** **

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

**FORM 10-KSB**

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

**FOR THE FISCAL YEAR ENDED DECEMBER31, 2005**

**COMMISSION FILE NUMBER 0-2564**

**TELESOURCEINTERNATIONAL, INC.**

(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
| **Delaware**                                                   | ** ** | **6770**                                                  | ** ** | **59-3671568**                       |
|----------------------------------------------------------------|------------|-----------------------------------------------------------|------------|--------------------------------------|
| State or other  jurisdiction of  Incorporation or organization |       | PRIMARY STANDARD  INDUSTRIAL  CLASSIFICATION CODE  NUMBER |       | I.R.S. Employer  Identification  No. |

 

**860Parkview BlvdLombard, Illinois 60148**

 

REGISTRANT’STELEPHONE NUMBER, INCLUDING AREA CODE

**(630)620-4787**

 

SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THEACT:

**COMMONSTOCK, PAR VALUE $.01 PER SHARE**

(Title of each class)

SECURITIES REGISTEREDPURSUANT TO SECTION 12(B) OF THE ACT:

**NONE**

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined inRule 405 of the Securities Act Yes  o  No  x

Indicateby check mark if the registrant is not required to file reports pursuant toSection 13 or Section 15(d) of the Act. Yes  o  No  x

Indicateby check mark whether the Registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the Registrant wasrequired to file such reports) and (2) has been subject to such filingrequirements for the past 90 days. Yes  o    No  x

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 of RegulationS-K is not contained herein, and will not be contained, to the best ofRegistrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment to theForm 10-K. x

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, or a non-accelerated filer.  (as defined in ExchangeAct Rule 12b-2 of the Act).
| Large accelerated filer  o |   | Accelerated Filer  o |   | Non-accelerated Filer  x |
|--------------------------------------|--------|--------------------------------|--------|------------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined inRule12b-2 of the Act. Yes  o    No  x

Statethe aggregate market value of the voting and non-voting common equity held bynon-affiliates computed by reference to the price at which the common equitywas last sold, or the average bid and asked price of such common equity, as ofthe last business day of the registrant’s most recently completed second fiscalquarter. The Registrant’s voting stock held by non-affiliates of theRegistrant on December 31, 2005 was approximately $52,050.

Numberof shares of $0.01 par value Common Stock outstanding as of the close ofbusiness on June 30, 2006: 93,438,140 shares.

Documents Incorporated by Reference

None

 

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# **TABLE OF CONTENTS**

|            | ** ** | ** **                                                                                  | ** ** | **Page** |
|------------|------------|---------------------------------------------------------------------------------------------|------------|----------|
| ** ** | ** ** | **PART I**                                                                                  |       |     |
| Item 1.    |       | Description of Business                                                                     |       | 3        |
|       |       |                                                                                        |       |     |
| Item 2.    |       | Properties                                                                                  |       | 9        |
|       |       |                                                                                        |       |     |
| Item 3.    |       | Legal Proceedings                                                                           |       | 9        |
|       |       |                                                                                        |       |     |
| Item 4.    |       | Submission of Matters to a  Vote of Security Holders                                        |       | 10       |
|       |       |                                                                                        |       |     |
|       |       | **PART II**                                                                                 |       |     |
|       |       |                                                                                        |       |     |
| Item 5.    |       | Market for the Registrant’s  Common Equity and Related Stockholder Matters             |       | 10       |
|       | ** ** | ** **                                                                                  |       |     |
| Item 6.    |       | Management’s  Discussion and Analysis of Results of Operations and Financial Condition |       | 13       |
|       |       |                                                                                        |       |     |
| Item 7.    |       | Financial  Statements and Supplementary Data                                                |       | 17       |
|       |       |                                                                                        |       |     |
| Item  8    |       | Changes  in and Disagreements with Accountants on Accounting and Financial Disclosure       |       | 18       |
|       |       |                                                                                        |       |     |
| Item  8A   |       | Controls  and Procedures                                                                    |       | 18       |
|       |       |                                                                                        |       |     |
| Item 8B    |       | Other  Information                                                                          |       | 19       |
|       |       |                                                                                        |       |     |
| ** ** | ** ** | **PART III**                                                                                |       |     |
|       |       |                                                                                        |       |     |
| Item  9.   |       | Directors  and Executive Officers of the Registrant                                         |       | 20       |
|       |       |                                                                                        |       |     |
| Item 10.   |       | Executive  Compensation                                                                     |       | 21       |
|       |       |                                                                                        |       |     |
| Item 11.   |       | Security  Ownership of Certain Beneficial Owners and Management                             |       | 21       |
|       |       |                                                                                        |       |     |
| Item  12.  |       | Certain  Relationships and Related Transactions                                             |       | 23       |
|       |       |                                                                                        |       |     |
| Item 13.   |       | Exhibits,  Financial Statement Schedules and Reports on Form 8-K                            |       | 24       |
|       |       |                                                                                        |       |     |
| Item  14.  |       | Principal  Accountant Fees and Services                                                     |       | 25       |

 

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**PART I**

**ITEM 1. BUSINESS**

Theterms “Telesource,” “Company,” “our,” and “us,” as used in this annual report,refer to Telesource International Inc.

Youare cautioned that the Form 10-KSB contains “forward-looking statements” withinthe meaning of the Private Securities Litigation Reform Act of 1995. When thewords “believes,” “plans,” “anticipates,” “will likely result,” “will continue,”“projects,” “expects,” and similar expressions are used in the Form 10_KSB,they are intended to identify “forward-looking statements,” and such statementsare subject to certain risks and uncertainties which could cause actual resultsto differ materially from those projected. Furthermore, the Company’s plans,strategies, objective, expectations and intentions are subject to change at anytime at the discretion of management and the Board. These forward-lookingstatements speak only as of the date this report is filed. The company does notintend to update the forward-looking statements contained in this report, so asto reflect events or circumstances after the date hereof or to reflect theoccurrence of unanticipated events, except as may occur as part of its ongoingperiodic reports filed with the SEC.

**1a) GENERAL**

Telesource International(“Telesource” and/or the “Company”) is an international company engagedprimarily in the operation of energy conversion power plants. The companypreviously operated as an international engineering and construction companyand during 2005 completed all remaining construction projects. The Company haschanged its marketing strategy in the construction market. The Company may seeknew projects on a limited basis in coordination with other companies inpossible joint venture partnerships. The primary partner in these projectswould most likely be with Sayed Hamid Behbehani & Sons Co. W.L.L. (“SHBC”),which owns in excess of 85% of the Company’s outstanding shares. Telesourcecommon stock currently trades on the “pink sheets” under the ticker symbol “TSCI.”

The Company conducts itsoperations through the parent company and its two subsidiaries located in four geographiclocations. Telesource located in Lombard, Illinois U.S.A. is the Company’sheadquarters where it also operates a small service for the procurement, exportand shipping of U.S. fabricated products for use by the Company’s subsidiariesor for resale to customers outside of the mainland. The Company’s subsidiary,Telesource Fiji, Ltd., is located on the island of Fiji where it maintains andoperates diesel fired electric power generation plants for the sale ofelectricity in the country. Additionally, the Company also is attempting todevelop future construction and other energy related business activities inFiji. The Company’s Mariana subsidiary, Telesource CNMI, Inc., is on the islandof Tinian, an island in the Commonwealth of 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 Saipan, the Company maintainsoffices for coordinating marketing and development activities in the region andis responsible for all operations including the development of futureconstruction projects and energy conversion opportunities in the region.

The Company waspreviously engaged independently in the construction of airports, correctionalfacilities, museum improvements, radio towers and single family homes. TheCompany’s new strategy, effective in 2006, will be to engage in constructionactivities in partnership with SHBC.

PowerPlant Operation and Maintenance

Ouragreement with the governmental agency in the Commonwealth of the NorthernMariana Islands is for the management of one of their power plants. Under theterms of this agreement, Telesource designed, financed and built the powerplant. Telesource obtained financing for the project through a $25,000,000 lineof credit from the Commercial Bank of Kuwait, New York branch. For theconstruction of the first

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phaseof this power plant, Telesource is paid $180,000 per month for ten years by thegovernmental agency. Each monthly payment is secured by a promissory note inthe amount of $180,000 issued by the Commonwealth Utilities Corporation.

Telesourcehas a 20-year lease on the land on which the power plant is built, plus titleto the entire plant and a two-month escrow account of no less than $360,000 onwhich Telesource has a first lien. In the event of the governmental agency isunable to meet its obligations either to make payments of monthly maintenancefees or on the promissory notes, Telesource may sell, lease, assign or transferthe power plant or any part of the plant equipment.

In thefirst phase of the project, the governmental agency also pays Telesource aproduction fee based upon a fixed fee per kilowatt-hour for each kilowatt-hourproduced on its behalf. In the second phase, which added 10-megawatts ofcapacity, the governmental agency has agreed to pay Telesource an additionalproduction fee per kilowatt-hour. In addition, the governmental agency paysTelesource a monthly service fee for operating and maintaining the power plant.

In May2001, the governmental agency and Telesource executed Change Order No. 3 to theTinian Power Plant Contract. Change Order No. 3 provides a suspension in theEscalator on the variable payments from January 1, 2001 to December 31, 2005.This Change Order extends the term of the contract from an expiration of 10years following commissioning of the last constructed phase (currently Phase IIwas commissioned in March 2000 and therefore the contract was to have expiredin March 2010) to an new expiration date of March 31, 2020. Change Order No. 3does not include an expansion of the power generation capacity of the powerplant. The power plant will continue to operate at its current maximumgeneration capacity of 20 Mwh. Effectively, the contract has been extended foran additional 10 years. Power rates agreed to under the original contract andChange Order No. 1 remain unchanged. Change Order No. 3 does provide thecustomer with an early termination option related to the extended agreementbeginning on March 31, 2010 and available annually thereafter; however, thecustomer is required to give a six-month notice and to pay an early terminationfee of $6,000,000. Change Order No. 3 prohibits the customer from purchasingpower from any source other than Telesource for the first 30 MW. The expandedagreement executed under Change Order No. 3 only extends the power generationcontract term and does not require additional performance by Telesource, withrespect to building additional power generation capacity.

ChangeOrder No. 3 does require Telesource to upgrade the power distribution system incertain areas of the Tinian Island. The Company is responsible for thecosts of the upgrade which include labor and material. The Company estimatesthe cost of this upgrade to be approximately in the range of $800,000 to $1.3million and to be completed in 2006.

PotentialFuture Power Plant Construction and Power Supply

Basedon previous experience, management believes there will be a growing demand forpower around the world; however competition and deregulation could eliminatethe financial feasibility of these projects and thereby prevent Telesource fromtaking advantage of the expected growth in demand. In the U.S., two-thirds ofthe country’s installed plants are 25 or more years old and need to be replacedand re-powered, principally with new combustion turbines. The world’s use ofelectricity is projected to increase by two-thirds over the forecast horizon,from 13 trillion kilowatt hours in 1999 to 22 trillion kilowatt-hours in 2020.The strongest growth rates in electricity consumption are projected for thedeveloping world. The most rapid expansion in electricity use is expected fordeveloping Asia and Central and South America, with average annual growth ratesexceeding 3.5 percent between 1999 and 2020. In the industrialized world,electricity consumption is expected to grow at a more modest pace. Slowerpopulation and economic growth, along with the market saturation of certainelectronic appliances (such as washers and dryers) and efficiency gains fromelectrical appliances help to explain the expected slower growth of electricityuse in the industrialized nations, although growing computer usage and theintroduction of new electronic devices could modulate that trend in the future.Telesource also believes that those situations where the local governments lackthe up-front funding to build the additional power plants will represent anopportunity for Telesource to find alternative solutions up to and includinghaving Telesource locate the needed project

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financing.Without the additional energy, Telesource believes that many of theinfrastructure upgrades envisioned by local governments will be unable tooccur. In Telesource’s experience, in return for securing project financing ina manner similar to that obtained for the project in the Commonwealth of theNorthern Mariana Islands, local governments will be willing to enter intocontracts which guarantee Telesource a minimum amount of power consumption,coupled with long-term operation and maintenance contracts.

Telesourceanticipates that these contracts will generally be secured by governmentalguarantees, promissory notes, liens and collateral on the land and in thephysical power plants.

ConstructionServices

Asnoted above, Telesource has implemented a new strategy for the constructionmarket. SHBC’s depth of experienced personnel and success in the constructionindustry combined with Telesource’s experience and contacts will be thefoundation for the Company’s future growth in this market segment. The Companyhas been pre-qualified for bidding on the construction of a United StatesEmbassy in Fiji. Once the RFP for the embassy project is released, the Companyintends on submitting a bid for this project. The Company has extensive experiencein Fiji, primarily from operating power plants. Through this experience it hasdeveloped a strong understanding of the economic and business climate and hasdeveloped strong relations with local businesses. It is the Company’sintentions to obtain other opportunities in Fiji. Similarly, the Company’sextensive construction experience in the Commonwealth of Northern MarianaIslands has resulted in developing strong relationships within the governmentunits as well as the business community. Additionally, the Company will relyheavily upon SHBC to provide more effective personnel to manage newconstruction projects. This in combination with implementing strong financialsystems to monitor construction projects will provide stronger controls overproject management. 

ActiveConstruction Projects and Services

TheCompany currently has no active construction projects. The Company completedthe Adult Correctional Facility in Saipan during 2005. This project has awarranty period of up to three years for certain components, of which therehave been no material claims. 

CompletedConstruction Projects and Services

TheCompany has completed several projects in the last two years. These projectsinclude the Adult Correction Facility in Saipan, building the New PalauNational Museum on the island of Palau. In addition, the Company completedconstructing a 7,800 linear foot airport runway on the Island of Tinian. (SeeCommitments and Contingencies in the footnotes to the financial statements) 

PowerGeneration Construction Projects

Telesource’spower generation business involves building power plants, operating powerplants for a contracted period of time, selling wholesale power to the clientto be distributed on their power grid and the transfer of the ownership of theproperties to the client at the end of the contract.

In1997, a governmental agency located in the Commonwealth of the Northern MarianaIslands, awarded Telesource CNMI a contract to design, build and operate a10-30 megawatt power plant. The initial 10 megawatts power plant was completedwithin budget and on time and the plant has been operational since March 1999.The second phase of the project was completed in March 2000, also within budgetand on time. 

InMarch 2003, Telesource was awarded a 20-year, multi-million dollar, energyconversion agreement with the Fiji Electric Authority for the operation andmaintenance of three diesel power plants with generation capacity of 78 MW. Thetwo power plants are located in Kinoya and Vuda, Fiji. Telesource and the FijiElectric Authority have completed and executed the Energy Conversion Agreement.The Company is in the process of completing negotiations to manage a recentlynewly built power plant in Kinoya. The

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Companywill be responsible for managing the power plant and will receive additionalfees for providing these services.

In2000, Telesource was contracted to expand two existing power stations in Fiji,and to add additional power generators with a combined production capacity of32 MWh for a fixed price of approximately $12.1 million. This project wascompleted in late 2001 at a cost of $11.1 million. Performance for thiscontract was divided between Telesource and Telesource Fiji, Ltd., a subsidiaryof Telesource International, based on the location and type of service to beperformed. The contract with the customer reflected this arrangement. Thiscontract was a performance pay contract (i.e., as specified milestones werereached, Telesource billed the customer and receives payments within 30 days).

Salesand Marketing Strategies

Thecompany has determined that it will be very selective and enter into newconstruction projects in a joint venture with SHBC. Meanwhile, a significantfocus of its marketing efforts will be in the power generation business. Telesource’spower generation projects are obtained through a public bid process, andclients are either governments or governmental agencies. In obtainingcontracts: 

·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

Theindependent power industry has grown rapidly over the past twenty years. Thereare a large number of suppliers in the wholesale market and a surplus ofcapacity, which has led to intense competition in this market. The principalsources of competition in this market include traditional regulated utilitiesthat have excess capacity, unregulated subsidiaries of regulated utilities,energy brokers and traders, energy service companies in the development andoperation of energy-producing projects and the marketing of electric energy, equipmentsuppliers and other non-utility generators like Telesource. Competition in thisindustry is substantially based on price with competitors discovering lowercost alternatives for providing electricity. The electric industry is alsocharacterized by rapid changes in regulations, which Telesource expects couldcontinue to increase competition. Telesource does not believe the Tinian powerplant would be significantly impacted by competition in the wholesale energymarket since its revenues are subject to contracted rates which aresubstantially fixed for several years.

Telesourcealso competes in the market to develop power generation facilities. The primarybases of competition in this market are the quality of development plans, theability of the developer to finance and complete the project and the price. Insome cases, competitive bidding for a development opportunity is required. Competitionfor attractive development opportunities is expected to be intense as there area number 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.

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Presently,there is significant merger and consolidation activity occurring in theelectric industry. From time to time, Telesource may consider merger andacquisition proposals when they appear to present an opportunity to enhancestockholder value. Telesource is not involved in any of these discussions ornegotiations at this time and there can be no assurance that any opportunitieswill develop.

Customerdependence

Telesource depends on two customers forpower-generation revenues. The loss of either single customer could causeTelesource’s revenues to decline.

SinceMarch 1999, Telesource began deriving a portion of its revenues from the saleof electric power. Under Telesource’s agreement with a governmental agency, theelectrical power generated at Telesource’s power generation facility is ownedby the governmental agency. Telesource is paid a fee to produce the electricpower. The governmental agency in turn sells the electric power to the varioususers throughout the Island of Tinian. If the end-user customer defaults orincreases in power use do not materialize as anticipated, Telesource’s revenuebase may not grow to support other operations.

Telesourceoperates two additional power plants for a period of 20 years within Fiji forone customer, the Fiji Electric Authority. Telesource is to operate the twopower plants in Fiji by converting fuel provided by the customer intoelectricity for which Telesource receives a fee. The Fiji Electric Authority inturn sells the power produced to various users in Fiji. If the end-usercustomer defaults or increases in power use do not materialize as anticipated,Telesource’s revenue base may not grow to support other operations.

EnergyRegulation

Telesource’sprojects are subject to regulation under federal and local energy laws andregulations. Telesource is subject to the requirements established by itspermitting authorities, i.e. the Department of Environmental Quality (“DEQ”)and the Environmental Protection Agency (“EPA”).

Presently,neither the Customer Choice Act nor proposed legislation dealing with U.S.energy policy directly impacts Telesource because the legislation andrestructuring plan pertain to the retail market or new contracts in thewholesale market. However, as discussed above, Telesource could be impacted inthe future by, among other things, increases in competition as a result ofderegulation. Telesource is actively monitoring these developments in energyproceedings in order to evaluate the impact on existing projects and also toevaluate new business opportunities created by the restructuring of theelectric industry.

EnvironmentalRegulation

Telesource’sprojects are subject to regulation under federal, foreign and localenvironmental laws and regulations and must also comply with the applicablelaws pertaining to the protection of the environment, primarily in the areas ofwater and air pollution. These laws and regulations in many cases require alengthy and complex process of obtaining and maintaining licenses, permits andapprovals from federal and local agencies. As regulations are enacted oradopted in any of these jurisdictions, Telesource cannot predict the effect ofcompliance therewith on its business. Telesource’s failure to comply with allapplicable requirements could result in delays in proceeding with any projectsunder development or require modifications to operating facilities. Duringperiods of non-compliance, Telesource’s operating facilities may be forced toshutdown until the instances of non-compliance are corrected. Telesource isresponsible for ensuring compliance of its facilities with applicablerequirements and, accordingly, attempts to minimize these risks by dealing withreputable contractors and using appropriate technology to measure compliancewith the applicable standards. 

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Insuranceand Bonding

Telesourcemaintains general and excess liability, construction equipment, and workers’compensation insurance; all in amounts consistent with industry practices.Telesource believes its insurance programs are adequate subject to deductiblessome of which are approximately $3.0 million.

Telesourcewas required to provide bonding for the airport runway project on the island ofTinian. This project has partial funding from the U.S. Government (the FederalAviation Administration “FAA”) and consequently, U.S. Treasury Listed Bondingwas required. During 2002, Telesource was required to provide bonding for theprison project on the island of Saipan. This project has partial funding fromthe U.S. Government and therefore, U.S. Treasury Listed Bonding was required.In order to secure the required bonding, Telesource’s largest shareholder,SHBC, provided a letter of credit to the surety equal to 100% of the contractvalue of $17 million. Telesource’s ability to obtain additional surety bondingdepends upon its capitalization, working capital, past performance, managementexpertise and other factors, which may change from time to time. During 2005,the Company was released from the bonding requirement and consequently, SHBCwas also released from the letter of credit requirements.

Employees

Telesource,as of January 2006, employed 111 people, consisting of 14 employees inmanagement, 7 engineers and technical staff members, 9 support staff membersand 81 hourly employees. All of Telesource’s employees are nonunion workers,although Telesource may employ union subcontractors from time to time.

Telesource’snon-engineering level employees are hourly workers, while its engineering andsupervisory staffs are on monthly salaries.

Sourcesand availability of raw materials

Telesource relies on third parties for importantraw materials and technical expertise. Telesource’s ability to enter into newengagements or to conduct the business in a profitable manner will be harmed ifits access to these important resources is limited or becomes too costly.

Telesourcerelies on third-party suppliers for raw materials like wood, steel andconcrete; for fabrication of technical equipment subsystems including dieselgeneration and technical expertise. Telesource’s ability to obtaincost-effective raw materials, fabrication services and technical assistance issubject to a number of external factors which are outside of its control,including:

·                  Thirdparties may increase the price of the raw materials, fabrication services ortechnical assistance they provide.

·                  Third-partyraw material suppliers, fabricators or technical expertise providers may decidenot to provide Telesource with materials or services.

·                  Telesourcehas no long-term contracts with third-party suppliers of raw materials,fabrication services or technical expertise providers.

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

Reportsto Security Holders

TheCompany files various reports with Securities and Exchange Commission asrequired. Currently, the Company selected to file under the Small Businessregulations and files 10-QSB and 10KSB’s.

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Thepublic may read and copy any material the Company files with the SEC at the SEC’sPublic Reference Room at 100 F. Street, N.E., Washington, D.C. 20549 or bycalling 1-800SEC-0330. In addition the Company files electronically and theirfilings can be obtained at http://www.sec.gov. 

**ITEM 2. PROPERTIES**

Properties

Telesourcemaintains leased office space and leases land for storage of constructionequipment. Telesource’s Mariana subsidiary’s head office in the Commonwealth ofthe Northern Mariana Islands is leased for a term which extended throughDecember 2004 and is currently on a month-to-month renewal. In the corporateoffices in Illinois, Telesource has an office space leased through April, 2007.The Company’s office in the Republic of Palau was closed in August 2005.Management believes its existing arrangements for its office facilities areadequate.

**ITEM 3. LEGAL PROCEEDINGS**

In theordinary course of its business Telesource becomes involved from time to timein legal proceedings and claims asserted by and against Telesource. It is theopinion of management that the ultimate disposition of these routine pendingmatters will not have a materially adverse impact on the Company.

TheCommonwealth Port Authority (“CPA”) and Telesource were in negotiations overthe final billing for the West Tinian Airport Project (“WTA”). As of December 31,2004, Telesource had reflected approximately $1.8 million of retentions inaccounts receivable related to the WTA. Approximately $891,000 of theoutstanding retention receivable was collected in 2005 in connection with apartial settlement agreement that was entered into in August 2005.Telesource claimed that in addition to the remaining unpaid retentionsreceivable recorded under the original contract terms and related to workperformed through 2003 that it is also due additional amounts for workperformed outside of the original scope of the contract. During 2005 and 2006,the Company has collected the full December 31, 2004 outstandingretention, as well as additional amounts in settlement of all claims. TheCompany had a continuing warranty obligation for three years from the date offinal acceptance for which there were no material claims.

The Company, in 1999 was awarded a contract to build45 housing units for the Northern Marina Housing Agency, a government unit. Thehouses were built and subsequently occupied. The Northern Marianas HousingCorporation has filed a lawsuit against Telesource and two other parties for$3.0 million in damages related to this project. These claims involveallegations of various construction defects. The Company estimates that, if theplaintiff is successful, the Company may have an estimated liability in therange of $300,000 to $650,000. The Company recorded a $300,000 estimated lossduring the year ended December 31, 2004. Telesource has denied any liability andwill aggressively defend itself to dismiss this claim.

Telesource’s power generation activities involvesignificant risks of environmental damage, equipment damage and failures,personal injury and fines and costs imposed by regulatory agencies. Thoughmanagement believes its insurance programs are adequate, if a liability claimis made against it, or if there is an extended outage or equipment failure ordamage at Telesource’s power plant for which it is inadequately insured orsubject to a coverage exclusion, and Telesource is unable to defend againstthese claims successfully or obtain indemnification or warranty recoveries,Telesource may be required to pay substantial amounts, which could have amaterially adverse effect on its financial condition. Although the equipment iscovered under its insurance, the Company is liable for the deductible of5,000,000 FJD (approximately $2,870,000 USD at December 31, 2005).

Telesource offers warranties on its constructionservices and power generating plants. Telesource does not maintain any materialwarranty reserves because these warranties are usually backed by warrantiesfrom its

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vendors. Should Telesource be required to cover thecost of repairs not covered by the warranties of Telesource’s vendors or shouldone of Telesource’s major vendors be unable to cover future warranty claims,Telesource could be required to outlay substantial funds, which could harm itsfinancial condition. 

**ITEM 4. SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS**

None

**PART II**

**ITEM 5. MARKET FOR THE REGISTRANT’SCOMMON EQUITY AND RELATED STOCKHOLDER MATTERS**

MARKETINFORMATION. On November 1, 2001, Telesource’s common stock began trading onthe Over-the-Counter Bulletin Board under the symbol “TSCI” and currently istraded in the Pink Sheets. Prior to that time, Telesource’s common stock wasnot listed for trading.

Thefollowing table sets forth high and low sales prices for the common stock forthe periods indicated as reported by the Over-the-Counter Bulletin Board sinceNovember 1, 2001:

|                | ** ** | **HIGH**   | ** ** | **LOW**    | ** ** |
|----------------|------------|------------|------------|------------|------------|
| 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       |       |
| ** **     | ** ** | ** ** | ** ** | ** ** | ** ** |
| 2004           |       |       |       |       |       |
| First Quarter  |       | 1.10       |       | 0.42       |       |
| Second Quarter |       | 1.15       |       | 0.42       |       |
| Third Quarter  |       | 0.42       |       | 0.02       |       |
| Fourth Quarter |       | 0.02       |       | 0.02       |       |
|           |       |       |       |       |       |

 

On themost recent trade date of January 27, 2006, the stock traded at $.25 per sharefor 1,300 shares.

HOLDERS.As of December 31, 2005, there were 184 shareholders of record.

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EquityCompensation Plans

2000Non-Employee Director’s Stock Option Plan

InJanuary 2001, the Company’s board of directors adopted the 2000Non-Employee Director’s Stock Option Plan that provides for the issuance ofnonqualified stock options to outside directors. Under the terms of this plan,under which 285,000 shares of common stock were reserved for issuance, optionsto purchase common stock are granted at not less than fair market value, becomeexercisable over a 3 year period from the date of grant (vesting occursannually on the grant date at 33.3% of the grant), and expire 10 years from thedate of grant.

|                                                        | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **Weighted  average  shares**   | ** ** | **Exercise  price**             | ** ** | **Weighted  average  shares** | ** ** | **Exercise  price** | ** ** |
| Options outstanding  at January 1                 |       | 225,000                         |       | $                               | 1.25       |   | 225,000 |   | $ | 1.25 |   |
| Granted                                                |       | —                          |       |                            |       | — |   |   |   |
| Exercised                                              |       | —                          |       |                            |       | — |   |   |   |
| Cancelled                                              |       | —                          |       |                            |       | — |   |   |   |
| Options  outstanding at December 31               |       | 225,000                         |       | 1.25                            |       | 225,000 |   | 1.25 |   |
| Options  exercisable at December 31               |       | 225,000                         |       | 1.25                            |       | 225,000 |   | 1.25 |   |
| Shares available  for future grant at December 31 |       | 60,000                          |       |                            |       | 60,000 |   |   |   |
|                                                        |            |                                 |            |                                 |            |  |  |  |  |  |  |

 

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

InJanuary 2001, the Company’s board of directors adopted the 2000 IncentiveStock Option Plan that provides for the issuance of qualified stock options toemployees. Under the terms of this plan, under which 888,000 shares of commonstock were reserved for issuance, options to purchase common stock are grantedat not less 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. As of December31, 2005, no options had been awarded under this plan.

**UNREGISTEREDSALES OF SECURITIES**.

Weissued unregistered securities in the following transactions during 2005:

·                  OnMarch 2, 2005 we issued 800,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $400,000.

·                  OnMarch 23, 2005 we issued 600,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $300,000.

·                  OnMarch 29, 2005 we issued 1,000,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $500,000.

·                  DuringMarch and May of 2005, the Company issued 5,186,543 shares of common stockpursuant to an exemption under Regulation S of the Securities Act for$2,593,272.

11

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·                  OnApril 7, 2005 we issued 1,000,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $500,000.

·                  OnApril 27, 2005 we issued 1,000,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $500,000.

·                  OnMay 10, 2005 we issued 1,000,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $500,000.

·                  OnMay 25, 2005 we issued 1,000,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $500,000.

·                  OnJune 3, 2005 we issued 2,500,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $1,000,000.

·                  OnJune 30, 2005 we issued 600,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $300,000.

·                  OnAugust 19, 2005 we issued 2,250,000 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $450,000.

·                  OnSeptember 21, 2005 we issued 2,500,000 shares of our common stock pursuant toan exemption under Regulation S of the Securities Act for $500,000.

·                  OnNovember 9, 2005 we issued 19,683,078 shares of our common stock pursuant to anexemption under Regulation S of the Securities Act for $3,936,616 to convertdebt into equity.

·                  OnNovember 15, 2005 we issued 1, 750,000 shares of our common stock pursuant toan exemption under Regulation S of the Securities Act for $350,000.

·                  OnNovember 28, 2005 we issued 3,000,000 shares of common stock pursuant to anexemption under Regulation S of the Securities Act for $600,000.

Thefunds received from these sales were used to reduce long term debt, vendorpayables and support on-going operations.

12

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**ITEM 6.**                    MANAGEMENT’SDISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONSAND 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**

Revenuesfor the year ended December 31, 2005 were $5.9 million compared to $20.7million for the year ended December 31, 2004. Net loss to common stockholderswas $5.4 million for 2005, a decrease of $12.1 or 69.2%  from 2004’s $17.5 million loss.  Basicand diluted net loss to common stockholders per share was $0.08 per share for2005 compared to $0.83 per share for 2004.

**Liquidity**

As ofDecember 31, 2005, the Company’s total liabilities exceed total assets by$8.2million.  The Company continues to rely on equity sales to SHBC andbank financing to support its operations.  The Company’s ability torefinance its existing bank debt is critical to provide funding to satisfy theCompany’s obligations as they mature. As of December 31, 2005 the Company hadtotal outstanding debt of $17.3 million of which $2.8 million is due in 2006.As of December 31, 2005 the Company had an accumulated deficit of $59.4 millionand total stockholders’ deficit of $8.2 million.

TheCompany incurred operating losses of $4.7 million and $12.4 million for theyears ended December 31, 2005 and 2004, respectively. The Company incurred netlosses to common stockholders of $5.4 million and $17.5 million for the yearsended December 31, 2005 and 2004, respectively.

Cashused in operating activities was $3.5 million and $7.4 million for the yearsended December 31, 2005 and 2004 respectively. Funds provided by net borrowingsand stock sales amounted to $2.0 million and $7.7 million for the years endedDecember 31, 2005 and 2004, respectively.

During2005 management worked to address operating and working capital deficits bycontinuing its efforts to eliminate its most unprofitable business segment,specifically construction. As reported in Item 5, herein, management has raised$9.0 million in 2005 through the issuance of common stock.  In addition,the Company was previously able to raise $6.4 million through the sale ofcommon stock during 2004. Such sales were made in private, unregistered salesof the Company’s securities.  The additional equity raised during 2005 wasused to pay down debt and fund continuing operations. Much of the debtobligations coming due during 2005 are project financing based and the Companyrepaid a portion of these obligations with cash generated through thecollection of project receivables and billings.  These collections on theprojects along with the expected additional equity were sufficient to coverTelesource’s 2005 obligations.  The Company has and expects to continue toseek support from its principal stockholder, SHBC, for its operations, forworking capital needs, debt repayment, and business expansion as may berequired. SHBC has continued its support of the Company. SHBC has agreed toguarantee or provide letters of credit covering all of the Company’s debt of$17.3 million.

TheCompany plans to raise approximately $4.4 million of funding from its principleshareholder, SHBC, in 2006. As of June 30, 2006 the Company has received $2.7million of these anticipated funds through loans with SHBC related companies.In addition, management expects to have shareholders increase the authorizednumber of common stock shares at its 2006 annual general meeting. Uponobtaining the increased share authorization, management expects to convert thefunds it received in 2006 from debt into equity.

13

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**OPERATING SEGMENTS**

Telesource’sbusiness consists of the following operating segments: power generation andconstruction of power plants, trading, and construction services. Revenue ofthe power generation and construction of power plants segment includessales-type lease revenues. The power generation activities occurred in theCommonwealth of Northern Mariana Islands, a U.S. territory, (“CNMI”) andconstruction of power plants occurred in Fiji. Construction services occurredin the CNMI and the Republic of Palau while trading activities occurred in theUnited States and the CNMI. Telesource has completed all construction projects,except for certain warranty work associated with the Adult CorrectionalFacility located in Saipan. Telesource as noted earlier is changing itsconstruction strategy. Telesource is concentrating its efforts on expanding itspower generation services in the Pacific region.

**OVERVIEW**

During2005, total assets decreased from 2004 by $8.9 million due primarily to thereduction in our construction segment. Cash decreased by $1.5 million as we reduced our construction relatedpayables.  Similarly, our constructionreceivables also decreased as we received payments from our customers and suchfunds were applied to construction related payables.  Costs and estimated earnings in excess ofbillings decreased by $1.4 million, as we completed our construction related contracts.  Net investment in sales-type lease wasreduced by $2.0 million, through the normal amortization of the sale/leasebackamount related to the construction agreement of the Tinian power plant.  Property, plant and equipment decreased by$818,586 due primarily to the sale or write down of impaired constructionassets.

TheCompany’s, vendor payable liabilities also decreased by $5.4 million as wereduced our vendor payable balances to construction related vendors.  In addition, we also reduced our total longterm debt by $8.0 million from the proceeds received through the combination ofequity sales as well as conversion of certain debt to equity.  The sales of the securities were primarily toSHBC and their affiliates.

Totalrevenues decreased by $14.8 million due primarily to the decrease inconstruction related activities.  Powergeneration revenues increased by $614,357. Cost of revenues decreased by $20.8 million, again due to reducedconstruction activity.

Operatingexpenses decreased by $1.7 million in 2005 primarily as a result of reducedservices from outside legal, accounting and other professional services.

**RESULTS OF OPERATIONS**

**Comparison of the twelve months ended December 31, 2005 and2004**

*Service Fees - Power Generation Plant*.Service fees - power generation plant increased 19.0% to $3.8 million in 2005from $3.2 million in 2004. The increase in service fees - power generationplant is attributed to the $.6 million in revenues from the operation andmaintenance of two diesel power plants in Fiji for the entire year of 2006.  The service fees are a function of the amountof energy demand, which in turn is produced by the engines we operate andmaintain.  In 2005, demand was high andall of the engines were operating during the year, unlike the previous yearwhen one of the engines required a major overhaul.  The power generation revenues at the Tinianpower plant were unchanged at $1.1 million in 2005 from 2004.

14

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*Construction Revenues* - Constructionrevenues, including related party, decreased 92.2% to $1.2million in 2005 from$16.0 million in 2004. The decrease in construction revenues is attributed tomanagement’s efforts to wrap up its older construction contracts. The backlogof remaining construction projects is $0.0 at December 31, 2005.  Thisreflects management’s efforts to complete existing contracts and implement itsnew strategy of joint venturing with SHBC on new projects. Telesource has beenpre-qualified to bid on a United States Embassy project Fiji.  It is the Company’s intention to submit a bidin conjunction with SHBC for the construction of a new embassy in Fiji.

*Service Fees -*Sales decreased 100% to $0in 2005 from $95,788 in 2004. Reduced demand for ancillary services provided byTelesource.  In general these servicesare not likely to reoccur in the future.

*Service Fees – related party -*. Servicefees decreased to $7,062 in 2005 down from $89,940 in 2004.  The decrease was due to a reduced demand forour services in locating products to be used by SHBC.

*Rental Income* - Rental income decreased90.2% in 2005 to $28,420 from $288,899 in 2004. The decrease in rental incomewas a result of the termination of two separate short term lease agreementswith Fiji Electric Authority and the government of Guam.  The lease agreements were to providetemporary power generation equipment.

*Finance Lease Revenues*. Finance leaserevenues decreased 17.7% to $0.8 million in 2005 from $1.0 million in 2004.Finance lease revenue for the Tinian power plant will decrease each year untilthe investment in sales type lease is fully amortized in March 2009.

***Expenses***

*Construction Costs* - Total constructioncosts (including related party and third party) decreased 94.6% to $1.1 millionin 2005, down from $21.3 million in 2004. This decrease reflects the completionof existing construction contracts during in 2005.  The Company had not negotiated any newcontracts during 2005.

*Provision for Warranty Expense:*Provisionfor warranty represents a contingent liability for the Koblerville project atDecember 31, 2004.

*Provision for Unbilled and Uncollected Contracts-  *Provisionfor unbilled contracts in progress decreased to $21,572 from $1,329,058 in2004. The 2005 expense was for some minor amounts related to the AdultCorrectional Facility.  The 2004 amountwas an estimate of a write off uncollectible accounts.

*Operation and Maintenance Costs – Power Generation Plant*- Operation and maintenance costs — power generation plant increased 41.3% to$4.1 million in 2005 from $2.9 million in 2004. The increase was due to the major overhaul of three engines in Fiji aswell as purchases of spare parts required for rebuilding of engines in Tinian.

*Salaries and Employee Benefits* -  Salaries and employee benefits decreased by $253,171 due to management’scontinuing efforts to reduce costs during 2005 through staff reductions.

*Occupancy and Equipment* - Occupancy andequipment expenses increased 14.5% to $366,957 in 2005 from $320,533 in 2004.The slight increase was a result of cost associated with closing an office inSaipan and the land rent for the idle construction equipment.

 *General and Administrative Expenses* -  General and administrative expenses decreased 34.4% to $3.2 million in2005 from $4.9 million in 2004. The decrease is due to lower professional feesduring 2005 for audit, legal and other outside professional fees.

*Impairmentof long-lived assets* increased by 13.0% to $385,926 from$341,392 in 2004, due to the decline in the construction segment.  Consequently, the Company reviewed all fixedassets, particularly the construction related assets and determined thatcertain items were impaired.

15

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*Other income/ (expense)* -  Other expense decreased to $685,423 in 2005from $1.4 million in 2004 due to lower interest expense as a result ofdecreasing the Company’s long term debt.

*Income Tax Expense* - Telesource recognizedan income tax credit of $12,932 in 2005 and $74,435 in 2004 resulting from thereversal of a 2003 tax accrual which had occurred due to compliance with FijianInternal Revenue Department tax regulations. Telesource had net operating losscarry forwards for U.S. purposes at December 31, 2005 of approximately $11.2million.  The Company has approximately $36.2 million of net operatingloss carry forwards for the Commonwealth of Northern Mariana Islands.

**SUBSEQUENT EVENTS**

None

16

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**ITEM 7. FINANCIALSTATEMENTS AND SUPPLEMENTARY DATA**

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

Consolidated Financial Statements

December 31, 2005 and 2004

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

**Table of Contents**
|                                                                               | ** ** | **Page** |
|-------------------------------------------------------------------------------|------------|----------|
|                                                                          |       |     |
| Report  of Independent Registered Public Accounting Firm                      |       | F - 1    |
|                                                                          |       |     |
| Consolidated  Balance Sheets                                                  |       | F - 2    |
|                                                                          |       |     |
| Consolidated  Statements of Operations                                        |       | F - 3    |
|                                                                          |       |     |
| Consolidated  Statements of Stockholders’ Deficit and Comprehensive Loss |       | F - 4    |
|                                                                          |       |     |
| Consolidated  Statements of Cash Flows                                        |       | F - 5    |
|                                                                          |       |     |
| Notes  to Consolidated Financial Statements                                   |       | F - 6    |

 

17

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**REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTINGFIRM**

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

We have audited the accompanying consolidated balancesheets of Telesource International, Inc. as of December 31, 2005 and 2004, andthe related consolidated statements of operations, stockholders' deficit,comprehensive loss and cash flows for the years then ended. These financialstatements are the responsibility of the company's management. Ourresponsibility is to express an opinion on these financial statements based onour 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 theCompany's internal control over financial reporting. Accordingly, we express nosuch opinion. An audit includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements. An audit also includesassessing the accounting principles used and significant estimates made bymanagement, as well as evaluating the overall financial statement presentation.We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred toabove present fairly, in all material respects, the financial position ofTelesource International, Inc. as of December 31, 2005 and 2004, and theresults of its operations, changes in stockholders' deficit, comprehensive lossand its cash flows for the years then ended in conformity with accountingprinciples generally accepted in the United States of America.

The accompanying financial statements have beenprepared assuming that the Company will continue as a going concern. Asdiscussed in Note 2(b) to the financial statements, the Company has sufferedrecurring loses from operations and has a net capital deficiency that raisesubstantial doubt about its ability to continue as a going concern.Management's plans regarding these matters are also described in Note 2(b). Thefinancial statements do not include any adjustments that might result from theoutcome of this uncertainty.

L J SOLDINGER ASSOCIATES, LLC

Deer Park, IllinoisJune 23, 2006

F-1

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**Consolidated Balance SheetsDecember 31, 2005 and 2004
| ** **                                                                                                                                                                                                                    | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Assets**                                                                                                                                                                                                                    | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Current assets:                                                                                                                                                                                                               | ** ** | ** **                      | ** ** | ** **                      | ** ** |
| Cash and cash  equivalents                                                                                                                                                                                                    |       | $                               | 477,944    |                            | 1,972,729  |   |
| Accounts  receivable less allowance for doubful accounts of $26,177 at December 31,  2005 and $20,678 at December 31, 2004.                                                                                                   |       | 2,021,136                       |       | 4,840,313                       |       |
| Accounts  receivable — related party                                                                                                                                                                                     |       | 10,397                          |       | —                          |       |
| Current portion  of net investment in sales-type lease                                                                                                                                                                        |       | 2,142,552                       |       | 1,951,040                       |       |
| Costs and  estimated earnings in excess of billings                                                                                                                                                                           |       | 3,670                           |       | 1,379,359                       |       |
| Prepaid expenses  and other current assets                                                                                                                                                                                    |       | 1,316,841                       |       | 1,763,975                       |       |
| Total current  assets                                                                                                                                                                                                         |       | 5,972,540                       |       | 11,907,416                      |       |
| Net investment in  sales-type lease – long term                                                                                                                                                                          |       | 5,391,333                       |       | 7,533,885                       |       |
| Property, plant, and  equipment, net                                                                                                                                                                                          |       | 566,090                         |       | 1,384,676                       |       |
| Other assets                                                                                                                                                                                                                  |       | 42,358                          |       | 24,757                          |       |
| Total assets                                                                                                                                                                                                                  |       | $                               | 11,972,321 |                            | 20,850,734 |   |
| **Liabilities and Stockholders’ Deficit**                                                                                                                                                                                |       |                            |       |                            |       |
| Current  liabilities:                                                                                                                                                                                                         |       |                            |       |                            |       |
| Current portion  of long-term debt                                                                                                                                                                                            |       | $                               | 3,131,938  |                            | 5,332,340  |   |
| Accounts payable                                                                                                                                                                                                              |       | 1,051,622                       |       | 4,009,522                       |       |
| Accounts payable  — related party                                                                                                                                                                                        |       | 133,289                         |       | 2,598,948                       |       |
| Accrued expenses                                                                                                                                                                                                              |       | 1,674,919                       |       | 2,482,899                       |       |
| Billings in  excess of costs and estimated earnings                                                                                                                                                                           |       | —                          |       | 108,643                         |       |
| Accrued losses  on contracts in progress                                                                                                                                                                                      |       | —                          |       | 1,985,557                       |       |
| Other current  liabilities                                                                                                                                                                                                    |       | 22,739                          |       | —                          |       |
| Total current  liabilities                                                                                                                                                                                                    |       | 6,014,507                       |       | 16,517,909                      |       |
| Long-term debt -  related party                                                                                                                                                                                               |       | —                          |       | 2,580,000                       |       |
| Long-term debt                                                                                                                                                                                                                |       | 14,201,531                      |       | 17,493,623                      |       |
| Total  liabilities                                                                                                                                                                                                            |       | 20,216,038                      |       | 36,591,532                      |       |
| Commitments and  contingencies (note 16)                                                                                                                                                                                      |       |                            |       |                            |       |
|                                                                                                                                                                                                                          |       |                            |       |                            |       |
| Stockholders’ deficit:                                                                                                                                                                                                   |       |                            |       |                            |       |
| Convertible  Preferred Stock, $0.01 par value authorized 50,000,000 shares, none issued  and outstanding at December 31, 2005 and 2004.                                                                                       |       |                            |       |                            |       |
| Common stock,  $0.01 par value, authorized 100,000,000 shares. 93,438,140 shares issued and  outstanding at December 31, 2005 and 24,400,000 shares issued and 25,168,519  shares issuable at December 31, 2004, respectively |       | 934,381                         |       | 495,685                         |       |
| Additional  paid-in capital                                                                                                                                                                                                   |       | 50,352,181                      |       | 37,860,989                      |       |
| Accumulated  deficit                                                                                                                                                                                                          |       | (59,448,751                     | )          | (54,082,141                     | )          |
| Accumulated  comprehensive income (loss), including foreign exchange                                                                                                                                                          |       | (81,528                         | )          | (15,331                         | )          |
| Total  stockholders’ deficit                                                                                                                                                                                             |       | (8,243,717                      | )          | (15,740,798                     | )          |
| Total  liabilities and stockholders’ deficit                                                                                                                                                                             |       | $                               | 11,972,321 |                            | 20,850,734 |   |

 

See accompanying notes to consolidated financialstatements.

F-2

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIESConsolidated Statements of OperationsYears ended December 31, 2005 and 2004**
| ** **                                                | ** ** | **2005**   | ** ** | **2004**    | ** ** |
|-----------------------------------------------------------|------------|------------|------------|-------------|------------|
| Revenues:                                                 |       |       |       |        |       |
| Construction revenues                                     |       | $          | 1,248,079  |        | 16,023,844 |   |
| Service fees – power generation plant                |       | 3,841,366  |       | 3,227,009   |       |
| Service Fees                                              |       | —     |       | 95,788      |       |
| Service Fees – related party                         |       | 7,062      |       | 89,940      |       |
| Rental income                                             |       | 28,420     |       | 288,899     |       |
| Finance lease revenue                                     |       | 808,960    |       | 983,354     |       |
| Gross revenues                                            |       | 5,933,887  |       | 20,708,834  |       |
| Costs and  expenses:                                      |       |       |       |        |       |
| Construction costs                                        |       | 1,136,888  |       | 16,147,193  |       |
| Construction costs – related party                   |       | —     |       | 5,185,333   |       |
| Operation and maintenance costs - power generation  plant |       | 4,066,161  |       | 2,878,415   |       |
| Costs of service                                          |       | 89,594     |       | 230,149     |       |
| Provision for warranty reserve                            |       | —     |       | 300,000     |       |
| Provision for unbilled and uncollected accounts           |       | 21,572     |       | 1,329,058   |       |
| Cost of revenues                                          |       | 5,314,215  |       | 26,070,148  |       |
| Gross profit                                              |       | 619,672    |       | (5,361,314  | )          |
| Operating  expenses:                                      |       |       |       |        |       |
| Salaries and employee benefits                            |       | 1,379,765  |       | 1,632,936   |       |
| Occupancy and equipment                                   |       | 366,957    |       | 320,533     |       |
| General and administrative                                |       | 3,181,143  |       | 4,849,735   |       |
| Impairment of long-lived asset                            |       | 385,926    |       | 241,970     |       |
| Total operating expenses                                  |       | 5,313,791  |       | 7,045,174   |       |
| Operating loss                                            |       | (4,694,119 | )          | (12,406,488 | )          |
| Other  income/(expense):                                  |       |       |       |        |       |
| Interest expense, net                                     |       | (1,118,386 | )          | (1,508,277  | )          |
| Other income/(expense), net                               |       | 432,963    |       | 129,015     |       |
| Total other expense                                       |       | (685,423   | )          | (1,379,262  | )          |
| Loss before income taxes                                  |       | (5,379,542 | )          | (13,785,750 | )          |
| Income tax  benefit                                       |       | (12,932    | )          | (74,435     | )          |
| Net loss                                                  |       | (5,366,610 | )          | (13,711,315 | )          |
| Dividend on  preferred stock                              |       | —     |       | 3,739,929   |       |
| Net loss to common stockholders                           |       | (5,366,610 | )          | (17,451,244 | )          |
| Basic and diluted net loss per share                      |       | $          | (0.08      | )           | (0.83      | ) |
| Weighted average shares  outstanding                      |       | 64,350,919 |       | 21,108,652  |       |

 

See accompanying notes to consolidated financialstatements.

F-3

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**Consolidated Statements of Stockholders’ Deficit andComprehensive LossYears ended December 31, 2005 and 2004
| ** **                                                                  | ** ** | ** **               | ** ** | **Common stock** | ** ** | **Additional** | ** ** | ** **  | ** ** | ** **      | ** ** | **Accumulated**   | ** ** | **Total**         | ** **  |
|-----------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------|------------|----------------|------------|-------------|------------|-----------------|------------|-------------------|------------|-------------------|-------------|
| ** **                                                                  | ** ** | **Preferred stock** | ** ** | ** **            | ** ** | **Par**        | ** ** | **paid-in** | ** ** | **Accumulated** | ** ** | **Comprehensive** | ** ** | **comprehensive** | ** **  | **stockholders’** | ** ** |
| ** **                                                                  | ** ** | **Shares**               | ** ** | **Value**             | ** ** | **Shares**     | ** ** | **value**   | ** ** | **capital**     | ** ** | **deficit**       | ** ** | **loss**          | ** **  | **income (loss)** | ** ** | **deficit** | ** ** |
| Balance at December 31,  2003                                               |       | 9,799,999                |       | $                     | 14,700,000 |           | 17,000,000 |        | $          | 170,000         |       | $                 | 7,777,225  |              | $           | (36,630,897 | ) |   |   | $ | 17,157 |   | $ | (13,966,515 | ) |
|                                                                        |       | —                   |       |                  |       |           |       |        |       |            |       |              |       |              |        |   |   |   |   |
| Sale of common stock -  5,200,000 shares at $1.00 per share            |       | —                   |       | —                |       | 5,200,000      |       | 52,000      |       | 5,148,000       |       | —            |       | —            |        | — |   | 5,200,000 |   |
| Sale of common stock -  2,355,493 shares at $0.50 per share            |       |                     |       |                  |       | 2,355,493      |       | 23,555      |       | 1,154,191       |       | —            |       | —            |        | — |   | 1,177,746 |   |
| Conversion of Preferred  Stock into Common Stock at $1.50 per share         |       | (9,799,999               | )          | (14,700,000           | )          | 9,799,999      |       | 98,000      |       | 14,602,000      |       | —            |       | —            |        | — |   | — |   |
| Conversion of debt and  interest into Common Stock at $0.50 per share       |       | —                   |       | —                |       | 12,139,048     |       | 121,390     |       | 5,948,134       |       | —            |       | —            |        | — |   | 6,069,524 |   |
| Net loss at December 31,  2004                                              |       | —                   |       | —                |       | —         |       | —      |       | —          |       | (13,711,315       | )          | (13,711,315       | )           | — |   | (13,711,315 | ) |
| Preferred Dividend                                                          |       |                     |       |                  |       |           |       |        |       |            |       | (3,551,729        | )          |              |        |   |   | (3,551,729 | ) |
| Conversion of Preferred  Dividends into Common Stock                        |       |                     |       |                  |       | 3,073,979      |       | 30,740      |       | 3,043,239       |       |              |       |              |        |   |   | 3,073,979 |   |
| Issuance of 500,000  common stock warrants granted in September 2004        |       |                     |       |                  |       |           |       |        |       | 188,200         |       | (188,200          | )          |              |        |   |   |   |   |
| Foreign currency  translation adjustment                                    |       | —                   |       | —                |       | —         |       | —      |       | —          |       | —            |       | (32,488           | )           | (32,488 | ) | (32,488 | ) |
| Comprehensive loss                                                          |       |                     |       |                  |       |           |       |        |       |            |       |              |       | $                 | (13,743,803 | ) |   |   |   |   |
| 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 -  12,186,543 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 at December 31,  2005                                              |       | —                   |       | —                |       | —         |       | —      |       | —          |       | (5,366,610        | )          | (5,366,610        | )           | — |   | (5,366,610 | ) |
| 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 | ) |

 

Seeaccompanying notes to consolidated financial statements.

F-4

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

ConsolidatedStatements of Cash Flows

Years ended December 31,2005 and 2004
| ** **                                                                   | ** ** | **2005**    | ** ** | **2004**   | ** **  |
|------------------------------------------------------------------------------|------------|-------------|------------|------------|-------------|
| Cash flows from  operating activities:                                       |       |        |       |       |        |
| Net loss                                                                     |       | $           | (5,366,610 | )          | (13,711,315 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities: |       |        |       |       |        |
| Depreciation                                                                 |       | 385,908     |       | 492,694    |        |
| (Gain) on disposal of  fixed assets                                          |       | (23,097     | )          | (122,658   | )           |
| Interest expense paid  through issuance of common stock                      |       | —      |       | 139,524    |        |
| Provision for unbilled  and uncollected accounts                             |       | 21,572      |       | 1,329,058  |        |
| Impairment of  long-lived assets                                             |       | 385,926     |       | 341,392    |        |
| ** **                                                                   | ** ** | ** **  | ** ** | ** ** | ** **  |
| Changes in assets and  liabilities:                                          |       |        |       |       |        |
| Receivables                                                                  |       | 2,787,201   |       | (504,564   | )           |
| Prepaid expenses and  other current assets                                   |       | 447,134     |       | (1,371,268 | )           |
| Costs and estimated  earnings in excess of billings                          |       | 1,375,689   |       | 2,181,093  |        |
| Net investment in  sales-type lease                                          |       | 1,951,040   |       | 1,776,646  |        |
| Other assets                                                                 |       | (17,601     | )          | 103,306    |        |
| Accounts payable                                                             |       | (2,957,902  | )          | (2,226,701 | )           |
| Accounts payable -  related party                                            |       | 390,957     |       | 1,941,330  |        |
| Accrued expenses                                                             |       | (807,973    | )          | 2,434,651  |        |
| Billings in excess of  cost and estimated earnings                           |       | (108,643    | )          | —     |        |
| Accrued loss on  contracts in progress                                       |       | (1,985,557  | )          | —     |        |
| Income taxes payable                                                         |       | —      |       | (74,947    | )           |
| Other liabilities                                                            |       | 22,739      |       | (86,304    | )           |
|                                                                         |       |        |       |       |        |
| Net cash used in  operating activities                                       |       | (3,499,217  | )          | (7,358,063 | )           |
|                                                                         |       |        |       |       |        |
| Cash flows from  investing activities:                                       |       |        |       |       |        |
| Proceeds from maturity  of certificate of deposit                            |       | —      |       | —     |        |
| Proceeds from sale of  equipment                                             |       | 139,400     |       | 460,330    |        |
| Capital expenditures                                                         |       | (69,550     | )          | (267,872   | )           |
|                                                                         |       |        |       |       |        |
| Net cash provided by  (used in) investing activities                         |       | 69,850      |       | 192,458    |        |
|                                                                         |       |        |       |       |        |
| Cash flows from  financing activities:                                       |       |        |       |       |        |
| Proceeds from  borrowings                                                    |       | 7,500,000   |       | 4,250,000  |        |
| Proceeds of long-term  debt - related party                                  |       | —      |       | 2,580,000  |        |
| Principal payments on borrowings  - related party                            |       | (1,500,000  | )          | —     |        |
| Principal payments on  borrowings                                            |       | (12,992,493 | )          | (5,046,455 | )           |
| Proceeds from sale of  common stock                                          |       | 8,993,272   |       | 6,377,747  |        |
| Payment of preferred  stock dividends                                        |       | —      |       | (477,750   | )           |
|                                                                         |       |        |       |       |        |
| Net cash provided by  financing activities                                   |       | 2,000,779   |       | 7,683,542  |        |
| Effect of exchange rate  changes on cash                                     |       | (66,197     | )          | (32,488    | )           |
| Net increase (decrease)  in cash and cash equivalents                        |       | (1,494,785  | )          | 485,449    |        |
|                                                                         |       |        |       |       |        |
| Cash and cash  equivalents at beginning of year                              |       | 1,972,729   |       | 1,487,280  |        |
|                                                                         |       |        |       |       |        |
| Cash and cash  equivalents at end of year                                    |       | $           | 477,944    |       | 1,972,729   |   |
|                                                                         |       |        |       |       |        |
| Supplemental  disclosure:                                                    |       |        |       |       |        |
| Cash paid during the  year for interest                                      |       | $           | 1,029,088  |       | 1,325,248   |   |
| Cash paid during the year for income taxes                                   |       | —      |       | —     |        |

 

See accompanying notes toconsolidated financial statements.

F-5

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated FinancialStatements**

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

TelesourceInternational, Inc. (“Telesource” or the “Company”) was incorporated inDelaware in 1994. Telesource was formed to facilitate various intra-corporateactivities and, until July 1999, was a wholly owned subsidiary of Sayed HamidBehbehani & Sons Co. W.L.L. (‘SHBC”), a Kuwait-based civil, electrical, andmechanical engineering and construction company. Telesource entered intocontracts as an international engineering and construction company for variousprojects including airport runways as well as moving large radio broadcasttowers. In addition, Telesource also constructed and manages the operation ofenergy conversion power plants. In Tinian, an island in the Commonwealth of theNorthern Mariana Islands (U.S. Territory), the Company operates a diesel firedelectric power generation plant for the sale of electricity to the local powergrid. In Fiji, the Company operates two diesel fired electric power generationplants for the sale of electricity to the local power grid. The Company’sfacility in Lombard, Illinois, handles the procurement, export, and shipping ofU.S. fabricated products for use by the Company’s subsidiaries or for resale tocustomers outside of the mainland.

TheCompany conducts its operations through the parent and its two subsidiaries.The Company’s Telesource International division includes its trading business. TheCompany’s Mariana subsidiary, Telesource CNMI, Inc., handles construction andmanagement of the Company’s energy conversion facilities in the Commonwealth ofthe Northern Mariana Islands. The Company’s second subsidiary, Telesource Fiji,Ltd., handles the Company’s power generation activities in Fiji.

Telesourcehas three main operating segments: power generation and construction of powerplants, trading and construction services. The power generation activitiescommenced in March 1999.

**(2)****                     Summaryof Significant Accounting Policies**

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

Theconsolidated financial statements include the accounts of the Company and itswholly owned subsidiaries: Telesource International ,Telesource CNMI Inc., andTelesource Fiji, Ltd. All significant intercompany transactions and accountshave been eliminated.

***(b)******                      GoingConcern***

Asof December 31, 2005, the Company’s total liabilities exceeded its total assetsby $8.2 million. The Company relies heavily on financing from banks as well asits principle investors, SHBC to support its operations. As of December 31,2005 the Company had total outstanding debt of $17.3 million of which $2.8million is due in 2006 and $10.0 million is due in 2007. As of December 31,2005 the Company had an accumulated deficit of $59.4 million and totalstockholders’ deficit of $8.2 million.

TheCompany incurred a net loss to common stockholders of $5,366,610 and$17,451,244 for the years ended December 31, 2005 and 2004, respectively.

Cashused in operating activities was $3,499,217 and $7,358,063, for the years endedDecember 31, 2005 and 2004, respectively. Funds provided by net borrowings andstock sales amounted to $2,000,779 and $7,683,542 for the years ended December31, 2005 and 2004, respectively.

TheCompany’s net working capital deficiency, total debt, recurring losses and negativecash flows from operations raise substantial doubt and questions about theCompany’s ability to

F-6

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** **

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

continueas a going concern. The Consolidated Financial Statements do not include anyadjustments relating to the recoverability of assets and the classification ofliabilities that might be necessary should we be unable to continue as a goingconcern.

Althoughthe Company has been experiencing a net working capital deficiency, as well asrecurring losses and negative cash flows from operations, the Company plans toraise approximately $4.4 million of funding from its principle shareholder,SHBC in 2006. As of June 30, 2006, the Company has received $2.7 million ofthese anticipated funds through loans with SHBC related companies. During thelatter part of 2005, a new management team was promoted and hired to develop aplan to improve operations. The new management team has begun to assess each ofthe business segments and is developing a strategy to improve the financialcondition of the Company. Management plans to improve profitability and cashflow by reducing costs and securing additional projects. However, no assurancecan be given that such increased revenues will be achieved. The Company has andexpects to continue to seek support from its principal stockholder, SHBC, forits operations, and for working capital needs, debt repayment, and businessexpansion as may be required. SHBC has continued its support of the Company.

The Company’s ability to continue operations isdependent upon raising capital through debt and equity financing. There can beno assurance that the Company will successfully raise the required futurefinancing on terms desirable to the Company. If the Company does not obtain theneeded funds, it will likely be required to delay development of itsoperations, alter its business plan, or in the extreme situation, ceaseoperations.

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

Telesourcerecords as cash equivalents all highly liquid short-term investments withoriginal maturities of three months or less.

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

Allassets and liabilities denominated in foreign currencies are translated at the exchangerate on the balance sheet date. Revenues, costs, and expenses are translated ataverage rates of exchange prevailing during the period. Translation adjustmentsare deferred as a separate component of stockholders’ equity. Gains and lossesresulting from foreign currency transactions are included in the consolidatedstatements of operations.

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

The Companymaintains its cash accounts at numerous financial institutions. Certain ofthese financial institutions are located in foreign countries which do not haveFederal Deposit Insurance Corporation, “FDIC” insurance. Those accounts coveredby the FDIC are insured up to $100,000 per institution. As of December 31,2005, the amount of bank deposits that exceeded or are not covered by the FDICinsurance was $179,645.

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

TheCompany receives variable monthly payments as compensation for its productionof power. The variable payments are recognized based upon power produced andbilled to the customer as earned during each accounting period.

Revenuefrom construction contracts and construction revenues on power plants, with theexception of the power plant constructed on Tinian which is accounted for usingthe sales-type

F-7

----

** **

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

leasemethod of accounting as discussed below, is recognized using thepercentage-of-completion method of accounting, based upon costs incurred andestimated total projected costs. Cost of revenue consists of direct costs oncontracts, including labor and materials, amounts payable to subcontractors,direct overhead costs, equipment expense (primarily depreciation, maintenance,and repairs), interest associated with construction projects, and insurancecosts. Contracts frequently extend over a period of more than one year andrevisions in cost and profit estimates during construction are recognized inthe accounting period in which the facts that require the revision becomeknown. Losses on contracts are provided for in total when determined,regardless of the degree of project completion. Claims for additional contractrevenue are recognized in the period when it is probable that the claim willresult in additional revenue and the amount can be reasonably estimated.

TheCompany accounts for its leasing activities in accordance with the requirementsof Statement of Financial Accounting Standards No. 13, *Accounting for Leases*. Revenue associatedwith the sale of the Tinian power plant constructed and sold under a sales-typelease, measured as the present value of noncancelable rents, was recognized inconnection with recording the loss on sale in 1997 and 1998. The Companyrecognizes finance lease revenue on the resulting sales-type lease receivableat a constant rate using the interest method. Service revenues received fromoperating and maintaining the Tinian power plant for the duration of the leaseare recognized as earned based on actual kilowatt hours of electricity producedand delivered to the lessee’s customers. To the extent that variable paymentsbased on kilowatt-hours of production exceed the fair value of operation andmaintenance services provided, the Company recognizes such contingent paymentsas additional finance lease revenue as they are earned.

Revenuefrom the Company’s brokering of U.S. fabricated goods is recognized at the timeof shipment. The sales revenues for U.S. fabricated goods are recognized net ofcosts of goods sold due to title transferring from the manufacturer directly tothe Company’s customer, with the risk of loss borne by the customer at the timeof transfer. The Company recognizes management fees and energy sales revenue inthe period in which the commodity is delivered or at the time the work isperformed. Telesource recognizes rental revenue on the accrual basis pursuantto contractual arrangements between the Company and its customers.

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

Property,plant, and equipment are stated at cost less accumulated depreciation.Depreciation is computed using the straight-line method at rates sufficient todepreciate the cost over the estimated economic lives of the assets.Depreciable lives used for 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 |       | 5 years                             |       |

 

Costand accumulated depreciation are eliminated from the accounts when assets aresold or retired and any resulting gain or loss is reflected in operations inthe year of disposition.

F-8

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** **

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

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

TheCompany accounts for long-lived assets in accordance with the provisions ofStatement of Financial Accounting Standards No. 144, *Accounting for the Impairment of Long-Lived Assets*.This statement requires that long-lived assets and certain identifiableintangibles be reviewed for impairment whenever events or changes incircumstances indicate that the carrying amount of an asset may not berecoverable. Recoverability of assets to be held and used is measured by acomparison of the carrying amount of an asset to future net cash flows expectedto be generated by the asset. If such assets are considered to be impaired, theimpairment to be recognized is measured by the amount by which the carryingamount of the assets exceeds the fair value of the assets. Assets to bedisposed of are reported at the lower of the carrying amount or fair value lesscosts to sell. Fair values are determined based on quoted market value,discounted cash flows or internal and external appraisals, as applicable.During 2005 and 2004 Telesource recognized asset impairment charges of $385,926and $341,392, respectively, related to certain construction equipment held byTelesource. See Note 6.

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

TelesourceInternational, Inc., Telesource CNMI, Inc., and Telesource Fiji, Ltd. fileseparate corporation income tax returns. Telesource International, Inc. andCommsource International, Inc. are U.S. corporations that file separate U.S.corporate income tax returns. 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. There is no corporate income tax in Palau.

Deferredincome taxes are accounted for under the asset and liability method. Deferredtax assets and liabilities are recognized for the estimated future taxconsequences attributable to differences between the financial statementcarrying amounts of existing assets and liabilities and their respective incometax bases. Deferred tax assets and liabilities are measured using enacted taxrates expected to apply to taxable income in the years in which those temporarydifferences are expected to be recovered or settled. The effect on deferred taxassets and liabilities of a change in tax rates is recognized in income in theperiod that includes the enactment date.

Avaluation reserve is recorded to offset a portion of the deferred tax benefitif management has determined it is more likely than not that the deferred taxassets will not be realized.

TheCompany’s subsidiary, Telesource CNMI, Inc., in the Commonwealth of theNorthern Mariana Islands (CNMI) prepares its corporate income tax returns basedon the local tax code. The tax code used is outlined in the “Covenant toEstablish a Commonwealth of the Northern Mariana Islands in Political Unionwith the United States,” which adopted the Internal Revenue Code as the localterritorial income tax regime. Beginning January 1, 1985, 95% of anyincome tax due on the CNMI source income is rebated to the extent that itexceeds local business gross receipts taxes. In 1995, the rebate percent wasdecreased and currently ranges from 90% decreasing to 50% depending upon theamount of taxable income. The amounts paid for the gross receipts tax amountedto $302,405 and $1,081,722 in 2005 and 2004, respectively, and are included ingeneral and administrative expenses on the accompanying consolidated statementsof operations.

F-9

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

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

Thepreparation of financial statements in conformity with accounting principlesgenerally accepted in the United States of America requires management to makeestimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period. Actual results could differ from those estimates.

Significantestimates used in preparing these financial statements include those assumed incomputing profit percentages under the percentage-of-completion revenue recognitionmethod. It is at least reasonably probable that the estimates used will changewithin the next year as the construction projects are completed.

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

TheCompany’s financial instruments include cash and cash equivalents, receivables,short-term debt, accounts payable, and long-term debt. The gross carryingamount of the notes receivable related to the sales-type lease approximatesfair value as the notes have been discounted at a rate approximating theCompany’s borrowing rate. The carrying amount of the long-term debtapproximates fair value due to the variable interest rates. The carryingamounts of other financial assets and liabilities approximate fair valuebecause of the short maturities of those instruments.

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

TheCompany has stock incentive plans that provide for stock-based employeecompensation, including the granting of stock options to certain key employees.The plans are more fully described in note 12. The Company accounts for thestock incentive plans in accordance with the recognition and measurementprinciples of APB Opinion No. 25, *Accountingfor Stock Issued to Employees*, and related Interpretations. Underthis method, compensation expense is recorded on the date of grant only if thecurrent market price of the underlying stock exceeds the exercise price. Underthe Company’s stock incentive plans, stock options are granted at exerciseprices that equal the market value of the underlying common stock on the dateof grant. Therefore, no compensation expense related to stock options isrecorded in the Consolidated Statements of Operations.

Statementof Financial Accounting Standards (SFAS) No. 123, *Accounting for Stock-Based Compensation* (SFAS 123),established accounting and disclosure requirements using a fair-value basedmethod of accounting for stock-based employee compensation plans. As allowed bySFAS 123, the Company has elected to continue to apply the intrinsicvalue-based method of accounting described above, and has adopted only thedisclosure requirements of SFAS 123. There was no stock based compensationgranted in 2005 and 2004.

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

TheCompany’s power generation equipment has required maintenance schedules basedupon hours of service and capacity. The Company accounts for this maintenanceas costs are incurred.

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

TheCompany has a concentration of risk with two significant customers. The Companywas contracted by the Commonwealth Utilities Corporation (CUC) to construct andoperate a power

F-10

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

generationfacility. In March 1999, the power generation plant became operational. Powerrevenues from this plant began in March 1999 and are earned under the terms ofa long-term power energy conversion agreement with this customer. Revenues fromthe CUC were $1.9 million and $2.1 million for 2005 and 2004, respectively.

Uponcommissioning of the Company’s power plant on the island of Tinian for Phase Iin March 1999, the Company received 120 promissory notes each in the amount of$180,000 representing the guaranteed payment due from CUC over the term of theagreement. The par value balance of promissory notes outstanding was $6.8million and $9.0 million as of December 31, 2005 and 2004, respectively.The discounted value of the promissory notes was $5.9 million and $7.4 millionat December 31, 2005 and 2004, respectively. Under the agreement the Companyalso receives a monthly operation and maintenance fee of $50,000 for 120months. The discounted value of the operation and maintenance fee was $1.6million and $2.1 million at December 31, 2005 and 2004, respectively. Thepromissory notes have been included in the original net investment insales-type lease as discussed in note 7. Revenues from the Tinian powerplant were 32.5% and 10.2% of the Company’s revenues for 2005 and 2004,respectively. Gross receivables for the investment in sales-type lease were$8.7 million and $11.5 million at December 31, 2005 and 2004, respectively.

Thesecond significant customer is the Fiji Electric Authority (FEA). The Companysigned a 20-year operations and maintenance agreement with the FEA in April2003 and recognized revenues under the contract of $2.7 million and $2.3million in 2005 and 2004, respectively.

TheCompany previously had several construction contracts for projects to becompleted in Saipan, Tinian, Palau and Guam. These projects have all beencompleted and the Company has not bid on any new contracts in 2005. However, itis the Company’s intention to bid on new construction contracts in conjunctionwith its major investor, SHBC.

**(4)****                     AccountsReceivable**

Accountsreceivable consist of the following at December 31, 2005 and 2004:
|                                                   | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|-----------------------|------------|
| ** **                                        | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Construction  contracts completed and in progress |       | $                     | 801,071    |   | $ | 1,698,211 |   |
| Retainages                                        |       | 486,547               |       | 3,072,971 |   |
| Trade and Other                                   |       | 770,092               |       | 89,809 |   |
|                                              |       | 2,057,710             |       | 4,860,991 |   |
| Less allowance  for doubtful accounts             |       | 26,177                |       | 20,678 |   |
| Net accounts  receivable                          |       | $                     | 2,031,533  |   | $ | 4,840,313 |   |

 

Retainagesare all due within the next 12 months. The allowance for doubtful accountsat December 31, 2005 and 2004 were $26,177 and $20,678, respectively. Directwrite-offs of uncollectible accounts were $16,074 and $1,329,058 in 2005 and2004, respectively.

F-11

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

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

Long-termconstruction contracts in progress accounted for using thepercentage-of-completion method consisted of:
|                                                                                        | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                             | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Costs incurred  on uncompleted contracts                                               |       | $                     | 3,670      |   | $ | 32,603,724 |   |
| Estimated  earnings (loss)                                                             |       | 0                     |       | (1,277,459 | ) |
|                                                                                   |       | 3,670                 |       | 31,326,265 |   |
| Less billings to  date                                                                 |       | 0                     |       | 32,041,106 |   |
|                                                                                   |       | $                     | 3,670      |   | $ | (714,841 | ) |
| Included in the  accompanying consolidated balance sheet under the following captions: |       |                  |       |   |   |
| Costs and estimated earnings in excess of billings                                     |       | $                     | 3,670      |   | $ | 1,379,359 |   |
| Billings in excess of costs and estimated earnings                                     |       | 0                     |       | (108,643 | ) |
| Accrued losses on contracts in progress                                                |       | 0                     |       | (1,985,557 | ) |
|                                                                                   |       | $                     | 3,670      |   | $ | (714,841 | ) |

 

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

|                                                 | ** ** | **2005**  | ** ** | **2004**  | ** ** |
|-------------------------------------------------|------------|-----------|------------|-----------|------------|
| Buildings/Leasehold  improvements               |       | $         | 2,730      |      | $          | 192,022 |   |
| Transportation  equipment                       |       | 286,778   |       | 499,980   |       |
| Construction  machinery and equipment           |       | 1,091,843 |       | 2,760,600 |       |
| Office furniture  and equipment                 |       | 194,169   |       | 754,471   |       |
| Computer and  communication equipment           |       | 102,764   |       | 180,193   |       |
|                                            |       | 1,678,284 |       | 4,387,266 |       |
| Less accumulated  depreciation and amortization |       | 1,112,194 |       | 3,002,590 |       |
| Net property,  plant, and equipment             |       | $         | 566,090    |      | $          | 1,384,676 |   |

 

Totaldepreciation expense was $385,908 and $492,694, in 2005 and 2004, respectively.Depreciation for construction machinery and equipment is recognized as aproject expense when appropriate.

TheCompany recognized an asset impairment charge of $385,926 in 2005 and $341,392during 2004 attributable to construction equipment to be sold during 2005 and2006 and the write- off of abandoned assets. The Company has reported $385,926and 241,970 in 2005 and 2004 of this impairment in operating expenses and$99,421 in construction costs in 2004.

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

TheCompany’s contract with Commonwealth Utilities Corporation (CUC) for theconstruction and operation of a power plant on the island of Tinian isaccounted for as a sales-type lease. The minimum lease payments due under theagreement began upon commissioning of the first phase of the power plant andare comprised of a guaranteed monthly payment of $180,000 for one hundred andtwenty (120) months, and an operation and maintenance fee of $50,000 duemonthly for one hundred and twenty (120) months. These minimum lease paymentswere discounted at an interest rate of 6.74%, which was the ten-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 theplant was commissioned and the Company began collecting payments on thepromissory notes and service fees for operating the plant. The Company alsoreceives variable monthly production fee payments based upon the Kwh producedplus an additional fee for Kwh produced in excess of the first 5,140,000 Kwh producedeach month. The variable payments are recognized based upon power produced anddelivered to the customer as earned during each accounting period. Service feesearned in 2005 and 2004 were not in excess of the estimated fair value of theservices performed.

F-12

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

Theoriginal net investment in sales-type lease was recognized in June 1997,the date the contract was executed. The components of the net investment in sales-typelease are as follows:
|                                         | ** ** | **December 31** | ** ** | **June 20, 1997** | ** ** |
|-----------------------------------------|------------|----------------------|------------|-----------------------------|------------|
| ** **                              | ** ** | **2005**             | ** ** | **2004**                    | ** ** | **inception** | ** ** |
| Guaranteed  monthly payment             |       | $                    | 6,840,000  |                        | $          | 9,000,000 |   | $ | 21,600,000 |   |
| Minimum  operation and maintenance fee  |       | 1,900,000            |       | 2,500,000                   |       | 6,000,000 |   |
| Total minimum lease payments receivable |       | 8,740,000            |       | 11,500,000                  |       | 27,600,000 |   |
| Less unearned  income                   |       | 1,206,115            |       | 2,015,075                   |       | 9,750,000 |   |
| Net investment in sales-type lease      |       | $                    | 7,533,885  |                        | $          | 9,484,925 |   | $ | 17,850,000 |   |
|                                    |       |                 |       |                        |       |   |   |
| Current portion                         |       | $                    | 2,142,552  |                        | $          | 1,951,040 |   |   |   |
| Long-term  portion                      |       | 5,391,333            |       | 7,533,885                   |       |   |   |
|                                    |       |                 |       |                        |       |   |   |
|                                    |       | $                    | 7,533,885  |                        | $          | 9,484,925 |   |   |   |

 

Thefuture minimum lease payments to be collected by the Company are $2,760,000each year through 2008 and $460,000 in 2009.

Whenthe Company recognized the net investment in sales-type lease at the inceptionof the agreement in June 1997, the Company also recognized a loss on thesale of Phase I in the amount of $1,748,713. The Company recognized a loss onthe sale of Phase II for the entire amount of the construction costs for PhaseII, as there were no additional minimum lease payments related to this phase.The loss recognized on the sale of Phase II occurred when the contract forPhase II was executed in November 1998, and amounted to $12,521,457.

PhaseI of the power plant was commissioned in March of 1999. Phase II wascommissioned in March of 2000. The Company recognized power generationrevenues from billings on the Tinian power plant of $1,120,560 and $1,078,392for the years ended December 31, 2005 and 2004, respectively.

F-13

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

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

Long-termdebt consists of the following at December 31, 2005 and 2004: 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | **December 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------|------------|------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                        | ** ** | **2005**         | ** ** | **2004**         | ** ** |
| 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.                                                                                                                                                                                       |       | 710,967          |       | 1,186,926        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| 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.                                                                                                                                                                                            |       | 224,948          |       | 374,913          |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| 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. |       | 8,860,000        |       | 11,020,000       |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Commercial Bank of Kuwait loan, due on September 30,  2005 with quarterly payment of interest of LIBOR + 2.5%.Principal payment on  maturity. Secured by a standby letter of credit issued by Al Ahli Bank of  Kuwait for $7,875,000 and a guarantee from SHBC and two of SHBC’s  shareholders. In March 2005, this was refinanced with Arab Banking  Corporation.                                                                                           |       | —           |       | 7,500,000        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Sayed Hamid Behbehani & Sons (SHBC), annual  interest payments at 6.0% of unpaid balance. Unsecured and maturing December  7, 2006. This loan was converted to common stock in November 2005.                                                                                                                                                                                                                                                                 |       | —           |       | 2,580,000        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Al Ahli Bank loan due on September 30, 2005 with  variable payment of interest of 6.25%. Secured by a guarantee from Sayed  Hamid Behbehani & Sons Co. In May 2005, this loan was repaid.                                                                                                                                                                                                                                                                     |       | —           |       | 2,540,494        |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Arab Banking Corporation Loan Facility with interest  payments due in six month periods (September 30, 2006 and March 31, 2007),  and principal balance due March 31, 2007. Interest is charged at 1.25% plus  LIBOR. Guaranteed by Al Ahli Bank of Kuwait.                                                                                                                                                                                                       |       | 7,500,000        |       | —           |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| ANZ loans due April, July and September, 2005 with  interest of 7.75% payable in monthly installments. One loan was paid-off in  full on April 13, 2005, while the other two were paid-off early on June 27,  2005.                                                                                                                                                                                                                                               |       | —           |       | 133,904          |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| 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%.                                                                                                                                                                                                                                                                                                           |       | 28,227           |       | 51,526           |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| VB Holdings Motor Vehicle due on September 24,  2006 with monthly principal and interest payments of $1,000. Interest is  charged at 7.75%.                                                                                                                                                                                                                                                                                                                  |       | 9,327            |       | 18,201           |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Notes Payable                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       | 17,333,469       |       | 25,405,964       |       |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                              |       |             |       |             |       |
| Less current portion                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | 3,131,938        |       | 5,332,340        |       |
| Total long-term debt                                                                                                                                                                                                                                                                                                                                                                                                                                              |       | $                | 14,201,531 |             | 20,073,624 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |            |                  |            |                  |            |  |

 

F-14

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

Scheduledmaturities of debt outstanding as of December 31, 2005 are as follows:

| Years ending  December 31: |   |      |       |
|---------------------------------|--------|-----------|------------|
| 2006                            |   | $         | 3,131,938  |   |
| 2007                            |   | 9,661,531 |       |
| 2008                            |   | 2,160,000 |       |
| 2009                            |   | 2,380,000 |       |
|                            |   | $         | 17,333,469 |   |

 

TheCompany’s debt agreements contain various covenants. The Company was inviolation of a debt covenant with Bank of Hawaii and the Commercial Bank ofKuwait requirement for the delivery of audited financial statements within 90days of year-end. The Company was also in violation of certain financialcovenants with the Bank of Hawaii. The Company has obtained waivers from bothbanks for violation of these covenants.

Theloan covenants with the Bank of Hawaii require that the Company obtain writtenconsent from the Bank for loans in excess of $2.0 million. Through July 31,2006, the Company has borrowed $2.7 million from SHBC affiliated companieswithout obtaining written consent from the bank. Due to the covenant violationthe entire debt with the Bank of Hawaii has been classified as current.

During2004, the Company had a debt covenant violation on its loan with the Al AhliBank of Kuwait (“ABK”). The debt covenant required a payment to the bank of 50%of all collections on the radio relay station project in Tinian and the capitolrelocation project in Palau. The Company failed to make the required paymentsto ABK when the collections occurred during the last half of 2004. This creditfacility was renewed on October 3, 2004, with a maturity date ofSeptember 30, 2005. The Company paid-off the facility during the secondquarter of 2005.

Subsequentto December 31, 2005, the Company repaid its loan with ANZ bank which maturedon October 1, 2004, and also transferred its loan of $7.5 million with theCommercial Bank of Kuwait to the Arab Banking Corporation (“ABC”). The loantransferred to ABC will mature on March 31, 2006.

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

TheCompany has a 401K non-matching retirement plan named TelesourceInternational, Inc. Retirement Plan (“Plan”). The Plan allows employeeswho elect to participate, to contribute up to the

F-15

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

**Notes to Consolidated Financial Statements**

allowablemaximum amount into a fund managed by Aetna. There were no contributions tothis plan in 2004 or 2005.

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

*Preferred Stock*

AtDecember 31, 2005, the Company had 50.0 million shares of Series ACumulative Convertible Preferred Stock (The Preferred Shares) authorized. Noneof these shares are issued nor outstanding as December 31, 2005. Holders of thePreferred Shares are entitled to receive cumulative cash dividends at theannual rate of 6.5%. The Preferred Shares have no voting rights and rank senioras to dividends and upon liquidation to the common stock.

AtDecember 31, 2003, the Company had 9.8 million shares of the PreferredShares outstanding. Holders of the Preferred Shares were entitled to receivecumulative cash dividends at the annual rate of 6.5% per share payablesemi-annually.

ThePreferred Shares were convertible, in whole or in part, at the option of theholders thereof, into shares of common stock on a one-for-one basis for aperiod of five years from the closing date of the Preferred Shares agreement.The Company had the option to force conversion to common stock for a period oftime as defined by each agreement. All accumulated dividends plus any dividendsearned up through the forced conversion date would have been payable to theholder at the time of forced conversion.

Holdersof the Preferred Shares had no voting rights and the Preferred Shares rankedsenior as to dividends and upon liquidation to the common stock.

In2004, the Company paid preferred dividends of $477,750 for the six months endedJune 30, 2004.

Duringthe fourth quarter of 2004, the Company agreed to convert all of the preferredstock on a one for one basis plus the accumulated dividend due of $477,750 onthe preferred stock into common stock at a conversion price of $1.00 per share.The Company also issued additional shares of its common stock as an inducementfor the preferred stockholders to convert their preferred stock into commonstock. The additional shares were in lieu of payment of the present value offuture preferred stock dividends. In accordance with FAS 84 (Induced Conversionof Convertible Debt an amendment of APB Opinion No. 26) the Companyrecorded a dividend in the amount of $2.6 million related to the additionalshares issued.

OnJuly 31, 2004, Telesource International, Inc. held its 2004 annualmeeting of stockholders. At the annual meeting, the stockholders ratified theamendment to the Company’s Articles of Incorporation to increase the number ofauthorized preferred stock from 10,000,000 to 50,000,000.

*Common Stock Offerings*

Asof December 31, 2005, 93,438,140 shares of the Company’s common stock wereissued and outstanding, and as of December 31, 2004, 49,568,519 shareswere issued or issuable.

F-16

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

During2005 Telesource issued 24,186,543 Common Shares via 22 sales transactionstotaling $10,336,616 in proceeds. Additionally, the Company issued19,683,078 Common Shares in 4 debt conversion transactions totaling $2,593,271.

TheCompany sold 1,000,000 shares of common stock to an investor, Al AmalInvestments, on January 27, 2004 at $1 per share. Proceeds from the salewere received by the Company on January 27, 2004.

TheCompany issued common stock to two investors who are related parties during thesecond quarter of 2004 in the amount of 4,200,000 shares at a price of $1.00per share for a total consideration of $4,200,000. Subsequent toSeptember 30, 2004 and during the fourth quarter of 2004, the Company soldcommon stock to two investors in the amount of 2,355,493 shares at a price of$0.50 per share for a total consideration of $1,177,747. During the fourthquarter of 2004, the Company agreed to convert all of the preferred stock intocommon stock on a one for one basis plus the accumulated current and presentvalue of future dividends due on the preferred stock at a conversion price of$1.00 per share.

Duringthe fourth quarter of 2004, the Company also agreed to convert debt payable forboth principal and interest to Bent Marketing in the amount of $5,552,024 at aconversion price of $0.50 per share into 11,104,048 shares of common stock. TheCompany also agreed to convert debt payable for both principal and interest toSolas Investments in the amount of $517,500 at a conversion price of $0.50 pershare into 1,035,000 shares of common stock.

OnSeptember 17, 2004, Telesource issued warrants to certain Preferredstockholders for the purchase of 500,000 shares of Telesource’s common stock atan exercise price of $0.50 per share. This was done as consideration ondeferment of Preferred Stock Dividends which were payable in 2005. The warrantsissued in 2004 will expire five years from the date of grant. As of December 31,2004, there were no exercises of these warrants. The Company recorded adividend in the amount of $188,200 related to the value of the warrants.

In2003, Telesource issued warrants to certain purchasers of the Preferred sharesfor the purchase of 2,499,999 shares of Telesource’s common stock at anexercise price of $1.50 per share. The warrants issued in 2003 will expire ondates ranging from July 18, 2008 to December 15, 2008. As of December 31, 2005there have been no exercises of these warrants.

 **(11)   Earnings Per Share**

In accordance with the disclosure requirements ofStatement of Financial Accounting Standards No. 128, *Earnings Per Share*(SFAS 128), areconciliation of the numerator and denominator of basic and diluted earningsper share is provided as follows:
|                                                                                                        | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------|------------|------------|------------|
| Numerator –  basic and diluted loss per share Net loss                                            |       | $          | (5,366,610 | )          | $          | (13,711,315 | ) |
| Less: Preferred stock dividends                                                                        |       | —     |       | (3,739,929 | )          |
| Net loss available to common stockholders                                                              |       | $          | (5,366,610 | )          | $          | (17,451,244 | ) |
|                                                                                                   |       |       |       |       |       |
| Denominator –  basic and diluted loss per share – weighted average common shares outstanding |       | 64,350,919 |       | 21,108,652 |       |
| Basic and diluted  earnings per share                                                                  |       | $          | (0.08      | )          | $          | (0.83 | ) |

 

Fully-vestedoptions to purchase 225,000 shares of common stock granted under the 2000non-employee director stock option plan, and 2,999,999 warrants wereoutstanding at December 31,

F-17

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

2005,but not included in the computation of diluted earnings per share as the effectof the conversion of these instruments would be anti-dilutive.

**(12)   Stock Option Plans**

TheCompany has adopted the disclosure-only provisions of SFAS 123, *Accounting for Stock-Based Compensation*for employee based stock compensation.

***2000 Non-EmployeeDirector’s Stock Option Plan***

InJanuary 2001, the Company’s board of directors adopted the 2000Non-Employee Director’s Stock Option Plan that provides for the issuance ofnonqualified stock options to outside directors. Under the terms of this plan,under which 285,000 shares of common stock were reserved for issuance, optionsto purchase common stock are granted at not less than fair market value, becomeexercisable over a 3 year period from the date of grant (vesting occursannually on the grant date at 33.3% of the grant), and expire 10 years from thedate of grant.

Changesin options outstanding are summarized as follows:
|                                                        | ** ** | **December 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|--------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **                                             | ** ** | **Weighted  average  shares**   | ** ** | **Exercise  price**             | ** ** | **Weighted  average  shares** | ** ** | **Exercise  price** | ** ** |
| Options  outstanding at January 1                 |       | 225,000                         |       | $                               | 1.25       |   | 225,000 |   | $ | 1.25 |   |
| Granted                                                |       | —                          |       |                            |       | — |   |   |   |
| Exercised                                              |       | —                          |       |                            |       | — |   |   |   |
| Cancelled                                              |       | —                          |       |                            |       | — |   |   |   |
| Options  outstanding at December 31               |       | 225,000                         |       | 1.25                            |       | 225,000 |   | 1.25 |   |
| Options  exercisable at December 31               |       | 225,000                         |       | 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. As of July 20, 2006 he has not exercised hisoptions.

F-18

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

***2000 IncentiveStock Option Plan***

InJanuary 2001, the Company’s board of directors adopted the 2000 IncentiveStock Option Plan that provides for the issuance of qualified stock options toemployees. Under the terms of this plan, under which 888,000 shares of commonstock were reserved for issuance, options to purchase common stock are grantedat not less 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. As of December31, 2005, no options had been awarded under this plan.

***2000 Non-QualifiedStock Option Plan***

InJanuary 2001, the Company’s board of directors adopted the 2000 Non-QualifiedStock Option Plan that provides for the issuance of nonqualified stock optionsto employees. Under the terms of this plan, under which 27,000 shares of commonstock were reserved for issuance, options to purchase common stock are grantedat less than fair market value, become exercisable immediately on the date ofgrant, and expire 10 years from the date of grant. As of December 31,2005, no options had been awarded under this plan.

**(13)   Financial Instruments WithOff-balance Sheet Risk and Concentrations of Credit Risk**

Derivativefinancial instruments – Historically the Company has not engaged in hedgingactivities and currently does not hold any hedging instruments to minimizeforeign exchange rate or interest risk.

Standbyletters of credit and financial guarantees – The Company is liable for itsobligations, some of which are further secured under letters of credit obtainedby SHBC on behalf of the Company, and other financial guarantees totalingapproximately $9.4 million and $9.1million at December 31, 2005 and 2004respectively. The Company’s management does not believe it is practicable toestimate the fair values of these financial instruments and does not expect anylosses from their resolution.

**(14)   Related-party Transactions– Not described elsewhere**

Certainof the Company’s executive officers, directors, and major stockholders are alsoowners, officers, and/or directors of SHBC located in Kuwait. SHBC is a civil,electrical, and mechanical engineering firm and construction contractor with750 employees and over 30 years of experience. SHBC and itsaffiliates was the sole stockholder of Telesource International prior toJuly 1999 and now own approximately 95.3% of the common stock outstanding.SHBC and Telesource International bid and compete within the same industries;however, SHBC has agreed, in writing, not to bid projects within the UnitedStates and its possessions. Additionally, SHBC and its majority stockholders,Fouad Behbehani and Nasrallah Behbehani, have signed as guarantors onTelesource CNMI’s promissory note with the Commercial Bank of Kuwait, New YorkBranch. SHBC and its majority stockholders have also signed as guarantors on a$625,000 letter of credit issued to the Bank of Hawaii to secure twoinstallment 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.

Additionally,from time to time the Company may hire, on a part time or temporarybasis, individuals employed by SHBC to provide assistance to Telesource oncertain projects. The rates paid do not exceed the fair market value of similarservices provided by unrelated third parties. The Company did not hire any SHBCemployees to provide assistance on contracts during 2005 and 2004.

F-19

----

 

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

Thefollowing table provides a summary of financial information related to allservices provided to SHBC by the Company:
|                               | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------------|------------|----------|------------|----------|------------|
| Construction  revenues        |       | $        | —     |     | $          | — |   |
| Sales                         |       | 7,062    |       | 89,940   |       |
| Total related  party revenues |       | $        | 7,062      |     | $          | 89,940 |   |

 

Thefollowing table summarizes all balances related to transactions with SHBC asDecember 31, 2005 and 2004:

|                            | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Accounts payable  to SHBC  |       | $                     | 126,497    |   | $ | 2,490,410 |   |
| Other current  liabilities |       | —                |       | — |   |
|                            |            |                       |            |  |  |  |  |

 

Thebalance of accounts payable to SHBC was substantially due to costs of materialspurchased by SHBC on behalf of Telesource for use on the airport and prisonprojects. In addition, the Company purchased various materials and equipmentfrom SHBC in the amount of $171,481 and $5.2 million during 2005 and 2004,respectively. These materials and equipment were primarily for the prisonproject in Saipan and the projects on Guam and Palau.

TheCompany held an investment in Telebond Insurance Corporation atDecember 31, 2003 in the amount of $77,695. On November 9, 2004, theCompany sold its investment in Telebond for $90,000 and recognized a gain ofthe sale in the amount of $4,194. The Company purchased insurance from Telebondand paid premiums of $0 and $130,349 during the year ended December 31, 2005and 2004, respectively. Telebond provided employment bonds along with bid,performance, and payment bonds for the Company’s projects. Telebond is not aU.S. Treasury listed bonding company. Most bid, performance, and payment bondsfor the Company are secured from third party vendors. The Company’s formerPresident and CEO, K.J. Semikian, had served on Telebond Insurance Corporation’sboard of directors and was President of Telebond, and owned 10% of the stock ofTelebond.

TheCompany paid Computhink, Inc. a total of $102,837 in 2005 and $84,623 in2004. The payments to Computhink, Inc. cover rent for office spaceoccupied by the Company and for computer hardware and software provided byComputhink, Inc. Nidal Zayed, Telesource’s Chief Executive Officer serveson the Board of Directors for Computhink. The Company owed Computhink $6,791and $34,838, respectively, at December 31, 2005 and 2004. See note 16.

F-20

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

**(15)   Income Taxes**

Incometax expense (benefit) consists of:

|                                     | ** ** | **Current** | ** ** | **Deferred** | ** ** | **Total** | ** ** |
|-------------------------------------|------------|-------------|------------|--------------|------------|-----------|------------|
| Year ended  December 31, 2005:      |       |        |       |         |       |      |       |
| U.S. Federal                        |       | $           | —     |         | $          | —    |       | $ | — |   |
| State and local                     |       | —      |       | —       |       | —    |       |
| U.S. possession                     |       | —      |       | —       |       | —    |       |
| Foreign                             |       | (12,932     | )          | —       |       | (12,932   | )          |
|                                |       | $           | —     |         | $          | —    |       | $ | — |   |
| Year ended  December 31, 2004: |       |        |       |         |       |      |       |
| U.S. Federal                        |       | $           | —     |         | $          | —    |       | $ | — |   |
| State and local                     |       | —      |       | —       |       | —    |       |
| U.S. possession                     |       | —      |       | —       |       | —    |       |
| Foreign                             |       | (74,435     |       | —       |       | (74,435   | )          |
|                                |       | $           | (74,435    | )            | $          | —    |       | $ | (74,435 | ) |

 

Theforeign tax expense (benefit) was incurred in connection with the Company’soperations in Fiji and is based upon earnings (loss) within Fiji. The averagetax rate for Fiji was 31%.

In2005 and 2004 the Company recorded a loss for financial reporting purposes aswell as a loss for income tax reporting purposes and therefore, no current U.S.income tax expense has been reflected in the accompanying consolidatedstatements of operations.

Thetax effects of temporary differences that give rise to significant portions ofthe deferred tax assets and deferred tax liabilities at December 31, 2005 and2004 are presented below:
|                                                                  | ** ** | **2005**   | ** ** | **2004**    | ** ** |
|------------------------------------------------------------------|------------|------------|------------|-------------|------------|
| Deferred tax  assets:                                            |       |       |       |        |       |
| Contribution carryover                                           |       | $          | 0          |        | $          | 10,000 |   |
| Net operating loss carryforwards                                 |       | 16,620,000 |       | 14,700,000  |       |
| Accrued expenses                                                 |       | 95,000     |       | 202,500     |       |
| Total gross deferred tax assets                                  |       | 16,715,000 |       | 14,912,500  |       |
| Less valuation  allowance                                        |       | 16,715,000 |       | (14,912,500 | )          |
| Net deferred tax asset                                           |       | $          | —     |        | $          | — |   |
| Deferred tax  liability – excess tax over book depreciation |       | $          | —     |        | $          |   |   |

 

Thedifference between the expected income tax benefit and the actual isattributable to the valuation allowance.

Thevaluation allowance for deferred tax assets as of December 31, 2005 and 2004was $16,715,000 and $14,912,500 respectively. The net change in the totalvaluation allowance for the years ended December 31, 2005 and 2004 was anincrease of $1,802,500 and an increase of $2,307,784 , respectively. Inassessing the realizability of deferred tax assets, management considerswhether it is

F-21

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

morelikely than not that some portion or all of the deferred tax assets will not berealized. The ultimate realization of deferred tax assets is dependent upon thegeneration of future taxable income during the periods in which those temporarydifferences become deductible. Management believes that the valuation allowancereduces the recognition of deferred tax assets to a level that reflects theamount that is more likely than not to be realized, considering the taxplanning strategies available to the Company.

AtDecember 31, 2005, the Company has total net operating loss carryforwards fromU.S. operations of approximately $11 million and approximately $36 million fromits operations in the Commonweath of Northern Mariana Islands and Fiji,respectively. The net operating loss carryforwards expire in the years 2017through 2025. Certain of these net operating losses may be subject to alimitation on future utilization due to ownership changes or foreign tax laws.

A reconciliation of the differences between incometaxes computed at the U.S. federal statutory rate of 34% and the Company’sreported provision for income taxes is as follows:

|                                                    | ** ** | **Year Ended December 31,** | ** ** |
|----------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                         | ** ** | **2005**                                   | ** ** | **2004** | ** ** |
| Income tax  benefit at statutory rate              |       | $                                          | (1,829,050 | ) | $ | (4,687,155 | ) |
| Benefit not  recognized due to valuation allowance |       | $                                          | 1,816,118  |   | $ | 4,612,720 |   |
|                                               |       |                                       |       |   |   |
| Provision (benefit)  for income taxes              |       | $                                          | (12,932    | ) | $ | (74,435 | ) |
|                                               |       |                                       |       |   |   |
| Effective tax rate                                 |       | 0                                          | %          | 0 | % |

 

**(16)   Commitments andContingencies**

Minimumrental commitments under all noncancelable-operating leases, primarily relatedto property, vehicles, and construction equipment, in effect at December 31,2005 are:
| Years ending December 31, | ** ** |
|------------------------------------------|------------|
| 2006                                     |       | $ | 81,892 |   |
| 2007                                     |       | $ | 31,639 |   |
| 2008                                     |       | $ | 6,198 |   |
| 2009                                     |       | $ | 4,351 |   |
| 2010                                     |       | $ | 1,088 |   |
| TOTAL                                    |       | $ | 125,168 |   |

 

Leaseexpense was$157,781 and $169,270 for the years ended December 31, 2005 and2004, respectively.

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

Mr. KhajadourSemikan, the Company’s former Chief Executive Officer, had an employmentagreement with the Company. His agreement was not renewed by the Board and hisemployment with the Company was terminated in August of 2005. Mr. BudCurley, the Chief Financial Officer of Telesource, resigned from his positionin August of 2005. Mr. Nidal Zayed was appointed Acting ChiefExecutive Officer by the Board in September, 2005. In addition, Mr. GregGrosvenor was hired as the Chief Financial Officer of Company inAugust 2005. Mr. Grosvenor does not have an employment contract withthe Company. Telesource entered into an employment agreement with KhajadourSemikian in June 1999, Nidal Zayed in August 1999, and Bud Curley inApril 2001. The

F-22

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

termof the agreement with Mr. Semikian was from July 1, 1999 toJuly 1, 2002, which was extended to July 3, 2004. Under the terms ofthe agreement, Mr. Semikian was required to devote his full time to theCompany’s business. The Company agreed to pay him an annualized base salary of$220,000 during 1999, increased to $270,000 in 2000. During 2004, the Company’sBoard of Directors reduced Mr. Semikian’s salary to $216,000.Mr. Semikian did not receive any cash bonuses which, if awarded, wouldhave been at the Board’s discretion.

Theterm of the agreement with Mr. Zayed was from September 1, 1999 toSeptember 1, 2002, and was extended to July 3, 2004 and expired.Under the terms of the agreement, Mr. Zayed’s responsibilities compriseserving as the number two operating officer accountable for the full range ofoperations. The Company agreed to pay him an annualized base salary of $125,000per year for the term of the agreement. The payment of cash bonuses toMr. Zayed will be at the Board’s discretion. The Company has also agreedto provide Mr. Zayed with health insurance for him and his family alongwith a company car. Effective with the termination of Mr. Semikian’semployment, Mr. Zayed became the Company’s Acting CEO. His salary wasincreased to $165,000.

Theterm of the original agreement with Mr. Curley was from April 1, 2001to October 1, 2003, and was renewed to October 1, 2005. As notedearlier, Mr. Curley resigned his position in August of 2005. Underthe terms of the agreement, Mr. Curley was required to devote his fulltime to the Company’s business. The Company agreed to pay him an annualizedbase salary of $165,000 during the period from April 1, 2001 toOctober 31, 2001, and $175,000 from November 1, 2001 toOctober 1, 2005. The payment of cash bonuses to Mr. Curley, for whichhe received none, would have been at the Board’s discretion. The Company agreedto provide Mr. Curley with health insurance for him and his family duringhis employment. The Company also agreed to provide Mr. Curley with a$10,000 per year car allowance during the term of his agreement.

TheCompany is involved in various litigation proceedings arising in the ordinarycourse of business. In the opinion of management, the ultimate disposition ofthese matters will not have a material adverse effect on the Company’sfinancial position, results of operations, or liquidity.

TheCommonwealth Port Authority (“CPA”) and Telesource have completed negotiationsover the final billing for the West Tinian Airport Project (“WTA”). As ofDecember 31, 2004, Telesource has reflected approximately $1.8 million ofretentions in accounts receivable related to the WTA. Approximately $891,000 ofthe outstanding retention receivable was collected in 2005 in connection with apartial settlement agreement which was entered into in August 2005.Telesource claims that in addition to the remaining unpaid retentionsreceivable recorded under the original contract terms and related to workperformed through 2003 that it is also due additional amounts for work performedoutside of the original scope of the contract. The Company has collected theDecember 31,2004 outstanding retention, as well as, additional amounts insettlement of all claims during 2005 and 2006. The Company had a continuingwarranty obligation for three years from the date of final acceptance for whichthere were no material claims.

TheCompany, in 1999 was awarded a contract to build 45 housing units for theNorthern Marina Housing Agency, a government unit. The houses were built andsubsequently occupied. The Northern Marianas Housing Corporation has filed alawsuit against Telesource and two other parties for $3.0 million in damagesrelated to this project. These claims involve allegations of variousconstruction defects. The Company estimates that, if the plaintiff issuccessful, the Company may have an estimated liability in the range of$300,000 to $650,000. The Company recorded a $300,000 estimated loss during theyear ended 12-31-2004. Telesource has denied any liability and willaggressively defend itself to dismiss these claims.

TelesourceInternational’s power generation activities involve significant risks ofenvironmental damage, equipment damage and failures, personal injury and fines andcosts imposed by regulatory

F-23

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

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 5,000,000 FJD(approximately $2,870,000 USD at December 31, 2005).

TelesourceInternational offers warranties on its construction services and powergenerating plants. Telesource International does not maintain any materialwarranty reserves because these warranties are usually backed by warrantiesfrom its vendors. Should Telesource International be required to cover the costof repairs not covered by the warranties of Telesource International’s vendorsor should one of Telesource International’s major vendors be unable to coverfuture warranty claims, Telesource International could be required to outlaysubstantial funds, which could harm its financial condition.

TheCompany has an agreement with the Commonwealth of the Northern Mariana Islandsto manage one of their power plants. In accordance with Change Order No. 3of this agreement, the Company is required to upgrade the power distributionsystem in certain areas of the Tinian Island. The Company is responsible forthe costs of the upgrade which include labor and material. The Company estimatesthe cost of this upgrade to be approximately in the range of $800,000 to $1.3million and to be completed in 2006.

InOctober 2005, the Company entered into a credit facility agreement up toapproximately FJD350,000 with Australia and new Zealand Banking Group Limited (“ANZBGL”).Interest will be charged at the rate of 7.75% per annum. This facility isrevolving and is subject to annual review. Also in addition to the revolvingcredit facility the Company entered into a FJD200,000 master lease agreement topurchase motor vehicles.

TheCompany operates a power plant on the island of Tinian. The power plantrequires a permit with the Department of Environmental Quality. The Companycurrently has a temporary permit and expects to receive a permanent permit.However, substantial consequences could occur if the Company does not receive apermanent permit.

**(17)   Business SegmentInformation**

Telesource has three operating segments: powergeneration and construction of power plants, trading, and construction services.The power generation and construction of power plants segment includessales-type lease revenues recognized. There were no material amounts oftransfers between segments. Any inter segment revenues have been eliminated.The following table sets forth certain segment information for the periodsindicated:

|                                | ** ** | **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 |   |
|                                |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |

 

F-24

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

|                                | ** ** | **December 31, 2004**                                 | ** ** |
|--------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                     | ** ** | **Power  generation  and  construction  of power  plants** | ** ** | **Trading** | ** ** | **Construction** | ** ** | **Total** | ** ** |
| Revenue                        |       | $                                                               | 4,386,241  |   | $ | 185,728 |   | $ | 16,136,865 |   | $ | 20,708,834 |   |
| Interest  expense, net         |       | 1,128,855                                                       |       | — |   | 379,422 |   | 1,508,277 |   |
| Depreciation and  amortization |       | 27,597                                                          |       | 1,462 |   | 463,635 |   | 492,694 |   |
| Income tax expense(benefit)    |       | (74,435                                                         | )          | — |   | — |   | (74,435 | ) |
| Net loss                       |       | (824,190                                                        | )          | 50,585 |   | (12,937,710 | ) | (13,711,315 | ) |
| Total capital  expenditures    |       | 30,434                                                          |       | — |   | 237,438 |   | 267,872 |   |
| Total assets                   |       | 14,305,113                                                      |       | 110,502 |   | 6,435,119 |   | 20,850,734 |   |
|                           |       |                                                            |       |   |   |   |   |   |   |
|                                |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |

 

Thebasis used to attribute revenues to individual countries is based upon wherethe services are provided.

Thepower generation segment includes revenues from the Company’s power station onTinian, Commonwealth of the Northern Mariana Islands in the amounts of$1,929,520 and $2,061,746 for 2005 and 2004, respectively. Power generationrevenues for 2005 also include revenues from the Company’s operation andmaintenance of three power plants in Fiji in the amount of $2,720,806 and$2,148,617 for 2005 and 2004, respectively.

Revenuesfrom the Company’s related party, SHBC, were $7,062 and $89,940 for 2005 and2004, respectively.

Revenuesrecognized within the construction segment were earned in Cyprus, Palau and inTinian, the Commonwealth of the Northern Mariana Islands.

Revenuesgenerated by the Company’s Guam office were none and $72,494 for 2005 and 2004,respectively. Other revenues recognized within the trading segment for allperiods presented were earned in the United States.

Long-termassets located in the Commonwealth of the Northern Mariana Islands were $5.8million and $8.9 million as of December 31, 2005 and 2004, respectively. Fixedassets located in Fiji were $138,917 and $141,339 as of December 31, 2005 and2004, respectively.

**(18)   Subsequent Events**

Subsequent to December 31, 2005:

The Company obtained funds through various loanagreements with SHBC affiliated companies totaling $2.7 million. These loanshave a term of one year with an interest rate at 6%.

Weston Marsh a director of the Company, resigned his position effectiveJune 1, 2006. Mr. Marsh’s resignation was voluntarily tendered in response tothe Company’s recent expressed desire to reduce the size of the Board from sixmembers to five.

F-25

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Notes to Consolidated Financial Statements

**(19)   SupplementaryDisclosure of Cash Flow Information**

During2005 and 2004, the Company had some non-cash transactions as follows:

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.

Duringthe fourth quarter of 2004, the Company agreed to convert all of the preferredstock outstanding into 9,799,999 shares of common stock on a one for one basis.The Company also agreed to convert all the accumulated dividends of $477,750into 477,750 shares of common stock. The Company also issued 2,596,229 sharesof common stock as an inducement for the preferred stockholders to converttheir preferred stock into common stock.

Duringthe fourth quarter of 2004, the Company agreed to convert debt payable for bothprincipal and interest to Bent Marketing in the amount of $5,552,024 at aconversion price of $0.50 per share into 11,104,048 shares of common stock. TheCompany also agreed to convert debt payable for both principal and interest toSolas Investments in the amount of $517,500 at a conversion price of $0.50 pershare into 1,035,000 shares of common stock.

In2004, the Company recorded a dividend of $188,200 related to 500,000 warrantsgranted to preferred stockholders for deferment of 2005 preferred dividends.

F-26

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**ITEM 8. CHANGES IN AND DISAGREEMENTSWITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

None

**ITEM 8A. CONTROLS AND PROCEDURES**

Telesourceis committed to maintaining disclosure controls and procedures that aredesigned to ensure that information required to be disclosed in its ExchangeAct reports is recorded, processed, summarized and reported within the timeperiods specified in the Commission’s rules and forms, and that suchinformation is accumulated and communicated to its management, including itsChief Executive Officer and Chief Financial Officer, as appropriate, to allowfor timely decisions regarding required disclosure. In designing and evaluatingthe disclosure controls and procedures, management recognizes that any controlsand procedures, no matter how well designed and operated, can provide onlyreasonable assurance of achieving the desired control objectives and aresubject 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.

Deficienciesin the Company’s Controls and Procedures

Inconnection with the review of the Company’s financial statements for thequarter ended March 31, 2004, L J Soldinger Associates LLC, theindependent registered accounting firm, notified the Audit Committee andmanagement, of certain deficiencies they identified that existed in the designand operation of our internal controls that L J Soldinger Associates LLCconsiders to be material weaknesses in the effectiveness of the Company’sinternal controls pursuant to standards established by the American Instituteof Certified Public Accountants. A “material weakness” is a reportablecondition in which the design or operation of one or more of the specificinternal control components has a defect or defects that could have a materialadverse effect on the Company’s ability to record, process, summarize andreport financial data in the financial statements in a timely manner. Thematerial weaknesses identified by the independent registered accounting firmincluded the following weaknesses in various financial areas of the Company:

·      Failed to maintain its accounting recordsin an accurate, orderly, timely manner which precluded the Company from meetingthe regulatory filing deadlines.

·      Maintaining an inefficient consolidationprocess which fails to provide readily identifiable information, ortransparency, as to the source of the accounting data and related consolidatingadjustments made - both at the parent and subsidiary levels.

·      Recording various journal entries at theconsolidation level but not recording them at the subsidiary level resulting inaccumulated differences between the consolidated trial balances and subsidiarytrial balances.

·      Failing to timely perform an internalreview of the general ledger account balances in order to i) identify andcorrect bookkeeping errors, ii) make required period end accruals, and iii)reconcile supporting detail to account balances.

·      Lack of appropriate procedures toestablish and maintain appropriate cost estimates for construction projects.

·      Lack of appropriate controls related tomaintaining a current accurate backlog schedule.

·      Maintaining accounting records for theGuam office on spreadsheets outside of the Company’s standard accounting software.

·      Failure to prepare orderly and concisesupporting detail records for amounts comprising expense accruals.

·      Lack of certain controls relating tomonitoring and investigating intercompany balances and related differences andelimination of the intercompany balances in the consolidation process.

We havetaken measures to improve the effectiveness of our internal controls and webelieve these efforts address the matters described above. Certain measures wehave taken include, but are not limited to, the following:

·      Appointed Nidal Zayed as Chief ExecutiveOfficer;

·      Appointed Greg Grosvenor as ChiefFinancial Officer;

·      centralized our United States regionalfinance organization, with direct reporting responsibilities to the ChiefFinancial Officer;

·      exited the construction related businesswhich contributed to our losses as well as many of the related internal controlweaknesses.

·      established training plans for personnel.

18

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Asrequired by Rule 13a-15(b) of the Exchange Act, Telesource has carried out anevaluation, under the supervision and with the participation of its management,including its Chief Executive Officer and its Chief Financial Officer, of theeffectiveness of the design and operation of its disclosure controls andprocedures. The evaluation examined those disclosure controls and procedures asof December 31, 2005, the end of the period covered by this report. Based uponthe evaluation and the communication from our independent registered accountingfirms, Telesource’s management, including its Chief Executive Officer and itsChief Financial Officer, concluded that, Telesource’s disclosure controls andprocedures were ineffective.

It willtake some time before we have in place the rigorous disclosure controls andprocedures, including internal controls and procedures, that our Board ofDirectors and senior management are striving for. As a result of our efforts,however, we believe that our Consolidated Financial Statements fairly present,in all material respects, our financial condition, results of operations andcash flows as of, and for, the periods presented and that this Form 10-KSB, andthat this report contains the information required to be included in accordancewith the Exchange Act.

During2005, we continued to make improvements in our financial reporting bycontinuing to hire qualified personnel and refine our formal review processes.We will continue to assess our internal controls and procedures and will takeany further actions that we deem necessary.

ChangesIn Internal Control Over Financial Reporting

During2005, there were no changes in our internal control over the financialreporting or in other factors that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reportingduring the period covered by this Report.

CEO andCFO Certifications — The Certifications of our CEO and CFO which are attachedas Exhibits 31(1) and 31 (2) to this Report include information about ourdisclosure controls and procedures and internal control over financialreporting. These Certifications should be read in conjunction with theinformation contained in this Item 9a for a more complete understanding of thematters covered by the Certifications.

**ITEM 8B. OTHER INFORMATION**

**NONE**

19

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# **PART III**

**ITEM 9. DIRECTORS AND EXECUTIVEOFFICERS OF THE REGISTRANT**

Aformer Director and CEO, Khajadour Semikian terminated his employment during2005. Directors are elected for one-year terms and are elected at each annualmeeting of stockholders.  As of December31, 2005 Telesource’s Board of Directors were:
| **Name and Age;  Years Served as  Director**                | ** ** | **Principal Occupation for Past Five Years; Other Directorships**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
|---------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| Ralph Beck  Age 66  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 44  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 62  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 55  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 63  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. |
|                                                                            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| Weston W. Marsh  Age 55  Director Since 1999,  resigned effective June 1, 2006. |       | Mr. Marsh is a member of the law firm Freeborn &  Peters. Prior to joining Freeborn & Peters in September 1990, Mr. Marsh  served as the Assistant General Counsel for the nation’s seventh largest  railroad. Mr. Marsh obtained his law degree from the University of Illinois,  where he graduated with honors, Order of the Coif, and was associate editor  of the Law Review. He received his B.A. from Yale University and an M.B.A.  from the University of Chicago, where he graduated first in his class.                                                                                                                                                                                                                                                                                 |
|                                                                            |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |
| 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.                                                                                                                                                                                                                                                                                                                                                                                        |

 

20

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**Code ofEthics**

TheCompany has adopted a code of ethics that applies to all employees of theCompany. Copy of the Company’s code of ethics can be obtained by writing toTelesource International, 860 Parkview Blvd, Lombard, Il. 60148.

**ITEM 10.EXECUTIVE COMPENSATION**

**SUMMARYCOMPENSATION TABLE**

 
| Name and  Principal Position | ** ** | **Year** | ** ** | **Salary (1)** | ** ** | **Bonus** | ** ** | **All Other Annual  Compensation(2)** | ** ** |
|----------------------------------------|------------|----------|------------|---------------------|------------|-----------|------------|-------------------------------------------------|------------|
|                                   |       |     |       |                |       |      |       |                                            |       |
| Nidal Zayed                            |       | 2005     |       | $                   | 141,385    |      | $          | —                                          |       | $ | 22,302 |   |
| Chief Executive Officer                |       | 2004     |       | $                   | 128,000    |      | $          | —                                          |       | $ | 22,302 |   |
|                                        |       | 2003     |       | $                   | 125,000    |      | $          | —                                          |       | $ | 24,756 |   |
|                                   |       |     |       |                |       |      |       |                                            |       |
| Khajadour Semikian (3)                 |       | 2005     |       | $                   | 161,200    |      | 0          |                                            | $          | 18,581 |   |
| President and                          |       | 2004     |       | $                   | 263,919    |      | $          | —                                          |       | $ | 27,871 |   |
| Chief Executive Officer                |       | 2003     |       | $                   | 278,167    |      | $          | —                                          |       | $ | 59,931 |   |

 

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(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 $ 11,036 in 2005 and $10,245 in2004 . Telesource provided Mr. Zayed with health insurance for him and hisfamily at a cost of , $7,605 in 2005 and $12,057 in 2004.

(3)   The formerCEO, Mr. Semikian’s contract was not renewed by the Board in 2005 andconsequently his last day of employment with the Company was August 31, 2005. Mr.Nidal Zayed, formerly the COO was promoted to the CEO position vacated by Mr.Semikian on September 1, 2005.

**StockOptions**

As ofDecember 31, 2005 there were no stock options outstanding to any persons otherthan nonemployee directors.

**DirectorsCompensation**

TheCompany paid an annual fee to each Director (except for Nidal Zayed) in theamount of $20,000 and $20,000 for 2005 and 2004, respectively. Such fees arepaid in cash. For a discussion of Telesource’s executive team, please see Item4. (a). Executive Officers of the Registrant

**ITEM 11. SECURITY OWNERSHIP OFCERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

Thefollowing table contains information as of December 31, 2005 regarding theownership of the Common Stock of the Company by: (i) all persons who, tothe knowledge of the Company,  were thebeneficial owners of 5% or more of the outstanding shares of Common Stock ofthe Company, (ii) each director and director nominee of the Company,(iii) the Chief Executive Officer and the two other

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mosthighly compensated executive officers of the Company as of September 30, 2005,whose salary and bonus for the fiscal year ended December 31, 2005 exceeded$100,000, and (iv) all executive officers and directors of the Company asa group:

 
| **Name**                                                          | ** ** | **Amount and  Nature  of Beneficial  Ownership (1)** | ** ** | **Percent of  Common Stock  Outstanding (2)** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                                          | ** ** | ** **                                                   | ** ** |
| Sayed Hamid  Behbehani & Sons, Co. W.L.L. (3)                 |       | 89,052,140                                                          |       | 95.31                                                        | %          |
| K.J. Semikian  (former CEO)                                       |       | 200,000                                                             |       | *                                                            |       |
| Max Engler(4)                                                     |       | 95,000                                                              |       | *                                                            |       |
| Ibrahim Ibrahim                                                   |       | 55,000                                                              |       | *                                                            |       |
| Jeff Adams                                                        |       | 46,000                                                              |       | *                                                            |       |
| Ralph Beck                                                        |       | 45,000                                                              |       | *                                                            |       |
| Weston Marsh (6)                                                  |       | 45,000                                                              |       | *                                                            |       |
| Nidal Z. Zayed                                                    |       | —                                                              |       | *                                                            |       |
|                                                              |       | —                                                              |       | *                                                            |       |
| All Executive Officers  and Directors as a Group (8 Persons) |       | 261,000                                                             |       | 1.1                                                          | %          |

 

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*       Less than 1%

(1)   Except asindicated in the footnotes to this table, the persons named in the table havesole voting and investment power with respect to all shares of Common Stockshown as beneficially owned by them, subject to community property laws whereapplicable. Amounts include 45,000 options for non-employee directors. WestonMarsh resigned effective June 1, 2006.

(2)   Calculatedon the basis of 93,438,140 shares of Common Stock outstanding as of December31, 2005. Excludes 45,000 options that were exercisable within 60 days ofDecember 31, 2005 held by non-employee directors. None of the options wereexercised and the Company did not incur any expenses associated with theseoptions.

(3)   Includes89,052,140 shares of Common Stock held by eight members of the Behbehani familyor their affiliates.

(4)   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.

(5)   As ofDecember 31, 2005 there were no stock options outstanding to any persons otherthan nonemployee directors

(6)   Mr. Marshresigned as a director effective June 1, 2006.

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Shownbelow is information as of December 31, 2005 with respect to the shares ofCommon Stock that 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 |       | 225,000                                                                                                          | (1)        | 1.25                                                                                 |       | 975,000                                                                                                                             | (2)        |

 

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(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. CERTAIN RELATIONSHIPS ANDRELATED TRANSACTIONS**

Certainof the Company’s executive officers, directors, and major stockholders are alsoowners, officers, and/or directors of SHBC located in Kuwait. SHBC is a civil,electrical, and mechanical engineering firm and construction contractor with750 employees and over 30 years of experience. SHBC and itsaffiliates were the sole stockholder of Telesource International prior to July1999 and now own approximately 95.3% of the common stock outstanding. SHBC andTelesource International bid and compete within the same industries; however,SHBC has agreed, in writing, not to bid on projects within the United Statesand its possessions. Additionally, SHBC and its majority stockholders, FouadBehbehani and Nasrallah Behbehani, have signed as guarantors on Telesource CNMI’spromissory note with the Commercial Bank of Kuwait, and as guarantors on a$7,500,000 credit facility for Telesource with the Arab Banking Corporation ofBahrain. SHBC and its majority stockholders have also signed as guarantors on a$625,000 letter of credit issued to the Bank of Hawaii to secure a $625,000credit facility.

Thesecredit facilities were used to finance the construction activities on the powerplant, the West Tinian Airport expansion project, and to provide financing forother 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 provide assistance to Telesource on certainprojects in the Northern Mariana Islands.

TheCompany held an investment in Telebond Insurance Corporation atDecember 31, 2003 in the amount of $77,695. On November 9, 2004, theCompany sold its investment in Telebond for $90,000 and recognized a gain ofthe sale in the amount of $4,194. The Company purchased insurance from Telebondand paid premiums of $130,349 during the year ended December 31, 2004. Telebondprovided employment bonds along with bid, performance, and payment bonds forthe Company’s projects. Telebond is not a U.S. Treasury listed bonding company.Most bid, performance, and payment bonds for the Company are secured from thirdparty vendors. The Company’s former President and CEO, K.J. Semikian, hadserved on Telebond Insurance Corporation’s board of directors and was Presidentof Telebond, and owned 10% of the stock of Telebond.

TheCompany paid Computhink, Inc. $102,837 in 2005 for rent, and computer support. TheCompany shares office space with Computhink in its Lombard office. Nidal Zayed,the Company’s Chief Executive Officer serves on the Board of Directors ofComputhink. K.J. Semikian, Telesource’s former Chief Executive Officer formerlyserved on the Board of Directors for Computhink.

TheCompany held an investment in Telebond Insurance Corporation atDecember 31, 2003 in the amount of $77,695 which was sold in 2004. TheCompany purchased insurance from Telebond and paid premiums of $0 and $45,863,during the years ended December 31, 2005 and 2004, respectively. Telebondprovides employment bonds along with bid, performance, and payment bonds forthe Company’s projects. Telebond is not a U.S. Treasury listed bonding company.Most bid, performance, and payment bonds for the Company are secured from thirdparty vendors. The Company’s former President and CEO, K.J. Semikian, served onTelebond Insurance Corporation’s board of directors and as President ofTelebond, and owns 10% of the stock of Telebond.

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**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 **                                                                                                                                                                                             |   |
|                |       |                                                                                                                                                                                                                               |   |
| 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**                                                                 |   |
| 10.06               |       | Memorandum of Understanding between Sayed Hamid  Behbehani & Sons, Co. W.L.L. and Telesource International, Inc. regarding  right of first refusal for certain areas**                                                         |
|                |       |                                                                                                                                                                                                                               |
| 10.07               |       | Memorandum of Understanding between Sayed Hamid  Behbehani & Sons, Co. W.L.L. and Telesource International, Inc. regarding  commission fees **                                                                                 |
|                |       |                                                                                                                                                                                                                               |
| 10.10               |       | Note Agreement between the Commercial Bank of  Kuwait, New York Branch, and Telesource International CNMI, Inc. dated August  20, 1998**                                                                                           |
|                |       |                                                                                                                                                                                                                               |
| 10.10A              |       | Note Agreement between the Commercial Bank of  Kuwait, New York Branch, and Telesource CNMI, Inc. dated December 11, 2001 **                                                                                                       |
|                |       |                                                                                                                                                                                                                               |
| 10.11               |       | Term Loan Agreement between the Kuwait Real Estate  Bank and Telesource International CNMI, Inc. dated May 2, 1999**                                                                                                               |
|                |       |                                                                                                                                                                                                                               |
| 10.12               |       | Line of Credit Agreement between the Bank of Hawaii  and Telesource International CNMI, Inc.**                                                                                                                                     |
|                |       |                                                                                                                                                                                                                               |
| 10.13               |       | Credit Agreement between Hongkong and Shanghai Bank  Corporation, Limited and Telesource CNMI, Inc. dated January 21, 2000**                                                                                                       |
|                |       |                                                                                                                                                                                                                               |
| 10.13A              |       | Credit Agreement between Hongkong and Shanghai Bank  Corporation, Limited and Telesource CNMI, Inc. dated March 26, 2002 **                                                                                                        |
|                |       |                                                                                                                                                                                                                               |
| 10.14               |       | Lease of Tinian Land between the Commonwealth  Utilities Corporation and Telesource International CNMI, Inc.**                                                                                                                     |
|                |       |                                                                                                                                                                                                                               |
| 10.15               |       | Employment Contract between K.J. Semikian and  Telesource International, Inc.**                                                                                                                                                    |
|                |       |                                                                                                                                                                                                                               |
| 10.16               |       | Employment Contract between Nidal Z. Zayed and  Telesource International, Inc.**                                                                                                                                                   |
|                |       |                                                                                                                                                                                                                               |
| 10.17               |       | Employment Contract between Bud Curley and  Telesource International, Inc. **                                                                                                                                                      |
|                |       |                                                                                                                                                                                                                               |
| 10.18               |       | Adoption Agreement for Aetna Life Insurance and  Annuity Company Standardized 401(k) Profit Sharing Plan and Trust between  Aetna Life Insurance and Annuity Company and Commsource International, Inc.  dated November 13, 1998** |

 

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|   |   |                                                                                                                                                                          |
|--------|--------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 10.19  |   | Agreement for Design, Supply of Plant and Equipment,  Private Construction, Maintenance and Operation, and Transfer of Ownership,  Change Order Number 3 dated May 11, 2001** |
|   |   |                                                                                                                                                                          |
| 10.20  |   | Telesource International, Inc. 2000 Incentive Stock  Option Plan **                                                                                                           |
|   |   |                                                                                                                                                                          |
| 10.21  |   | Telesource International, Inc. 2000 Non-Qualified  Stock Options Plan **                                                                                                      |
|   |   |                                                                                                                                                                          |
| 10.22  |   | Telesource International, Inc. 2000 Non-Employee  Director Stock Option Plan **                                                                                               |
|   |   |                                                                                                                                                                          |
| 10.23  |   | Warrant to Purchase 1,000,000 Shares of Common Stock  between SHBC and Telesource International, Inc. **                                                                 |
|   |   |                                                                                                                                                                          |
| 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 *                                                                                                                                                              |

 

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*      Filed herewith

**  Previouslyfiled

**ITEM 14. PRINCIPAL ACCOUNTANT FEESAND SERVICES**

TheAudit Committee pre-approves audit services and permitted non-audit services(including the fees and terms thereof) to be performed for the Corporation byits independent registered accountants, LJ Soldinger Associates LLC. Thefollowing table presents fees for professional services rendered by LJSoldinger Associates LLC for the respective periods indicated:

 
| **SERVICES PERFORMED**  | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Audit Fees (Note  1)         |       | $        | 285,000    |     | $          | 582,261 |   |
| Audit-Related  Fees (Note 2) |       | 0        |       | 0        |       |
| Tax Fees (Note  3)           |       | 9,500    |       | 12,220   |       |
| All Other Fees  (Note 4)     |       | 0        |       | 0        |       |
|                         |       |     |       |     |       |
| Total Fees                   |       | $        | 294,500    |     | $          | 594,481 |   |

 

NOTESTO 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.

4.     All otherfees principally would include fees billed for products and services providedby the accountant, other than the services reported under the three captionsabove

**ITEM 15(a)(3). EXECUTIVE COMPENSATIONPLANS AND ARRANGEMENTS**

Thefollowing executive compensation plans and arrangements are listed incorporatedby reference in this Form 10-K:

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**SIGNATURES**

PURSUANTTO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BYTHE UNDERSIGNED THEREUNTO DULY AUTHORIZED.

 
|                     | **TELESOURCE INTERNATIONAL, INC.**    |
|---------------------|---------------------------------------|
|                | (Registrant)                          | ** ** |
|                |                                  |
| Date July 31,  2006 | /s/ Nidal Zayed                       |   |   |
|                | Nidal Zayed                           |   |   |
|                | President and Chief Executive Officer |   |   |
|                     |                                       |  |  |  |  |

 

PURSUANTTO THE REQUIREMENTS OF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HASBEEN SIGNED BELOW BY THE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND INTHE CAPACITIES INDICATED ON July 21, 2006.

 
|        | /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          |   |                                 |
|   |                     |   |                                 |
|   | /s/ Greg  Grosvenor      |   | Chief Financial Officer              |
|   | Greg Grosvenor           |   |                                 |

 

 

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