments of  $3,513.05 bearing interest rates ranging between 10.5% and 11.5% per annum.                                                                                                                                                                                                                            |       | 119,446          |       | 0                |       |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |   |
| ANZ loan due on  July 17, 2007 with monthly principal and interest payments of $2,000  collateralized by automobiles. Interest is charged at 8.0%.                                                                                                                                                                                                                                                                                                                |       | 0                |       | 28,227           |       |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |   |
| VB Holdings  Motor Vehicle due on September 24, 2006 with monthly principal and interest  payments of $1,000. Interest is charged at 7.75%.                                                                                                                                                                                                                                                                                                                       |       | 0                |       | 9,327            |       |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |   |
| Notes Payable                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       | $                | 14,630,396 |             | $          | 17,333,469 |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |   |
| Less current  portion                                                                                                                                                                                                                                                                                                                                                                                                                                             |       | 2,513,107        |       | 3,131,938        |       |   |
| Long term portion                                                                                                                                                                                                                                                                                                                                                                                                                                                 |       | $                | 12,117,289 |             | $          | 14,201,531 |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |            |                  |            |                  |            |  |  |  |  |  |

 

During November 2006, the Company revised its creditfacility agreement with Australia and New Zealand Banking Group Limited (“ANZBGL”).The revised credit facility is in the amount of FJD $200,000 (approximately$121,000 USD at December 31, 2006) for the purchase or leasing of vehicles. Interestwill be charged at the rate of 11.5% per annum. This facility is revolving andis subject to annual review. As of December 31, 2006 the Company has drawn uponthe credit facility in the amount of FJD $197,529 (approximately $119,446 USD).

Scheduled maturities of debt outstanding as ofDecember 31, 2006 are as follows:
| Years ending  December 31: | ** ** | ** ** | ** ** |
|----------------------------|------------|------------|------------|
| 2007                       |       | $          | 2,513,107  |   |
| 2008                       |       | 9,702,157  |       |
| 2009                       |       | 2,415,132  |       |
| 2010                       |       | 0          |       |
| 2011                       |       | 0          |       |
|                       |       | $          | 14,630,396 |   |

** **

**(9)****                 401K Plan**

The Company has a 401K non-matching retirement plannamed Telesource International, Inc. Retirement Plan (“Plan”). The Plan allowsemployees who elect to participate, to contribute up to the allowable maximumamount into a fund managed by Aetna. There were no contributions to this planin 2006 or 2005.

**(10)****              Stockholder’s Equity**

*PreferredStock*

The Company has 50million shares of Series A Cumulative Convertible Preferred Stock (ThePreferred Shares) authorized. None of these Preferred Shares are issued noroutstanding as of December 31, 2006 or 2005. Holders of the Preferred Sharesare entitled to receive cumulative cash dividends at the annual rate of 6.5%.The Preferred Shares have no voting rights and rank senior as to dividends andupon liquidation to the common stock.

29

----

Common Stock Offerings

As of December 31, 2006, 105,067,661 shares of theCompany’s common stock were issued and outstanding compared to 93,438,140shares at December 31, 2005.

During 2006 Telesource issued 8,279,521 Common Sharesin debt conversion transactions totaling $4,139,760. In addition the Companyissued 3,350,000 shares in four transactions totaling $1,675,000.

During 2005 Telesource issued 24,186,543 Common Sharesvia twenty-two sales transactions totaling $10,336,616 in proceeds.Additionally, the Company issued 19,683,078 Common Shares in four debtconversion transactions totaling $2,593,271.

**(11)   EarningsPer Share**

In accordance with the disclosure requirements ofStatement of Financial Accounting Standards No. 128, *Earnings Per Share*(SFAS 128), a reconciliation of thenumerator and denominator of basic and diluted earnings per share is providedas follows:
|                                                                                                        | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Numerator —  basic and diluted loss per share Net loss                                            |       | $          | (3,471,819 | )          | $          | (5,366,610 | ) |
| Less: Preferred stock dividends                                                                        |       | —     |       | —     |       |
| Net loss available to common stockholders                                                              |       | $          | (3,471,819 | )          | $          | (5,366,610 | ) |
|                                                                                                   |       |       |       |       |       |
| Denominator —  basic and diluted loss per share — weighted average common shares outstanding |       | 93,501,812 |       | 64,350,919 |       |
| Basic and diluted  earnings per share                                                                  |       | $          | (0.04      | )          | $          | (0.08 | ) |

 

Fully-vested options to purchase 180,000 shares ofcommon stock granted under the 2000 non-employee director stock option plan,and 2,999,999 warrants were outstanding at December 31, 2006 and 2005, but notincluded in the computation of diluted earnings per share as the effect of theconversion of these instruments would be anti-dilutive (i.e. reduce the lossper share).

These warrants, issued at various dates in 2003 and2004, expire in 2008 and 2009 and are exercisable between $0.50 and $1.50 pershare.

**(12)   StockOption Plans**

The Companyadopted SFAS No. 123R, “Share-Based Payment,” as of January 1, 2006, using themodified prospective application. Under this method, all equity-basedcompensation awarded after the adoption date will be determined under the fairvalue provision of SFAS No. 123R. Additionally, for all equity-basedcompensation awarded prior to the adoption date, compensation for the portionof awards for which the requisite service is performed after the adoption dateis recognized as service is rendered.

***2000 Non-Employee Director’s Stock Option Plan***

In January 2001, the Company’s board of directorsadopted the 2000 Non-Employee Director’s Stock Option Plan that provides forthe issuance of nonqualified stock options to outside directors. Under theterms of this plan, under which 285,000 shares of common stock were reservedfor issuance, options to purchase common stock are granted at not less

30

----

than fair market value, become exercisable over a 3 yearperiod from the date of grant (vesting occurs annually on the grant date at33.3% of the grant), and expire 10 years from the date of grant.

Changes in options outstanding are summarized asfollows:

 
|                                                   | ** ** | **December 31, 2006**         | ** ** | **December 31, 2005** | ** ** |
|---------------------------------------------------|------------|-------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **Weighted  average  shares** | ** ** | **Exercise  price**   | ** ** | **Weighted  average  shares** | ** ** | **Exercise  price** | ** ** |
| Options  outstanding at January 1                 |       | 180,000                       |       | $                     | 1.25       |   | 225,000 |   | $ | 1.25 |   |
| Granted                                           |       | —                        |       |                  |       | — |   |   |   |
| Exercised                                         |       | —                        |       |                  |       | — |   |   |   |
| Cancelled                                         |       | —                        |       |                  |       | — |   |   |   |
| Options  outstanding at December 31               |       | 180,000                       |       | 1.25                  |       | 225,000 |   | 1.25 |   |
| Options  exercisable at December 31               |       | 180,000                       |       | 1.25                  |       | 225,000 |   | 1.25 |   |
| Shares available for  future grant at December 31 |       | 60,000                        |       |                  |       | 60,000 |   |   |   |
|                                                   |            |                               |            |                       |            |  |  |  |  |  |  |

 

During2006, Wes Marsh resigned as a Director. Participants of this plan have 90 daysto exercise their options after separation of service. Mr. Marsh did notexercise his options.

***2000 Incentive Stock Option Plan***

In January 2001, the Company’s board of directorsadopted the 2000 Incentive Stock Option Plan that provides for the issuance ofqualified stock options to employees. Under the terms of this plan, under which888,000 shares of common stock were reserved for issuance, options to purchasecommon stock are granted at not less than fair market value, become exercisableover a 3 year period from the date of grant (vesting occurs annually on thegrant date at 33.3% of the grant), and expire 10 years from the date of grant.As of December 31, 2006, no options had been awarded under this plan.

***2000 Non-Qualified Stock Option Plan***

In January 2001, the Company’s board of directorsadopted the 2000 Non-Qualified Stock Option Plan that provides for the issuanceof nonqualified stock options to employees. Under the terms of this plan, underwhich 27,000 shares of common stock were reserved for issuance, options topurchase common stock are granted at less than fair market value, becomeexercisable immediately on the date of grant, and expire 10 years from the dateof grant. As of December 31, 2006, no options had been awarded under this plan.

**(13)   FinancialInstruments With Off-balance Sheet Risk and Concentrations of Credit Risk**

Derivative financial instruments — Historically theCompany has not engaged in hedging activities and currently does not hold anyhedging instruments to minimize foreign exchange rate or interest risk.

Standby letters of credit and financial guarantees —The Company is liable for its obligations, some of which are further securedunder letters of credit obtained by SHBC on behalf of the Company, and otherfinancial guarantees totaling approximately $14.6 and $17.3 million at December31, 2006 and 2005, respectively. The Company’s management does not believe itis practicable to estimate the fair values of these financial instruments anddoes not expect any losses from their resolution.

31

----

(14)   Related-partyTransactions — Not described elsewhere

Certain of the Company’s executive officers,directors, and major stockholders are also owners, officers, and/or directorsof SHBC located in Kuwait. SHBC is a civil, electrical, and mechanicalengineering firm and construction contractor with 750 employees and over 30 yearsof experience. SHBC and its affiliates were the sole stockholders of TelesourceInternational prior to July 1999 and now own approximately 95.8% of the commonstock outstanding. SHBC and Telesource International bid and compete within thesame industries; however, SHBC has agreed, in writing, not to bid projectswithin the United States and its possessions. Additionally, SHBC and itsmajority stockholders, Fouad Behbehani and Nasrallah Behbehani, have signed asguarantors on Telesource CNMI’s promissory note with the Commercial Bank ofKuwait, New York Branch. SHBC and its majority stockholders have also signed asguarantors on a $625,000 letter of credit issued to the Bank of Hawaii tosecure two installment loans. These credit facilities were used to finance theconstruction activities on the power plant, the West Tinian Airport expansionproject, and to provide financing for other projects. See note 8. Furthermore,as noted above SHBC and Telesource International, Inc. have formed a jointventure (TSI/SHBC JV) to bid on future construction projects.

Additionally, from time to time the Company may hire,on a part time or temporary basis, individuals employed by SHBC to provideassistance to Telesource on certain projects. The rates paid do not exceed thefair market value of similar services provided by unrelated third parties. TheCompany did not hire any SHBC employees to provide assistance on contractsduring 2006 and 2005.

The following table provides a summary of financialinformation related to all services provided to SHBC by the Company:
|                               | ** ** | **2006** | ** ** | **2005** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Sales                         |       | 9,544    |       | 7,062    |       |
| Total related  party revenues |       | $        | 9,544      |     | $          | 7,062 |   |
|                               |            |          |            |          |            |  |  |

 

The following table summarizes all balances related totransactions with SHBC as of December 31, 2006 and 2005:
|                           | ** ** | **December 31,** | ** ** |
|---------------------------|------------|------------------|------------|
| ** **                | ** ** | **2006**         | ** ** | **2005** | ** ** |
| Accounts payable  to SHBC |       | $                | 197,397    |   | $ | 126,497 |   |
|                      |       |             |       |   |   |
|                           |            |                  |            |  |  |  |  |

 

The balance of accounts payable to SHBC in 2006 and2005 was substantially due to costs of the stand by letter of credits purchasedby SHBC on behalf of Telesource for use on the airport and prison projects. TheCompany recorded $90,391 and $171,481 in 2006 and 2005, respectively, relatingto these standby letter of credits and for other materials.

During 2006, the Company had short term borrowings of$3,992,000 from SHBC at an interest rate of 6%. The Company converted$3,992,000 principle and $148,760 of interest into common stock. See Footnote10.

The Company paid Computhink, Inc. a total of $ 87,888in 2006 and $102,837 in 2005. The payments to Computhink, Inc. represent rentfor office space occupied by the Company and for computer hardware and softwareprovided by Computhink, Inc. Nidal Zayed, Telesource’s Chief Executive Officerserves on the Board of Directors for Computhink. The Company owed Computhink$14,527 and $6,792, respectively, at December 31, 2006 and 2005. See note 16.

32

----

The Company also rents office space as well as landfrom Retsa in Saipan and Tinian. Retsa is an affiliated company of SHBC. TheCompany paid Retsa $125,526 and $56,348 in 2006 and 2005, respectively. Thefollowing table summarizes all balances related to transactions with Retsa asof December 31, 2006 and 2005:
| ** **                 | ** ** | **December 31,** | ** ** |
|----------------------------|------------|------------------|------------|
| ** **                 | ** ** | **2006**         | ** ** | **2005** | ** ** |
| Accounts payable to  Retsa |       | $                | 1,050      |   | $ | 45,966 |   |
|                            |            |                  |            |  |  |  |  |

 

Total related party accounts payable are summarized asfollows:
| ** **                     | ** ** | **December 31** | ** ** |
|--------------------------------|------------|----------------------|------------|
| ** **                     | ** ** | **2006**             | ** ** | **2005** | ** ** |
| Accounts payable to SHBC       |       | $                    | 197,397    |   | $ | 126,497 |   |
| Accounts payable to Computhink |       | 14,527               |       | 6,792 |   |
| Accounts payable to  Retsa     |       | 1,050                |       | 45,966 |   |
|                           |       | $                    | 212,974    |   | $ | 179,255 |   |

 

**(15)   IncomeTaxes**

Income tax expense (benefit) consists of:
| ** **                     | ** ** | **Current** | ** ** | **Deferred** | ** ** | **Total** | ** ** |
|--------------------------------|------------|-------------|------------|--------------|------------|-----------|------------|
| Year ended December 31,  2006: |       |        |       |         |       |      |       |
| U.S. Federal                   |       | $           | —     |         | $          | —    |       | $ | — |   |
| State and local                |       | —      |       | —       |       | —    |       |
| U.S. possession                |       | —      |       | —       |       | —    |       |
| Foreign                        |       | 464,565     |       | —       |       | 464,565   |       |
|                           |       | $           | 464,565    |         | $          | —    |       | $ | 464,565 |   |
| Year ended December 31,  2005: |       |        |       |         |       |      |       |
| U.S. Federal                   |       | $           | —     |         | $          | —    |       | $ | — |   |
| State and local                |       | —      |       | —       |       | —    |       |
| U.S. possession                |       | —      |       | —       |       | —    |       |
| Foreign                        |       | (12,932     | )          | —       |       | (12,932   | )          |
|                           |       | $           | (12,932    | )            | $          | —    |       | $ | (12,932 | ) |

 

The foreign tax expense (benefit) was incurred inconnection with the Company’s operations in Fiji and is based upon earnings(loss) within Fiji. The average tax rate for Fiji was 31%. Fiji had pre-taxincome of $1,329,000 in 2006.

In 2006 and 2005 the Company recorded a loss forfinancial reporting purposes as well as a loss for income tax reportingpurposes and therefore, no current U.S. income tax expense has been reflectedin the accompanying consolidated statements of operations.

The tax effects of temporary differences that giverise to significant portions of the deferred tax assets and deferred taxliabilities at December 31, 2006 and 2005 are presented below:
| ** **                                                       | ** ** | **2006**   | ** ** | **2005**   | ** ** |
|------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Deferred tax assets:                                             |       |       |       |       |       |
| Net operating  loss carryforwards                                |       | $          | 18,900,000 |       | $          | 16,620,000 |   |
| Accrued expenses                                                 |       | 100,000    |       | 95,000     |       |
| Total gross  deferred tax assets                                 |       | 19,000,000 |       | 16,715,000 |       |
| Less valuation  allowance                                        |       | 19,000,000 |       | 16,715,000 |       |
| Net deferred tax  asset                                          |       | $          | —     |       | $          | — |   |
| Deferred tax liability  — excess tax over book depreciation |       | $          | —     |       | $          | — |   |

 

33

----

The valuation allowance for deferred tax assets as ofDecember 31, 2006 and 2005 was $19,000,000 and $16,715,000, respectively. Thenet change in the total valuation allowance for the years ended December 31,2006 and 2005 was an increase of $2,285,000 and an increase of $1,802,500,respectively. In assessing the realizability of deferred tax assets, managementconsiders whether it is more likely than not that some portion or all of thedeferred tax assets will not be realized. The ultimate realization of deferredtax assets is dependent upon the generation of future taxable income during theperiods in which those temporary differences become deductible. Managementbelieves that the valuation allowance reduces the recognition of deferred taxassets to a level that reflects the amount that is more likely than not to berealized, considering the tax planning strategies available to the Company.

At December 31, 2006, the Company has total netoperating loss carryforwards from U.S. operations of approximately $13 millionand approximately $41 million from its operations in the Commonweath ofNorthern Mariana Islands. The net operating loss carryforwards expire in theyears 2017 through 2026. Certain of these net operating losses may be subjectto a limitation on future utilization due to ownership changes or foreign taxlaws.

A reconciliation of thedifferences between income taxes computed at the U.S. federal statutory rate of34% the Fiji tax rate of 31% and the Company’s reported provision for incometaxes is as follows:
| ** **                                                     | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------------------|------------|-----------------------------|------------|
| ** **                                                     | ** ** | **2006**                    | ** ** | **2005** | ** ** |
| Income tax (benefit) at  statutory rate                        |       | $                           | (1,022,466 | ) | $ | (1,829,050 | ) |
| Difference between U.S.  tax rate and Fiji tax rate            |       | (39,866                     | )          |   |   |
| Adjustment of prior  year’s deferred tax estimate         |       | (765,520                    | )          |   |   |
| Other                                                          |       | 7,417                       |       |   |   |
| Provision/(benefit) not  recognized due to valuation allowance |       | 2,285,000                   |       | 1,816,118 |   |
|                                                           |       |                        |       |   |   |
| Provision (benefit) for income taxes                           |       | $                           | 464,565    |   | $ | (12,932 | ) |

 

**(16)   Commitmentsand Contingencies**

Minimum rental commitments under allnoncancelable-operating leases, primarily related to property, vehicles, andconstruction equipment, in effect at December 31, 2006 are:

| Years ending December 31, | ** ** |
|---------------------------|------------|
| 2007                      |       | $ | 40,423 |   |
| 2008                      |       | 14,289 |   |
| 2009                      |       | 12,530 |   |
| 2010                      |       | 2,499 |   |
| 2011                      |       | 1,018 |   |
| TOTAL                     |       | $ | 70,759 |   |

 

Lease expense was $151,595 and $157,781 and for theyears ended December 31, 2006 and 2005, respectively.

On May 1, 2005, the Company entered into a sublease withComputhink, Inc. for a term of two years. The sublease requires a base rentalamount of $5,332 per month which includes rent and reception services.

The Company is involved in various litigationproceedings arising in the ordinary course of business. In the opinion ofmanagement, the ultimate disposition of these matters will not have a materialadverse effect on the Company’s financial position, results of operations, orliquidity.

34

----

Telesource previouslycompleted negotiations over the final billing for the West Tinian AirportProject (“WTA”). The Company had a continuing warranty obligation for threeyears from the date of final acceptance, which was December 3, 2003 and forwhich there were no material claims.

The Company, in 1999 wasawarded a contract to build 45 housing units for the Northern Marina HousingAgency, a government unit. The houses were built and subsequently occupied. TheNorthern Marianas Housing Corporation has filed a lawsuit against Telesourceand two other parties for $3.0 million in damages related to this project.These claims involve allegations of various construction defects. The Companyestimates that, if the plaintiff is successful, the Company may have anestimated liability in the range of $500,000 to $1,200,000. The Company accrueda $300,000 estimated loss in 2004 and an additional $200,000 in 2006. Theseamounts are reflected under accrued expenses as of December 31, 2006.Telesource has denied any liability and will aggressively defend itself todismiss these claims.

Telesource International’s power generation activitiesinvolve significant risks of environmental damage, equipment damage andfailures, personal injury and fines and costs imposed by regulatory agencies.Though management believes its insurance programs are adequate, if a liabilityclaim is made against it, or if there is an extended outage or equipmentfailure or damage at Telesource International’s power plant for which it isinadequately insured or subject to a coverage exclusion, and TelesourceInternational is unable to defend against these claims successfully or obtainindemnification or warranty recoveries, Telesource International may berequired to pay substantial amounts, which could have a materially adverseeffect on its financial condition. Although the equipment is covered under itsinsurance, the Company is liable for the deductible of 1,250,000 FJD(approximately $755,875 USD at December 31, 2006).

Telesource International offers warranties on itsconstruction services and power generating plants. Telesource Internationaldoes not maintain any material warranty reserves because these warranties areusually backed by warranties from its vendors. Should Telesource Internationalbe required to cover the cost of repairs not covered by the warranties ofTelesource International’s vendors or should one of Telesource International’smajor vendors be unable to cover future warranty claims, TelesourceInternational could be required to outlay substantial funds, which could harmits financial condition.

The Company has an agreement with the Commonwealth ofthe Northern Mariana Islands to manage one of their power plants. In accordancewith Change Order No. 3 of this agreement, the Company is required to upgradethe power distribution system in certain areas of the Tinian Island. TheCompany is responsible for the costs of the upgrade which include labor andmaterial. The Company has incurred approximately $876,000 in costs associatedwith this upgrade through December 31, 2006. The Company will be seeking certificationof the upgrade by the client. Such certification includes certain negotiatingissues that may affect the remaining costs to complete the upgrade. The Companyprojects the completion of the upgrade in 2007 and estimates the additionalcosts to be approximately in the range of $48,000 to $125,000.

During November 2006, the Company revised its creditfacility agreement with Australia and New Zealand Banking Group Limited (“ANZBGL”).The revised credit facility is in the amount of FJD $200,000 (approximately$121,000 USD at December 31, 2006). This credit facility is primarily for thepurchase or lease of vehicles. Interest is charged at the rate of 11.5% perannum.

The Company operates a power plant on the island ofTinian. The power plant requires a permit with the Department of EnvironmentalQuality. The Company currently has a temporary permit and expects to receive apermanent permit. However, substantial consequences could occur if the Companydoes not receive a permanent permit.

35

----

**(17)   Business SegmentInformation**

Telesource has three operating segments: powergeneration and construction of power plants, trading, and constructionservices. The power generation and construction of power plants segmentincludes sales-type lease revenues recognized. There were no material amountsof transfers between segments. Any inter segment revenues have been eliminated.The following table sets forth certain segment information for the periodsindicated:
|                                | ** ** | **December 31, 2006**                                      | ** ** |
|--------------------------------|------------|------------------------------------------------------------|------------|
| ** **                     | ** ** | **Power  generation  and  construction  of power  plants** | ** ** | **Trading** | ** ** | **Construction** | ** ** | **Total** | ** ** |
| Revenue                        |       | $                                                          | 5,454,240  |   | $ | 9,544 |   | $ | 46,000 |   | $ | 5,509,784 |   |
| Interest expense, net          |       | 1,304,840                                                  |       | — |   | — |   | 1,304,840 |   |
| Depreciation and  amortization |       | 203,735                                                    |       | — |   | — |   | 203,735 |   |
| Income tax expense  (benefit)  |       | 464,565                                                    |       | — |   | — |   | 464,565 |   |
| Net income (loss)              |       | (3,459,502                                                 | )          | (58,317 | ) | 46,000 |   | (3,471,819 | ) |
| Total capital  expenditures    |       | 397,166                                                    |       | — |   | — |   | 397,166 |   |
| Total assets                   |       | 11,059,447                                                 |       | 8,182 |   | 3,670 |   | 11,071,299 |   |
|                                |            |                                                            |            |  |  |  |  |  |  |  |  |  |  |

 
|                                | ** ** | **December 31, 2005**                                      | ** ** |
|--------------------------------|------------|------------------------------------------------------------|------------|
| ** **                     | ** ** | **Power  generation  and  construction  of power  plants** | ** ** | **Trading** | ** ** | **Construction** | ** ** | **Total** | ** ** |
| Revenue                        |       | $                                                          | 4,678,746  |   | $ | 7,062 |   | $ | 1,248,079 |   | $ | 5,933,887 |   |
| Interest expense, net          |       | 128,264                                                    |       | — |   | 990,122 |   | 1,118,386 |   |
| Depreciation and  amortization |       | 137,697                                                    |       | — |   | 248,211 |   | 385,908 |   |
| Income tax expense  (benefit)  |       | (12,932                                                    | )          | — |   | — |   | (12,932 | ) |
| Net income (loss)              |       | (3,462,542                                                 | )          | (88,417 | ) | (1,815,651 | ) | (5,366,610 | ) |
| Total capital  expenditures    |       | 69,550                                                     |       | — |   | — |   | 69,550 |   |
| Total assets                   |       | 10,196,260                                                 |       | 4,484 |   | 1,771,577 |   | 11,972,321 |   |
|                                |            |                                                            |            |  |  |  |  |  |  |  |  |  |  |

 

The basis used to attribute revenues to individualcountries is based upon where the services are provided.

The power generation segment includes revenues fromthe Company’s power station on Tinian, Commonwealth of the Northern MarianaIslands in the amounts of $1,596,938 and $1,957,940 for 2006 and 2005,respectively. Also included in power generation revenues are billings from thetwo power plants in Fiji in the amount of $3,857,303 and $2,720,806 for 2006and 2005, respectively.

Revenues from the Company’s related party, SHBC, were$9,544 and $7,062 for 2006 and 2005, respectively.

Revenues recognized within the construction segmentderived from the IBB Project in 2006, and from the IBB, Adult CorrectionalFacility and three Palau projects in 2005.

36

----

Long-term assets located in the Commonwealth of theNorthern Mariana Islands were $3.1 million and $5.8 million as of December 31,2006 and 2005, respectively. Fixed assets located in Fiji were $449,054 and$138,917 as of December 31, 2006 and 2005, respectively.

**(18)    SubsequentEvents**

The Company issued unregistered securities to SHBC inthe following transactions subsequent to December 31, 2006:

·      On February 1, 2007 weissued 310,000 shares of common stock for $155,000.

·      On February 19, 2007 weissued 730,000 shares of common stock for $365,000.

·      The Company transferred$1,145,000 into the TSI/SHBC JV, LP during the first quarter of 2007. Thistransfer represented the Companies beginning equity contribution.

**(19)   Supplementary Disclosure of Cash Flow Information**

During the fourth quarter of 2006, the Companyconverted short term debt payable due to SHBC in the amount of $4,139,760 at aconversion price of $0.50 per share into 827,951 shares of common stock.

Duringthe fourth quarter of 2005, the Company agreed to issue 19,683,078 shares ofcommon stock to SHBC, in payment of debt due SHBC amounting to $3,936,616.

During2006, the Company purchased vehicles in Fiji for $126,472 in exchange for longterm debt.

**(20)****          ****Change in Accounting Estimate**

The Company changed the estimated useful life that isthe basis for calculating depreciation expense on certain of its assets. Thischange was required as a result of evaluating these assets and their estimatedfuture benefit. The estimated life of these assets was previously 120 months or10 years and these assets had been purchased between 1997 and 2003. As ofJanuary 1, 2006, the remaining useful life of these assets was determined to beone year.

The Company determined the net book value of theseaffected assets as of January 1, 2006 and depreciated this balance over thenext 12 months ended December 31, 2006. The effect of this change resulted inan increase in the operating loss from continuing operations in the amount ofapproximately $55,875 during the twelve month period ended December 31, 2006.

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

None

**ITEM 8A.     CONTROLS AND PROCEDURES**

Telesource is committed to maintaining disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in its Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the Commission’s rules andforms, and that such information is accumulated and communicated to itsmanagement, including its Chief Executive Officer and Chief Financial Officer,as appropriate, to allow for timely decisions

37

----

regarding required disclosure. In designing andevaluating the disclosure controls and procedures, management recognizes thatany controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectivesand are subject to certain limitations, including the exercise of judgment byindividuals, the difficulty in identifying unlikely future events, and thedifficulty to eliminate misconduct completely. As a result, there can be noassurance that our disclosure controls and procedures will prevent all errorsor fraud or ensure that all material information will be made known tomanagement in a timely manner.

**Conclusion Regarding the Effectiveness ofDisclosure Controls and Procedures**

Under the supervision and with the participation ofmanagement, including the Chief Executive Officer (“CEO”) and Chief Financial Officer(“CFO”), the Company conducted an evaluation of its disclosure controls andprocedures, as such term is defined under Rule 13a-15(e) promulgated under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”) as of December31, 2006. Based on this evaluation, its CEO and CFO concluded the Company’sdisclosure controls are effective.

The following represent either changes to internalcontrols or other factors that could significantly affect internal controlsduring the quarter ended December 31, 2006:

There were no changes in our internal control in thefourth quarter.

**ITEM 8B.       OTHER INFORMATION**

**NONE**

38

----

# **PART III**

**ITEM 9.        DIRECTORSAND EXECUTIVE OFFICERS OF THE REGISTRANT**

Directors are elected for one-year terms and areelected at each annual meeting of stockholders. As of the date of this reportTelesource’s Board of Directors are:
| Name and Age;  Years Served as Director                                       | ** ** | **Principal Occupation for Past Five Years; Other  Directorships**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |
|-------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Ralph Beck   Age 67   Chairman of the Board Director since 1999               |       | Mr. Beck is a principal of Global Construction  Solutions, L.L.C. From 1994 to 1998, Mr. Beck served as the President of  Kajima Construction Services, Inc., a North American investment of a global  engineering and construction firm. From 1965 to 1994, Mr. Beck was with the  Turner Corporation, an international engineering and construction firm. Mr.  Beck served as the chairman of the board for Turner Steiner International  from 1987 to 1994, and as a senior vice president for Turner Corporation.                                                                                                                                                                                                                                                                                           |
|                                                                          |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Nidal Zayed   Age 45   Director Since 1998 Chief Executive Officer since 2005 |       | Nidal Zayed, President & Chief Executive  Officer, joined Telesource International in January 1996. He is also engaged  in the practice of law. He received a law degree from Loyola University  School of Law in 1985 and a B.A. in Accounting from Loyola University of  Chicago in 1982. He serves as Chairman for Computhink Incorporated and has  been a director for Computhink since 1994.                                                                                                                                                                                                                                                                                                                                                                                                           |
|                                                                          |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Jeffery Adams   Age 63   Director Since 1999                                  |       | Mr. Adams is an Electrical Engineer trained in the  United Kingdom. From 1978 to 1986, Mr. Adams served as the marketing director  of Babcock Industries and Electrical Group of Companies. In 1986, Mr. Adams  became an independent international sales marketing consultant. From 1987 to  present, Mr. Adams is the general manager for Trafex Ltd., an engineering supplies  company serving the Middle East.                                                                                                                                                                                                                                                                                                                                                                                              |
|                                                                          |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Max Engler   Age 56   Director Since 1997                                     |       | From 1988 to present Mr. Engler has been an  independent Financial Consultant and is also on the Board of Directors of  various companies in Switzerland and abroad. From 1984 to 1988 Mr. Engler  headed the Private Banking desk (Middle East and Far East) of Bank Leu as  Vice President. He is a director of Computhink Incorporated, Belmoral S.A.,  Computhink Ltd., Telesource International CNMI Inc., Retsa Development Inc.,  Golden Osprey Ltd., Computhink Technology Ltd., FSD Holdings PLC, Litra  Holdings AG, Linos Finanz AG, Trafex Ltd., R.C.W. Enterprises S.A., Formvac  S.A., Sanop AG, and Protea Beratungs-und Finanz AG.                                                                                                                                                              |
|                                                                          |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Ibrahim M. Ibrahim   Age 64   Director Since 1999                             |       | Mr. Ibrahim is now with the Al Ahli Bank of Kuwait  in the commercial lending area since 2002 and has been Head of International  Banking for Commercial Bank of Kuwait from 2001 through 2002 and the Head of  International Banking for The Gulf Bank K.S.C. in Kuwait from 1986 to 2001.  Mr. Ibrahim served as the Vice President and Head of Credit and Marketing for  the First National Bank of Chicago for the middle east region from 1984 to  1986 and he also served as the Vice President and General Manager of  Continental Illinois Bahrain Branch from 1969 to 1984. Mr. Ibrahim received  his M.B.A. in International Business from De Paul University, his M.S. in  Taxation and Islamic Law from the University of Alexandria and his B.A. in  Accounting from the University of Alexandria. |
|                                                                          |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Greg Grosvenor   Age 54   Chief Financial officer Since August, 2005          |       | Mr. Grosvenor has been Chief Financial Officer at  several companies including a publicly traded restaurant chain AMCH, Smith  Bucklin & Associates and Metropolitan Pier and Exposition Authority. In  addition he formerly worked at Hyatt Corporation, Galileo, Anixter  International and PriceWaterhouse Coopers. He is a CPA and graduated from  Loyola University in 1976 with a B.A. majoring in accounting.                                                                                                                                                                                                                                                                                                                                                                                        |

 

39

----

**Code of Ethics**

The Company has adopted a code of ethics that appliesto all employees of the Company. Copy of the Company’s code of ethics can beobtained by writing to Telesource International, 860 Parkview Blvd, Lombard,Il. 60148.

**ITEM 10.        EXECUTIVECOMPENSATION**

**SUMMARYCOMPENSATION TABLE**
| **Name and  Principal Position** | ** ** | **Year** | ** ** | **Salary (1)** | ** ** | **Bonus** | ** ** | **All Other Annual  Compensation(2)** | ** ** |
|----------------------------------|------------|----------|------------|----------------|------------|-----------|------------|---------------------------------------|------------|
|                             |       |     |       |           |       |      |       |                                  |       |
| Nidal Zayed                      |       | 2006     |       | $              | 168,000    |      |       |                                  | $          | 21,340 |   |
| Chief Executive  Officer         |       | 2005     |       | $              | 141,385    |      | $          | —                                |       | $ | 22,302 |   |
|                             |       | 2004     |       | $              | 128,000    |      | $          | —                                |       | $ | 22,302 |   |
|                             |       |     |       |           |       |      |       |                                  |       |
| Greg Grosvenor                   |       | 2006     |       | $              | 135,000    |      | $          | 20,000                                |       | $ | 17,502 |   |
| Chief Financial Officer          |       |     |       |           |       |      |       |                                  |       |

 

----

(1)             Includessalary paid by Telesource International, before any salary reduction forcontributions to Telesource International’s 401(k) Savings Plan.

(2)             Telesourceprovided a vehicle to Mr. Zayed at a cost of $11,080 in 2006 and $ 11,036 in2005. Telesource provided Mr. Zayed with health insurance for him and hisfamily at a cost of $10,258 in 2006 and $7,605 in 2005. The company providedhealth insurance to Mr. Grosvenor and his family of $17,502 in 2006.

**Stock Options**

As of December 31, 2006 there were no stock optionsoutstanding to any persons other than nonemployee directors.

**Directors Compensation**

The Company paid an annual fee to each Director(except for Nidal Zayed) in the amount of $20,000 in both 2006 and 2005,respectively. Such fees are paid in cash.

Financial Expert

The Company does not have a separate audit committee. Boardmember Max Engler has been designated as the financial expert as it is definedin the regulations.

**ITEM 11.        SECURITY OWNERSHIP OF CERTAIN BENEFICIALOWNERS AND MANAGEMENT**

The following table contains information as ofDecember 31, 2006 regarding the ownership of the Common Stock of the Companyby: (i) all persons who, to the knowledge of the Company, were the beneficialowners of 5% or more of the outstanding shares of Common Stock of the Company,(ii) each director and director nominee of the Company, (iii) the ChiefExecutive Officer and the two other most highly compensated executive officersof the Company whose salary and bonus for the fiscal year ended December 31,2006 exceeded $100,000, and (iv) all executive officers and directors of theCompany as a group:

40

----

 
| **Name**                                                      | ** ** | **Amount and  Nature  of Beneficial  Ownership (1)** | ** ** | **Percent of  Common Stock  Outstanding (2)** | ** ** |
|---------------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------|------------|
| ** **                                                    | ** ** | ** **                                           | ** ** | ** **                                    | ** ** |
| SHBC and Affiliated  Companies                                |       | 100,681,661                                          |       | 95.8                                          | %          |
| Max Engler(4)                                                 |       | 95,000                                               |       | *                                             |       |
| Ibrahim Ibrahim                                               |       | 55,000                                               |       | *                                             |       |
| Jeff Adams                                                    |       | 46,000                                               |       | *                                             |       |
| Ralph Beck                                                    |       | 45,000                                               |       | *                                             |       |
| Nidal Z. Zayed                                                |       | —                                               |       | *                                             |       |
| Greg Grosvenor                                                |       | —                                               |       | *                                             |       |
| All Executive Officers and Directors   as a Group (7 Persons) |       | 241,000                                              |       | 0.2                                           | %          |

 

----

*                           Less than 1%

(1)                   Exceptas indicated in the footnotes to this table, the persons named in the tablehave sole voting and investment power with respect to all shares of CommonStock shown as beneficially owned by them, subject to community property lawswhere applicable. Amounts include 45,000 options for non-employee directors.

(2)                   Calculatedon the basis of 105,067,661 shares of Common Stock outstanding as of December31, 2006. Excludes 45,000 options that were exercisable within 60 days ofDecember 31, 2006 held by non-employee directors. None of the options wereexercised and the Company did not incur any expenses associated with theseoptions.

(3)                   Max Englerserves as a director for Litra Holding AG. Litra Holding AG owns directly495,000 shares of Telesource International’s common stock. Based uponinformation provided to Telesource International, Telesource International doesnot consider these shares to be beneficially owned by Mr. Engler.

(4)                   As of December31, 2006 there were no stock options outstanding to any persons other thannon-employee directors

41

----

Shown below isinformation as of December 31, 2006 with respect to the shares of Common Stockthat may be issued under Telesource’s equity compensation plans.

 
| ** **                                            | ** ** | **Number of shares to be  issued upon exercise  of outstanding options** | ** ** | **Weighted average  exercise price of   outstanding options** | ** ** | **Number of shares  remaining available  for future issuance  under equity  compensation plans** | ** ** |
|-------------------------------------------------------|------------|--------------------------------------------------------------------------|------------|---------------------------------------------------------------|------------|--------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans    approved by shareholders |       | 180,000(1)                                                               |       | 1.25                                                          |       | 975,000(2)                                                                                       |       |

 

----

(1)             Includesthe number of shares that may be issued upon the exercise of outstandingoptions to purchase shares of Telesource Common Stock under Telesource’s stockoption plans.

(2)             Includesshares available for future issuance under Telesource’s stock option plans,excluding shares quantified under Column 1.

**ITEM 12.****                       CERTAINRELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE**

Certain of the Company’s executive officers, directors,and major stockholders are also owners, officers, and/or directors of SHBClocated in Kuwait. SHBC is a civil, electrical, and mechanical engineering firmand construction contractor with 750 employees and over 30 years of experience.SHBC and its affiliates were the sole stockholder of Telesource Internationalprior to July 1999 and now own approximately 95.8% of the common stockoutstanding. SHBC and Telesource International bid and compete within the sameindustries; however, SHBC has agreed, in writing, not to bid on projects withinthe United States and its possessions. Additionally, SHBC and its majoritystockholders, Fouad Behbehani and Nasrallah Behbehani, have signed asguarantors on Telesource CNMI’s promissory note with the Commercial Bank of Kuwait,and as guarantors on a $7,500,000 credit facility for Telesource with the ArabBanking Corporation of Bahrain. SHBC and its majority stockholders have alsosigned as guarantors on a $625,000 letter of credit issued to the Bank ofHawaii to secure a $625,000 credit facility.

These credit facilities were used to finance theconstruction activities on the power plant, the West Tinian Airport expansionproject, and to provide financing for other projects. See note 8.

Additionally, from time to time the Company may hire,on a part time or temporary basis, individuals employed by SHBC to provideassistance to Telesource on certain projects in the Northern Mariana Islands.

The Company paid Computhink, Inc. $87,888 in 2006 forrent, and computer support. The Company shares office space with Computhink inits Lombard office. Nidal Zayed, the Company’s Chief Executive Officer serveson the Board of Directors of Computhink.

**Director Independence**

The Company is a “Controlled Company” as that term isdefined by the Listing Requirements of NASDAQ. As such, if the Company were acompany listed on the NASDAQ trading market, it would not be required to complywith the director independence guidelines established thereby.

42

----

**ITEM 13.       EXHIBITS**
| EXHIBIT  NUMBER | ** ** | **EXHIBIT DESCRIPTION**                                                                                                                                                              |   |
|-----------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|
|            |       |                                                                                                                                                                                 |   |
| 2.01            |       | Amended and Restated  Agreement and Plan of Merger and Plan of Reorganization among Sixth Business  Service Group and Telesource International, Inc. Appendix A**                    |   |
|            |       |                                                                                                                                                                                 |   |
| 3.01            |       | Certificate of  Incorporation of Telesource International **                                                                                                                         |   |
|            |       |                                                                                                                                                                                 |   |
| 3.02            |       | By-laws of Telesource  International **                                                                                                                                              |   |
|            |       |                                                                                                                                                                                 |   |
| 3.03            |       | Amendment to Certificate  of Incorporation*                                                                                                                                          |   |
|            |       |                                                                                                                                                                                 |   |
| 10.01           |       | Agreement for Design,  Supply of Plant and Equipment, Private Construction, Maintenance and  Operation, and Transfer of Ownership dated June 10, 1997**                              |   |
|            |       |                                                                                                                                                                                 |   |
| 10.02           |       | Agreement for Design,  Supply of Plant and Equipment, Private Construction, Maintenance and  Operation, and Transfer of Ownership, Change Order Number 1, dated November  30, 1998** |   |
|            |       |                                                                                                                                                                                 |   |
| 10.03           |       | Agreement for Design,  Supply of Plant and Equipment, Private Construction, Maintenance and  Operation, and Transfer of Ownership, Change Order Number 2, dated November  30, 1998** |   |
|            |       |                                                                                                                                                                                 |   |
| 10.04           |       | Agreement and Contract  for Construction of Koblerville Expansion Project between the Northern  Mariana Islands and Telesource International dated July 28, 1998**                   |   |
|            |       |                                                                                                                                                                                 |   |
| 10.05           |       | Memorandum of  Understanding between Sayed Hamid Behbehani & Sons, Co. W.L.L. and  Telesource International, Inc. regarding right of first refusal for certain  areas**          |
|            |       |                                                                                                                                                                                 |
| 10.06           |       | Memorandum of  Understanding between Sayed Hamid Behbehani & Sons, Co. W.L.L. and  Telesource International, Inc. regarding commission fees **                                   |
|            |       |                                                                                                                                                                                 |
| 10.07           |       | Note Agreement between  the Commercial Bank of Kuwait, New York Branch, and Telesource International  CNMI, Inc. dated August 20, 1998**                                             |
|            |       |                                                                                                                                                                                 |
| 10.08           |       | Note Agreement between  the Commercial Bank of Kuwait, New York Branch, and Telesource CNMI, Inc.  dated December 11, 2001 **                                                        |
|            |       |                                                                                                                                                                                 |
| 10.09           |       | Term Loan Agreement  between the Kuwait Real Estate Bank and Telesource International CNMI, Inc.  dated May 2, 1999**                                                                |
|            |       |                                                                                                                                                                                 |
| 10.10           |       | Line of Credit  Agreement between the Bank of Hawaii and Telesource International CNMI,  Inc.**                                                                                      |
|            |       |                                                                                                                                                                                 |
| 10.11           |       | Lease of Tinian Land  between the Commonwealth Utilities Corporation and Telesource International  CNMI, Inc.**                                                                      |
|            |       |                                                                                                                                                                                 |
| 10.12           |       | Loan Facility Agreement  between Arab Banking Corporation and Telesource International Inc. dated  March 22, 2005*                                                                   |
|            |       |                                                                                                                                                                                 |
| 10.13           |       | Telesource  International, Inc. 2000 Incentive Stock Option Plan **                                                                                                                  |
|            |       |                                                                                                                                                                                 |
| 10.14           |       | Telesource  International, Inc. 2000 Non-Qualified Stock Options Plan **                                                                                                             |
|            |       |                                                                                                                                                                                 |
| 10.15           |       | Telesource  International, Inc. 2000 Non-Employee Director Stock Option Plan **                                                                                                      |
|            |       |                                                                                                                                                                                 |

 

43

----

 
| 10.16  |   | Warrant to Purchase 1,000,000  Shares of Common Stock between SHBC and Telesource International, Inc. **                           |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                               |
| 10.17  |   | Telesource  International, Inc. Sayed Hamid Behbehani & Sons Co., Joint Venture, L.P.  Agreement*                              |
|   |   |                                                                                                                               |
| 10.18  |   | Common Stock Purchase  Agreement between Telesource International, Inc. and Ernil Continental S.A.,  BVI dated February 26, 2007.* |
|   |   |                                                                                                                               |
| 10.19  |   | Common Stock Purchase  Agreement between Telesource International, Inc. and Halbarad Group, LTD.,  BVI dated February 26, 2007*    |
|   |   |                                                                                                                               |
| 31.1   |   | Rule  13a-14(a)/15d-14(a) Certification of CEO*                                                                                    |
|   |   |                                                                                                                               |
| 31.2   |   | Rule  13a-14(a)/15d-14(a) Certification of CFO*                                                                                    |
|   |   |                                                                                                                               |
| 32.1   |   | Section 1350  Certification — Chief Executive Officer *                                                                       |
|   |   |                                                                                                                               |
| 32.2   |   | Section 1350  Certification Chief Financial Officer *                                                                              |
|   |   |                                                                                                                               |
| 99.1   |   | Code of Ethics **                                                                                                                  |
|   |   |                                                                                                                               |

 

----

*               Filed herewith

**       Previouslyfiled

**ITEM 14.        PRINCIPAL ACCOUNTANT FEES AND SERVICES**

The Audit Committee pre-approves audit services andpermitted non-audit services (including the fees and terms thereof) to beperformed for the Corporation by its independent registered accountants, L JSoldinger Associates LLC. The following table presents fees for professionalservices rendered by L J Soldinger Associates LLC for the respective periodsindicated:

| SERVICES PERFORMED      | ** ** | **2006** | ** ** | **2005** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Audit Fees (Note 1)          |       | $        | 210,000    |     | $          | 285,000 |   |
| Audit-Related Fees  (Note 2) |       | 0        |       | 0        |       |
| Tax Fees (Note 3)            |       | 23,000   |       | 23,000   |       |
| All Other Fees (Note 4)      |       | 0        |       | 0        |       |
|                         |       |     |       |     |       |
| Total Fees                   |       | $        | 233,000    |     | $          | 308,000 |   |

 

NOTES TO PRECEDING TABLE

1.                Audit fees represent fees billed forprofessional services provided in connection with the audit of our annualfinancial statements, reviews of our quarterly financial statements, auditservices provided in connection with statutory and regulatory filings for thoseyears and audit services provided in connection with securities registrationand/or other issues resulting from that process.

2.                Audit-related fees represent feesbilled primarily for assurance and related services reasonably related to theperformance of the audit or reviews of our financial statements.

3.                Tax fees principally represent feesbilled for tax preparation.

44

----

4.               Allother fees principally would include fees billed for products and servicesprovided by the accountant, other than the services reported under the threecaptions above

**ITEM15(a)(3).         EXECUTIVE COMPENSATIONPLANS AND ARRANGEMENTS**

The following executive compensation plans andarrangements are listed incorporated by reference in this Form 10-K:

**2000Incentive Stock Option Plan******

In January 2001, the Company’s board of directorsadopted the 2000 Incentive Stock Option Plan that provides for the issuance ofqualified stock options to employees. Under the terms of this plan, under which888,000 shares of common stock were reserved for issuance, options to purchasecommon stock are granted at not less than fair market value, become exercisableover a 3 year period from the date of grant (vesting occurs annually on thegrant date at 33.3% of the grant), and expire 10 years from the date of grant.As of December 31, 2006, no options had been awarded under this plan.

 

45

----

 

**SIGNATURES**

PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OFTHE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORTTO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED THEREUNTO DULY AUTHORIZED.

 
|                            | **TELESOURCE INTERNATIONAL, INC.**     |
|----------------------------|----------------------------------------|
|                       | (Registrant)                           | ** ** |
|                       |                                   |
| Dated:  April 2, 2007 | /s/ Nidal Zayed                        |   |   |
|                       | Nidal Zayed                            |   |   |
|                       | President and Chief  Executive Officer |   |   |
|                       |                                   |   |   |
|                       | /s/ Greg Grosvenor                     |   |   |
|                       | Greg Grosvenor                         |   |   |
|                       | Chief Financial Officer                |   |   |
|                            |                                        |  |  |  |  |

 

PURSUANT TO THE REQUIREMENTS OF THE SECURITIESEXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BY THE FOLLOWINGPERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIES INDICATED ON March30, 2007.

 
|        | /s/  Ralph Beck          |   | Chairman of the Board  of Directors   |
|--------|--------------------------|--------|---------------------------------------|
|   | Ralph  Beck              |   |                                  |
|   |                     |   |                                  |
|   |                     |   |                                  |
|   | /s/  Nidal Z. Zayed      |   | Director and Chief  Executive Officer |
|   | Nidal  Z. Zayed          |   |                                  |
|   |                     |   |                                  |
|   |                     |   |                                  |
|   | /s/  Max Engler          |   | Director                              |
|   | Max  Engler              |   |                                  |
|   |                     |   |                                  |
|   |                     |   |                                  |
|   | /s/Jeffery  Adams        |   | Director                              |
|   | Jeffery  Adams           |   |                                  |
|   |                     |   |                                  |
|   |                     |   |                                  |
|   |  /s/Ibrahim Ibrahim |   | Director                              |
|   | Ibrahim  Ibrahim         |   |                                  |
|   |                     |   |                                  |

 

 

46

----