**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-K**

 

**ANNUAL REPORT PURSUANT TO SECTION13 OR 15(D)**

**OF THE SECURITIES EXCHANGE ACT OF1934**

** **

**FOR THE FISCAL YEAR ENDEDDECEMBER 31, 2004**

** **

**COMMISSION FILE NUMBER 0-2564**

 

**TELESOURCE INTERNATIONAL, INC.**

(EXACT NAME OF REGISTRANTAS SPECIFIED IN ITS CHARTER)

 

| **Delaware**                    | ** ** | **6770**                     | ** ** | **59-3671568**                      |
|---------------------------------|------------|------------------------------|------------|-------------------------------------|
| State or other  jurisdiction of |       | PRIMARY STANDARD  INDUSTRIAL |       | I.R.S. Employer  Identification No. |
| Incorporation or  organization  |       | CLASSIFICATION  CODE NUMBER  |       |                                |

 

REGISTRANT’S TELEPHONENUMBER, INCLUDING AREA CODE

**(630) 620-4787**

 

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

 

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

(Title of each class)

 

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

 

**NONE**

 

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

 

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

 

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

 

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

 

Indicate by check mark whether the registrant is alarge accelerated filer, an accelerated filer, or a non-accelerated filer.  (as defined in Exchange Act Rule 12b-2 of theAct).

 
| Large accelerated filer  o |   | Accelerated Filer  o |   | Non-accelerated Filer  ý |
|--------------------------------------|--------|--------------------------------|--------|-----------------------------------------|

 

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

 

State the aggregate market value of the voting andnon-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was last sold, or the average bid and askedprice of such common equity, as of the last business day of the registrant’smost recently completed second fiscal quarter. The Registrant’s voting stock held by non-affiliates of the Registranton December 31, 2004 was approximately $52,050.

 

Number of shares of $0.01par value Common Stock outstanding as of the close of business on May 5, 2005:52,968,519 shares.

 

Documents Incorporated by Reference

 

Annual report to securityholders for fiscal year ended December 31, 2004

 

 

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# **TABLEOF CONTENTS**

 
| ** ** | ** **                                                                                  | **Page**   |
|------------|---------------------------------------------------------------------------------------------|------------|
| ** ** | **PART I**                                                                                  |       |
| Item 1.    | Business                                                                                    | 3          |
|       |                                                                                        |       |
| Item 1a.   | Risk Factors                                                                                | 10         |
|       |                                                                                        |       |
| Item 2.    | Properties                                                                                  | 15         |
|       |                                                                                        |       |
| Item 3.    | Legal Proceedings                                                                           | 16         |
|       |                                                                                        |       |
| Item  4.   | Submission  of Matters to a Vote of Security Holders                                        | 16         |
|       |                                                                                        |       |
| Item  4A   | Executive  Officers of the Registrant                                                       | 17         |
|       |                                                                                        |       |
| ** ** | **PART II **                                                                           | ** ** |
|       |                                                                                        |       |
| Item 5.    | Market for  the Registrant’s Common Equity and Related Stockholder Matters             | 18         |
|       |                                                                                        |       |
| Item 6.    | Selected Financial  Data                                                                    | 21         |
|       |                                                                                        |       |
| Item 7.    | Management’s  Discussion and Analysis of Results of Operations and Financial Condition | 23         |
|       |                                                                                        |       |
| Item 8.    | Financial  Statements and Supplementary Data                                                |       |
|       |                                                                                        |       |
| Item 8A    | Equity  Compensation Plan Information                                                       | 41         |
|       |                                                                                        |       |
| Item 9.    | Changes in  and Disagreements with Accountants on Accounting and Financial Disclosure       | 42         |
|       |                                                                                        |       |
| Item 9A    | Controls and  Procedures                                                                    | 42         |
|       |                                                                                        |       |
| Item 9B    | Other Information                                                                           | 45         |
|       |                                                                                        |       |
| ** ** | **PART III**                                                                                | ** ** |
|       |                                                                                        |       |
| Item 10.   | Directors  and Executive Officers of the Registrant                                         | 46         |
|       |                                                                                        |       |
| Item 11.   | Executive Compensation                                                                      | 47         |
|       |                                                                                        |       |
| Item 12.   | Security  Ownership of Certain Beneficial Owners and Management                             | 47         |
|       |                                                                                        |       |
| Item 13.   | Certain  Relationships and Related Transactions                                             | 48         |
|       |                                                                                        |       |
| Item 14.   | Principal  Accountant Fees and Services                                                     | 49         |
|       |                                                                                        |       |
| ** ** | **PART IV**                                                                                 | ** ** |
|       |                                                                                        |       |
| Item 15.   | Exhibits,  Financial Statement Schedules and Reports on Form 8-K                            | 51         |

 

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**PART I**

 

**ITEM 1. BUSINESS**

 

**GENERAL**

 

Telesource Internationalis an international company engaged primarily in the operation of energyconversion power plants. The company previously operated as an internationalengineering and construction company and is in the process of completing openconstruction projects. The Company has changed its marketing strategy in theconstruction market.  The Company mayseek new projects on a limited basis in coordination with other companies inpossible joint venture partnerships.  Theprimary partner in these projects would most likely be with Sayed HamidBehbehani & Sons Co. W.L.L. (“SHBC”), which owns in excess of 85% of theCompany’s outstanding shares.

 

Telesource Internationalcorporate headquarters are located in Lombard, Illinois. TelesourceInternational conducts its operations through two subsidiaries: (i) TelesourceCNMI, which manages construction and management of the energy conversionfacilities in the Commonwealth of the Northern Mariana Islands and operated abranch office in Guam (closed during 2005); (ii) Telesource Fiji, Limited, whichmanages the power generation activities in Fiji. Telesource’s Palau operations(closed in 2004) were carried out by Telesource International.

 

Telesource has historicallyoperated in three main business segments: power generation and construction ofpower plants, construction services and brokerage of goods and services. Thepower generation management and the construction of power plant businesssegments commenced in March 1999.

 

Telesource International,Inc. was formed in 1994 to facilitate various intra-corporate activities and,until July 1999, was a wholly owned subsidiary of Sayed Hamid Behbehani &Sons Co. W.L.L. (“SHBC”), a Kuwait-based civil, electrical and mechanicalconstruction company.

 

Construction Services

 

As noted above,Telesource is in the process of implementing a new strategy for theconstruction market.  This decision wasbased upon the amount of losses incurred by the company in the constructionmarket.  Telesource International’sMicronesian construction services were primarily carried out through TelesourceInternational’s Mariana subsidiary, Telesource CNMI.

 

Active ConstructionProjects and Services

 

In February 2002, through a competitive bidding process, Telesource wasawarded a contract to construct a 334-bed prison in accordance with therequirements specified by the U.S. Department of Justice. This contract isvalued at $18.5 million and was 90.8% complete as of December 31, 2004. Theprison project has been completed as of December 2005.

 

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In January 2003,Telesource received a Notice of Award for a $5.9 million contract forconstruction services on the second phase of the Palau National CapitolRelocation Project. Funding for the project has come through a grant from theGovernment of Taiwan. The project is for the supply and installation ofcladdings and ornamental trims to the President’s Building, the ExecutiveBuilding, the Legislative Building, and the Judiciary Building. The projectalso includes the construction of a mechanical and electrical yard, a drainagesystem with wastewater handling and a pumping station. The contract, withchange orders is valued at $6.5 million and was 87.5% complete at December 31,2004. This project was substantially completed by August 2005 and the Company’soffice in Palau was closed.

 

In March 2003, Telesourcereceived a Notice of Award for a $5.7 million contract to expand an existingradio relay broadcast station located in the Commonwealth of Northern MarianaIslands for an agency of the U.S. Government Department of State; theBroadcasting Board of Governors International Broadcasting Bureau. The existingstation was constructed by Telesource and began operations in 2000. Theexpansion of this radio relay station was for the addition of two short waveantennas. This contract, with change orders had a total value of $5.9 millionwas 96.6% complete at December 31, 2004. This project was completed during 2005.

 

In May 2002, Telesourcereceived a contract to design and construct a 10-year landfill in the Republicof Palau. In December 2002, the scope of this contract was modified to call forthe design and permitting of a 50-year landfill and construction of a road tothe landfill. The contract was valued at $1.1 million and was 99.4% complete atDecember 31, 2004. During 2005, due to financial limitations of the client theproject was discontinued.  After aprolonged delay, the Company negotiated a release on the project during 2005whereby, the Company agreed to close the project upon full payment by theclient of all amounts invoiced to date totaling $1,057,843. The balance duefrom the client has been collected and the project is now closed.

 

Completed ConstructionProjects and Services

 

In July 2002, Telesourcereceived a Notice of Award for a contract to construct the New Belau NationalMuseum project in the Republic of Palau. Funding for the project has comethrough a grant from the Government of Taiwan. The project consists of therenovation of the small original Museum building and the design andconstruction of a museum building totaling approximately 15,500 squarefeet.  The project also includes the development of an outdooramphitheater and terraced seating into the natural grade of the project site.The design phase of the project began in late July 2002 with physicalconstruction starting in March 2003. The contract is valued at $2.3 million andwas complete at December 31, 2004.

 

In 2000, through a competitive bidding process,Telesource International was awarded a contract to construct a 7,800 linearfoot airport runway on the Island of Tinian. This contract is valued at $19.1million and was completed on March 11, 2004.  The Commonwealth Port Authority (CPA) andTelesource are currently in negotiations over the final billing for the WestTinian Airport Project (WTA). The Company and the CPA reached an agreement inAugust 2005 whereby the Company is to receive 50% of the retention within 90days and the balance in the first quarter of 2006.  As of December 31, 2004, Telesource has reflectedapproximately $1.8 million of retentions in accounts receivable related to theWTA.  Of this amount, approximately $.9million has been collected.

 

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Specialized ConstructionProcesses

 

Building an airport or abroadcasting facility is not like the construction of a more conventionalbuilding. Because of the high levels of radio frequency emissions or thegeneration of electrical currents, every part of the structure is integratedinto the overall design and plays a role in making the overall facility saferand more efficient.

 

The building of thesespecialized structures requires additional engineering skills, the knowledge ofspecialized construction techniques and relationships with specialized subcontractors.The situation is made more difficult when building offshore, where distancefrom raw materials and subcontractors becomes a risk factor.

 

Past and Present PowerGeneration Construction Projects

 

Telesource International’spower generation business involves:

 

•Building the power plants

 

•Operating the power plants for a contracted period of time

 

•Selling wholesale power to the client to be distributed on their power grid

 

•The transfer of the ownership of the properties to the client at the end of thecontract.

 

In 1997, a governmentalagency located in the Commonwealth of the Northern Mariana Islands, awardedTelesource CNMI a contract to design, build and operate a 10-30 megawatt powerplant.

 

The initial 10 megawattspower plant was completed within budget and on time and the plant has beenoperational since March 1999. The second phase of the project was completed inMarch 2000, also within budget and on time. The third phase will be constructedat Telesource CNMI’s discretion as the demand for power increases. Accordingly,if power demand fails to meet Telesource International’s projections, thisphase may never be constructed.

 

In March 2003, Telesourcewas awarded a 20-year, multi-million dollar, energy conversion agreement withthe Fiji Electric Authority for the operation and maintenance of three dieselpower plants with generation capacity of 78 MW. The two power plants arelocated in Kinoya, Vuda and Labasa, Fiji. Telesource and the Fiji ElectricAuthority has completed and executed the Energy Conversion Agreement.

 

In 2000, TelesourceInternational was contracted to expand two existing power stations in Fiji, andto add additional power generators with a combined production capacity of 32Mwh 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 International and Telesource Fiji,Ltd., a subsidiary of Telesource International, based on the location and typeof service to be performed. The contract with the customer reflected thisarrangement. This contract

 

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was a performance paycontract (i.e., as specified milestones were reached, Telesource billed thecustomer and receives payments within 30 days).

 

Power Plant Operation andMaintenance

 

Our agreement with thegovernmental agency in the Commonwealth of the Northern Mariana Islands is forthe management of one of their power plants. Under the terms of this agreement,Telesource International designed, financed and built the power plant.Telesource International obtained financing for the project through a$25,000,000 line of credit from the Commercial Bank of Kuwait, New York branch.  For the construction of the first phase ofthis power plant, Telesource International is paid $180,000 per month for tenyears by the governmental agency. Each monthly payment is secured by apromissory note in the amount of $180,000 issued by the Commonwealth UtilitiesCorporation.

 

Telesource Internationalhas 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 International has a first lien. In the event of the governmentalagency is unable to meet its obligations either to make payments of monthlymaintenance fees or on the promissory notes, Telesource International may sell,lease, assign or transfer the power plant or any part of the plant equipment.

 

In the first phase of theproject, the governmental agency also pays Telesource a production fee basedupon a fixed fee per kilowatt-hour for each kilowatt-hour produced on itsbehalf for the first 5,140,000-kilowatt hours per month. In the second phase,which added 10-megawatts of capacity, the governmental agency has agreed to payTelesource International an additional production fee per kilowatt-hourproduced over the initial 5,140,000-kilowatt hours per month. In addition, thegovernmental agency pays Telesource a service fee of $50,000 per month foroperating and maintaining the power plant.

 

In May 2001, thegovernmental agency and Telesource executed Change Order No. 3 to the TinianPower Plant Contract. Change Order No. 3 provides a suspension in the Escalatoron the variable payments from January 1, 2001 to December 31, 2005. This ChangeOrder extends the term of the contract from an expiration of 10 years followingcommissioning of the last constructed phase (currently Phase II wascommissioned in March 2000 and therefore the contract was to have expired inMarch 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.  Change Order No. 3 does require Telesource toupgrade the power distribution system in certain

 

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areas of the TinianIsland.  The Company is responsible forthe costs of the upgrade which include labor and material.  The Company estimates the cost of thisupgrade to be approximately in the range of $800,000 to $1.3 million and to becompleted in 2006.

 

Potential Future PowerPlant Construction and Power Supply

 

Based on previousexperience, management believes there will be a growing demand for power aroundthe world; however competition and deregulation could eliminate the financialfeasibility of these projects and thereby prevent Telesource International fromtaking advantage of the expected growth in demand.  In the U.S., two-thirds of the country’sinstalled plants are 25 or more years old and need to be replaced andre-powered, principally with new gas 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 International also believes that those situations where the localgovernments lack the up-front funding to build the additional power plants willrepresent an opportunity for Telesource International to find alternativesolutions up to and including having Telesource International locate the neededproject financing. Without the additional energy, Telesource Internationalbelieves that many of the infrastructure upgrades envisioned by localgovernments will be unable to occur. In Telesource International’s experience,in return for securing project financing in a manner similar to that obtainedfor the project in the Commonwealth of the Northern Mariana Islands, localgovernments will be willing to enter into contracts which guarantee TelesourceInternational a minimum amount of power consumption, coupled with long-termoperation and maintenance contracts.

 

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

 

Sales and MarketingStrategies

 

The company hasdetermined that it will be very selective and enter into new constructionprojects in a joint venture with SHBC. Meanwhile, a significant focus of its marketing efforts will be in thepower generation business.  TelesourceInternational’s power generation projects are obtained through a public bidprocess, and clients are either governments or governmental agencies. Inobtaining contracts:

 

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•Telesource International reviews market trends in the geographic locations itpresently operates, specifically Fiji and Saipan.  Telesource International’s research alsoincludes analyzing numerous government documents and reviewing previous andcurrent requests for management of power generation facility bids.

 

•Telesource International is actively involved in public relations with thegovernments and agencies that might contract for Telesource International’sservices. Much of this effort is informational, learning the specific needs ofeach governmental agency while at the same time explaining what servicesTelesource International has to offer.

 

•Telesource International has created and provides to potential clients a surveyto help governmental agencies evaluate whether Telesource International’sresources and services might be more efficient and cost-effective than theircurrent system.

 

## Competition

 

The independent powerindustry has grown rapidly over the past twenty years. There are a large numberof suppliers in the wholesale market and a surplus of capacity, which has ledto intense competition in this market. The principal sources of competition inthis market include traditional regulated utilities that have excess capacity,unregulated subsidiaries of regulated utilities, energy brokers and traders,energy service companies in the development and operation of energy-producingprojects and the marketing of electric energy, equipment suppliers and othernon-utility generators like Telesource International. Competition in thisindustry is substantially based on price with competitors discovering lowercost alternatives for providing electricity. The electric industry is also characterized by rapid changes inregulations, which Telesource International expects could continue to increasecompetition.  Telesource Internationaldoes not believe the Tinian power plant would be significantly impacted bycompetition in the wholesale energy market since its revenues are subject tocontracted rates which are substantially fixed for several years.

 

Telesource Internationalalso 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.  In some cases, competitive bidding for adevelopment opportunity is required. Competition for attractive development opportunities is expected to beintense as there are a number of competitors in the industry interested in thelimited number of opportunities.  Many ofthe companies competing in this market have substantially greater resources.Telesource International believes its project development experience and itsexperience in creating strategic alignments with other development firms withgreater financial and technical resources could enable Telesource to continueto compete effectively in the development market if and when opportunitiesarise. Presently, Telesource International believes there are a number ofopportunities for project development worldwide for projects similar to thosepreviously developed by Telesource. However, Telesource International is currently evaluating whether itshould seek development opportunities in other areas outside of the SouthPacific to diversify its activities.

 

Presently, there issignificant merger and consolidation activity occurring in the electricindustry.  From time to time, TelesourceInternational may consider merger and acquisition proposals

 

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when they appear topresent an opportunity to enhance stockholder value. Telesource Internationalis not involved in any of these discussions or negotiations at this time andthere can be no assurance that any opportunities will develop.

 

Energy Regulation

 

Telesource International’sprojects are subject to regulation under federal and local energy laws andregulations.  Telesource International issubject to the requirements established by its permitting authorities, i.e. theDepartment of Environmental Quality (“DEQ”) and the Environmental ProtectionAgency (“EPA”).

 

Presently, neither theCustomer Choice Act nor proposed legislation dealing with U.S. energy policydirectly impacts Telesource International because the legislation andrestructuring plan pertain to the retail market or new contracts in thewholesale market.  However, as discussedabove, Telesource International could be impacted in the future by, among otherthings, increases in competition as a result of deregulation.  Telesource International is activelymonitoring these developments in energy proceedings in order to evaluate theimpact on existing projects and also to evaluate new business opportunitiescreated by the restructuring of the electric industry.

 

Environmental Regulation

 

Telesource International’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 andregulations in many cases require a lengthy and complex process of obtainingand maintaining licenses, permits and approvals from federal and localagencies.  As regulations are enacted oradopted in any of these jurisdictions, Telesource International cannot predictthe effect of compliance therewith on its business.  Telesource International’s failure to complywith all applicable requirements could result in delays in proceeding with anyprojects under development or require modifications to operatingfacilities.  During periods ofnon-compliance, Telesource International’s operating facilities may be forcedto shutdown until the instances of non-compliance are corrected.  Telesource International is responsible forensuring compliance of its facilities with applicable requirements and,accordingly, attempts to minimize these risks by dealing with reputablecontractors and using appropriate technology to measure compliance with theapplicable standards.

 

Insurance and Bonding

 

Telesource Internationalmaintains general and excess liability, construction equipment, and workers’compensation insurance; all in amounts consistent with industry practices.Telesource International believes its insurance programs are adequate subjectto deductibles some of which are approximately $3.0 million.

 

Telesource Internationalwas 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

 

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Saipan. This project haspartial funding from the U.S. Government and therefore, U.S. Treasury ListedBonding was required. In order to secure the required bonding, Telesource’slargest shareholder, SHBC, provided a letter of credit to the surety equal to100% of the contract value of $17 million. Telesource International’s abilityto obtain additional surety bonding depends upon its capitalization, workingcapital, past performance, management expertise and other factors, which maychange from time to time. During 2005, the Company was released from thebonding requirement and consequently, SHBC was also released from the letter ofcredit requirements.

 

Employees

 

Telesource International,as of January 2005, employed 137 people, consisting of 11 employees inmanagement, 8 engineers and technical staff members, 25 support staff membersand 104 hourly employees. All of Telesource International’s employees arenonunion workers, although Telesource International may employ unionsubcontractors from time to time.

 

Ninety percent ofTelesource International’s project teams include engineers and technical staff,due to the technical nature of its construction contracts. Working on a powerplant, broadcasting facility or other technical construction site requires ahigher level of expertise and a greater attention to safety issues.

 

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

 

**1a. RISKFACTORS**

 

THIS ANNUAL REPORTON FORM 10-K CONTAINS CERTAIN FORWARD-LOOKING STATEMENTS WITHIN THE MEANING OFTHE PRIVATE SECURITIES LITIGATION REFORM ACT OF 1995, PARTICULARLY STATEMENTSREGARDING MARKET OPPORTUNITIES, MARKET SHARE GROWTH, COMPETITIVE GROWTH, GROSSPROFIT, AND SELLING, GENERAL AND ADMINISTRATIVE EXPENSES AND THE INVESTMENTCONSIDERATIONS ARE LISTED BELOW. THESE FORWARD-LOOKING STATEMENTS INVOLVE RISKSAND UNCERTAINTIES THAT COULD CAUSE ACTUAL RESULTS TO DIFFER MATERIALLY FROMTHOSE IN ANY SUCH FORWARD-LOOKING STATEMENTS. SUCH RISKS AND UNCERTAINTIES INCLUDE,BUT ARE NOT LIMITED TO ADVERSE CHANGES IN GENERAL ECONOMIC CONDITIONS,INCLUDING CHANGES IN THE SPECIFIC MARKETS FOR TELESOURCE’S SERVICES, ADVERSEBUSINESS CONDITIONS, DECREASED OR LACK OF GROWTH IN THE MECHANICAL ANDELECTRICAL CONSTRUCTION AND FACILITIES SERVICES INDUSTRIES, INCREASEDCOMPETITION, PRICING PRESSURES AND RISK ASSOCIATED WITH FOREIGN OPERATIONS ANDOTHER FACTORS.

 

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**InvestmentConsiderations**

 

*Telesource International has riskrelated to its ability to continue as a going concern.*

 

As of December 31, 2004, the Company’s currentliabilities exceeded its current assets by $4.6 million and its totalliabilities exceed total assets by $15.7 million. The Company relies heavily onbank financing and equity infusion from its principle stockholder, SHBC andaffiliated companies, to support its operations.  The equity infusion from SHBC and affiliatedcompanies, and its ability to refinance its existing bank debt is critical toprovide funding to satisfy the Company’s obligations as they mature. As ofDecember 31, 2004 the Company had total outstanding debt of $25,405,964 ofwhich $5,332,340 is due in 2005. As of December 31, 2004 the Company hadan accumulated deficit of $54.1 million and total stockholders’ deficit of $15.7million.

 

The Company incurred operating losses of $12,406,488,$5,217,223, and $3,118,300 for the years ended December 31, 2004, 2003, and2002, respectively. The Company incurred net losses of $13,711,315, $6,629,441,$4,886,397 for the years ended December 31, 2004, 2003, and 2002, respectively.

 

The Company has experienced several years of networking capital deficiencies, increasing stockholders’ deficit, recurringlosses, and negative cash flows from operations. Management intends to work toaddress these uncertainties by continuing its efforts to raise additionalcapital, increase revenues, and control costs with the goal of achievingprofitability. Subsequent to the year-end, the Company completed privateplacements of the Company’s common stock with net proceeds of $6.4 million inadditional capital. Management expects the increase in revenues to be achievedby focusing its efforts in the power plant operation and maintenance agreementsand/or from existing long-term power plant operation and maintenance agreementsas a result of continued expansion on the island of Tinian and in the countryof Fiji. However, no assurance can be given that such increased revenues willbe achieved. Although management believes that the Company will be cash flowpositive in 2005 including debt payments, the Company has and expects tocontinue to seek support from its principal stockholder, SHBC and affiliatedcompanies, for its operations, and for working capital needs, debt repayment,and business expansion as may be required. SHBC has continued its support ofthe Company. SHBC has agreed to guarantee or provide letters of credit covering$22,622,333 of the Company’s total debt of $25,405,964.

 

The Company’s ability to continue operations is dependentupon raising capital through debt and equity financing.  There can be no assurance that the Companywill successfully raise the required future financing on terms desirable to theCompany.  If the Company does not obtainthe needed funds, it will likely be required to delay development of itsoperations, alter its business plan, or in the extreme situation, ceaseoperations.

 

TelesourceInternational - Risks related to power generation activities

 

*TelesourceInternational’s power-generating facility could be shut down unexpectedly,making it difficult to sustain revenues and cash flow.*

 

TelesourceInternational owns a diesel fired electric generating facility with a maximumpower generation capacity of 20 mega-watts (Mw) located on the island of Tinian,in the Commonwealth of the Northern Mariana Islands, a U.S. possession. Thisfacility from time to time may experience both scheduled and unscheduledshutdowns. Periodically, the facility will incur scheduled shutdowns in orderto perform maintenance procedures to equipment that cannot

 

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beperformed while the equipment is operating. The facility may also incurunscheduled shutdowns or may be required to operate at reduced capacity levelsfollowing the detection of equipment malfunctions, or following minimumgeneration orders received by the utility. During periods when the facility is shutdown or operating at reducedcapacity levels, Telesource International may incur losses due to the loss ofits operating revenues and/or due to additional costs which may be required tocomplete any maintenance procedures. It is not possible for it to predict thefrequency of future unscheduled shutdowns or to predict the extent ofmaintenance that may be required during shutdowns related to equipmentmaintenance.

 

*TelesourceInternational depends on two customers for power-generation revenues. The lossof either single customer could cause Telesource International’s revenues todecline.*

 

Since March 1999,Telesource International began deriving a portion of its revenues from the saleof electric power. Under Telesource International’s agreement with agovernmental agency, the electrical power generated at Telesource International’spower generation facility is owned by the governmental agency.  Telesource International is paid a fee toproduce the electric power.  Thegovernmental agency in turn sells the electric power to the various users throughoutthe Island of Tinian.  If the end-usercustomer defaults or increases in power use do not materialize as anticipated,Telesource International’s revenue base may not grow to support otheroperations.

 

During 2003, Telesourceadded the operation of two additional power plants for a period of 20 yearswithin Fiji for one customer, the Fiji Electric Authority. Telesource is tooperate the two power plants in Fiji by converting fuel provided by thecustomer into electricity for which Telesource receives a fee. The FijiElectric Authority in turn sells the power produced to various users in Fiji.If the end-user customer defaults or increases in power use do not materializeas anticipated, Telesource International’s revenue base may not grow to supportother operations.

 

*TelesourceInternational’s insurance or reserves may be insufficient to cover futureclaims on Telesource International’s power generation activities.*

 

TelesourceInternational’s power generation activities involve significant risks ofenvironmental damage, equipment damage and failures, personal injury and fines andcosts imposed by regulatory agencies. Though management believes its insuranceprograms are adequate, if a liability claim is made against it, or if there isan extended outage or equipment failure or damage at Telesource International’spower plant for which it is inadequately insured or subject to a coverageexclusion, and Telesource International is unable to defend against theseclaims successfully or obtain indemnification or warranty recoveries,Telesource International may be required to pay substantial amounts, whichcould have a materially adverse effect on its financial condition.

 

TelesourceInternational - Risks related to construction activities

 

12

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*TelesourceInternational will likely experience significant fluctuation in quarterlyresults, which makes it difficult for investors to make reliableperiod-to-period comparisons of its business.*

 

Telesource International’squarterly operating results will depend on revenues from contracts for majorprojects. Telesource International can only undertake a specific number ofprojects at any one time. Furthermore, Telesource International has implementeda plan to seek new construction projects on a limited basis in coordinationwith other companies in possible joint venture partnerships.  The primary partner in these projects wouldmost likely be with Sayed Hamid Behbehani & Sons Co. W.L.L. (“SHBC”), whichowns in excess of 85% of the Company’s outstanding shares.  Consequently revenues and results of operationswithin the quarter and possibly subsequent periods will be unfavorable duringthis transition. Customers may also cancel or defer existing contracts resultingin reduced revenues for a quarter. Though management intends to take steps toadjust spending in a timely manner to compensate for any unexpected revenueshortfalls, it may not be successful. For example staffing reductions cannot beimplemented quickly due to local labor and employment laws in the Commonwealthof Northern Mariana Islands, which limit our ability to release employees atwill, and losses could result. Accordingly, any such revenue shortfalls couldresult in continued operating losses.

 

*Telesource International’s revenues are derived mainly from fixed-price contracts that may lead to variations in profits due to a failure to control costs.*

 

All of Telesource International’s construction revenues are derived from fixed-price contracts. Because Telesource International assumes the risk of performing such contracts at the stipulated price, any change in the estimate of ultimate costs to be incurred under the contract or to control costs during contract performance could result in losses or reduced profits for particular fixed-price contracts, which, in turn, could result in periods of operating losses.

 

*TelesourceInternational’s principal market is highly competitive, and if TelesourceInternational is unable to compete successfully in this market, it may beunable to increase its operations or become profitable.*

 

Themarket for energy related services is highly competitive and rapidly changing.Telesource International competes directly with other firms that focus onproviding general operation, maintenance and related construction services for powerplants. Many of Telesource International’s competitors have well-establishedreputations for building and operating plants with longer operating historiesand significantly greater financial, technical, marketing, personnel and otherresources than Telesource International. Telesource International is subject tocompetition that is expected to increase in the future. If TelesourceInternational does not successfully compete in its market, its growthopportunities will be limited and its business will not grow and its revenuesmay be reduced.

 

*TelesourceInternational relies on third parties for important raw materials and technicalexpertise. Telesource International’s ability to enter into new engagements orto conduct the business in a profitable manner will be harmed if its access tothese important resources is limited or becomes too costly.*

 

TelesourceInternational relies on third-party suppliers for raw materials like wood,steel and concrete; for fabrication of technical equipment subsystems includingdiesel generation and technical expertise. Telesource International’s abilityto obtain cost-effective raw materials,

 

13

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fabricationservices and technical assistance is subject to a number of external factorswhich 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 International with materials or services.

 

•                  TelesourceInternational has no long-term contracts with third-party suppliers of rawmaterials, fabrication services or technical expertise providers.

 

•                  TelesourceInternational’s third-party contracts are usually short term in duration andare cancelable by such third party.

 

IfTelesource International fails to obtain what it needs from these providers, itmay not be able to successfully compete for new business or to completeexisting engagements profitably.

 

*TelesourceInternational is subject to substantial claims for warranty coverage which, ifsuch claims arise, could harm its financial condition.*

 

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.

 

TelesourceInternational - Other risks

 

*TelesourceInternational is subject to several inherent risks of conducting businessinternationally.*

 

TelesourceInternational’s international operations are subject to the inherent risks ofdoing business abroad. The loss of any or all of Telesource International’sinternational suppliers and customers could harm Telesource International’sability to deliver Telesource International’s construction services and powerservices on time and cause Telesource International’s sales to decline.Telesource International’s financial performance could be harmed by many eventsand circumstances relating to international operations, including:

 

•  Shippingdelays and cancellations;

•  Increasesin import duties and tariffs;

•  Foreignexchange rate fluctuations;

•  Changesin foreign laws and regulations; and

•  Politicaland economic instability.

 

14

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*TelesourceInternational is subject to government regulation. Both the costs of complianceand the penalties imposed for a failure to comply could be substantial.*

 

Althoughmanagement does not believe that compliance with applicable regulatoryrequirements has harmed Telesource International’s operations in the pastrelative to its competitors, government regulations can change, which couldincrease Telesource International’s costs of compliance with theserequirements. In addition, Telesource International’s power generationoperations require operating permits granted by governmental agencies.Telesource International believes that tighter regulations for the protectionof the environment and other factors will make it increasingly difficult toobtain new permits and renewal of existing permits may be subject to morerestrictive conditions than currently exist. Failure to comply with these lawsand regulations could result in fines, additional licensing requirements or therevocation of Telesource International’s licenses in the particularjurisdiction. The costs of compliance could affect adversely operating results.If a substantial fine or other penalty is imposed, Telesource International’sbusiness and financial condition could be harmed.

 

*IfTelesource International does not manage its growth effectively, its futurebusiness prospects could be harmed.*

 

TelesourceInternational will need to expand in anticipation of a growing user base andlarger demand for Telesource International’s services. The focus on developmentof new business could cause disruptions of existing operations adversely affectingTelesource International’s business. Expansion will require TelesourceInternational to make significant up front expenditures for increasingTelesource International’s sales and marketing efforts and to hire and trainadditional project managers, engineers and facilities operators as well asincur costs in connection with constructing power plants to be owned byTelesource. Telesource may not be successful in expanding its operations ormaintaining adequate management, financial and operating systems and controlsof its larger business base.

 

*TelesourceInternational’s largest stockholder and its affiliates own approximately 85% ofthe common stock and their interests may not be the same as the minoritystockholders who will have little or no influence over Telesource International’sactivities.*

 

Thelargest stockholder, SHBC, is able to control the outcome of all matterssubmitted to a vote of the holders of common stock, including the election ofdirectors, amendments to Telesource’s certificate of incorporation and approvalof significant corporate transactions. SHBC owns beneficially approximately 85%of the common stock.

 

**ITEM2.  PROPERTIES**

 

Properties

 

Telesource Internationalmaintains leased office space and leases land for storage of constructionequipment. Telesource International’s Mariana subsidiary’s head office in theCommonwealth of the Northern Mariana Islands is leased for a term whichextended through December 2004 and is

 

15

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currently on amonth-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.

 

**ITEM3. LEGAL PROCEEDINGS**

 

In the ordinary course of its business Telesource becomes involved fromtime to time in legal proceedings and claims asserted by and againstTelesource. It is the opinion of management that the ultimate disposition ofthese routine pending matters will not have a materially adverse impact on theCompany.

 

The Commonwealth Port Authority (“CPA”) and Telesource are currently innegotiations over the final billing for the West Tinian Airport Project (“WTA”).As of December 31, 2004, Telesource has reflected approximately $1.8 million ofretentions in accounts receivable related to the WTA.  Approximately $891,000 of the outstandingretention receivable was collected in 2005 as partial settlement agreement wasentered into in August 2005. Telesource claims that in addition to theremaining unpaid retentions receivable recorded under the original contractterms and related to work performed through 2003 that it is also due additionalamounts for work performed outside of the original scope of the contract. Norevenue for this additional work has been reflected in the accompanyingconsolidated financial statements. Although CPA has acknowledged that work wasperformed outside of the original contract scope, it has requested additionaldocumentation before it will make a final determination regarding payment onthe additional work and the retentions. CPA claims they are due approximately$468,000 in liquidated damages related to delay of completion. Telesource isdisputing those claims and believes that the resolution of this matter will nothave a material adverse effect on its financial condition.  The Company has a continuing warrantyobligation for three years from the date of final acceptance, not yet determined.

 

**ITEM4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS**

 

None

 

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**ITEM4(a). EXECUTIVE OFFICERS OF THE REGISTRANT**

 

As reported later in subsequent events, Khajadour Semikian and BudCurley the former CEO and CFO of the Company, respectively, terminated theiremployment during 2005.  The followingprovides the names, ages and backgrounds of Telesource International’s current executiveofficers:

 
| **Name and  Age; Years   Served as Director** | ** ** | **Principal Occupation for Past  Five Years; Other Directorships**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                       |
|-----------------------------------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                                          |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| Nidal  Zayed  Age 44  Director Since 1998     |       | Nidal Zayed, President  and 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.                                                                                                                                                                                                                                                                                                                      |
|                                          |       |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |
| Greg  Grosvenor  Age 54                       |       | Greg  Grosvenor, Chief Financial Officer, joined Telesource International in August  2005. He served as Chief Financial Officer at AM-CH, Inc. where he led the  sale and dissolution of AM-CH, Inc. Mr. Grosvenor also led the restructuring  of all finance operations as well as the restructuring of debt and ultimately  the profitable sale of Smith Bucklin to a new group of investors. Prior to  Smith Bucklin, Mr. Grosvenor served as the Chief Financial Officer at  Metropolitan Pier & Exposition and as Controller at the corporate offices  of Hyatt Hotels. Mr. Grosvenor has also worked at Galileo, an airline  reservation software company, Anixter International and PriceWaterhouse  Coopers. |

 

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**PART II**

 

**ITEM5. MARKET FOR THE REGISTRANT’S COMMON 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”. Prior to that time,Telesource’s common stock was not listed for trading.

 

The followingtable sets forth high and low sales prices for the common stock for the periodsindicated as reported by the Over-the-Counter Bulletin Board since November 1,2001:

 
| ** **     | ** ** | **HIGH** | ** ** | **LOW** | ** ** |
|----------------|------------|----------|------------|---------|------------|
| 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    |       |
|           |       |     |       |    |       |
| 2003           |       |     |       |    |       |
| First Quarter  |       | 1.70     |       | 1.25    |       |
| Second Quarter |       | 1.50     |       | 1.45    |       |
| Third Quarter  |       | 1.50     |       | 1.10    |       |
| Fourth Quarter |       | 1.10     |       | 0.55    |       |

 

As of January 6, 2006, the latest stock quote forTelesource was $0.02 per share.

 

UNREGISTERED SALES OF SECURITIES.

 

We issued unregisteredsecurities in the following transactions during 2004 and for the eleven monthsended November 30, 2005:

 

•                  On January 27, 2004 we issued1,000,000 shares of our common stock pursuant to an exemption under RegulationS of the Securities Act for $1,000,000

 

•                  On April 8, 2004 we issued 1,000,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $1,000,000

 

•                  On April 20, 2004 we issued 1,000,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $1,000,000

 

•                  On May 10, 2004 we issued 500,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $500,000

 

•                  On May 14, 2004 we issued 600,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $600,000

 

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•                  On June 11, 2004 we issued 1,100,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $1,100,000

 

•                  On October 1, 2004 we issued 74,580shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $37,290

 

•                  On October 19, 2004 we issued1,100,000 shares of our common stock pursuant to an exemption under RegulationS of the Securities Act for $550,000

 

•                  On November 9, 2004 we issued 400,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $200,000

 

•                  On December 2, 2004 we issued 700,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $350,000

 

•                  On December 29, 2004 we issued 80,913shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $40,457

 

•                  On December 31, 2004 we issued12,139,048 shares of our common stock pursuant to an exemption under RegulationS of the Securities Act for $6,069,524 in conversion of debt

 

•                  On December 31, 2004 we issued 4,198,172shares of our common stock pursuant to an exemption under Regulation S of theSecurities Acts for $4,785,000 in conversion of preferred stock and dividendson preferred stock.

 

•                  On December 31, 2004 we issued3,434,868 shares of our common stock pursuant to an exemption under RegulationS of the Securities Acts for $3,915,000 in conversion of preferred stock anddividends on preferred stock.

 

•                  On December 31, 2004 we issued5,240,938 shares of our common stock pursuant to an exemption under RegulationS of the Securities Acts for $6,000,000 in conversion of preferred stock anddividends on preferred stock.

 

•                  On March 2, 2005 we issued 800,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $400,000.

 

•                  On March 23, 2005 we issued 600,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $300,000.

 

•                  On March 29, 2005 we issued 1,000,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $500,000.

 

•                  During March and May of 2005, theCompany issued 5,186,543 shares of common stock pursuant to an exemption underRegulation S of the Securities Act for $2,593,272.

 

•                  On April 7, 2005 we issued 1,000,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $500,000.

 

•                  On April 27, 2005 we issued 1,000,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $500,000.

 

19

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•                  On May 10, 2005 we issued 1,000,000shares of our common stock pursuant to an exemption under Regulation S of the SecuritiesAct for $500,000.

 

•                  On May 25, 2005 we issued 1,000,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $500,000.

 

•                  On June 3, 2005 we issued 2,500,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $1,000,000.

 

•                  On June 30, 2005 we issued 600,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $300,000.

 

•                  On August 19, 2005 we issued2,250,000 shares of our common stock pursuant to an exemption under RegulationS of the Securities Act for $450,000.

 

•                  On September 21, 2005 we issued2,500,000 shares of our common stock pursuant to an exemption under RegulationS of the Securities Act for $500,000.

 

•                  On November 9, 2005 we issued19,683,078 shares of our common stock pursuant to an exemption under RegulationS of the Securities Act for $3,936,616 to convert debt into equity.

 

•                  On November 15, 2005 we issued 1, 750,000shares of our common stock pursuant to an exemption under Regulation S of theSecurities Act for $350,000.

 

•                  On November 28, 2005 the Companyreceived a subscription for 3,000,000 shares of common stock pursuant to anexemption under Regulation S of the Securities Act for $600,000.

 

 

HOLDERS. As of November 30, 2005, there were 185shareholders of record.

 

DIVIDENDS. Telesource began paying dividends during2003 on the preferred stock which was issued on the following dates:

 
| **Date Preferred Stock   Was Issued** | ** ** | **Number of Shares of   Preferred Stock Issued** | ** ** |
|---------------------------------------|------------|--------------------------------------------------|------------|
|                                  |       |                                             |       |
| December 16, 2002                     |       | 2,000,000                                        |       |
| March 6, 2003                         |       | 2,000,000                                        |       |
| March 20, 2003                        |       | 666,666                                          |       |
| July 18, 2003                         |       | 466,666                                          |       |
| August 15, 2003                       |       | 1,666,667                                        |       |
| August 19, 2003                       |       | 333,333                                          |       |
| October 6, 2003                       |       | 666,667                                          |       |
| November 18, 2003                     |       | 1,333,333                                        |       |
| December 8, 2003                      |       | 333,333                                          |       |
| December 15, 2003                     |       | 333,334                                          |       |
| Total                                 |       | 9,799,999                                        |       |

 

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During the fourth quarter of 2004, the Company agreedto convert all of the preferred stock into common stock on a one-for-one basisplus accumulated dividends as of December 31, 2004 and the present value offuture preferred dividends at a conversion price of $1.00 per share.

 

Holders of Series A Preferred Stock were entitled toreceive dividends when and as declared by the Board of Directors. Telesource isprecluded from declaring or paying dividends on common stock unless allrequired dividends have been paid in full on Series A Preferred Stock.

 

The Company had 9.8 million shares of Series ACumulative Convertible Preferred Stock (The Preferred Shares) outstanding priorto the conversion of all outstanding preferred stock into common stock atDecember 31, 2004.  Holders of thePreferred Shares were entitled to receive cumulative cash dividends at theannual rate of 6.5% or 6.0% per share payable semi-annually, when and ifdeclared by the Board of Directors.

 

The Preferred Shares were convertible, in whole or inpart, at the option of the holders thereof, into shares of common stock on aone-for-one basis for a period of five years from the closing date of thePreferred Shares agreement.  The Companyhad the option to force conversion to common stock for a period of time asdefined by each agreement.  Allaccumulated dividends plus any dividends earned up through the forced conversiondate would have been payable to the holder at the time of forced conversion.

 

Holders of the Preferred Shares had no voting rightsand the Preferred Shares rank senior as to dividends and upon liquidation tothe common stock.

 

At December 31, 2004, and December 31, 2003, theCompany owed accrued dividends of $0 and $204,358, respectively. An unpaidpreferred divided in the amount of $477,500 plus the present value of futurepreferred dividends in the amount of $2,596,229 were converted into common stockon December 31, 2004 at a conversion price of $1.00 per share. During 2004,Telesource had declared and paid $477,750 of dividends on the Series APreferred Stock. No dividends were paid on Telesource’s common stock during2004 or 2003, and Telesource does not anticipate that it will pay dividends onits common stock in the foreseeable future.

** **

**ITEM 6.****         ****SELECTEDFINANCIAL DATA**

**(IN THOUSANDS, EXCEPT PER SHARE DATA)**

 

The following selected financial data as of and for the years endedDecember 31, 2004, 2003, 2002, 2001, and 2000, has been derived from theaudited consolidated financial statements of Telesource International, Inc. andsubsidiaries. The consolidated financial statements as of December 31, 2004 and2003, and for each of the years in the three-year period ended December 31,2004, are included elsewhere in this Form 10-K. This selected financial datashould be read in conjunction with the consolidated financial statements andthe notes thereto included elsewhere in this Form 10-K.

 

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| ** **                                                        | ** ** | **Twelve Months Ended** | ** ** |
|-------------------------------------------------------------------|------------|-------------------------|------------|
| ** **                                                        | ** ** | **December 31,**        | ** ** |
| ** **                                                        | ** ** | **2004**                | ** ** | **2003** | ** ** | **2002** | ** ** | **2001** | ** ** | **2000** | ** ** |
| **Income Statement Data: ($ in 000’s)**                 |       |                    |       |   |   |   |   |   |   |   |   |
| Construction  revenues                                            |       | $                       | 16,024     |   | $ | 14,381 |   | $ | 16,566 |   | $ | 11,824 |   | $ | 7,810 |   |
| Construction  revenues – related party                       |       | —                  |       | — |   | 838 |   | — |   | 852 |   |
| Construction  revenues on power plants                            |       | —                  |       | — |   | — |   | 4,053 |   | 536 |   |
| Service fees –  power generation plant                       |       | 3,227                   |       | 2,968 |   | 1,130 |   | 858 |   | 692 |   |
| Sales, net                                                        |       | 24                      |       | 44 |   | 397 |   | 131 |   | 1,070 |   |
| Other revenues                                                    |       | 1,434                   |       | 2,633 |   | 1,390 |   | 1,420 |   | 1,545 |   |
| Other revenues –  related party                              |       | —                  |       | — |   | — |   | — |   | 84 |   |
| Gross revenues                                                    |       | 20,709                  |       | 20,026 |   | 20,321 |   | 18,286 |   | 12,590 |   |
|                                                              |       |                    |       |   |   |   |   |   |   |   |   |
| Construction  costs                                               |       | 19,347                  |       | 15,871 |   | 15,913 |   | 12,382 |   | 7,145 |   |
| Construction  costs on power plants                               |       | —                  |       | — |   | — |   | 3,504 |   | 496 |   |
| Operations &  maintenance costs – power generation plant |       | 2,878                   |       | 2,589 |   | 1,224 |   | 1,159 |   | 991 |   |
| Provision for  warranty expense                                   |       | 300                     |       | — |   | — |   | — |   | — |   |
| Provision for  losses on contracts in progress                    |       | 1,986                   |       | — |   | — |   | — |   | — |   |
| Provision for  unbilled and uncollected amounts                   |       | 1,329                   |       | — |   | — |   | — |   | — |   |
| Other cost                                                        |       | 230                     |       | 697 |   |   |   |   |   |   |   |
| Gross profit  (loss)                                              |       | (5,361                  | )          | 869 |   | 3,184 |   | 1,241 |   | 3,958 |   |
|                                                              |       |                    |       |   |   |   |   |   |   |   |   |
| Salaries and  employee benefits                                   |       | 1,633                   |       | 1,646 |   | 1,702 |   | 1,849 |   | 1,580 |   |
| Occupancy and  equipment                                          |       | 320                     |       | 381 |   | 342 |   | 561 |   | 535 |   |
| General and  administrative expenses                              |       | 4,850                   |       | 3,983 |   | 4,258 |   | 3,735 |   | 3,359 |   |
| Impairment of  long-lived asset                                   |       | 242                     |       | 76 |   | — |   | — |   | — |   |
| Operating (loss)  income                                          |       | (12,406                 | )          | (5,217 | ) | (3,118 | ) | (4,904 | ) | (1,516 | ) |
| Other income  (expense):                                          |       |                    |       |   |   |   |   |   |   |   |   |
| Interest income                                                   |       | —                  |       | — |   | 3 |   | 33 |   | 125 |   |
| Interest expense                                                  |       | (1,508                  | )          | (1,416 | ) | (1,791 | ) | (2,399 | ) | (2,427 | ) |
| Other income,  net                                                |       | 129                     |       | 72 |   | 20 |   | 44 |   | 80 |   |
| Total other  expense                                              |       | (1,379                  | )          | (1,344 | ) | (1,768 | ) | (2,322 | ) | (2,222 | ) |
| Loss before  taxes                                                |       | (13,786                 | )          | (6,561 | ) | (4,886 | ) | (7,226 | ) | (3,738 | ) |
| Income tax  expense                                               |       | 74                      |       | 68 |   | — |   | 19 |   | 4 |   |
| Net loss                                                          |       | $                       | (13,711    | ) | $ | (6,629 | ) | $ | (4,886 | ) | $ | (7,245 | ) | $ | (3,742 | ) |
| ** **                                                        | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Preferred dividends**                                           |       | 3,740                   |       | 570 |   | — |   | — |   | — |   |
| **Net loss applicable to common stockholders**                    |       | $                       | (17,451    | ) | $ | (7,199 | ) | $ | (4,886 | ) | $ | (7,245 | ) | $ | (3,742 | ) |
| ** **                                                        | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Common Share Data:**                                            | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Net loss per  share                                               |       | (0.83                   | )          | (0.48 | ) | (0.33 | ) | (0.52 | ) | (0.36 | ) |
| Weighted average  common shares outstanding (in 000’s)       |       | 21,109                  |       | 15,016 |   | 15,000 |   | 13,849 |   | 10,356 |   |
| Period end  shares outstanding (in 000’s)                    |       | 49,569                  |       | 17,000 |   | 15,000 |   | 15,000 |   | 13,000 |   |
| ** **                                                        | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Balance Sheet Data:**                                           | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Total assets                                                      |       | 20,850                  |       | 24,783 |   | 25,160 |   | 24,022 |   | 30,496 |   |
| Working capital  deficit                                          |       | (4,610                  | )          | (5,558 | ) | (20,370 | ) | (14,332 | ) | (3,400 | ) |
| Short-term debt                                                   |       | 5,332                   |       | 9,242 |   | 20,700 |   | 15,500 |   | 7,127 |   |
| Long-term  obligations                                            |       | 20,074                  |       | 20,310 |   | 17,000 |   | 20,000 |   | 27,021 |   |
| Shareholders’  deficit                                       |       | (15,741                 | )          | (13,967 | ) | (23,601 | ) | (18,566 | ) | (13,534 | ) |
| ** **                                                        | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| **Performance Data:**                                             | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Loss on total  assets                                             |       | (65.8                   | )%         | (26.8 | )% | (19.4 | )% | (30.2 | )% | (12.3 | )% |
| **Capital Ratio:**                                                | ** ** | ** **              | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** | ** ** |
| Quick ratio                                                       |       | 64.7                    | %          | 69.9 | % | 35.9 | % | 36.6 | % | 80.0 | % |
|                                                                   |            |                         |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**ITEM 7.****          MANAGEMENT’S DISCUSSIONAND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION**

 

**HIGHLIGHTS**

 

Revenues for the year ended December 31, 2004 were$20.7 million, compared to $20.0 million and $20.3 million for the years endedDecember 31, 2003 and 2002, respectively. Net loss to common stockholders was$17.5 million for 2004, an increase of $10.3 million, or 142.4% from the lossof $7.2 million for 2003.  Basic anddiluted net loss to common stockholders per share was $0.83 per share for 2004,compared to $0.48 per share for 2003 and $0.33 per share for 2002.

 

**Liquidity**

 

As of December 31, 2004,the Company’s current liabilities exceeded its current assets by $4.6 millionand its total liabilities exceed total assets by $15,740,798.  The Company relies heavily on equity salesand bank financing to support its operations. The Company’s ability to refinance its existing bank debt is critical toprovide funding to satisfy the Company’s obligations as they mature. As ofDecember 31, 2004 the Company had total outstanding debt of $25.4 million ofwhich $5.3 million is due in 2005. As of December 31, 2004 the Company had anaccumulated deficit of $54.1 million and total stockholders’ deficit of $15.7million.

 

The Company incurredoperating losses of $12,406,488, $5,217,223 and $3,118,300 for the years endedDecember 31, 2004, 2003 and 2002, respectively. The Company incurred net lossesto common stockholders of $17,451,244, $7,198,916 and $4,886,397 for the yearsended December 31, 2004, 2003 and 2002, respectively.

 

Cash used in operatingactivities was $7,358,063, $6,283,959, and $2,031,793 for the years endedDecember 31, 2004, 2003 and 2002, respectively. Funds provided by netborrowings and stock sales amounted to $7,683,542, $8,187,300, and $2,200,000for the years ended December 31, 2004, 2003 and 2002, respectively.

 

During 2004 managementworked to address the operating and working capital deficits by continuing itsefforts to eliminate unprofitable business segments, specifically construction.As reported in Item 5, herein, management has raised $6.4 million in 2005through the issuance of common stock.  Inaddition, the Company was previously able to raise $6.3 million and $2.0million through the sale of common stock during 2004 and 2003, respectively. Ineach case such sales were made in private, unregistered sales of the Company’ssecurities.  The additional equity raisedduring 2005 was used to pay down debt and fund continuing operations. Much ofthe debt obligations coming due during 2005 are project financing based and theCompany repaid a portion of these obligations with cash generated through thecollection of project receivables and billings. These collections on the projects along with the expected additionalequity are believed by management to be sufficient to cover Telesource’s 2005obligations.  The Company has and expectsto continue to seek support from its principal stockholder, SHBC, for itsoperations, for working capital needs, debt repayment, and business expansionas may be required. SHBC has continued its support of the Company. SHBC hasagreed to guarantee or provide letters of credit covering $22,622,333 of theCompany’s total debt of $25,405,963.

 

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**OPERATING SEGMENTS**

 

Telesource’s business consists of the followingoperating segments: power generation and construction of power plants, trading,and construction services. Revenue of the power generation and construction ofpower plants segment includes sales-type lease revenues. The power generationactivities occurred in the Commonwealth of Northern Mariana Islands, a U.S.territory, (“CNMI”) and construction of power plants occurred in Fiji.Construction services occurred in the CNMI and the Republic of Palau whiletrading activities occurred in the United States and the CNMI. Telesource iscommitted to completing the construction projects currently under contract;however, Telesource as noted earlier, is changing its construction strategy.Telesource is concentrating its efforts on expanding its power generationservices in the Pacific region.

 

**OVERVIEW**

 

During 2004, our cost ofconstruction projects as a percentage of construction revenues increased to 119.4%from 110.4% in 2003.  The increase incosts as a percentage of construction revenues was due to project delays andadditional unforeseen costs incurred on the projects. As noted earlier, we are alteringour strategy in the construction segment of our business due to these losses.

 

The following information is based on, and should beread with, our consolidated financial statements and the related notes theretoincluded elsewhere in this Form 10-K. Our consolidated gross profit decreasedto a gross loss of ($5,361,314) in 2004 from a gross profit of $869,332 in2003. Our consolidated net loss increased to ($13.7) million in 2004 from ($6.6)million in 2003, primarily due to the lower margin recognized on ourconstruction segment.

 

**RESULTSOF OPERATIONS**

 

**REVENUES**

 

**Overview**

 

**TelesourceInternational is an international engineering and construction company, whichhas among its operations power generation and specialty construction servicesin the Commonwealth of the Northern Mariana Islands and the Republic of Palau.Telesource International operates a diesel fired electric power generationplant for the sale of electricity to the local power grid in CNMI. Telesourcesigned an agreement to take over the operation and maintenance of three dieselfired electric power generation plants in Fiji beginning in 2003 for a periodof 20 years. Telesource International’s facility in Lombard, Illinois handlesthe procurement, export and shipping of U.S. fabricated products for use byTelesource International’s subsidiaries or for resale to customers outside ofthe mainland.**

 

Telesource Internationalwas formed in 1994 to facilitate various intra-corporate activities and, until July 1999, was a wholly owned subsidiary ofSHBC, a Kuwait-based civil, electrical and mechanical construction company. Operationsare conducted primarily through subsidiaries. Telesource Internationalcurrently has two subsidiaries. Telesource CNMI, Inc. handles construction and management for the powerfacilities in the Commonwealth of the Northern

 

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Mariana Islands.Telesource CNMI, Inc. had branch offices in Guam, Telesource Pacifica andPacifica Power Resources. Telesource Fiji, Ltd. was established to overseeTelesource International, Inc.’s power plant construction activities withinFiji, which currently involves the installation of additional power generatorsfor existing power plants in Fiji. Construction activities in the Republic ofPalau were managed through Telesource International.

 

Telesource International has three main operating segments: powergeneration and construction of power plants, construction services and tradingactivities.

 

Revenue from construction and construction of power plants isrecognized using the percentage-of-completion method of accounting based uponcosts incurred and projected costs. Construction revenue includes revenuesrecognized by Telesource International, Inc.’s power plant construction segmentand from other projects ranging from housing development to the construction ofairports and prisons. The construction of power generation plants is consideredby management to be a part of Telesource International, Inc.’s power generationand construction of power plants segment. Cost of revenue consists of directcosts on contracts, including labor and materials, amounts payable tosubcontractors, direct overhead costs, equipment expense (primarilydepreciation, maintenance and repairs), and interest associated withconstruction projects and insurance costs. Depreciation is provided usingstraight-line methods for construction equipment. Contracts frequently extendover a period of more than one year and revisions in cost and profit estimatesduring construction are reflected in the accounting period in which the factsthat require the revision become known. Losses on contracts, if any, are providedwhen determined, regardless of the degree of project completion. Claims foradditional contract revenue are recognized in the period when it is probablethat the claim will result in additional revenue and the amount can be reliablyestimated. The foregoing as well as the stage of completion and mix ofcontracts at different margins may cause fluctuations in gross profit betweenperiods.

 

Construction revenues on power plants are recognized using thepercentage-of-completion method of accounting, based upon costs incurred andprojected costs. This revenue is separated on the face of the consolidatedfinancial statements due to its origin within Telesource International’s powergeneration and construction of power plants segment. Cost of revenue consistsof direct costs on contracts, including labor and materials, amounts payable tosubcontractors, direct overhead costs, equipment expense (primarily depreciation,maintenance and repairs), and interest associated with construction projectsand insurance costs. Depreciation is provided using straight-line methods forconstruction equipment. Contracts frequently extend over a period of more thanone year and revisions in cost and profit estimates during construction arereflected in the accounting period in which the facts that require the revisionbecome known. Losses on contracts, if any, are provided in total whendetermined, regardless of the degree of project completion. Claims foradditional contract revenue are recognized in the period when it is probablethat the claim will result in additional revenue and the amount can be reliablyestimated. The foregoing as well as the stage of completion and mix of contractsat different margins may cause fluctuations in gross profit between periods.

 

Telesource accounts for its leasing activities in accordance with therequirements of Statement of Financial Accounting Standards No. 13, *Accounting for Leases.*Revenue associated with the sale ofthe Tinian power plant constructed and sold under a sales-type lease, measuredas the present value of non-cancelable rents, was recognized in connection withrecording the loss on sale in 1997 and 1998. Telesource recognizes financelease revenue on the resulting sales-type lease

 

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receivable at a constant rate using the interest method. Servicerevenues received from operating and maintaining the Tinian power plant for theduration of the lease are recognized as earned based on actual kilowatt hoursof electricity produced and delivered to the lessee’s customers. To the extentthat variable payments based on kilowatt-hours of production exceed the fairvalue of operation and maintenance services provided, Telesource recognizessuch contingent payments as additional finance lease revenue as they areearned.

 

Sales revenues are derived from brokering of U.S.fabricated goods and management of various projects outside of Telesource International’sconstruction and power generation segments. Sales of goods exported arerecognized at the time of shipment. When an order is received, the customer’sproduct specifications are sent to the manufacturer and upon completion thegoods are shipped from the manufacturer directly to the customer. In mostcases, the risk of loss during shipping is either borne by the manufacturer orthe customer. Telesource International is responsible for payment to themanufacturer; however, Telesource normally collects payment from the customerbefore the manufacturer is paid. The sales revenues are recognized net of costof goods sold. In 1999, Telesource entered into an agreement with its primarycustomer, SHBC, to charge a flat fee of 7.5% of the invoice amount for allorders executed by Telesource on behalf of SHBC.

 

Service revenues are recognized in the period in whichthe work is performed. Service revenues consist of amounts billed to SHBC forproject management of the radio relay station and for other types of servicesprovided to local customers for small projects. Rental income consists of feescollected on rental of equipment to SHBC for use in construction of the radiorelay station as well as to local customers. The rental fees are billed on a monthly basis for equipment used duringthe billing period. Telesource recognizes rental revenue on the accrual basispursuant to contractual arrangements between Telesource and its customers.

 

Finance lease revenues are recognized on the amortization of the minimumlease payments for the power plant located on the Island of Tinian that werediscounted upon execution of the contract in June of 1997 at an interest rateof 6.74%. The amortization of the minimum lease payments began in March 1999 atan effective interest rate of 9.40% and will fully amortize in March 2010.

 

Construction costs are comprised of both variable and semi-variableexpenses, including labor and materials, amounts payable to subcontractors,direct overhead costs, equipment expense (primarily depreciation, maintenanceand repairs), interest associated with construction projects and insurancecosts. Depreciation is provided using straight-line methods for constructionequipment.

 

Construction costs on power plants are comprised of both variable andsemi-variable expenses, including labor and materials, amounts payable tosubcontractors, direct overhead costs, equipment expense (primarilydepreciation, maintenance and repairs), interest associated with constructionprojects and insurance costs. Depreciation is provided using straight-linemethods for construction equipment. These costs are disclosed separately fromconstruction costs due to their origin within the power generation segment.

 

Operations and maintenance costs – power generation plant consist oflabor, direct overhead costs, equipment expense (primarily maintenance andrepairs), and insurance costs. These costs are recognized as incurred.

 

26

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Salaries and employee benefits consist of all wagesand benefits for management and staff wages and benefits that are not directlyassociated with a particular project, that is, idle costs for employees arecharged to general and administrative expense. Telesource’s principal market,the Commonwealth of the Northern Mariana Islands, allows employers to importguest employees. The local labor laws require employers importing guestemployees, principally from the Philippines, to execute a one-year employmentcontract with the guest employee. Since Telesource has a few large contracts,this can lead to short periods of inactivity for some employees. As Telesourcecontinues to grow, this issue is expected to be minimized; however, it may havea significant impact on Telesource’s operating results.

 

Occupancy and equipment expense consist of rent, utilities and officeequipment for Telesource International’s offices in Illinois, CNMI, Guam andFiji.

 

General and administrative expenses consist primarily of depreciation,telephone expense, insurance, travel, financial and legal expenses and a grossrevenue tax incurred on Telesource International’s operations in theCommonwealth of the Northern Mariana Islands.

 

Telesource International, Inc., Telesource CNMI, Inc. and TelesourceFiji, Ltd. file separate corporate income tax returns. TelesourceInternational, Inc. is a U.S. corporation that files U.S. corporate taxreturns. Telesource CNMI, Inc. is a Commonwealth of the Northern Mariana Islandcorporation and files a corporation tax return for this commonwealth. TelesourceFiji, Ltd. is a Fijian corporation and files a Fijian corporation tax return.

 

Deferred income taxes are accounted for under the asset and liabilitymethod. Deferred tax assets and liabilities are recognized for the estimatedfuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective income tax bases. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date.

 

**TINIAN POWER PLANT**

 

**Phase I**

 

In June 1997, TelesourceInternational entered into a contract to construct and operate a power plant onthe island of Tinian. The June 1997 agreement (hereafter referred to as PhaseI) called for Telesource International to construct a 10Mwh power generationplant with the capacity to add an additional 20Mwh of power at later dates, andto operate the power plant for a period of 10 years from the date ofcommissioning. Phase I was commissioned in March 1999. The terms for Phase Icall for fixed payments of $180,000 per month plus a production fee charged perKwh produced for the first 5,140,000 Kwh produced each month (hereafterreferred to as the Base Load). The agreement also provides that TelesourceInternational will receive a monthly service fee of $50,000 for a period of 10years from the date of commissioning. Following the conclusion of that 10-yearperiod, the only payments Telesource International will receive for the BaseLoad only the production fee charged on the amount of Kwh produced, as adjustedfor inflation per the agreement.

 

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# **Phase II**

 

In November 1998,Telesource International received a change order instructing Telesource to addan additional 10Mwh of power generation capacity (hereafter referred to asPhase II). This change order provided for Telesource International to receiveonly variable payments in the form of a production fee produced in excess ofthe Base Load (hereafter referred to as the Expansion Rate) and for thesepayments to occur over a ten-year period commencing upon the commissioning ofPhase II. After the completion of the ten-year period, the production feechanges will decrease for all power produced. Phase II was commissioned inMarch 2000 and increased the power plant’s total generation capacity to itsmaximum current level of 20Mwh.  Theplant only operates at the 10 Mwh level and will continue until demandincreases to higher levels.  It is notknown, if and when additional demand may increase on Tinian.

 

# **Expanded Agreement**

 

In May 2001, TelesourceInternational received a third change order extending the term of the agreementfor an additional ten years or to March 31, 2020 (hereafter referred to as theExpanded Agreement). The Expanded Agreement leaves the option to expand thepower plant by adding an additional 10Mwh of generation capacity unchanged. Thepower generation plant currently has 20Mwh of production capacity, which can beincreased to 30Mwh by installing the appropriate power generators. Theproduction rates for the Base Load and the Expansion Rate do not change fromthe amounts originally agreed upon.  Inaddition, the expanded agreement requires Telesource to upgrade the existingoverhead power distribution system.  TheCompany is responsible for the costs of the upgrade which include labor andmaterials.  The Company estimates thecost of this upgrade to be approximately in the range of $800,000 to $1.3million and to be completed in 2006.

 

**Accounting for the Constructionof the Power Plant**

 

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

 

The original netinvestment in sales-type lease was recognized in June 1997, the date thecontract was executed. The components of the net investment in sales-type leaseat December 31, 2004, 2003 and 2002 are as follows:

 

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| ** **                                  | ** ** | **December 31** | ** ** | ** ** | ** ** |
|---------------------------------------------|------------|-----------------|------------|------------|------------|
| ** **                                  | ** ** | **2004**        | ** ** | **2003**   | ** ** | **2002** | ** ** | **Inception** | ** ** |
| Total minimum lease payments to be received |       | $               | 9,000,000  |       | 11,160,000 |   | 13,320,000 |   | 21,600,000 |   |
| Add: Operation and maintenance fee          |       | 2,500,000       |       | 3,100,000  |       | 3,700,000 |   | 6,000,000 |   |
| Minimum lease  payments receivable          |       | 11,500,000      |       | 14,260,000 |       | 17,020,000 |   | 27,600,000 |   |
|                                        |       |            |       |       |       |   |   |   |   |
| Less: unearned income                       |       | 2,015,075       |       | 2,998,429  |       | 4,140,589 |   | 9,750,000 |   |
|                                        |       |            |       |       |       |   |   |   |   |
| Net investment  in sales-type lease         |       | $               | 9,484,925  |       | 11,261,571 |   | 12,879,411 |   | 17,850,000 |   |

 

When Telesourcerecognized the net investment in sales-type lease at the inception of theagreement in June 1997, Telesource also recognized a loss on the sale of PhaseI in the amount of $1,748,713. In 1998, Telesource recognized a loss on thesale of Phase II in the amount of $12,521,457 (equal to the entire amount ofthe construction costs for Phase II, as there were no additional minimum leasepayments related to this phase). The loss recognized on the sale of Phase IIwas recognized when the contract for Phase II was executed in November 1998.

 

Phase I of the powerplant was commissioned in March of 1999. Phase II was commissioned in March of2000. Telesource recognized power generation revenues of $1,078,392,$1,131,144, and $1,130,172 for the years ended December 31, 2004, 2003, and 2002,respectively. No power generation income was recognized during 1998.

 

Revenues for thiscontract consist of the present value of the total contractual minimum leasepayments, which were recognized at lease inception. The minimum lease paymentswere discounted using an interest rate of 6.74% and the minimum lease paymentsare comprised of a guaranteed monthly payment along with an operation andmaintenance fee. Interest earned on the minimum lease payments, which isrecognized over the lease term so as to yield a constant percentage return onthe net investment in the lease beginning in March 1999, is included in financelease revenues in the consolidated statements of operations.

 

Telesource also receivesvariable monthly payments as compensation for its production of power. Thevariable payments are recognized based upon power produced and billed to thecustomer as earned during each accounting period.

 

The total construction costs for thepower plant were $32,120,170. A substantial portion (approximately $14,270,000)of the repayment to Telesource International for these construction costs isexpected to come from the variable production fees that will be recognized asrevenue when power is produced and billed to the customer. Due to the fact thatthe agreement does not provide for any minimum production fees, there is noguarantee that Telesource International will recover all of the constructioncosts incurred to construct the power plant; however, the agreement doesrequire the customer to purchase 100% of its power from TelesourceInternational until the maximum power generation capacity has been reached eachmonth. The future minimum lease payments to be collected by Telesource are$2,760,000 each year through 2008 and $460,000 in 2009.

 

Future revenue related tothe construction and operation of the power plant will be recorded as servicefees until the amount exceeds the estimated fair value of the servicesperformed.

 

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Amounts in excess of thefair value of the services performed will be accounted for as additionalfinance lease revenue.

 
| ** **                  | ** ** | **Disclosure of Contractual Obligations at December 31, 2004** | ** ** |
|-----------------------------|------------|----------------------------------------------------------------|------------|
| ** **                  | ** ** | **Payments Due by Period**                                     | ** ** |
| ** **                  | ** ** | ** **                                                     | ** ** | **Less than** | ** ** | ** ** | ** ** | ** ** | ** ** | **More than** | ** ** |
| **Contractual Obligations** | ** ** | **Total**                                                      | ** ** | **1 Year** | ** ** | **1 - 3 Years** | ** ** | **3 - 5 Years** | ** ** | **5 Years** | ** ** |
|                        |       |                                                           |       |   |   |   |   |   |   |   |   |
| Long Term Debt Obligations  |       | $                                                              | 20,073,624 |   | $ | — |   | $ | 17,693,623 |   | $ | 2,380,000 |   | $ | — |   |
| Capital Lease Obligations   |       | —                                                         |       | — |   | — |   | — |   | — |   |
| Operating Lease Obligations |       | 294,034                                                        |       | 136,693 |   | 157,341 |   | — |   | — |   |
| Purchase Obligations        |       | —                                                         |       | — |   | — |   | — |   | — |   |
| Other Long-Term Liabilities |       | —                                                         |       | — |   | — |   | — |   | — |   |
|                             |            |                                                                |            |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

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**Results of Operations**

 

The following table sets forth results of operationsexpressed as a percentage of total revenues:

 

| ** **                                                        | ** ** | **Twelve Months Ended  December 31,** | ** ** |
|-------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                                        | ** ** | **2004**                                             | ** ** | **2003** | ** ** | **2002** | ** ** |
| **Revenues:**                                                     |       |                                                 |       |   |   |   |   |
| Construction  revenues                                            |       | 77.4                                                 | %          | 71.8 | % | 81.5 | % |
| Construction  revenues – related party                       |       | —                                               |       | — |   | 4.1 |   |
| Service fees –  power generation plant                       |       | 15.6                                                 |       | 14.8 |   | 5.6 |   |
| Sales, net                                                        |       | 0.1                                                  |       | 0.2 |   | 1.5 |   |
| Sales, net –  related party                                  |       | 0.4                                                  |       | — |   | 0.4 |   |
| Rental income                                                     |       | 1.4                                                  |       | 4.6 |   | 0.3 |   |
| Rental income –  related party                               |       | —                                               |       | — |   | — |   |
| Management fees –  related party                             |       | —                                               |       | — |   | 0.3 |   |
| Service fees                                                      |       | 0.4                                                  |       | 2.9 |   | — |   |
| Finance lease  revenues                                           |       | 4.7                                                  |       | 5.7 |   | 6.3 |   |
| Gross revenues                                                    |       | 100.0                                                |       | 100.0 |   | 100.0 |   |
| **Costs and expenses:**                                           |       |                                                 |       |   |   |   |   |
| Construction  costs                                               |       | 93.4                                                 |       | 79.3 |   | 78.2 |   |
| Operations &  maintenance costs – power generation plant |       | 13.9                                                 |       | 12.9 |   | 6.0 |   |
| Rental costs                                                      |       | —                                               |       | 2.7 |   | — |   |
| Cost of service                                                   |       | 1.1                                                  |       | 0.8 |   | — |   |
| Provision for  warranty expense                                   |       | 1.5                                                  |       | — |   | — |   |
| Provision for  losses on contracts in progress                    |       | 9.6                                                  |       | — |   | — |   |
| Provision for  unbilled and uncollected accounts                  |       | 6.4                                                  |       | — |   | — |   |
| Gross (loss)  profit                                              |       | (25.9                                                | )          | 4.3 |   | 15.8 |   |
| **Operating expenses:**                                           |       |                                                 |       |   |   |   |   |
| Salaries and  employee benefits                                   |       | 7.9                                                  |       | 8.2 |   | 8.4 |   |
| Occupancy and  equipment                                          |       | 1.5                                                  |       | 1.9 |   | 1.7 |   |
| General and  administrative                                       |       | 23.4                                                 |       | 19.9 |   | 20.9 |   |
| Impairment of  long lived assets                                  |       | 1.2                                                  |       | 0.4 |   | — |   |
| Total operating  expenses                                         |       | 34.0                                                 |       | 30.4 |   | 31.0 |   |
|                                                              |       |                                                 |       |   |   |   |   |
| Operating loss                                                    |       | (60.0                                                | )          | (26.1 | ) | (15.3 | ) |
| **Other income (expense):**                                       | ** ** | ** **                                           | ** ** | ** ** | ** ** | ** ** | ** ** |
| Interest income                                                   |       | —                                               |       | — |   | — |   |
| Interest expense                                                  |       | (7.3                                                 | )          | (7.1 | ) | (8.8 | ) |
| Other income,  net                                                |       | 0.6                                                  |       | 0.4 |   | 0.1 |   |
| Total other expense                                               |       | (6.7                                                 | )          | (6.7 | ) | (8.7 | ) |
| Loss before  income taxes                                         |       | (66.6                                                | )          | (32.8 | ) | (24.0 | ) |
| Income tax  expense                                               |       | —                                               |       | (0.3 | ) | — |   |
| **Net  loss**                                                     | ** ** | **(66.2**                                            | **)**      | **(33.1** | **)** | **(24.0** | **)** |

 

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**Backlog**

 

The following scheduleshows a reconciliation of backlog representing the amount of revenue TelesourceInternational expects to realize from work to be performed on uncompletedcontracts accounted for using the percentage-of-completion method of accountingin progress at December 31, 2004:

 
| Balance at  December 31, 2003                              |   | $          | 15,098,231 |   |
|------------------------------------------------------------|--------|------------|------------|--------|
| New contracts,  change orders and claims added during 2004 |   | 1,144,865  |       |
|                                                       |   |       |       |
| Less:  Construction contract revenue recognized for 2004   |   | 16,023,844 |       |
|                                                       |   |       |       |
| Balance at  December 31, 2004                              |   | $          | 219,252    |   |

 

The backlog balance represents work under contractwhich remains to be completed. The decrease in the amount of the backlog from$15.1 million as of December 31, 2003 to $.2 million at December 31, 2004, is aresult of management’s efforts to complete existing projects and implement itsnew strategy as discussed above and concentrate future growth in the powergeneration segment.

 

**Comparison ofthe twelve months ended December 31, 2004 and 2003**

 

*ConstructionRevenues*. Construction revenues, including related party,increased 11.4% to $16.0 million in 2004 from $14.4 million in 2003. Theincrease in construction revenues is attributed to management’s efforts to wrapup its construction segment activities on the adult correctional facilityproject, the radio relay station expansion project and the three constructionprojects in the Republic of Palau. As noted earlier the backlog of remainingconstruction projects was only $.2 million at December 31, 2004 reflecting management’sefforts to complete existing contracts and implement its new strategy of jointventuring with SHBC on new projects. Telesource is committed to completing theconstruction projects currently under contract and Telesource is not activelybidding on additional construction contracts. Construction revenues are expectedto decrease in future periods.

* *

*Service Fees - Power Generation Plant*. Servicefees - power generation plant increased 8.7% to $3.2 million in 2004 from $3.0million in 2003. The increase in service fees - power generation plant isattributed to the $2.3 million in revenues from the operation and maintenanceof two diesel power plants in Fiji which was awarded to the Company by FijiElectric Authority during May 2003 and covers a period of 20 years. The energyconversion agreement covered the take-over and operation of the two facilitiesin Kinoya, and Vuda, Fiji. Telesource is concentrating its efforts on growingrevenues from power generation and expects to see additional growth in futureperiods. The power generation revenues at the Tinian power plant were unchangedat $1.1 million for 2004 and 2003.

* *

*Sales Revenues, Net*. Sales decreased 46% to$23,573 in 2004 from $43,636 in 2003. Sales to SHBC were $89,940 and $0 in 2004and 2003, respectively. Sales to SHBC are not expected to increase in futureperiods.

 

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*Rental Income*. Rental income decreased to$288,899 in 2004 from $919,063 in 2003. The decrease in rental income was aresult of short term lease agreement signed in 2003 with the Guam Power Authorityto assist the local utility in clean up efforts from a super typhoon, Pongsona,which struck Guam in December 2002. The short term lease agreement with theGuam Power Authority was completed in April 2003. Rental income during 2004 wasa result of the Company leasing company owned equipment in its local markets.

* *

*Service Fees*. Service fees decreased to $72,215 in 2004 from$571,776 in 2003. The decrease is due to the completion of a broadcast surveyperformed by the Company during 2003. During 2004, the Company did not have anysignificant service fee revenues.

* *

*Finance Lease Revenues*. Finance lease revenuesdecreased 13.9% to $1.0 million in 2004 from $1.1 million in 2003. Financelease revenue for the Tinian power plant will decrease each year until theinvestment in sales type lease is fully amortized in March 2009.

*** ***

***Expenses***

* *

*Construction Costs*. Total construction costs(includes related party and third party) increased 20.5% to $19.3 million ascompared to $15.9 million for 2003. While construction cost increased 20.5%during 2004 as compared to 2003, construction revenues increased 11.4%.Construction cost as a percentage of revenues were 120.6% for 2004 as comparedto 110.4% for 2003 which was due to cost overruns attributed to unforeseendelays encountered on the projects and potential warranty claims. The increasein cost resulted in lower margins and increased losses realized on constructionprojects.

* *

*Provision for Warranty Expense:*Provision for warrantyrepresents a contingent liability for the Koblerville project.

* *

*Provision for Losses in Progress*.  Provision for losses on contracts increasedto $1,985,557 in 2004 compared to $0 in 2003. This was a result of cost estimates exceeding total revenue and the lossbeing recorded in 2004.

* *

*Provision for Unbilled and Uncollected Contracts. *Provision for unbilledcontracts in progress increased to $1,329,058 from $0 as a result of a directwrite-off of accounts receivable.

* *

*Operation and Maintenance Costs – Power Generation Plant*.Operation and maintenance costs – power generation plant increased 11.2% to$2.9 million in 2004 from $2.6 million in 2003. The increase in operation andmaintenance costs was due to $1.7 million in costs from Fiji’s operation andmaintenance of two power plants during 2004 as compared to similar costs of$1.3 million during 2003. The increase in operation and maintenance cost forthe power generation plants in Fiji was due to a full year of operations in2004 versus approximately one-half year of operations in 2003, the year thecontract went into effect.

* *

*Salaries and Employee Benefits*.  Salaries and employee benefits decreased slightly($13,456 and 0.8%) from 2003 to 2004 reflecting management’s continuing effortsto reduce costs during 2004 through staff reductions.

* *

*Occupancy and Equipment*. Occupancy and equipmentexpenses decreased 15.8% to $320,533 in 2004 from $380,576 in 2003. Thedecrease in occupancy and equipment expense is attributed to a reduction inoffice space in Guam and Palau during 2004.

 

33

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*General and Administrative Expenses*.  General and administrative expenses increased21.7% to $4.8 million in 2004 from $3.98 million in 2003. The increase isattributed to higher professional fees during 2004 related to the 2004 and 2003audit and legal fees.

* *

*Other Expense,Net*. Other expense increased slightly to $1.4 million in 2004from $1.3 million in 2003.

* *

*Income Tax Expense*. Telesource recognized an incometax credit of $74,435 in 2004 resulting from the reversal of a 2003 tax accrualwhich had occurred due to compliance with Fijian Internal Revenue Departmenttax regulations. Telesource had net operating loss carry forwards for U.S.purposes at December 31, 2004 of approximately $8.5 million.  The Company has approximately $32.9 millionof net operating loss carry forwards for the Commonwealth of Northern MarianaIslands and $215,000 for Fiji.

** **

**Comparison of the twelve months ended December 31, 2003 and 2002**

* *

*Construction Revenues*. Construction revenues,including related party, decreased 17.4% to $14.4 million in 2003 from $17.4million in 2002. The decrease in construction revenues is attributed to thecompletion of the airport expansion project and the lower revenues from theprison project. The backlog was $15.1 million at December 31, 2003 and was$17.5 million at December 31, 2002. Telesource is committed to completing theconstruction projects currently under contract; however, Telesource is notactively bidding on additional construction contracts. Construction revenuesare expected to decrease in future periods.

* *

*Service Fees - Power Generation Plant*. Servicefees - power generation plant increased 162.6% to $3.0 million in 2003 from$1.1 million in 2002. The significant increase in service fees - power generationplant is attributed to the $2.0 million revenues from the operation andmaintenance of two diesel power plants in Fiji which was awarded to the Companyby Fiji Electric Authority during 2003 and covers a period of 20 years. Theenergy conversion agreement covered the take-over and operation of the twofacilities in Kinoya, and Vuda, Fiji. Telesource is concentrating its effortson growing revenues power generation and expects to see additional growth infuture periods.

* *

*Sales Revenues, Net*. Sales revenues decreased89% to $43,636 in 2003 from $397,376 in 2002. Sales to SHBC decreased to nonein 2003 from $89,998 in 2002. Sales to SHBC are not expected to increase infuture periods.

* *

*Rental Income*. Rental income increased to$919,063 in 2003 from $68,209 in 2002. The increase in rental income was aresult of short term lease agreement signed in 2003 with the Guam PowerAuthority to assist the local utility in clean up efforts from a super typhoon,Pongsona, which struck Guam in December 2002.

* *

*Service Fees*. Service fees increased to $571,776 in 2003 from$34,640 in 2002. The increase is a result of Telesource providing projectmanagement services to third parties.

* *

*Finance Lease Revenues*. Finance lease revenuesdecreased 11% to $1.1 million in 2003 from $1.3 million in 2002. Finance leaserevenue for the Tinian power plant will decrease each year until the investmentin sales type lease is fully amortized in March 2010.

 

34

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***Expenses***

 

*Construction Costs*. Total construction costs(includes related party and third party) were flat at $15.9 million for 2003and 2002. While construction cost remained flat during 2003 as compared to2002, construction revenues decreased 17.4% or from $17.4 million down to $14.4million in 2002 and 2003, respectively. Construction cost increased as apercentage of revenue due to unforeseen delays encountered on the projects. Theincrease in cost resulted in lower margins and losses realized on constructionprojects.

* *

*Operation and Maintenance Costs – Power Generation Plant*.Operation and maintenance costs – power generation plant increased 112% to$2,588,752 in 2003 from $1,224,202 in 2002. The increase in operation andmaintenance costs was due to $1.4 million in additional costs from Fiji’soperation and maintenance of two power plants during 2003.

* *

*Salaries and Employee Benefits*.  Salaries and employee benefits decreased 3%to $1.65 million in 2003 from $1.7 million in 2002. The decrease in salariesand employee benefits is attributed to management’s continuing efforts toreduce costs during 2003.

* *

*Occupancy and Equipment*. Occupancy and equipmentexpenses increased 11% to $380,576 in 2003 from $342,189 in 2002. The increasein occupancy and equipment expense is attributed to additional occupancyexpense incurred in Palau in the amount of $82,813 and $34,092 in Fiji during2003.

* *

*General and Administrative Expenses*.  General and administrative expenses decreased7% to $4.0 million in 2003 from $4.3 million in 2002. The decrease is attributedto lower bank service charges and decreased taxes and licenses.

* *

*Other Expense, Net*. Other expense decreased24% to $1.3 million in 2003 from $1.8 million in 2002. The decrease is a resultof lower interest expense due to a reduction in borrowings.

* *

*Income Tax Expense*. Telesource recognizedincome tax expense on revenues recognized in Fiji for 2003 in the amount of$68,446. Telesource had net operating loss carry-forwards for U.S. purposes atDecember 31, 2003 of approximately $32,000,000.

 

**Liquidity and Capital**

 

Since 1994, Telesource International’s primary sources of operatingfunds have been bank borrowings, contributions of equity capital and profitsrealized on projects completed. On December 31, 2004, 49,568,519 shares ofTelesource International’s common stock were issued or issuable. Telesource had17,000,000 shares issued and outstanding on December 31, 2003. The increase inoutstanding shares reflects the Company’s strategy to obtain additional fundsthrough stock issuance.

 

Cash used in operating activities during the twelve months endedDecember 31, 2004 and 2003 was $7.4 million and $6.3 million, respectively. Thecash used in operating activities was principally due to the net loss producedfrom construction activities.

 

Cash provided by investing activities was $192,458 for the twelvemonths ended December 31, 2004 as compared to cash used in investing activitiesof $660,784 for the twelve months ended

 

35

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December 31, 2003. The cash provided by investing activities during2004 is attributed to $460,330 of proceeds from the sale of equipment net ofthe purchase of equipment used within the construction and power generationoperations. The cash used in investing activities during 2003 is attributed tocapital purchases of $795,784 related to the purchase of seven bucket trucksused on the super typhoon cleanup efforts on Guam.

 

Cash provided byfinancing activities generated $7.7 million for the twelve months endedDecember 31, 2004 as compared to $8.2 million for 2003. The cash generated byfinancing activities during 2004 came from the proceeds from the sale of $6.4million in common stock.  Proceeds fromdebt financing in 2004 was $6.8 million and debt repayment was $5.0 million.The cash generated by financing activities during 2003 was produced through thesale of $11.7 million worth of preferred stock and $2 million of common stock.Debt repayments resulted in a net reduction in amount of debt held by $5.1million.

 

Telesource Internationalhad a working capital deficit of $4.3 million at December 31, 2004 and $5.6million at December 31, 2003. The decrease in the deficit is attributed mainlyto a current portion of long term debt being re-financed and a $1.9 millionprovision for costs in excess of billings on the remaining constructionprojects.

 

Telesource is substantially dependent upon SHBC to provide resourcesfor operating, working capital, and business expansion. To address the workingcapital deficit and reduce its dependence on debt financing obtained with thesupport of SHBC, Telesource plans on making some reductions on existing linesand renewing existing credit lines. The amount of the reductions is dependentupon the amounts of capital raised by Telesource International within the nexttwelve months.

 

Telesource International currently expects that its existing cashbalances, credit lines, additional borrowings secured in the first elevenmonths of 2005 and the sale of additional common stock in the amount of $6.4million subsequent to year end, together with funds available through SHBC willbe sufficient to meet anticipated cash requirements for at least the next 12months.

 

The Company will continue to seek additionalfunding through sale of its common stock, primarily to SHBC.  There can be no assurance that Telesourcewill be successful in such efforts. If Telesource International sellsadditional shares of common stock to raise funds, the terms and conditions ofthe issuances and any dilutive effect may have an adverse impact on theexisting stockholders. If additional financing beyond current levels becomesnecessary, there can be no assurance that the financing can be obtained onsatisfactory terms, if at all. In this event, Telesource International could berequired to restrict its operations.

 

**CRITICAL ACCOUNTINGPOLICIES**

 

Telesourcebelieves its most critical accounting policies are related to revenuerecognition on long-term contracts and the recoverability of long-lived assets.

 

36

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**Revenue Recognition on Long-Term Contracts**

 

Telesourceuses the percentage-of-completion method of accounting. Percentage ofcompletion accounting is the preferred method of accounting for long-termcontracts under accounting principles generally accepted in the United Statesof America, and accordingly, is the method used for revenue recognition withinTelesource’s industry. Percentage-of-completion is measured principally by theratio of costs incurred to date for each contract to the estimated total costsfor each contract at completion. Provisions for estimated losses on uncompletedcontracts are made in the period in which such losses are determined.

 

Applicationof percentage-of-completion accounting results in the recognition of costs andestimated earnings in excess of billings on uncompleted contracts within theconsolidated balance sheets. Costs and estimated earnings in excess of billingson uncompleted contracts reflected on the consolidated balance sheets arisewhen revenues have been recognized but the amounts cannot be billed under theterms of the contracts. Such amounts are recoverable from customers uponachievement of various measures of performance, including achievement ofcertain milestones, completion of specified units or completion of thecontract. Costs and estimated earnings in excess of billings on uncompletedcontracts also includes amounts Telesource seeks to collect from customers orothers for errors or changes in contract specifications or design, contractchange orders once approved as to both scope and price, or othercustomer-related causes of unanticipated additional contract costs. Suchamounts are recorded at estimated net realizable value when the scope and pricehave been agreed to by the client and Telesource.

 

Dueto uncertainties inherent within estimates employed to applypercentage-of-completion accounting, it is possible that estimates will berevised as project work progresses. Application of percentage of completionaccounting requires that the impact of those revised estimates be reported inthe consolidated financial statements prospectively.

*** ***

**Impairment of Long-Lived Assets**

 

The investment in sales-type lease along with our property, plant andequipment are considered to be long-lived assets. When we undergo changes inour business, including the closure or relocation of facilities, we may haveequipment and other assets that are no longer needed in our business. When thisoccurs, we estimate how much we believe we are likely to receive upon disposalof the assets and we record an impairment charge if this amount is less thanthe net carrying value. If actual market conditions for these assets are lessfavorable than those projected by management, additional impairment charges maybe required. During 2004 and 2003 Telesource recognized an asset impairmentcharge of $341,392 and $76,186, respectively, related to certain equipment heldby Telesource. Telesource did not incur any impairment of long-lived assets forequipment or other assets during 2002.

 

**NEW ACCOUNTINGPRONOUNCEMENTS**

 

In December 2003, the FASB issued FASB Interpretation No. 46(revised December 2003), *Consolidation of VariableInterest Entities*, which addresses how a business enterprise shouldevaluate whether it has a controlling financial interest in an entity throughmeans other than

 

37

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voting rights and accordingly should consolidate theentity.  FIN 46R replaces FASBInterpretation No. 46, *Consolidation of VariableInterest Entities*, which was issued in January 2003. The Companywill be required to apply FIN 46R to variable interests in VIEs created afterDecember 31, 2003.  For variableinterests in VIEs created before January 1, 2004, the Interpretation will beapplied beginning on January 1, 2005. For any VIEs that must be consolidatedunder FIN 46R that were created before January 1, 2004, the assets, liabilitiesand non-controlling interests of the VIE initially would be measured at theircarrying amounts with any difference between the net amount added to thebalance sheet and any previously recognized interest being recognized as thecumulative effect of an accounting change.  If determining the carryingamounts is not practicable, fair value at the date FIN 46R first applies may beused to measure the assets, liabilities and non-controlling interest of theVIE. The adoption of FIN 46R did not have a material effect on our financialposition, results of operations, or cash flows.

 

On December 16, 2004, the FASB issued FASB Statement No. 123R(revised 2004), Share-Based Payment, which is a revision of FASB Statement No.123, *Accounting for Stock-Based Compensation.*Statement 123(R) supersedes APB Opinion No. 25, *Accounting for Stock Issued to Employees,*and amends FASB Statement No. 95, *Statementof Cash Flows.*Generally, the approach in Statement 123(R) issimilar to the approach described in Statement 123. However, Statement 123(R) *requires*all share-based payments toemployees, including grants of employee stock options, to be recognized in theincome statement based on their fair values. Pro forma disclosure is no longeran alternative. Statement 123(R) must be adopted no later than July 1, 2005.Early adoption will be permitted in periods in which financial statements havenot yet been issued. We expect to adopt Statement 123(R) on July 1, 2005.Statement 123(R) permits public companies to adopt its requirements using oneof two methods: (1) A “modified prospective” method in which compensation costis recognized beginning with the effective date (a) based on the requirementsof Statement 123(R) for all share-based payments granted after the effectivedate and (b) based on the requirements of Statement 123 for all awards grantedto employees prior to the effective date of Statement 123(R) that remainunvested on the effective date. (2) A “modified retrospective” method whichincludes the requirements of the modified prospective method described above,but also permits entities to restate based on the amounts previously recognizedunder Statement 123 for purposes of pro forma disclosures either (a) all priorperiods presented or (b) prior interim periods of the year of adoption.

 

The Company is currently evaluating the adoption alternativesand expects to complete its evaluation by December 31, 2005. As permitted byStatement 123, the company currently accounts for share-based payments toemployees using Opinion 25’s intrinsic value method and, as such, generallyrecognizes no compensation cost for employee stock options. Accordingly, the adoptionof Statement 123(R)’s fair value method may have a significant impact on ourresult of operations, although it will have no impact on our overall financialposition. The impact of adoption of Statement 123(R) cannot be predicted atthis time because it will depend on levels of share-based payments granted inthe future. However, had we adopted Statement 123(R) in prior periods, theimpact of that standard would have approximated the impact of Statement 123 asdescribed in the disclosure of pro forma net income and earnings per share inNote 3 to our consolidated financial statements. Statement 123(R) also requiresthe benefits of tax deductions in excess of recognized compensation cost to bereported as a financing cash flow, rather than as an operating cash flow asrequired under current literature. This requirement will reduce net operatingcash flows and increase net financing cash flows in periods after adoption.While the company cannot estimate what those amounts will be in the future(because they depend on,

 

38

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among other things, when employees exercise stock options),there were no operating cash flows recognized in prior periods for such excesstax deductions.

 

**SUBSEQUENTEVENTS**

 

The Company has paid off its credit facilitywith Al Ahli Bank of Kuwait on May 29, 2005 prior to its maturity date ofSeptember 30, 2005. On March 22, 2005, the Company repaid a $7.5 million creditfacility it had with the Commercial Bank of Kuwait by transferring the loan tothe Arab Banking Corporation of Bahrain (“ABC”). The new credit facility withABC is for one year and has an interest rate of 4.63% for six months which willbe adjusted to ABC’s prime rate at September 29, 2005.

 

On August 22, 2005, the Company hired Greg Grosvenor to serveas the Company’s Chief Financial Officer. Previous Chief Financial Officer, BudCurley, resigned to pursue other interests.

 

On September 1, 2005, the Company named NidalZayed acting Chief Executive Officer and President. Mr. Zayed was previouslyExecutive Vice President and Chief Operations Officer of TelesourceInternational. Mr. Zayed replaces Mr. K.J. Semikian, whose contract was notrenewed by the Board.

 

During 2005, the Company issued an additional24,186,543 shares of common stock to existing shareholders, which resulted inapproximately $8,993,271 of proceeds of which approximately $2,593,000 was usedto repay principal and interest due to Al Ahli Bank of Kuwait.

 

On November 9, 2005 the Company issued19,683,078 shares of common stock in exchange for outstanding payables and debtdue SHBC in the amount of $3,936,616.

 

In October 2005, the Company entered into acredit facility agreement up to approximately FJD $350,000 with Australia andNew Zealand Banking Group Limited (“ANZBGL”). Interest will be charged at 7.75% per annum.  This facility is revolving and is subject toannual review.  Also in addition to therevolving credit facility the Company entered into a FJD$200,000 master leaseagreement to purchase motor vehicles.

 

****QUARTERLY RESULTS****

 

The following table sets forth selected unaudited financialinformation for the eight quarters in the period ended December 31, 2004. Thisinformation has been prepared on the same basis as the annual financialstatements and, in the opinion of management, contains all adjustmentsnecessary for a fair presentation thereof.

 

39

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**QUARTERLYFINANCIAL DATA**

(UNAUDITED — INTHOUSANDS, EXCEPT FOR PER SHARE DATA)

 
| ** **                            | ** ** | **2004 QUARTERS ENDED** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|
| ** **                            | ** ** | **MARCH 31**                 | ** ** | **JUNE 30** | ** ** | **SEPT. 30** | ** ** | **DEC. 31** | ** ** |
| Revenue                               |       | $                                 | 2,893      |   | 7,159 |   | 6,959 |   | 3,697 |   |
| Gross profit  (loss)                  |       | $                                 | (3,902     | ) | (506 | ) | (12 | ) | (941 | ) |
| As a percent of  revenue              |       | (134.9                            | )%         | (7.1 | )% | (0.17 | ) | (25.5 | )% |
| Net loss                              |       | $                                 | (6,024     | ) | (2,556 | ) | (1,851 | ) | (3,280 | ) |
| As a percent of  revenue              |       | (208.2                            | )%         | (35.7 | ) | (26.6 | )% | (88.7 | ) |
| Basic and  diluted net loss per share |       | $                                 | (0.33      | ) | (0.14 | ) | (0.10 | ) | (.26 | ) |
| Market price:                         |       |                              |       |   |   |   |   |   |   |
| High                                  |       | $                                 | 1.10       |   | 1.15 |   | .42 |   | .02 |   |
| Low                                   |       | $                                 | .42        |   | .42 |   | .02 |   | .02 |   |

 
| ** **                            | ** ** | **2003 QUARTERS ENDED** | ** ** |
|---------------------------------------|------------|-----------------------------------|------------|
| ** **                            | ** ** | **MARCH 31**                 | ** ** | **JUNE 30** | ** ** | **SEPT. 30** | ** ** | **DEC. 31** | ** ** |
| Revenue                               |       | $                                 | 6,268      |   | 3,443 |   | 6,422 |   | 3,894 |   |
| Gross profit                          |       | $                                 | 1,760      |   | (228 | ) | 117 |   | (780 | ) |
| As a percent of  revenue              |       | 28.1                              | %          | 6.6 | % | 1.8 | % | 20.0 | % |
| Net loss                              |       | $                                 | (192       | ) | (2,248 | ) | (1,965 | ) | (2,225 | ) |
| As a percent of  revenue              |       | (3.1                              | )%         | (65.3 | )% | (30.6 | )% | (57.1 | )% |
| Basic and  diluted net loss per share |       | $                                 | (0.01      | ) | (0.15 | ) | (0.13 | ) | (0.19 | ) |
| Market price:                         |       |                              |       |   |   |   |   |   |   |
| High                                  |       | $                                 | 1.70       |   | 1.50 |   | 1.50 |   | 1.10 |   |
| Low                                   |       | $                                 | 1.25       |   | 1.45 |   | 1.10 |   | 0.55 |   |

 

Net income per share calculations are based on theweighted average common shares outstanding for each period presented.

 

**ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK**

 

Telesource isexposed to market risk for changes in interest rates for borrowings under someof its credit facilities, which bear interest at variable rates. Because thesefacilities bear interest at variable rates, the fair value of the borrowingsare not significantly affected by changes in market interest rates.  A change in interest rates of 1.0% at December31, 2004 would affect Telesource’s interest expense on variable rate loans byapproximately $226,000 per year.

 

Amounts investedin Telesource’s foreign operations (Telesource Fiji, Ltd.) are translated intoU.S. dollars at the exchange rates in effect at year-end. The resultingtranslation adjustments are recorded as accumulated other comprehensive loss, acomponent of stockholders’ equity, in the consolidated balance sheets.

 

* * * * * *

 

40

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**ITEM8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA**

 

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

 

Consolidated Financial Statements

 

December 31, 2004 and 2003

 

(With Independent Auditors’ Report Thereon)

 

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**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

** **

**Tableof Contents**

 
|                                                                          | **Page** |
|-------------------------------------------------------------------------------|----------|
|                                                                          |     |
| Independent Auditors’ Reports                                            | F - 1    |
|                                                                          |     |
| Consolidated Balance Sheets                                                   | F - 3    |
|                                                                          |     |
| Consolidated Statements of Operations                                         | F - 4    |
|                                                                          |     |
| Consolidated Statements of Stockholders’ Deficit and Comprehensive  Loss | F - 5    |
|                                                                          |     |
| Consolidated Statements of Cash Flows                                         | F - 6    |
|                                                                          |     |
| Notes to Consolidated Financial Statements                                    | F - 7    |

 

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REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM

 

To the Board of Directors and Stockholders of

Telesource International, Inc.

 

We have audited the accompanying consolidatedbalance sheets of Telesource International, Inc. and subsidiaries as ofDecember 31, 2004, and the related consolidated statements of operations,stockholders’ deficit and comprehensive loss, and cash flows for the year endedDecember 31, 2004. These consolidated financial statements are theresponsibility of the company’s management. Our responsibility is to express anopinion on these consolidated financial statements based on our audit.

 

We conductedour audit in accordance with the standards of the Public Company Accounting OversightBoard (United States). Those standards require that we plan and perform theaudit to obtain reasonable assurance about whether the financial statements arefree of material misstatement. The company is not required to have, nor were weengaged to perform, an audit of its internal control over financial reporting.Our audit included consideration of internal control over financial reportingas a basis for designing audit procedures that are appropriate in thecircumstances, but not for the purpose of expressing an opinion on theeffectiveness of the company’s internal control over financial reporting.Accordingly, we express no such opinion. An audit also includes examining, on atest basis, evidence supporting the amounts and disclosures in the financialstatements, assessing the accounting principles used and significant estimatesmade by management, as well as evaluating the overall financial statementpresentation. We believe that our audit provides a reasonable basis for ouropinion.

 

In our opinion, the financial statementsreferred to above present fairly, in all material respects, the financialposition of Telesource International, Inc. and subsidiaries as of December 31,2004, and the results of its operations and its cash flows for the year endedDecember 31, 2004 in conformity with accounting principles generally acceptedin the United States of America.

 
| /s/ L J Soldinger  Associates, LLC      |   |
|-----------------------------------------|--------|
|                                    |
| Deer  Park, Illinois                    |
| January  25, 2006, except for Note 19,  |
| as  to which the date is March 10, 2006 |

 

F - 1

 

Report of Independent Registered Public Accounting Firm

 

The Board of Directors

Telesource International, Inc.:

 

We have audited the accompanying consolidated balance sheet of Telesource International, Inc. and subsidiaries (the Company) as of December 31, 2003, and the related consolidated statements of operations,  changes in stockholders’ deficit and comprehensive loss, and cash flows for each of the years in the two-year  period ended December 31, 2003.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement.  An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements.  An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation.  We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Telesource International, Inc. and subsidiaries as of December 31, 2003, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2003 in conformity with accounting principles generally accepted in the United States of America.

 

The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company’s recurring losses and negative cash flows from operations, dependency on its major shareholder for financial support and its net working capital deficiency raise substantial doubt about its ability to continue as a going concern.  Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of these uncertainties.

 
|              |   |   |   | /s/ KPMG LLP |   |   |
|-------------------|--------|--------|--------|--------------|--------|--------|
| Chicago, Illinois |   |   |   |         |   |   |
| June 11, 2004     |   |   |   |         |   |   |

 

F- 2

----

 

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

Consolidated Balance Sheets

 

December 31, 2004 and 2003

 
| ** **                                                                                                                                                                                          | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| **Assets**                                                                                                                                                                                          |       |        |       |        |       |
| Current  assets:                                                                                                                                                                                    |       |        |       |        |       |
| Cash and cash equivalents                                                                                                                                                                           |       | $           | 1,972,729  |        | $          | 1,487,280 |   |
| Accounts receivable less allowance for  doubtful accounts of  $20,678 at December 31, 2004 and $38,972 and December 31, 2003                                                                        |       | 4,840,313   |       | 5,685,485   |       |
| Current portion of net investment in  sales-type lease                                                                                                                                              |       | 1,951,040   |       | 1,776,646   |       |
| Costs and estimated earnings in excess of  billings                                                                                                                                                 |       | 1,379,359   |       | 3,560,452   |       |
| Prepaid expenses and other current assets                                                                                                                                                           |       | 1,763,975   |       | 372,029     |       |
| Total current assets                                                                                                                                                                                |       | 11,907,416  |       | 12,881,892  |       |
| Net  investment in sales-type lease – long term                                                                                                                                                |       | 7,533,885   |       | 9,484,925   |       |
| Property,  plant, and equipment, net                                                                                                                                                                |       | 1,384,676   |       | 2,288,562   |       |
| Other assets                                                                                                                                                                                        |       | 24,757      |       | 128,063     |       |
| Total assets                                                                                                                                                                                        |       | $           | 20,850,734 |        | $          | 24,783,442 |   |
| **Liabilities and Stockholders’ Deficit**                                                                                                                                                      | ** ** | ** **  | ** ** | ** **  | ** ** |
| Current  liabilities:                                                                                                                                                                               |       |        |       |        |       |
| Current portion of long-term debt                                                                                                                                                                   |       | $           | 5,332,340  |        | $          | 9,242,195 |   |
| Accounts payable                                                                                                                                                                                    |       | 4,009,522   |       | 6,236,223   |       |
| Accounts payable – related party                                                                                                                                                               |       | 2,598,948   |       | 657,618     |       |
| Accrued expenses                                                                                                                                                                                    |       | 2,482,899   |       | 1,895,889   |       |
| Billings in excess of costs and estimated  earnings                                                                                                                                                 |       | 108,643     |       | 246,559     |       |
| Accrued losses on contracts in progress                                                                                                                                                             |       | 1,985,557   |       | —      |       |
| Income tax payable                                                                                                                                                                                  |       | —      |       | 74,947      |       |
| Other current liabilities                                                                                                                                                                           |       | —      |       | 86,304      |       |
| Total current liabilities                                                                                                                                                                           |       | 16,517,909  |       | 18,439,735  |       |
| Long-term  debt – related party                                                                                                                                                                |       | 2,580,000   |       | —      |       |
| Long-term  debt                                                                                                                                                                                     |       | 17,493,623  |       | 20,310,222  |       |
| Redeemable  convertible preferred stock (note 10)                                                                                                                                                   |       | —      |       | —      |       |
|                                                                                                                                                                                                |       |        |       |        |       |
| Total liabilities                                                                                                                                                                                   |       | 36,591,532  |       | 38,749,957  |       |
|                                                                                                                                                                                                |       |        |       |        |       |
| Commitments  and contingencies (note 16)                                                                                                                                                            |       |        |       |        |       |
| Stockholders’  deficit:                                                                                                                                                                        |       |        |       |        |       |
| Convertible preferred stock, $0.01 par  value, authorized 50,000,000  shares, issued and none outstanding at December 31, 2004,   issued and outstanding 9,799,999 at December 31, 2003             |       | —      |       | 14,700,000  |       |
| Common stock, $0.01 par value, authorized  100,000,000 shares,   24,400,000 issued and 25,168,519 issuable at December 31, 2004   and 17,000,000 shares issued and outstanding at December 31, 2003 |       | 495,685     |       | 170,000     |       |
| Additional paid-in capital                                                                                                                                                                          |       | 37,860,989  |       | 7,777,225   |       |
| Accumulated deficit                                                                                                                                                                                 |       | (54,082,141 | )          | (36,630,897 | )          |
| Accumulated comprehensive income (loss)                                                                                                                                                             |       | (15,331     | )          | 17,157      |       |
| Total stockholders’ deficit                                                                                                                                                                    |       | (15,740,798 | )          | (13,966,515 | )          |
| Total liabilities and stockholders’ deficit                                                                                                                                                    |       | $           | 20,850,734 |        | $          | 24,783,442 |   |

 

See accompanying notes to consolidatedfinancial statements.

 

F - 3

----

 

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

 

Consolidated Statements of Operations

 

Years ended December 31, 2004, 2003, and 2002

 
| ** **                                                | ** ** | **2004**    | ** **  | **2003**   | ** ** | **2002**   | ** ** |
|-----------------------------------------------------------|------------|-------------|-------------|------------|------------|------------|------------|
| Revenues:                                                 |       |        |        |       |       |       |       |
| Construction revenues                                     |       | $           | 16,023,844  |       | $          | 14,381,282 |       | $ | 16,565,696 |   |
| Construction revenues – related party                |       | —      |        | —     |       | 838,331    |       |
| Service fees – power generation plant                |       | 3,227,009   |        | 2,968,257  |       | 1,130,172  |       |
| Sales, net                                                |       | 23,573      |        | 43,636     |       | 307,378    |       |
| Sales, net – related party                           |       | 89,940      |        | —     |       | 89,998     |       |
| Rental income                                             |       | 288,899     |        | 919,063    |       | 68,209     |       |
| Service fees                                              |       | 72,215      |        | 571,776    |       | 34,640     |       |
| Finance lease revenue                                     |       | 983,354     |        | 1,142,160  |       | 1,286,771  |       |
| Gross revenues                                            |       | 20,708,834  |        | 20,026,174 |       | 20,321,195 |       |
|                                                      |       |        |        |       |       |       |       |
| Costs and  expenses:                                      |       |        |        |       |       |       |       |
| Construction costs                                        |       | 14,161,636  |        | 13,635,711 |       | 15,912,633 |       |
| Construction costs – related party                   |       | 5,185,333   |        | 2,235,434  |       | —     |       |
| Operation and maintenance costs -  power generation plant |       | 2,878,415   |        | 2,588,752  |       | 1,224,202  |       |
| Rental costs                                              |       | —      |        | 541,043    |       | —     |       |
| Costs of service                                          |       | 230,149     |        | 155,902    |       | —     |       |
| Provision for warranty expense                            |       | 300,000     |        |       |       |       |       |
| Provision for losses on contracts in  progress            |       | 1,985,557   |        |       |       |       |       |
| Provision for unbilled and uncollected  accounts          |       | 1,329,058   |        | —     |       | —     |       |
| Cost of revenues                                          |       | 26,070,148  |        | 19,156,842 |       | 17,136,835 |       |
| Gross profit (loss)                                       |       | (5,361,314  | )           | 869,332    |       | 3,184,360  |       |
| Operating  expenses:                                      |       |        |        |       |       |       |       |
| Salaries and employee benefits                            |       | 1,632,936   |        | 1,646,392  |       | 1,702,139  |       |
| Occupancy and equipment                                   |       | 320,533     |        | 380,576    |       | 342,189    |       |
| General and administrative                                |       | 4,849,735   |        | 3,983,401  |       | 4,258,332  |       |
| Impairment of long-lived asset                            |       | 241,970     |        | 76,186     |       | —     |       |
| Total operating expenses                                  |       | 7,045,174   |        | 6,086,555  |       | 6,302,660  |       |
| Operating loss                                            |       | (12,406,488 | )           | (5,217,223 | )          | (3,118,300 | )          |
| Other income  (expense):                                  |       |        |        |       |       |       |       |
| Interest income                                           |       | —      |        | —     |       | 2,768      |       |
| Interest expense, net                                     |       | (1,508,277  | )           | (1,415,701 | )          | (1,791,328 | )          |
| Other income, net                                         |       | 129,015     |        | 71,929     |       | 20,463     |       |
| Total other expense                                       |       | (1,379,262  | )           | (1,343,772 | )          | (1,768,097 | )          |
| Loss before income taxes                                  |       | (13,785,750 | )           | (6,560,995 | )          | (4,886,397 | )          |
| Income tax  expense (benefit)                             |       | (74,435     | )           | 68,446     |       | —     |       |
| Net loss                                                  |       | (13,711,315 | )           | (6,629,441 | )          | (4,886,397 | )          |
| Dividend on  preferred stock                              |       | (3,739,929  | )           | (569,475   | )          | —     |       |
| Net loss to common stockholders                           |       | $           | (17,451,244 | )          | $          | (7,198,916 | )          | $ | (4,886,397 | ) |
| Basic and  diluted net loss per share (note 11)           |       | $           | (0.83       | )          | $          | (0.48      | )          | $ | (0.33 | ) |
| Weighted  average shares outstanding                      |       | 21,108,652  |        | 15,016,438 |       | 15,000,000 |       |

 

See accompanying notes to consolidated financial statements.

 

F - 4

----

 

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

ConsolidatedStatements of Stockholders’ Deficit and Comprehensive Loss

Yearsended December 31, 2004, 2003, 2002, and 2001

 
| ** **                                                                     | ** ** | **Preferred  stock** | ** ** | **Common  stock** | ** **     | **Additional  paid-in  capital** | ** ** | **Accumulated  deficit** | ** ** | **Comprehensive  loss** | ** ** | **Accumulated  comprehensive  Income (Loss)** | ** ** | **Total  stockholders’  deficit** | ** **  |
|--------------------------------------------------------------------------------|------------|----------------------|------------|-------------------|----------------|----------------------------------|------------|--------------------------|------------|-------------------------|------------|-----------------------------------------------|------------|----------------------------------------|-------------|
| **Shares**                                                                     | ** ** | **Value**            | **Shares** | ** **        | **Par  value** |
| Balance at  December 31, 2001                                                  |       | —               |       | $                 | —         |                             | 15,000,000 |                     | $          | 150,000                 |       | $                                             | 5,797,225  |                                   | $           | (24,545,584 | ) | $ | — |   | $ | 32,090 |   | $ | (18,566,269 | ) |
| Net loss                                                                       |       | —               |       | —            |           | —                           |       | —                   |       | —                  |       | (4,886,397                                    | )          | (4,886,397                             | )           | — |   | (4,886,397 | ) |
| Foreign currency  translation adjustment                                       |       | —               |       | —            |           | —                           |       | —                   |       | —                  |       | —                                        |       | (147,983                               | )           | (147,983 | ) | (147,983 | ) |
| Comprehensive  income (loss)                                                   |       |                 |       |              |           |                             |       |                     |       |                    |       |                                          |       | $                                      | (5,034,380  | ) |   |   |   |   |
| Balance at  December 31, 2002                                                  |       | —               |       | —            |           | 15,000,000                       |       | 150,000                  |       | 5,797,225               |       | (29,431,981                                   | )          |                                   |        | (115,893 | ) | (23,600,649 | ) |
| Reclassification  of convertible preferred  stock, 2,000,000 shares (note 9)   |       | 2,000,000            |       | 3,000,000         |           | —                           |       | —                   |       | —                  |       | —                                        |       | —                                 |        | — |   | 3,000,000 |   |
|                                                                           |       |                 |       |              |           |                             |       |                     |       |                    |       |                                          |       |                                   |        |   |   |   |   |
| Sale of  convertible preferred stock -   7,799,999 shares at $1.50 per share   |       | 7,799,999            |       | 11,700,000        |           | —                           |       | —                   |       | —                  |       | —                                        |       | —                                 |        | — |   | 11,700,000 |   |
|                                                                           |       |                 |       |              |           |                             |       |                     |       |                    |       |                                          |       |                                   |        |   |   |   |   |
| Sale of common  stock -   2,000,000 shares at $1.00 per share                  |       | —               |       | —            |           | 2,000,000                        |       | 20,000                   |       | 1,980,000               |       | —                                        |       | —                                 |        | — |   | 2,000,000 |   |
| Preferred dividend                                                             |       | —               |       | —            |           | —                           |       | —                   |       | —                  |       | (569,475                                      | )          | —                                 |        | — |   | (569,475 | ) |
| Net loss                                                                       |       | —               |       | —            |           | —                           |       | —                   |       | —                  |       | (6,629,441                                    | )          | (6,629,441                             | )           | — |   | (6,629,441 | ) |
| Foreign currency  translation adjustment                                       |       | —               |       | —            |           | —                           |       | —                   |       | —                  |       | —                                        |       | 133,050                                |        | 133,050 |   | 133,050 |   |
| Comprehensive loss                                                             |       | —               |       |              |           |                             |       |                     |       |                    |       |                                          |       | $                                      | (6,496,391  | ) |   |   |   |   |
| 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 accrued interest into  Common Stock at $0.50 per share |       | —               |       | —            |           | 12,139,048                       |       | 121,390                  |       | 5,948,134               |       | —                                        |       | —                                 |        | — |   | 6,069,524 |   |
| Net loss                                                                       |       | —               |       | —            |           | —                           |       | —                   |       | —                  |       | (13,711,315                                   | )          | (13,711,315                            | )           | — |   | (13,711,315 | ) |
| Preferred dividend                                                             |       | —               |       | —            |           | —                           |       | —                   |       | —                  |       | (3,551,729                                    | )          | —                                 |        | — |   | (3,551,729 | ) |
| Conversion of  Preferred Stock  dividends into common stock                    |       | —               |       | —            |           | 3,073,979                        |       | 30,740                   |       | 3,043,239               |       | —                                        |       | —                                 |        | — |   | 3,073,979 |   |
| Issuance of  500,000 common stock warrants  granted 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 | ) |
|                                                                                |            |                      |            |                   |                |                                  |            |                          |            |                         |            |                                               |            |                                        |             |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

F- 5

----

 

**TELESOURCE INTERNATIONAL, INC.AND SUBSIDIARIES**

 

Consolidated Statements of Cash Flows

 

Years ended December 31, 2004, 2003, and 2002

 
| ** **                                                                   | ** ** | **2004**   | ** **  | **2003**    | ** ** | **2002**    | ** ** |
|------------------------------------------------------------------------------|------------|------------|-------------|-------------|------------|-------------|------------|
| Cash flows  from operating activities:                                       |       |       |        |        |       |        |       |
| Net loss                                                                     |       | $          | (13,711,315 | )           | $          | (6,629,441  | )          | $ | (4,886,397 | ) |
| Adjustments to reconcile net loss to net cash  used in operating activities: |       |       |        |        |       |        |       |
| Depreciation                                                                 |       | 492,694    |        | 553,845     |       | 501,554     |       |
| (Loss)/Gain on sale of fixed assets                                          |       | (122,658   | )           | 59,808      |       | —      |       |
| Interest expense paid through issuance of  common stock                      |       | 139,524    |        | —      |       | —      |       |
| Provision for unbilled and uncollected  accounts                             |       | 1,329,058  |        | —      |       | —      |       |
| Impairment of long-lived assets                                              |       | 341,392    |        | 76,186      |       | —      |       |
| Changes in assets and liabilities:                                           |       |       |        |        |       |        |       |
| Receivables                                                                  |       | (504,564   | )           | (1,867,217  | )          | (667,651    | )          |
| Prepaid expenses and other current assets                                    |       | (1,371,268 | )           | (110,650    | )          | 126,750     |       |
| Costs and estimated earnings in excess of  billings                          |       | 2,181,093  |        | 2,134,770   |       | (2,742,707  | )          |
| Net investment in sales-type lease                                           |       | 1,776,646  |        | 1,617,840   |       | 1,473,229   |       |
| Other assets                                                                 |       | 103,306    |        | 62,211      |       | 4,573       |       |
| Accounts payable                                                             |       | (2,226,701 | )           | 2,356,859   |       | 842,452     |       |
| Accounts payable - related party                                             |       | 1,941,330  |        | (3,078,665  | )          | 3,330,067   |       |
| Accrued expenses                                                             |       | 2,434,651  |        | (1,628,806  | )          | 197,264     |       |
| Income taxes payable                                                         |       | (74,947    | )           | 74,947      |       | (19,440     | )          |
| Other liabilities                                                            |       | (86,304    | )           | 94,354      |       | (191,487    | )          |
| Net cash used in operating activities                                        |       | (7,358,063 | )           | (6,283,959  | )          | (2,031,793  | )          |
|                                                                         |       |       |        |        |       |        |       |
| Cash flows  from investing activities:                                       |       |       |        |        |       |        |       |
| Proceeds from sale of equipment                                              |       | 460,330    |        | 135,000     |       | 13,922      |       |
| Capital expenditures                                                         |       | (267,872   | )           | (795,784    | )          | (142,158    | )          |
| Net cash provided by (used in) investing  activities                         |       | 192,458    |        | (660,784    | )          | (128,236    | )          |
|                                                                         |       |       |        |        |       |        |       |
| Cash flows  from financing activities:                                       |       |       |        |        |       |        |       |
| Proceeds from long-term debt                                                 |       | 4,250,000  |        | 14,932,483  |       | 11,400,000  |       |
| Proceeds of long-term debt - related party                                   |       | 2,580,000  |        | —      |       | —      |       |
| Payments of long-term debt                                                   |       | (5,046,455 | )           | (20,080,066 | )          | (12,200,000 | )          |
| Proceeds from sale of preferred stock                                        |       | —     |        | 11,700,000  |       | 3,000,000   |       |
| Proceeds from sale of common stock                                           |       | 6,377,747  |        | 2,000,000   |       | —      |       |
| Dividends paid                                                               |       | (477,750   | )           | (365,117    | )          | —      |       |
| Net cash provided by financing activities                                    |       | 7,683,542  |        | 8,187,300   |       | 2,200,000   |       |
| Effect of exchange rate changes on cash                                      |       | (32,488    | )           | —      |       | —      |       |
| Net increase (decrease) in cash and cash  equivalents                        |       | 485,449    |        | 1,242,557   |       | 39,971      |       |
| Cash and  cash equivalents at beginning of year                              |       | 1,487,280  |        | 244,723     |       | 204,752     |       |
| Cash and  cash equivalents at end of year                                    |       | $          | 1,972,729   |        | $          | 1,487,280   |       | $ | 244,723 |   |
| Supplemental  disclosure:                                                    |       |       |        |        |       |        |       |
| Cash paid during the year for interest                                       |       | $          | 1,325,248   |        | $          | 1,968,767   |       | $ | 2,112,655 |   |
| Cash paid during the year for income taxes                                   |       | —     |        | —      |       | 19,440      |       |

 

F- 6

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated Financial Statements

 

**(1)**                     Background

 

Telesource International, Inc. (“Telesource” or the “Company”) wasincorporated in Delaware in 1994. Telesource was formed to facilitate variousintra-corporate activities and, until July 1999, was a wholly ownedsubsidiary of Sayed Hamid Behbehani & Sons Co. W.L.L. (‘SHBC”), a Kuwait-basedcivil, electrical, and mechanical engineering and construction company.Telesource entered into contracts as an international engineering andconstruction company for various projects including airport runways as well asmoving large radio broadcast towers.  Inaddition, Telesource also constructed and manages the operation of energyconversion 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.

 

The Company conducts its operations through two subsidiaries. TheCompany’s Mariana subsidiary, Telesource CNMI, Inc., handles construction andmanagement of the Company’s energy conversion facilities in the Commonwealth ofthe Northern Mariana Islands and operated a branch office in Guam. TheCompany’s second subsidiary, Telesource Fiji, Ltd., handles the Company’s powergeneration activities in Fiji. The Company’s Palau operations were handleddirectly by the Company.

 

Telesource has three main operating segments: power generation andconstruction of power plants construction services and brokerage of goods andservices. The power generation activities commenced in March 1999.

** **

** (2)**                  Summary of Significant AccountingPolicies

*** ***

***(a)***                      Principlesof Consolidation

 

The consolidated financial statements include the accounts of theCompany and its wholly owned subsidiaries: Telesource CNMI Inc., CommsourceInternational, Inc., and Telesource Fiji, Ltd. All significant intercompanytransactions and accounts have been eliminated.

*** ***

***(b)***                      Liquidityand Deficits

 

As of December 31, 2004, the Company’s current liabilitiesexceeded its current assets by $4.3 million. The Company relies heavily onfinancing from banks as well as its principle investors, SHBC to support itsoperations. As of December 31, 2004 the Company had total outstanding debtof $25.4 million of which $5.3 million is due in 2005. As of December 31,2004 the Company had an accumulated deficit of $54.1 million and totalstockholders’ deficit of $15.7 million.

 

The Company incurred a net loss to common stockholders of $17,451,244,$7,198,916 and $4,886,397 for the years ended December 31, 2004, 2003, and2002, respectively.

 

Cash used in operating activities was $7,358,063, $6,283,959, and$2,031,793 for the years ended December 31, 2004, 2003, and 2002,respectively. Funds provided by net borrowings and stock sales amounted to$7,683,542, $8,187,300, and $2,200,000 for the years ended December 31,2004, 2003, and 2002, respectively.

 

F - 7

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated Financial Statements

 

Although the Company has been experiencing a net working capitaldeficiency, as well as recurring losses and negative cash flows fromoperations, the Company continues to raise the necessary funding from itsprinciple shareholder, SHBC.  Subsequentto year-end, the Company completed 28 private common stock placements with netproceeds of $12.9 million in additional capital. During 2005, a new managementteam was promoted and hired to develop a plan to improve operations.  The new management team has begun to assessall business segments and is developing a strategy to improve the financialcondition of the Company.  Managementwill continue to obtain necessary funds and expects to improve profitabilityand cash flow by reducing costs and securing additional projects.  Furthermore, the Company expects to increaserevenues from existing long-term power plant operation and maintenanceagreements as a result of continued expansion on the island of Tinian and inthe country of Fiji. However, no assurance can be given that such increasedrevenues will be achieved.  The Companyhas and expects to continue to seek support from its principal stockholder,SHBC, for its operations, and for working capital needs, debt repayment, andbusiness expansion as may be required. SHBC has continued its support of theCompany.

 

TheCompany’s ability to continue operations is dependent upon raising capitalthrough debt and equity financing.  Therecan be no assurance that the Company will successfully raise the requiredfuture financing on terms desirable to the Company.  If the Company does not obtain the neededfunds, it will likely be required to delay development of its operations, alterits business plan, or in the extreme situation, cease operations.

*** ***

***(c)***                       CashEquivalents

 

Telesource records as cash equivalents all highly liquid short-terminvestments with original maturities of three months or less.

*** ***

***(d)***                      ForeignCurrency

 

All assets and liabilities denominated in foreign currencies are translatedat the exchange rate on the balance sheet date. Revenues, costs, and expensesare translated at average rates of exchange prevailing during the period.Translation adjustments are deferred as a separate component of stockholders’equity. Gains and losses resulting from foreign currency transactions areincluded in the consolidated statements of operations.

*** ***

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

 

As of December 31, 2004, the Company has cash deposits at financial institutionexceeding Federal Deposit Insurance Corporation’s insurance limits by$1,666,154.

*** ***

***(f)***                         RevenueRecognition

 

Revenue from construction contracts and construction revenues on powerplants, with the exception of the power plant constructed on Tinian which isaccounted for using the sales-type lease method of accounting asdiscussed below, is recognized using the percentage-of-completionmethod of accounting, based upon costs incurred and estimated total projectedcosts. Cost of revenue consists of direct costs on contracts, including laborand materials, amounts payable to subcontractors, direct overhead costs,equipment expense (primarily depreciation, maintenance, and repairs), interestassociated with construction projects, and insurance costs. Contractsfrequently extend over a period of more than one year and revisions in cost andprofit estimates during construction are recognized in the accounting period inwhich the facts that require the revision become known. Losses on contracts

 

F - 8

----

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated Financial Statements

 

are provided for in total when determined, regardless of the degree ofproject completion. Claims for additional contract revenue are recognized inthe period when it is probable that the claim will result in additional revenueand the amount can be reasonably estimated.

 

The Company accounts for its leasing activities in accordance with therequirements of 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 leasereceivable at a constant rate using the interest method. Service revenuesreceived from operating and maintaining the Tinian power plant for the durationof the lease are recognized as earned based on actual kilowatt hours ofelectricity produced and delivered to the lessee’s customers. To the extentthat variable payments based on kilowatt-hours of production exceed thefair value of operation and maintenance services provided, the Companyrecognizes such contingent payments as additional finance lease revenue as theyare earned.

 

The Company also receives variable monthly payments as compensation forits production of power. The variable payments are recognized based upon powerproduced and billed to the customer as earned during each accounting period.

 

Revenue from the Company’s brokering of U.S. fabricated goods isrecognized at the time of shipment. The sales revenues for U.S. fabricatedgoods are recognized net of costs of goods sold due to title transferring fromthe manufacturer directly to the Company’s customer, with the risk of lossborne by the customer at the time of transfer. The Company recognizesmanagement fees and energy sales revenue in the period in which the commodityis delivered or at the time the work is performed. Telesource recognizes rentalrevenue on the accrual basis pursuant to contractual arrangements between theCompany and its customers.

*** ***

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

 

Property, plant, and equipment are stated at cost lessaccumulated depreciation. Depreciation is computed using the straight-linemethod at rates sufficient to depreciate the cost over the estimated economiclives of the assets. Depreciable lives used for financial reporting purposesare 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                          |       |

 

Cost and accumulated depreciation are eliminated from the accounts whenassets are sold or retired and any resulting gain or loss is reflected inoperations in the year of disposition.

*** ***

F - 9

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated Financial Statements

 

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

 

The Company accounts for long-lived assets in accordance with theprovisions of Statement of Financial Accounting Standards No. 144, *Accounting for the Impairment of Long-LivedAssets*. This statement requires that long-lived assets andcertain identifiable intangibles be reviewed for impairment whenever events orchanges in circumstances indicate that the carrying amount of an asset may notbe recoverable. 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. During 2004 and 2003 Telesource recognized an asset impairmentcharge of $341,392 and $76,186, respectively, related to certain construction equipment held byTelesource.  See Note 6.

*** ***

***(i)***                         IncomeTaxes

 

Telesource International, Inc., Commsource International, Inc.,Telesource CNMI, Inc., and Telesource Fiji, Ltd. file separate corporationincome tax returns. Telesource International, Inc. and CommsourceInternational, Inc. are U.S. corporations that file separate U.S. corporateincome tax returns. Telesource CNMI, Inc. is a Commonwealth of Northern MarianaIslands corporation and files a corporation tax return for this commonwealth.Telesource Fiji, Ltd. is a Fijian corporation and files a Fijian corporationtax return. There is no corporate income tax in Palau.

 

Deferred income taxes are accounted for under the asset and liabilitymethod. Deferred tax assets and liabilities are recognized for the estimatedfuture tax consequences attributable to differences between the financialstatement carrying amounts of existing assets and liabilities and theirrespective income tax bases. Deferred tax assets and liabilities are measuredusing enacted tax rates expected to apply to taxable income in the years inwhich those temporary differences are expected to be recovered or settled. Theeffect on deferred tax assets and liabilities of a change in tax rates isrecognized in income in the period that includes the enactment date.

 

A valuation reserve is recorded to offset a portion of the deferred taxbenefit if management has determined it is more likely than not that thedeferred tax assets will not be realized.

 

The Company’s subsidiary, Telesource CNMI, Inc., in the Commonwealth ofthe Northern Mariana Islands (CNMI) prepares its corporate income tax returnsbased on 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 $1,081,722, $400,509, and $1,037,861 in 2004, 2003, and 2002, respectively,and are included in general and administrative expenses on the accompanyingconsolidated statements of operations.

*** ***

***(j)***                         Use ofEstimates

 

The preparation of financial statements in conformity with accountingprinciples generally accepted in the United States of America requiresmanagement to make estimates and assumptions that affect

 

F - 10

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated Financial Statements

 

the reported amounts of assets and liabilities and disclosure ofcontingent assets and liabilities at the date of the financial statements andthe reported amounts of revenues and expenses during the reporting period.Actual results could differ from those estimates.

 

Significant estimates used in preparing these financial statementsinclude those assumed in computing profit percentages under thepercentage-of-completion revenue recognition method.  It is at least reasonably probable that theestimates used will change within the next year as the construction projectsare completed.

*** ***

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

 

The Company’s financial instruments include cash and cash equivalents,receivables, short-term debt, accounts payable, and long-term debt.The gross carrying amount of the notes receivable related to the sales-typelease approximates fair value as the notes have been discounted at a rateapproximating the Company’s borrowing rate. The carrying amount of the long-termdebt approximates 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

 

The Company has stock incentive plans that provide for stock-based employee compensation, including the granting of stock options to certain key employees. The plans are more fully described in note 12. The Company accounts for the stock incentive plans in accordance with the recognition and measurement principles of APB Opinion No. 25, *Accounting for Stock Issued to Employees*, and related Interpretations. Under this method, compensation expense is recorded on the date of grant only if the current market price of the underlying stock exceeds the exercise price. Under the Company’s stock incentive plans, stock options are granted at exercise prices that equal the market value of the underlying common stock on the date of grant. Therefore, no compensation expense related to stock options is recorded in the Consolidated Statements of Operations.

 

Statement of Financial Accounting Standards (SFAS) No. 123, *Accounting for Stock-Based Compensation*  (SFAS 123), established accounting and disclosure requirements using a fair-value based method of accounting for stock-based employee compensation plans. As allowed by SFAS 123, the Company has elected to continue to apply the intrinsic value-based method of accounting described above, and has adopted only the disclosure requirements of SFAS 123. The following table illustrates the effect on net loss and loss per share if the fair value-based recognition provisions of SFAS 123 had been applied to all outstanding and unvested awards in each period:

 

F - 11

 

**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated Financial Statements

 
| ** **                                                                                | ** ** | **Years ended December 31,** | ** **  |
|-------------------------------------------------------------------------------------------|------------|------------------------------|-------------|
| ** **                                                                                | ** ** | **2004**                     | ** **  | **2003** | ** ** | **2002** | ** ** |
| Net loss as  reported                                                                     |       | $                            | (13,711,315 | ) | $ | (6,629,441 | ) | $ | (4,886,397 | ) |
| Less stock-based compensation  expense determined under fair  value method for all awards |       | —                       |        | 41,183 |   | 42,810 |   |
| Pro forma net loss                                                                        |       | $                            | (13,711,315 | ) | $ | (6,670,624 | ) | $ | (4,929,207 | ) |
| Basic and  diluted loss per share:                                                        |       |                         |        |   |   |   |   |
| As reported                                                                               |       | $                            | —      |   | $ | (0.48 | ) | $ | (0.33 | ) |
| Pro forma                                                                                 |       | $                            | —      |   | $ | (0.48 | ) | $ | (0.33 | ) |

 

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

 

The Company’s power generation equipment has required maintenanceschedules based upon hours of service and capacity.  The Company accounts for this maintenance ascosts are incurred.

** **

**(3)**                     Customer Concentrations

 

The Company has a concentration of risk with four significantcustomers. The Company was contracted by the Commonwealth Utilities Corporation(CUC) to construct and operate a power generation facility. In March 1999, thepower generation plant became operational. Power revenues from this plant beganin March 1999 and are earned under the terms of a long-term power energyconversion agreement with this customer. Revenues from the CUC were $2.1million, $2.3 million, and $2.4 million for 2004, 2003, and 2002,respectively.  Another significantcustomer is the Commonwealth Ports Authority (CPA). In 2001, the Company wascontracted to construct an airport expansion project on the island of Tinian bythe CPA. The Company recognized revenues of $250,000, $1.8 million, and$10.8 million from the CPA for 2004, 2003, and 2002, respectively. Thethird significant customer is the Department of Public Works (DPW) in theCommonwealth of Northern Mariana Islands. In 2002, the Company was contractedto construct a prison for the DPW on the island of Saipan. The Companyrecognized revenues of $6.6 million, $6.5 million and $3 million for 2004, 2003and 2002 from the DPW. The fourth significant customer is the Fiji ElectricAuthority (FEA). The Company signed a 20-year operations and maintenanceagreement with the FEA in April 2003 and recognized revenues under the contractof $2.3 million and $1.8 million in 2004 and 2003, respectively.

 

In January 2003, the Company was awarded a contract for construction ofthe second phase of the Palau National Capital Relocation Project from TheNational Treasury of Palau.  Revenuesfrom this project were $4.8 million and $860,000 in 2004 and 2003,respectively.  In March 2003, the Companywas awarded a contract by an agency of the US Government Department of State;the Broadcasting Board of Governors International Broadcasting Bureau to expandan existing radio relay broadcast station located in the Commonwealth ofNorthern Mariana Islands.  Revenues fromthis project were $2.7 and $3 million in 2004 and 2003, respectively

 

Upon commissioning of the Company’s power plant on the island of Tinianfor Phase I in March 1999, the Company received 120 promissory notes each inthe amount of $180,000 representing the guaranteed payment due from CUC overthe term of the agreement. The par value balance of promissory notes

 

F - 12

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated Financial Statements

 

outstanding was $9.0 million and $11.2 million as ofDecember 31, 2004 and 2003, respectively. The discounted value of thepromissory notes was $7.4 million and $8.8 million at December 31,2004 and 2003, respectively. Under the agreement the Company also receives amonthly operation and maintenance fee of $50,000 for 120 months.  The discounted value of the operation andmaintenance fee was $2.1 million and $2.5 million at December 31,2004 and 2003, respectively. The promissory notes have been included in theoriginal net investment in sales-type lease as discussed in note 7.Revenues from the Tinian power plant were 10.2% and 10.9% of the Company’srevenues for 2004 and 2003, respectively. Gross receivables for the investmentin sales-type lease were $11,500,000 and $14,260,000 at December 31,2004 and 2003, respectively.

** **

**(4)**                     Accounts Receivable

 

Accounts receivable consist of the following atDecember 31, 2004 and 2003:

 
| ** **                                        | ** ** | **December 31,** | ** ** |
|---------------------------------------------------|------------|------------------|------------|
| ** **                                        | ** ** | **2004**         | ** ** | **2003** | ** ** |
| Construction  contracts completed and in progress |       | $                | 1,698,211  |   | $ | 2,518,583 |   |
| Retainages                                        |       | 3,072,971        |       | 3,175,037 |   |
| Other                                             |       | 89,809           |       | 30,837 |   |
|                                              |       | 4,860,991        |       | 5,724,457 |   |
| Less  allowance for doubtful accounts             |       | 20,678           |       | 38,972 |   |
| Net accounts receivable                           |       | $                | 4,840,313  |   | $ | 5,685,485 |   |

 

Retainages are all due within the next 12 months. The allowancefor doubtful accounts at December 31, 2004 and 2003 were $20,678 and $38,972,respectively.  Direct write-offs ofuncollectible accounts were $1,329,058 in 2004.

** **

F - 13

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

**(5)**       Costsand Estimated Earnings in Excess of Billings on Uncompleted Contracts

 

Long-termconstruction contracts in progress accounted for using the percentage-of-completionmethod consisted of:

 
| ** **                                                                             | ** ** | **December 31,** | ** ** |
|----------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                             | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Costs  incurred on uncompleted contracts                                               |       | $                     | 32,603,724 |   | $ | 34,720,687 |   |
| Estimated  earnings (loss)                                                             |       | (1,277,459            | )          | 2,657,203 |   |
|                                                                                   |       | 31,326,265            |       | 37,377,890 |   |
| Less  billings to date                                                                 |       | 32,041,106            |       | 34,063,997 |   |
|                                                                                   |       | $                     | (714,841   | ) | $ | 3,313,893 |   |
| Included in  the accompanying consolidated balance sheet under the following captions: |       |                  |       |   |   |
| Costs and  estimated earnings in excess of billings                                    |       | $                     | 1,379,359  |   | $ | 3,560,452 |   |
| Billings in  excess of costs and estimated earnings                                    |       | (108,643              | )          | (246,559 | ) |
| Accrued  losses on contracts in progress                                               |       | (1,985,557            | )          | — |   |
|                                                                                   |       | $                     | (714,841   | ) | $ | 3,313,893 |   |

 

See note 3 for adescription of customer concentrations.

 

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

 
| ** **                                      | ** ** | **2004**  | ** ** | **2003**  | ** ** |
|-------------------------------------------------|------------|-----------|------------|-----------|------------|
| Leasehold  improvements                         |       | $         | 192,022    |      | $          | 191,892 |   |
| Transportation  equipment                       |       | 499,980   |       | 701,182   |       |
| Construction  machinery and equipment           |       | 2,760,600 |       | 3,677,753 |       |
| Office  furniture and equipment                 |       | 754,471   |       | 702,191   |       |
| Computer and  communication equipment           |       | 180,193   |       | 176,543   |       |
|                                            |       | 4,387,266 |       | 5,449,561 |       |
| Less  accumulated depreciation and amortization |       | 3,002,590 |       | 3,160,999 |       |
| Net  property, plant, and equipment             |       | $         | 1,384,676  |      | $          | 2,288,562 |   |

 

Total depreciationexpense was $492,694, $553,845, and $501,554 in 2004, 2003, and 2002 respectively.Depreciation for construction machinery and equipment is recognized as aproject expense when appropriate.

 

The Company recognized anasset impairment charge of $341,392 during 2004 attributable to constructionequipment to be sold during 2005 and write off of abandoned assets. The Companyhas reported $241,970

 

F - 14

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

of this impairment inoperating expenses and $99,421 in construction costs. The Company recognized anasset impairment of $76,186 in 2003.

 

**(7)**       Investmentin Sales-type Lease

 

The Company’s contract with Commonwealth UtilitiesCorporation (CUC) for the construction and operation of a power plant on theisland of Tinian is accounted for as a sales-type lease. The minimum leasepayments due under the agreement began upon commissioning of the first phase ofthe power plant and are comprised of a guaranteed monthly payment of $180,000for one hundred and twenty (120) months, and an operation and maintenance feeof $50,000 due monthly for one hundred and twenty (120) months. These minimumlease payments were discounted at an interest rate of 6.74%, which was the ten-yearU.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 Kwhproduced each month. The variable payments are recognized based upon powerproduced and delivered to the customer as earned during each accounting period.Service fees earned in 2004, 2003, and 2002 were not in excess of the estimatedfair value of the services performed.

 

Theoriginal net investment in sales-type lease was recognized in June 1997, thedate the contract was executed. The components of the net investment in sales-typelease are as follows:

 
| ** **                               | ** ** | **December 31** | ** ** | **June 20, 1997  inception** | ** ** |
|------------------------------------------|------------|----------------------|------------|-----------------------------------|------------|
| ** **                               | ** ** | **2004**             | ** ** | **2003**                          | ** ** | ** ** |
| Guaranteed  monthly payment              |       | $                    | 9,000,000  |                              | $          | 11,160,000 |   | $ | 21,600,000 |   |
| Minimum  operation and maintenance fee   |       | 2,500,000            |       | 3,100,000                         |       | 6,000,000 |   |
| Total  minimum lease payments receivable |       | 11,500,000           |       | 14,260,000                        |       | 27,600,000 |   |
| Less  unearned income                    |       | 2,015,075            |       | 2,998,429                         |       | 9,750,000 |   |
| Net  investment in sales-type lease      |       | $                    | 9,484,925  |                              | $          | 11,261,571 |   | $ | 17,850,000 |   |
|                                     |       |                 |       |                              |       |   |
| Current  portion                         |       | $                    | 1,951,040  |                              | $          | 1,776,646 |   |   |
| Long-term  portion                       |       | 7,533,885            |       | 9,484,925                         |       |   |
|                                     |       |                 |       |                              |       |   |
|                                     |       | $                    | 9,484,925  |                              | $          | 11,261,571 |   |   |
|                                          |            |                      |            |                                   |            |  |  |  |  |  |  |  |  |  |  |

 

The future minimum leasepayments to be collected by the Company are $2,760,000 each year through 2008and $460,000 in 2009.

 

F - 15

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

When the Companyrecognized the net investment in sales-type lease at the inception of theagreement in June 1997, the Company also recognized a loss on the sale ofPhase I in the amount of $1,748,713. The Company recognized a loss on the saleof Phase II for the entire amount of the construction costs for Phase II, asthere were no additional minimum lease payments related to this phase. The lossrecognized on the sale of Phase II occurred when the contract for Phase II wasexecuted in November 1998, and amounted to $12,521,457.

 

Phase I of the power plant was commissioned in March of1999. Phase II was commissioned in March of 2000. The Company recognizedpower generation revenues from billings on the Tinian power plant of$1,078,392, $1,131,144, and $1,130,172 for the years ended December 31,2004, 2003, and 2002, respectively.

 

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

 

Long-termdebt consists of the following at December 31, 2004 and 2003:

 
| ** **                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **December 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|
| ** **                                                                                                                                                                                                                                                                                                                                                                                                         | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Bent Marketing Limited loan, bearing  interest of 7% per annum, unsecured and converted on December 31, 2004.                                                                                                                                                                                                                                                                                                 |       | $                     | —     |   | $ | 1,680,000 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |       |   |   |
| Bank of  Hawaii loan, due in quarterly installments of $118,750 and interest payable  monthly at the bank’s prime with the loan maturing on June 3, 2006,  secured by an irrevocable standby letter of credit for $1,250,000 issued by  Bank of New York on behalf of SHBC.                                                                                                                              |       | 1,186,926             |       | 1,662,500 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |       |   |   |
| Bank of  Hawaii loan, due in quarterly installments of $37,491 and interest payable  monthly at the bank’s prime with the loan maturing on June 3, 2006,  secured by an irrevocable standby letter of credit for $1,250,000 issued by  Bank of New York on behalf of SHBC.                                                                                                                               |       | 374,913               |       | 525,017 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |       |   |   |
| Citytrust Bank Loan, borrowings on  $1,000,000 revolving line of credit which expired on December 11, 2004.  Due in 90 days from date of drawdown including interest of 9.5% at December 11,  2004 secured by assignment of specific invoice from billing on the West  Tinian Airport Airside improvement project, guaranteed by Telesource  International Inc. This was paid off in December 2004. |       | —                |       | 430,375 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |       |   |   |
| Kuwait Real Estate Bank loan advances on  $3,000,000 credit line, due in installments of $1,000,000 on June 11,  2003, $1,000,000 on December 11, 2003 and $1,000,000 on April 11,  2004, including Interest of LIBOR + 2.5%. The loan is guaranteed by SHBC.                                                                                                                                       |       | —                |       | 1,000,000 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |       |   |   |
| Commercial Bank of Kuwait (CBK) loan,  restructured during                                                                                                                                                                                                                                                                                                                                                         |       |                  |       |   |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                    |            |                       |            |  |  |  |  |

 

F - 16

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| 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 of SHBC’s Stockholders. In the event the Company defaults on one  installment payment, the entire loan and accrued interest becomes due and  payable. In December 2003, the Company endorsed, in the favor of CBK, 62  CUC promissory notes of $180,000 each totaling $11,160,000. Additionally, a  lien was placed on the Tinian Power Plant. |   | 11,020,000 |       | 13,000,000 |   |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|------------|------------|------------|--------|
| Commercial  Bank of Kuwait loan, due on March 31, 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 stockholders. This loan was refinanced  with a new credit facility obtained from Arab Banking Corporation in March,  2005. (See Note 18).                                                                                                                                                                                                 |   | 7,500,000  |       | 7,500,000  |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |       |       |   |
| Al Ahli Bank  loan due on September 30, 2005 due in payments of 50% of all collections  from the radio relay project in Tinian and the capital project in Palau with  variable interest of 6.25% secured by a guarantee from SHBC. (See Note 18).                                                                                                                                                                                                                                                                                                                                                                             |   | 2,540,494  |       | 3,526,812  |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |       |       |   |
| Sayed Hamid  Behbehani & Sons Co. W.L.L. unsecured loan with the principle  balance due on December 7, 2006, with annual installments of interest at  6.0% of the unpaid balance to be paid on December 7 of each year. This  loan was converted to common stock in 2005. (See Note 18).                                                                                                                                                                                                                                                                                                                        |   | 2,580,000  |       | —     |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |       |       |   |
| ANZ loan due  on October 1, 2005 with interest of 7.75% payable in monthly  installments. This loan was paid in full in September, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |   | 133,903    |       | 117,491    |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |       |       |   |
| 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%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                            |   | 51,526     |       | 80,801     |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |       |       |   |
| VB Holdings  Motor Vehicle due on September 24, 2006 with monthly principal and  interest payments of $1,000. Interest is charged at 7.75%.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |   | 18,201     |       | 29,421     |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |       |       |   |
| Notes payable  to creditors                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |   | 25,405,963 |       | 29,552,417 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |       |       |   |
| Less current  portion                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   | 5,332,340  |       | 9,242,195  |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |   |       |       |       |   |
| Total  long-term debt                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              |   | $          | 20,073,623 |       | $      | 20,310,222 |   |
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |        |            |            |            |        |  |  |

 

F - 17

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

The Company’s debtagreements contain various covenants. The Company was in violation of a debtcovenant with Bank of Hawaii and the Commercial Bank of Kuwait requirement forthe delivery of audited financial statements within 90 days of year-end. TheCompany has obtained waivers from both banks for its financial statementreporting covenant violation.

 

Scheduledmaturities of debt outstanding as of December 31, 2004 are as follows:

 
| Years ending  December 31: |   |       |       |
|---------------------------------|--------|------------|------------|
| 2005                            |   | $          | 5,332,340  |   |
| 2006                            |   | 13,373,623 |       |
| 2007                            |   | 2,160,000  |       |
| 2008                            |   | 2,160,000  |       |
| thereafter                      |   | 2,380,000  |       |
|                            |   | $          | 25,405,963 |   |

 

During 2004, the Company hada debt covenant violation on its loan with the Al Ahli Bank of Kuwait (“ABK”).The debt covenant requires a payment to the bank of 50% of all collections onthe radio relay station project in Tinian and the capitol relocation project inPalau. The Company failed to make the required payments to ABK when thecollections occurred during the last half of 2004. This credit facility wasrenewed on October 3, 2004, with a maturity date of September 30,2005. The Company paid-off the facility during the second quarter of 2005.

 

Subsequent to December 31,2004, the Company repaid its loan with ANZ bank which matured on October 1,2004, and also transferred its loan of $7.5 million with the Commercial Bank ofKuwait to the Arab Banking Corporation (“ABC”). The loan transferred to ABCwill mature on March 31, 2006.

 

**(9)**      401KPlan

 

**The Company has a 401K non-matchingretirement plan named Telesource International, Inc. Retirement Plan (“Plan”).The Plan allows employees who elect to participate, to contribute up to theallowable maximum amount into a fund managed by Aetna.**

 

** (10)**    Stockholder’sEquity

 

***Preferred Stock***

 

On December 9, 2002,the Company entered into a Preferred Stock Subscription Agreement with Al SoorConsulting for Financial Management Co., W.L.L. (Al Soor), whereby Al Sooragreed to purchase 4,000,000 shares of newly designated series A convertiblepreferred stock, at a purchase price of $1.50 per share of Series Aconvertible preferred stock or a total amount of $6,000,000. The sale of the4,000,000 shares of Series A preferred stock occurred in two tranches of2,000,000 shares each on December 16, 2002 and on March 3, 2003.

 

F - 18

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

On March 31, 2003,the Company and Al Soor agreed to restructure the Certificate of Designationunderlying the Series A preferred stock sold to Al Soor in December of2002. The restructuring involved the elimination of the collateral provided toAl Soor, elimination of the redemption feature (the preferred stock was tohave been redeemed by payment of $6.0 million to Al Soor by the Company atmaturity in March 2008 provided that Al Soor had not converted thepreferred stock prior to maturity), added a provision to allow the Company toforce a conversion of the preferred stock to common stock at any time from January 1,2008 to March 31, 2008, and increased the coupon rate for dividends from6.0% to 6.5%. Accumulated dividends are due and payable upon conversion of thepreferred stock into common stock. As a result of the restructuring of theagreement, the preferred stock, which was classified as debt as of December 31,2002, was reclassified into equity.

 

At December 31,2003, the Company had 9.8 million shares of Series A CumulativeConvertible Preferred Stock (The Preferred Shares) outstanding. Holders of thePreferred Shares are entitled to receive cumulative cash dividends at theannual rate of 6.5% or 6.0% per share payable semi-annually.

 

The Preferred Shares wereconvertible, in whole or in part, at the option of the holders thereof, intoshares of common stock on a one-for-one basis for a period of five years fromthe closing date of the Preferred Shares agreement. The Company had the optionto force conversion to common stock for a period of time as defined by each agreement.All accumulated dividends plus any dividends earned up through the forcedconversion date would have been payable to the holder at the time of forcedconversion.

 

Holders of the PreferredShares had no voting rights and the Preferred Shares rank senior as todividends and upon liquidation to the common stock.

 

In 2004, the Company paidpreferred dividends of $477,750 for the six months ended June 30, 2004.

 

During the fourth quarter of2004, the Company agreed to convert all of the preferred stock on a one for onebasis plus the accumulated dividend due of $477,750 on the preferred stock intocommon stock at a conversion price of $1.00 per share. The Company also issuedadditional shares of its common stock as an inducement for the preferredstockholders to convert their preferred stock into common stock. The additionalshares were in lieu of payment of the present value of future preferred stockdividends. In accordance with FAS 84 (Induced Conversion of Convertible Debt anamendment of APB Opinion No. 26) the Company recorded a dividend in theamount of $2.6 million related to the additional shares issued.

 

On July 31, 2004,Telesource International, Inc. held its 2004 annual meeting ofstockholders. At the annual meeting, the stockholders ratified the amendment tothe Company’s Articles of Incorporation to increase the number of authorizedpreferred stock from 10,000,000 to 50,000,000.

 

*CommonStock Offerings*

 

As of December 31,2004, 49,568,519 shares of the Company’s common stock were issued or issuable,and as of December 31, 2003, 17,000,000 shares were issued andoutstanding.

 

The Company sold 1,000,000shares of common stock to an investor, Al Amal Investments, on January 27,2004 at $1 per share. Proceeds from the sale were received by the Company on January 27,2004.

 

The Company issued commonstock to two investors who are related parties during the second quarter of2004 in the amount of 4,200,000 shares at a price of $1.00 per share for atotal consideration of $4,200,000. Subsequent to September 30, 2004 andduring the fourth quarter of 2004, the Company sold

 

F - 19

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

common stock to twoinvestors in the amount of 2,355,493 shares at a price of $0.50 per share for atotal consideration of $1,177,747. During the fourth quarter of 2004, theCompany agreed to convert all of the preferred stock into common stock on a onefor one basis plus the accumulated current and present value of futuredividends due on the preferred stock at a conversion price of $1.00 per share.

 

During the fourth quarter of2004, the Company also agreed to convert debt payable for both principal andinterest to Bent Marketing in the amount of $5,552,024 at a conversion price of$0.50 per share into 11,104,048 shares of common stock. The Company also agreedto convert debt payable for both principal and interest to Solas Investments inthe amount of $517,500 at a conversion price of $0.50 per share into 1,035,000shares of common stock.

 

On September 17, 2004, Telesource issued warrantsto certain Preferred stockholders for the purchase of 500,000 shares ofTelesource’s common stock at an exercise price of $0.50 per share. This wasdone as consideration on deferment of Preferred Stock Dividends which werepayable in 2005. The warrants issued in 2004 will expire five years from thedate of grant. As of December 31, 2004, there were no exercises of thesewarrants. The Company recorded a dividend in the amount of $188,200 related tothe value of the warrants.

 

On December 29,2003, the Company issued 2,000,000 shares of its common stock in a privateplacement transaction for $2,000,000. The investor, Al Amal Investments, is arelated party in that certain of its key executives are also key executives ofSHBC.

 

In 2003, Telesource issued warrants to certainpurchasers of the Preferred shares for the purchase of 2,499,999 shares ofTelesource’s common stock at an exercise price of $1.50 per share. The warrantsissued in 2003 will expire on dates ranging from July 18, 2008 to December 15,2008. As of December 31, 2004 there have been no exercises of thesewarrants.

 

In January 2002,Telesource agreed to issue warrants to SHBC to purchase 1,000,000 shares ofTelesource’s common stock at an exercise price of $3.00 per share in connectionwith SHBC’s agreement to provide a standby letter of credit to Telesource to beused to secure financing with The Hongkong Shanghai Banking CorporationLimited. These warrants expired unexercised on December 31, 2003.

 

In January 2001,2,000,000 warrants were issued to SHBC in connection with an agreement wherebySHBC granted a $10,000,000 letter of credit to the Company. Each warrantallowed SHBC to receive one share of the Company’s common stock at an exerciseprice of $1 per share. The warrants were exercised on June 29, 2001resulting in an additional 2,000,000 shares of the Company’s common stock beingissued.

 

F - 20

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

**(11)**     EarningsPer Share

 

Inaccordance with the disclosure requirements of Statement of FinancialAccounting Standards No. 128, *EarningsPer Share*(SFAS 128), a reconciliation of the numerator anddenominator of basic and diluted earnings per share is provided as follows:

 
| ** **                                                                                             | ** ** | **2004**   | ** **  | **2003**   | ** ** | **2002**   | ** ** |
|--------------------------------------------------------------------------------------------------------|------------|------------|-------------|------------|------------|------------|------------|
| Numerator –  basic and diluted loss per share Net loss                                            |       | $          | (13,711,315 | )          | $          | (6,629,441 | )          | $ | (4,886,397 | ) |
| Less:  Preferred stock dividends                                                                       |       | (3,739,929 | )           | (569,475   | )          | —     |       |
| Net loss  available to common stockholders                                                             |       | $          | (17,451,244 | )          | $          | (7,198,916 | )          | $ | (4,886,397 | ) |
|                                                                                                   |       |       |        |       |       |       |       |
| Denominator – basic and  diluted loss per share – weighted average common shares outstanding |       | 21,108,652 |        | 15,016,438 |       | 15,000,000 |       |
| Basic and  diluted earnings per share                                                                  |       | $          | (0.83       | )          | $          | (0.48      | )          | $ | (0.33 | ) |

 

Fully-vested options topurchase 225,000 shares of common stock granted under the 2000 non-employeedirector stock option plan, and 2,999,999 warrants were outstanding at December 31,2004, but not included in the computation of diluted earnings per share as theeffect of the conversion of these instruments would be anti-dilutive.

 

For 2003, options topurchase 225,000 shares of common stock, 9,799,999 shares of convertiblepreferred stock and 2,499,999 warrants were outstanding at December 31,2003, but not included in the computation of diluted earnings per share as theeffect of the conversion of these instruments would be anti-dilutive.

 

For 2002, options topurchase 225,000 shares of common stock and 3,000,000 shares of convertiblepreferred stock were outstanding but not included in the computation of dilutedearnings per share as the effect of the conversion of these instruments wouldbe anti-dilutive.

 

**(12)**     StockOption Plans

 

The Company has adoptedthe disclosure-only provisions of SFAS 123, *Accounting for Stock-Based Compensation.* Had compensationcost for the Company’s stock option plans been determined using the fair valuemethod of accounting described in SFAS 123, the Company’s net loss wouldhave been equal to the pro forma amounts indicated in note 2 of the notesto consolidated financial statements.

 

F - 21

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

For purposes of calculating the compensation costconsistent with SFAS 123, the fair value of each option grant is estimatedon the date of grant using the binomial option-pricing model with the followingweighted average assumptions used for grants in 2003 and 2002:

 
| ** **                 | ** ** | **2003** | ** ** | **2002** | ** ** |
|----------------------------|------------|----------|------------|----------|------------|
| Risk free  interest rate   |       | 4        | %          | 4        | %          |
| Expected  volatility       |       | 30       | %          | 30       | %          |
| Expected  lives (in years) |       | 8        |       | 8        |       |
| Expected  dividend yield   |       | —   |       | —   |       |

 

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

 

In January 2001, the Company’s board of directorsadopted the 2000 Non-Employee Director’s Stock Option Plan that provides forthe issuance of nonqualified stock options to outside directors. Under theterms of this plan, under which 285,000 shares of common stock were reservedfor issuance, options to purchase common stock are granted at not less thanfair market value, become exercisable over a 3 year period from the dateof grant (vesting occurs annually on the grant date at 33.3% of the grant), andexpire 10 years from the date of grant.

 

Changesin options outstanding are summarized as follows:

 
| ** **                                             | ** ** | **December 31, 2004**    | ** ** | **December 31, 2003** | ** ** | **December 31, 2002**    | ** ** |
|--------------------------------------------------------|------------|-------------------------------|------------|----------------------------|------------|-------------------------------|------------|
| ** **                                             | ** ** | **Weighted  average  shares** | ** ** | **Exercise  price**        | ** ** | **Weighted  average  shares** | ** ** | **Exercise  price** | ** ** | **Weighted  average  shares** | ** ** | **Exercise  price** | ** ** |
| Options  outstanding at January 1                 |       | 225,000                       |       | $                          | 1.25       |                          | 225,000    |   | $ | 1.25 |   | 225,000 |   | $ | 1.25 |   |
| Granted                                                |       | —                        |       |                       |       | —                        |       |   |   | — |   | — |   |
| Exercised                                              |       | —                        |       |                       |       | —                        |       |   |   | — |   | — |   |
| Cancelled                                              |       | —                        |       |                       |       | —                        |       |   |   | — |   | — |   |
| Options  outstanding at December 31               |       | 225,000                       |       | 1.25                       |       | 225,000                       |       | 1.25 |   | 225,000 |   | 1.25 |   |
| Options  exercisable at December 31               |       | 225,000                       |       | 1.25                       |       | 225,000                       |       | 1.25 |   | 150,000 |   | 1.25 |   |
| Shares  available for future grant at December 31 |       | 60,000                        |       |                       |       | 60,000                        |       |   |   | 60,000 |   |   |   |
|                                                        |            |                               |            |                            |            |                               |            |  |  |  |  |  |  |  |  |  |

 

***2000 IncentiveStock Option Plan***

 

In January 2001, theCompany’s board of directors adopted the 2000 Incentive Stock Option Plan thatprovides for the issuance of qualified stock options to employees. Under theterms of this plan, under which 888,000 shares of common stock were reservedfor issuance, options to purchase common stock are granted at not less thanfair market value, become exercisable over a 3 year period from the dateof grant (vesting occurs annually on the grant date at 33.3% of the grant), andexpire 10 years from the date of grant. As of December 31, 2004, nooptions had been awarded under this plan.

 

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

 

In January 2001, theCompany’s board of directors adopted the 2000 Non-Qualified Stock Option Planthat provides for the issuance of nonqualified stock options to employees.Under the terms of this plan, under which 27,000 shares of common stock werereserved for issuance, options to purchase common stock are

 

F - 22

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

granted at less than fairmarket value, become exercisable immediately on the date of grant, and expire10 years from the date of grant. As of December 31, 2004, no optionshad been awarded under this plan.

 

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

 

Derivative financialinstruments – Historically the Company has not engaged in hedging activitiesand currently does not hold any hedging instruments to minimize foreignexchange rate or interest risk.

 

Standby letters of creditand financial guarantees – The Company is liable for its obligations, some ofwhich are further secured under letters of credit obtained by SHBC on behalf ofthe Company, and other financial guarantees totaling approximately $9.1 millionand $15.1 million at December 31, 2004 and 2003, respectively. The Company’smanagement does not believe it is practicable to estimate the fair values ofthese financial instruments and does not expect any losses from theirresolution.

 

**(14)**     Related-partyTransactions

 

Certain of the Company’sexecutive officers, directors, and major stockholders are also owners,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 July 1999and now own approximately 85% of the common stock outstanding. SHBC andTelesource International bid and compete within the same industries; however,SHBC has agreed, in writing, not to bid projects within the United States andits possessions. Additionally, SHBC and its majority stockholders, Fouad Behbehaniand Nasrallah Behbehani, have signed as guarantors on Telesource CNMI’spromissory note with the Commercial Bank of Kuwait, New York Branch. SHBC andits majority stockholders have also signed as guarantors on a $1,250,000 letterof credit issued to the Bank of Hawaii to secure a $1,250,000 credit facility.These credit facilities were used to finance the construction activities on thepower plant, the West Tinian Airport expansion project, and to providefinancing for other projects. See note 8.

 

Additionally, from timeto 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. During 2003, the Company hired SHBCemployees to provide assistance on a service contract to complete a survey ofradio transmissions in Iraq. The rates paid did not exceed the fair marketvalue of similar services provided by unrelated third parties. The Company didnot hire any SHBC employees to provide assistance on contracts during 2004.

 

Thefollowing table provides a summary of financial information related to allservices provided to SHBC by the Company:

 
| ** **                    | ** ** | **Years ended December 31,** | ** ** |
|-------------------------------|------------|-----------------------------------|------------|
| ** **                    | ** ** | **2004**                          | ** ** | **2003** | ** ** | **2002** | ** ** |
| Construction  revenues        |       | $                                 | —     |   | $ | — |   | $ | 838,331 |   |
| Sales                         |       | 89,940                            |       | — |   | 89,998 |   |
| Total  related party revenues |       | $                                 | 89,940     |   | $ | — |   | $ | 928,329 |   |

 

F - 23

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

Thefollowing table summarizes all balances related to transactions with SHBC as December 31,2004 and 2003:

 
| ** **                 | ** ** | **December 31,** | ** ** |
|----------------------------|------------|-----------------------|------------|
| ** **                 | ** ** | **2004**              | ** ** | **2003** | ** ** |
| Accounts  payable to SHBC  |       | $                     | 2,490,410  |   | $ | 657,618 |   |
| Other  current liabilities |       | —                |       | — |   |
|                            |            |                       |            |  |  |  |  |

 

The balance of accountspayable to SHBC was substantially due to costs of materials purchased by SHBCon behalf of Telesource for use on the airport and prison projects. Inaddition, the Company purchased various materials and equipment from SHBC inthe amount of $5.2 million and $2.2 million during 2004 and 2003, respectively.These materials and equipment were primarily for the prison project in Saipanand the projects on Guam and Palau.

 

The Company held aninvestment in Telebond Insurance Corporation at December 31, 2003 in theamount of $77,695. On November 9, 2004, the Company sold its investment inTelebond for $90,000 and recognized a gain of the sale in the amount of $4,194.The Company purchased insurance from Telebond and paid premiums of $130,349,$45,863, and $59,760 during the years ended December 31, 2004, 2003, and2002, respectively. Telebond provides 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.

 

The Company paidComputhink, Inc. a total of $84,623 in 2004. The payments to Computhink, Inc.cover rent for office space occupied by the Company and for computer hardwareand software provided by Computhink, Inc. K.J. Semikian, the Company’sChief Executive Officer, and Nidal Zayed, the Company’s Chief OperatingOfficer, serve on the Board of Directors for Computhink. The Company owedComputhink payables of $34,838 as of December 31, 2004. See note 16.

 

The Company sold2,000,000 shares of common stock to Ernil Continental (a related party) and2,200,000 shares of common stock to Halbarad Group Ltd. (a related party)during the second quarter of 2004 at a price of $1.00 per share for a totalconsideration of $4,200,000. During the fourth quarter of 2004, the Companysold 1,185,521 shares of common stock to Ernil Continental (a related party)and 1,169,972 shares of common stock to Halbarad Group Ltd. (a related party)at a price of $0.50 per share for a total consideration of $1,177,747.

 

F - 24

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

**(15)**     IncomeTaxes

 

Incometax expense (benefit) consists of:

 
| ** **                          | ** ** | **Current** | ** ** | **Deferred** | ** ** | **Total** | ** ** |
|-------------------------------------|------------|-------------|------------|--------------|------------|-----------|------------|
| Year ended December 31,  2004: |       |        |       |         |       |      |       |
| U.S. Federal                        |       | $           | —     |         | $          | —    |       | $ | — |   |
| State and  local                    |       | —      |       | —       |       | —    |       |
| U.S.  possession                    |       | —      |       | —       |       | —    |       |
| Foreign                             |       | (74,435     | )          | —       |       | (74,435   | )          |
|                                |       | $           | (74,435    | )            | $          | —    |       | $ | (74,435 | ) |
| Year ended December 31,  2003: |       |        |       |         |       |      |       |
| U.S. Federal                        |       | $           | —     |         | $          | —    |       | $ | — |   |
| State and  local                    |       | —      |       | —       |       | —    |       |
| U.S.  possession                    |       | —      |       | —       |       | —    |       |
| Foreign                             |       | 68,446      |       | —       |       | 68,446    |       |
|                                |       | $           | 68,446     |         | $          | —    |       | $ | 68,446 |   |
| Year ended December 31,  2002: |       |        |       |         |       |      |       |
| U.S. Federal                        |       | $           | —     |         | $          | —    |       | $ | — |   |
| State and  local                    |       | —      |       | —       |       | —    |       |
| U.S.  possession                    |       | —      |       | —       |       | —    |       |
| Foreign                             |       | —      |       | —       |       | —    |       |
|                                |       | $           | —     |         | $          | —    |       | $ | — |   |

 

The foreign tax expense(benefit) was incurred in connection with the Company’s operations in Fiji andis based upon earnings (loss) within Fiji. The average tax rate for Fiji was31%. In 2004, 2003, and 2002 the Company recorded a loss for financialreporting purposes as well as a loss for income tax reporting purposes andtherefore, no current U.S. income tax expense has been reflected in theaccompanying consolidated statements of operations.

 

F - 25

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

Thetax effects of temporary differences that give rise to significant portions ofthe deferred tax assets and deferred tax liabilities at December 31, 2004and 2003 are presented below:

 
| ** **                                                       | ** ** | **2004**    | ** ** | **2003**    | ** ** |
|------------------------------------------------------------------|------------|-------------|------------|-------------|------------|
| Deferred tax  assets:                                            |       |        |       |        |       |
| Contribution  carryover                                          |       | $           | 10,000     |        | $          | 10,000 |   |
| Net  operating loss carryforwards                                |       | 14,700,000  |       | 12,561,047  |       |
| Accrued  expenses                                                |       | 202,500     |       | 204,123     |       |
| Total gross  deferred tax assets                                 |       | 14,912,500  |       | 12,775,170  |       |
| Less  valuation allowance                                        |       | (14,912,500 | )          | (12,604,716 | )          |
| Net deferred  tax asset                                          |       | $           | —     |        | $          | 170,454 |   |
| Deferred tax  liability – excess tax over book depreciation |       | $           | —     |        | $          | (170,454 | ) |

 

The difference betweenthe expected income tax benefit and the actual is attributable to the valuationallowance.

 

The valuation allowancefor deferred tax assets as of December 31, 2004 and 2003 was $14,912,500and $12,604,716 respectively. The net change in the total valuation allowancefor the years ended December 31, 2004 and 2003 was an increase of$2,307,784 and an increase of $2,790,154, respectively. In assessing therealizability of deferred tax assets, management considers whether it is 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.

 

At December 31,2004, the Company has total net operating loss carryforwards from U.S.operations of approximately $9 million and approximately $33 million and$215,000 from its operations in the Commonweath of Northern Mariana Islands andFiji, respectively. The net operating loss carryforwards expire in the years2017 through 2024. Certain of these net operating losses may be subject toa limitation on future utilization due to ownership changes or foreign taxlaws.

 

**(16)**     Commitmentsand Contingencies

 

Minimumrental commitments under all noncancelable-operating leases, primarily relatedto property, vehicles, and construction equipment, in effect at December 31,2004 are:

 

F - 26

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 
| Years ending  December 31: |   |    |    |
|---------------------------------|--------|---------|---------|
| 2005                            |   | $       | 136,693 |   |
| 2006                            |   | 106,885 |    |
| 2007                            |   | 45,182  |    |
| 2008                            |   | 5,274   |    |
|                            |   | $       | 294,034 |   |

 

Lease expense was$169,270, $242,120, and $181,043 for the years ended December 31, 2004,2003, and 2002, respectively.

 

On May 1, 2005, theCompany entered into a sublease with Computhink, Inc. for a term of twoyears. The sublease requires a base rental amount of $5,332 per month whichincludes rent and reception services.

 

Mr. KhajadourSemikan, the Company’s Chief Executive Officer, had an employment agreementwith the Company. His agreement was not renewed by the Board and his employmentwith the Company was terminated in August of 2005. Mr. Bud Curley,the Chief Financial Officer of Telesource, resigned from his position in August of2005. Mr. Nidal Zayed was appointed Acting Chief Executive Officer by theBoard in September, 2005. In addition, Mr. Greg Grosvenor was hired as theChief Financial Officer of Company in August 2005. Mr. Grosvenor doesnot have an employment contract with the Company. Telesource entered into anemployment agreement with Khajadour Semikian in June 1999, Nidal Zayed in August 1999,and Bud Curley in April 2001. The term of the agreement with Mr. Semikianwas from July 1, 1999 to July 1, 2002, which was extended to July 3,2004. Under the terms of the agreement, Mr. Semikian was required todevote his full time to the Company’s business. The Company agreed to pay himan annualized base salary of $220,000 during 1999, increased to $270,000 in2000. During 2004, the Company’s Board of Directors reduced Mr. Semikian’ssalary to $216,000. Mr. Semikian did not receive any cash bonuses which,if awarded, would have been at the Board’s discretion.

 

The term of the agreementwith Mr. Zayed was from September 1, 1999 to September 1, 2002,and was extended to July 3, 2004 and expired. Under the terms of theagreement, Mr. Zayed’s responsibilities comprise serving as the number twooperating officer accountable for the full range of operations. The Company hasagreed to pay him an annualized base salary of $125,000 per year for the termof the agreement. The payment of cash bonuses to Mr. Zayed will be at theBoard’s discretion. The Company has also agreed to provide Mr. Zayed withhealth insurance for him and his family along with a company car. Effectivewith the termination of Mr. Semikian’s employment, Mr. Zayed hasbecome the Company’s Acting CEO. His salary was increased to $165,000.

 

The term of the originalagreement with Mr. Curley was from April 1, 2001 to October 1,2003, and was renewed to October 1, 2005. As noted earlier, Mr. Curleyresigned his position in August of 2005. Under the terms of the agreement,Mr. Curley was required to devote his full time to the Company’s business.The Company agreed to pay him an annualized base salary of $165,000 during theperiod from April 1, 2001 to October 31, 2001, and $175,000 from November 1,2001 to October 1, 2005. The payment of cash bonuses to Mr. Curley,for which he received none, would have been at the Board’s discretion. TheCompany agreed to provide Mr. Curley with health insurance for him and hisfamily during his employment. The Company also agreed to provide Mr. Curleywith a $10,000 per year car allowance during the term of his agreement.

 

F - 27

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

The Company is involvedin various litigation proceedings arising in the ordinary course of business.In the opinion of management, the ultimate disposition of these matters willnot have a material adverse effect on the Company’s financial position, resultsof operations, or liquidity.

 

TheCommonwealth Port Authority (“CPA”) and Telesource are currently innegotiations over the final billing for the West Tinian Airport Project (“WTA”).As of December 31, 2004, Telesource has reflected approximately $1.8million of retentions in accounts receivable related to the WTA. Approximately $891,000of the outstanding retention receivable was collected in 2005 in connectionwith a partial settlement agreement 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 workperformed outside of the original scope of the contract. No revenue for thisadditional work has been reflected in the accompanying consolidated financialstatements. Although CPA has acknowledged that work was performed outside ofthe original contract scope, it has requested additional documentation beforeit will make a final determination regarding payment on the additional work andthe retentions. CPA claims they are due approximately $468,000 in liquidateddamages related to delay of completion. Telesource is disputing those claimsand believes that the resolution of this matter will not have a materialadverse effect on its financial condition. The Company had a continuingwarranty obligation for three years from the date of final acceptance for whichthere were no material claims.

 

The Company, in 1999 wasawarded a contract to build 45 housing units for the Northern Marina HousingAgency, a government unit. The houses were built and subsequently occupied. Certainhomeowners in this housing project have threatened a lawsuit against Telesourceand two other parties. In accordance with generally accepted accountingprinciples, the Company was required to record an estimated liability of$300,000 for certain unsubstantiated claims. These claims involve allegationsof various construction defects. Telesource has denied any liability and willaggressively defend itself to dismiss these claims.

 

Telesource International’spower generation activities involve significant risks of environmental damage,equipment damage and failures, personal injury and fines and costs imposed byregulatory agencies. Though management believes its insurance programs areadequate, if a liability claim is made against it, or if there is an extendedoutage or equipment failure or damage at Telesource International’s power plantfor which it is inadequately insured or subject to a coverage exclusion, andTelesource International is unable to defend against these claims successfullyor obtain indemnification 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 $3,042,000 USD at December 31, 2004).

 

Telesource Internationaloffers warranties on its construction services and power generating plants. TelesourceInternational does not maintain any material warranty reserves because thesewarranties are usually backed by warranties from its vendors. Should TelesourceInternational be required to cover the cost of repairs not covered by thewarranties of Telesource International’s vendors or should one of TelesourceInternational’s major vendors be unable to cover future warranty claims,Telesource International could be required to outlay substantial funds, whichcould harm its financial condition.

 

The Company has anagreement with the Commonwealth of the Northern Mariana Islands to manage oneof their power plants. In accordance with Change Order No. 3 of thisagreement, the Company is required to upgrade the power distribution system incertain areas of the Tinian Island. The Company is responsible

 

F - 28

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

for the costs of theupgrade which include labor and material. The Company estimates the cost ofthis upgrade to be approximately in the range of $800,000 to $1.3 million andto be completed in 2006.

 

**(17)**     BusinessSegment Information

 

Telesourcehas three operating segments: power generation and construction of powerplants, trading, and construction services. The power generation andconstruction of power plants segment includes sales-type lease revenuesrecognized. There were no material amounts of transfers between segments. Anyinter segment revenues have been eliminated. The following table sets forthcertain segment information for the periods indicated:

 
| ** **                     | ** ** | **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 income  (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 |   |
|                                |            |                                                            |            |  |  |  |  |  |  |  |  |  |  |

 
| ** **                     | ** ** | **December 31, 2003**                                 | ** ** |
|--------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                     | ** ** | **Power  generation  and  construction  of power  plants** | ** ** | **Trading** | ** ** | **Construction** | ** ** | **Total** | ** ** |
| Revenue                        |       | $                                                               | 4,110,417  |   | $ | 72,494 |   | $ | 15,843,263 |   | $ | 20,026,174 |   |
| Interest  expense, net         |       | 1,415,703                                                       |       | — |   | (2 | ) | 1,415,701 |   |
| Depreciation  and amortization |       | 71,492                                                          |       | 22,502 |   | 459,851 |   | 553,845 |   |
| Income tax  expense            |       | 68,446                                                          |       | — |   | — |   | 68,446 |   |
| Net loss                       |       | (553,204                                                        | )          | — |   | (6,076,237 | ) | (6,629,441 | ) |
| Total  capital expenditures    |       | —                                                          |       | — |   | 795,784 |   | 795,784 |   |
| Total assets                   |       | 14,682,813                                                      |       | 3,569,685 |   | 6,530,944 |   | 24,783,442 |   |
|                                |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |

 

F - 29

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 
| ** **                     | ** ** | **December 31, 2002**                                 | ** ** |
|--------------------------------|------------|-----------------------------------------------------------------|------------|
| ** **                     | ** ** | **Power  generation  and  construction  of power  plants** | ** ** | **Trading** | ** ** | **Construction** | ** ** | **Total** | ** ** |
| Revenue                        |       | $                                                               | 2,416,943  |   | $ | 397,376 |   | $ | 17,506,876 |   | $ | 20,321,195 |   |
| Interest  income               |       | —                                                          |       | — |   | 2,768 |   | 2,768 |   |
| Interest  expense              |       | 1,791,328                                                       |       | — |   | — |   | 1,791,328 |   |
| Depreciation  and amortization |       | 4,125                                                           |       | 22,502 |   | 474,927 |   | 501,554 |   |
| Income tax  expense            |       | —                                                          |       | — |   | — |   | — |   |
| Net loss                       |       | (602,712                                                        | )          | (233,465 | ) | (4,050,220 | ) | (4,886,397 | ) |
| Total  capital expenditures    |       | —                                                          |       | 37,083 |   | 105,075 |   | 142,158 |   |
| Total assets                   |       | 14,053,008                                                      |       | 3,592,187 |   | 7,515,140 |   | 25,160,335 |   |
|                                |            |                                                                 |            |  |  |  |  |  |  |  |  |  |  |

 

The basis used toattribute revenues to individual countries is based upon where the services areprovided.

 

The power generationsegment includes revenues from the Company’s power station on Tinian,Commonwealth of the Northern Mariana Islands in the amounts of $2,061,746,$2,273,304, and $2,416,943 for 2004, 2003, and 2002, respectively. Powergeneration revenues for 2004 also include revenues from the Company’s operationand maintenance of three power plants in Fiji in the amount of $2,148,617.

 

Revenues from the Company’srelated party, SHBC, were $89,940, none, and $928,329 for 2004, 2003, and 2002,respectively. All other revenues recognized within the construction segment forall periods presented were earned in the Commonwealth of Mariana Islands.

 

Revenues generated by theCompany’s Guam office were $72,494, $72,494, and $307,378 for 2004, 2003, and2002, respectively. All other revenues recognized within the trading segmentfor all periods presented were earned in the United States.

 

Long-lived assets locatedin the Commonwealth of the Northern Mariana Islands were $8.9, $11.5 million,and $13.7 million as of December 31, 2004, 2003, and 2002, respectively.Long-lived assets located in Fiji were $141,339, $159,390 and $12,206 as of December 31,2004, 2003, and 2002, respectively. Long-lived assets located in Palau werenone and $38,207 as of December 31, 2004 and 2003, respectively and zeroin 2002.

 

**(18)**     SubsequentEvents

 

Subsequent to December 31, 2004

 

The Company has transferred its creditfacility of $7.5 million with the Commercial Bank of Kuwait to the Arab BankingCorporation with a new maturity date of March 31, 2006. The Companyrenewed and extended its loans with the Al Ahli Bank of Kuwait with a newcurrent maturity date of September 30, 2005; however, on May 29,2005, the Company’s debt to the Al Ahli Bank of Kuwait was repaid by theshareholder in a debt for stock transaction.

 

F - 30

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

During 2005, the Company issued anadditional 24,186,543 shares of common stock to existing shareholders, whichresulted in approximately $8,993,271 of proceeds of which approximately$2,593,000 was used to repay principal and interest due to Al Ahli Bank ofKuwait.

 

On August 22, 2005, theCompany hired Greg Grosvenor to serve as the Company’s Chief Financial Officer.Previous Chief Financial Officer, Bud Curley, resigned to pursue otherinterests.

 

On September 1, 2005, the Companynamed Nidal Zayed acting Chief Executive Officer and President. Mr. Zayedwas previously Executive Vice President and Chief Operations Officer ofTelesource International. Mr. Zayed replaces Mr. K.J. Semikian, whosecontract was not renewed by the Board.

 

On November 9,2005 the Company issued 19,683,078 shares of common stock in settlement ofoutstanding payables and debt due SHBC in the amount of $3,936,616.

 

In October 2005, the Company enteredinto a credit facility agreement up to approximately FJD350,000 with Australiaand New Zealand Banking Group Limited (“ANZBGL”). Interest will be charged atthe rate of 7.75% per annum. This facility is revolving and is subject toannual review. Also in addition to the revolving credit facility the Companyentered into a FJD200,000 master lease agreement to purchase motor vehicles.

 

The Company is completing theconstruction projects currently under contract, however, they are not activelybidding on additional construction contracts.

 

**(19)****    ****Additional Subsequent Events**

 

The Company accounts for its constructioncontracts in accordance with SOP 81-1 which requires when the current estimatesof total contract revenue and contract costs indicate a loss, a provision forthe entire loss on the contract should be made. Provisions for losses should bemade in the period in which they become evident. Additional information thatenhances and refines the estimating process obtained after the balance sheetdate but before the issuance of the financial statements should result in anadjustment of the unissued financial statements. In March 2006, theCompany determined that approximately $145,000 additional costs were incurredon a project than originally estimated and this project would now result in aloss. A provision for this additional loss of approximately $68,000 has beenaccrued in the accompanying financial statements.

 

**(20)****    ****Supplementary Disclosure of CashFlow Information**

 

During 2004 and 2003, theCompany had some non-cash transactions as follows:

 

During the fourth quarter of2004, the Company agreed to convert all of the preferred stock outstanding into9,799,999 shares of common stock on a one for one basis. The Company alsoagreed to convert all the accumulated dividends of $477,750 into 477,750 sharesof common stock. The Company also issued 2,596,229 shares of common stock as aninducement for the preferred stockholders to convert their preferred stock intocommon stock. (See note 10).

 

F - 31

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**TELESOURCEINTERNATIONAL, INC.AND SUBSIDIARIES**

 

Notes to Consolidated FinancialStatements

 

During the fourth quarter of2004, the Company agreed to convert debt payable for both principal andinterest to Bent Marketing in the amount of $5,552,024 at a conversion price of$0.50 per share into 11,104,048 shares of common stock. The Company also agreedto convert debt payable for both principal and interest to Solas Investments inthe amount of $517,500 at a conversion price of $0.50 per share into 1,035,000shares of common stock.

 

In 2004, the Companyrecorded a dividend of $188,200 related to 500,000 warrants granted topreferred stockholders for deferment of 2005 preferred dividends.

 

In 2003, the Companyreclassified $3,000,000 of preferred stock.

 

F - 32

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**ITEM8A. EQUITY COMPENSATION PLAN INFORMATION**

 

Shown below isinformation as of December 31, 2004 with respect to the shares of Common Stockthat may be issued under Telesource’s equity compensation plans.

 
| ** **                                          | ** ** | **Number of shares to be  issued upon exercise  of outstanding options** | ** ** | **Weighted average exercise  price of outstanding options** | ** ** | **Number of shares  remaining available  for future issuance  under equity  compensation plans** | ** ** |
|-----------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity  compensation plans approved by shareholders |       | 225,000                                                                                                          | (1)        | $                                                                                    | 1.25       |                                                                                                                                | 975,000    | (2) |
|                                                     |            |                                                                                                                  |            |                                                                                      |            |                                                                                                                                     |            |  |

 

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(1)          Includes thenumber of shares that may be issued upon the exercise of outstanding options topurchase shares of Telesource Common Stock under Telesource’s stock optionplans.

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

 

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**ITEM 9. CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

Change inRegistrants’ Certifying Accountants

 

As reported in theCompany’s August 2, 2004 Form 8K filed with the Securities and ExchangeCommission, the Company changed auditors from the previous firm of KPMG LLPeffective with their resignation on July 28, 2004.

 

In connection withthe audits of the previous two fiscal years ended December 2003, and throughthe date of KPMG LLP’s resignation on July 28, 2004, there were nodisagreements on any matter of accounting principles or practices, financialstatement disclosure or auditing scope or procedures, which disagreements ifnot resolved to KPMG LLP’s satisfaction, would have caused KPMG to makereference in connection with their opinion of the subject of the disagreement.

 

Effective July 28,2004, the Company engaged LJ Soldinger Associates, LLC as its new independentregistered public accountants.  Thedecision to engage LJ Soldinger Associates, LLC was made and approved by theAudit Committee of the Board of Directors.

 

During the mostrecent fiscal years and through July 28, 2004, the Company has not consultedwith LJ Soldinger Associates, LLC either: 1) the application of accountingprinciples to a specified transaction, either completed or proposed; or thetype of audit opinion that might be rendered on the Company’s financialstatements or ii) any matter that was either subject of a disagreement, as thatterm is defined in Item 304 (a) (1) (iv) of Regulation S-K.

 

**ITEM 9A. CONTROLS AND PROCEDURES**

 

Telesource International is committed to maintaining disclosurecontrols and procedures that are designed to ensure that information requiredto be disclosed in its Exchange Act reports is recorded, processed, summarizedand reported within the time periods specified in the Commission’s rules andforms, and that such information is accumulated and communicated to itsmanagement, including its Chief Executive Officer and Chief Financial Officer,as appropriate, to allow for timely decisions regarding required disclosure. Indesigning and evaluating the disclosure controls and procedures, managementrecognizes that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurance of achieving the desiredcontrol objectives and are subject to certain limitations, including theexercise of judgment by individuals, the difficulty in identifying unlikelyfuture events, and the difficulty to eliminate misconduct completely. As aresult, there can be no assurance that our disclosure controls and procedureswill prevent all errors or fraud or ensure that all material information willbe made known to management in a timely manner.

 

42

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Deficiencies in the Company’s Controls and Procedures

 

In connection with the review of the Company’sfinancial statements for the quarter ended March 31, 2004, L J SoldingerAssociates LLC, the independent registered accounting firm, notified the AuditCommittee and management, of certain deficiencies they identified that existedin the design and operation of our internal controls that L J SoldingerAssociates LLC considers to be material weaknesses in the effectiveness of theCompany’s internal controls pursuant to standards established by the AmericanInstitute of Certified Public Accountants. A “material weakness” is a reportable condition in which the design oroperation of one or more of the specific internal control components has adefect or defects that could have a material adverse effect on the Company’sability to record, process, summarize and report financial data in thefinancial statements in a timely manner. The material weaknesses identified by the independent registeredaccounting firm included the following weaknesses in various financial areas ofthe Company:

 

•                  Failed to maintain its accountingrecords in an accurate, orderly, timely manner which precluded the Company frommeeting the regulatory filing deadlines.

•                  Maintaining an inefficientconsolidation process which fails to provide readily identifiable information,or transparency, as to the source of the accounting data and relatedconsolidating adjustments made - both at the parent and subsidiary levels.

•                  Recording various journal entries atthe consolidation level but not recording them at the subsidiary levelresulting in accumulated differences between the consolidated trial balancesand subsidiary trial 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 relatedto maintaining a current accurate backlog schedule.

•                  Maintaining accounting records forthe Guam office on spreadsheets outside of the Company’s standard accountingsoftware.

•                  Failure to prepare orderly andconcise supporting 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.

 

During the course of their audit of our Consolidated FinancialStatements for the fiscal year ended December 31, 2003, our previousindependent auditors, KPMG LLP, advised management and the Audit Committee ofour Board of Directors that they had identified deficiencies in internalcontrol. The deficiencies are considered to be material weaknesses as definedunder standards established by the American Institute of Certified PublicAccountants.  The material weaknessesidentified are as follows:

 

•                  The monthly and quarterly closingprocedures did not provide information on a timely basis in order to meetfinancial reporting requirements, namely, the financial statements required byForm 10-K.

 

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•                  The monthly monitoring process forcertain projects in Saipan did not provide accurate project information on atimely basis for financial reporting purposes.

 

We have taken measures to improve the effectiveness of our internalcontrols and we believe these efforts address the matters described above.Certain measures we have taken through September 30, 2005 include, but are notlimited to, the following:

 

•                  Appointed Nidal Zayed as ChiefExecutive Officer;

•                  Appointed Greg Grosvenor as ChiefFinancial Officer;

•                  centralized our United Statesregional finance organization, with direct reporting responsibilities to theChief Financial Officer;

•                  exited the construction relatedbusiness which contributed to our losses as well as many of the relatedinternal control weaknesses.

•                  established training plans forpersonnel.

 

As required by Rule 13a-15(b) of the Exchange Act, Telesource hascarried out an evaluation, under the supervision and with the participation ofits management, including its Chief Executive Officer and its Chief FinancialOfficer, of the effectiveness of the design and operation of its disclosurecontrols and procedures. The evaluation examined those disclosure controls andprocedures as of December 31, 2004, the end of the period covered by thisreport. Based upon the evaluation and the communication from our independentregistered accounting firms, Telesource’s management, including its ChiefExecutive Officer and its Chief Financial Officer, concluded that, Telesource’sdisclosure controls and procedures were ineffective.

 

It will take some time before we have in place the rigorous disclosurecontrols and procedures, including internal controls and procedures, that ourBoard of Directors and senior management are striving for. As a result of ourefforts, however, we believe that our Consolidated Financial Statements fairlypresent, in all material respects, our financial condition, results ofoperations and cash flows as of, and for, the periods presented and that thisForm 10-K, and that this report contains the information required to beincluded in accordance with the Exchange Act.

 

During 2005, we continued to make improvements in our financialreporting by continuing to hire qualified personnel and refine our formalreview processes. We will continue to assess our internal controls andprocedures and will take any further actions that we deem necessary.

 

Changes In Internal Control Over Financial Reporting

 

During 2004, there were no changes in our internal control over thefinancial reporting or in other factors that have materially affected, or arereasonably likely to materially affect, our internal control over financialreporting during the period covered by this Report.

 

CEO and CFO Certifications – The Certifications of our CEO and CFOwhich are attached as Exhibits 31(1) and 31 (2) to this Report includeinformation about our disclosure controls and procedures and internal controlover financial reporting.  TheseCertifications should be read in conjunction with the information contained inthis Item 9a for a more complete understanding of the matters covered by theCertifications.

 

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**ITEM 9B.****          OTHER INFORMATION**

 

**NONE**

 

45

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# **PART III**

 

**ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THEREGISTRANT**

 

The Company currently has asix-member Board of Directors.  A formerDirector and CEO, Khajadour Semikian terminated his employment during2005.  Directors are elected for one-yearterms and are elected at each annual meeting of stockholders. Telesource’sBoard of Directors are:

 
| **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                             |       | 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                         |       | Mr.  Marsh is a member of the law firm Freeborn and Peters. Prior to joining  Freeborn and 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.                                                                                                                                                                                                                                                                                     |       |

 

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The Company paid an annual fee to each Director (except for Nidal Zayed)in the amount of $16,000 and $20,000 for 2004 and 2003, respectively. Such feesare paid in cash.  For a discussion ofTelesource’s executive team, please see Item 4. (a). Executive Officers of theRegistrant

 

**ITEM 11. EXECUTIVE COMPENSATION**

 

**SUMMARYCOMPENSATION TABLE**

 
| **Name and****Principal Position** | ** ** | **Year** | ** ** | **Salary (1)** | ** ** | **Bonus** | ** ** | **All Other Annual  Compensation(2)** | ** ** |
|----------------------------------------------|------------|----------|------------|---------------------|------------|-----------|------------|-------------------------------------------------|------------|
| Khajadour  Semikian (3)                      |       | 2004     |       | $                   | 263,919    |      | $          | —                                          |       | $ | 27,871 |   |
| President and                                |       | 2003     |       | $                   | 278,167    |      | $          | —                                          |       | $ | 59,931 |   |
| Chief Executive Officer                      |       | 2002     |       | $                   | 285,458    |      | $          | —                                          |       | $ | 50,458 |   |
|                                         |       |     |       |                |       |      |       |                                            |       |
| Nidal Zayed                                  |       | 2004     |       | $                   | 128,000    |      | $          | —                                          |       | $ | 22,302 |   |
| Executive Vice President                     |       | 2003     |       | $                   | 123,281    |      | $          | —                                          |       | $ | 24,756 |   |
|                                         |       | 2002     |       | $                   | 125,000    |      | $          | —                                          |       | $ | 25,191 |   |
|                                         |       |     |       |                |       |      |       |                                            |       |
| Bud Curley (4)                               |       | 2004     |       | $                   | 169,823    |      | $          | —                                          |       | $ | 22,801 |   |
| Vice President and                           |       | 2003     |       | $                   | 165,000    |      | $          | —                                          |       | $ | 13,700 |   |
| Chief Financial Officer                      |       | 2002     |       | $                   | 162,814    |      | $          | —                                          |       | $ | 23,387 |   |

 

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(1)          Includes salary paid by Telesource International, before any salaryreduction for contributions to Telesource International’s 401(k) Savings Plan.

(2)          Telesource provided Mr. Semikian with housing in Saipan at a cost of$36,000 in 2002 and 2003, and $24,000 in 2004. Telesource provided a vehicle toMr. Semikian in Saipan at a cost of $8,400 in 2002 and 2003 and at a cost of$2,479 for 2004. Telesource provided Mr. Semikian with health insurance at acost of $6,058 in 2002, $913 in 2003, and $7,082 in 2004.  Telesource provided a vehicle to Mr. Zayed ata cost of $11,667 in 2002, $ 8,843 in 2003 and $10,245 in 2004. Telesourceprovided Mr. Zayed with health insurance for him and his family at a cost of$13,524 in 2002, $15,913 in 2003, and $12,057 in 2004.  Telesource provided Mr. Curley with a carallowance of $10,000 for 2002 and, 2003, and $10,417 for 2004. Telesourceprovided Mr. Curley with health insurance for him and his family at a cost of$13,524 in 2002, $19,388 in 2003, and $19,443 in 2004. Telesource provided Mr.Curley with housing in Saipan at a cost of $7,800 in 2004.

(3)          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 COOwas promoted to the CEO position vacated by Mr. Semikian on September 1, 2005.

(4)          Mr. Curley re-signed from his position at Telesource effective August 31,2005.  Mr. Greg Grosvenor was hired asthe new Chief Financial Officer on August 22, 2005.

 

**ITEM 12.SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT**

 

The following table contains information as ofDecember 31, 2004 regarding the ownership of the Common Stock of the Companyby: (i) all persons who, to the knowledge of the Company,

 

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were the beneficial owners of 5% or more of the outstandingshares of Common Stock of the Company, (ii) each director and directornominee of the Company, (iii) the Chief Executive Officer and the twoother most highly compensated executive officers of the Company as of September30, 2005, whose salary and bonus for the fiscal year ended December 31, 2004exceeded $100,000, and (iv) all executive officers and directors of theCompany as a group:

 
| **Name**                                                          | ** ** | **Amount and  Nature  of Beneficial  Ownership (1)** | ** ** | **Percent of  Common Stock  Outstanding (2)** | ** ** |
|-------------------------------------------------------------------|------------|---------------------------------------------------------------------|------------|--------------------------------------------------------------|------------|
| ** **                                                        | ** ** | ** **                                                          | ** ** | ** **                                                   | ** ** |
| Sayed Hamid  Behbehani & Sons, Co. W.L.L. (3)                 |       | 20,739,000                                                          |       | 85.0                                                         | %          |
| K.J. Semikian  (former CEO)                                       |       | 200,000                                                             |       | *                                                            |       |
| Max Engler(4)                                                     |       | 50,000                                                              |       | *                                                            |       |
| Ibrahim Ibrahim                                                   |       | 10,000                                                              |       | *                                                            |       |
| Jeff Adams                                                        |       | 1,000                                                               |       | *                                                            |       |
| Ralph Beck                                                        |       | 0                                                                   |       | *                                                            |       |
| Weston Marsh                                                      |       | 0                                                                   |       | *                                                            |       |
| 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)          Exceptas indicated in the footnotes to this table, the persons named in the tablehave sole voting and investment power with respect to all shares of CommonStock shown as beneficially owned by them, subject to community property lawswhere applicable.

(2)          Calculatedon the basis of 24,400,000 shares of Common Stock outstanding as of December31, 2004, plus shares of Common Stock. Excludes certain options that were exercisable within 60 days ofDecember 31, 2003.  None of the optionswere exercised and the Company did not incur any expenses associated with theseoptions.

 

(3)          Includes2,020,000 shares of Common Stock held by eight members of the Behbehani familyor their affiliates. 

 

(4)          MaxEngler serves as a director for Litra Holding AG.  Litra Holding AG owns directly 495,000 sharesof Telesource International’s common stock. Based upon information provided to Telesource International, TelesourceInternational does not consider these shares to be beneficially owned by Mr.Engler. 

 

**ITEM 13. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

Certain of the Company’s executive officers, directors, andmajor stockholders are also owners, officers, and/or directors of SHBC locatedin Kuwait. SHBC is a civil, electrical, and mechanical engineering firm andconstruction contractor with 750 employees and over 30 years ofexperience. SHBC and its affiliates were the sole stockholder of TelesourceInternational prior to July 1999 and now own approximately 85% of the commonstock outstanding. SHBC and Telesource International bid and compete within thesame industries; however, SHBC has agreed, in writing, not to bid on projectswithin the United States and its possessions. Additionally, SHBC and itsmajority stockholders, Fouad Behbehani and Nasrallah Behbehani, have signed asguarantors on Telesource CNMI’s promissory note with the Commercial Bank ofKuwait, and as guarantors on a $7,500,000 credit facility for Telesource withthe Arab Banking Corporation of Bahrain. SHBC and its majority stockholdershave also signed as guarantors on a $1,250,000 letter of credit issued to theBank of Hawaii to secure a $1,250,000 credit facility.

 

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These credit facilities were used to finance the constructionactivities on the power plant, the West Tinian Airport expansion project, andto provide financing for other projects. See note 8.

 

Additionally, from time to time the Company may hire, on apart time or temporary basis, individuals employed by SHBC to provideassistance to Telesource on certain projects in the Northern MarianaIslands.  During 2003, the Company hiredSHBC employees to provide assistance on a service contract to complete a surveyof radio transmissions in Iraq. The rates paid did not exceed the fair marketvalue of similar services provided by unrelated third parties. The Company didnot hire any SHBC employees during 2004.

 

The Company paid Computhink, Inc. $84,623 in 2004 for rent,and computer support.  The Company sharesoffice space with Computhink in its Lombard office.  Nidal Zayed, the Company’s Chief ExecutiveOfficer, and K.J. Semikian its former Chief Executive Officer served on theBoard of Directors for Computhink.

 

The Company held an investment in Telebond InsuranceCorporation at December 31, 2003 in the amount of $77,695 which was soldin 2004. The Company purchased insurance from Telebond and paid premiums of $45,863,$59,760, and $23,566 during the years ended December 31, 2004, 2003, and 2002,respectively. Telebond provides employment bonds along with bid, performance,and payment bonds for the Company’s projects. Telebond is not a U.S. Treasurylisted bonding company. Most bid, performance, and payment bonds for theCompany are secured from third party vendors. The Company’s former Presidentand CEO, K.J. Semikian, served on Telebond Insurance Corporation’s board ofdirectors and as President of Telebond, and owns 10% of the stock of Telebond.

 

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

 

The Audit Committee pre-approves audit services and permitted non-auditservices (including the fees and terms thereof) to be performed for the Corporationby its independent registered accountants. L J Soldinger Associates, LLC was retained to perform the audit of the2004 annual financial statements and perform the SAS 100 reviews on thefinancial statements relating to each of the first three quarters of 2004.  KPMG LLP was retained to perform the audit ofthe 2003 annual financial statements and perform the SAS 100 reviews on thefinancial statements relating to each of the first three quarters of 2003.  The following table presents fees forprofessional services rendered by these firms for the respective periodsindicated:

 
| **SERVICES PERFORMED**  | ** ** | **2004** | ** ** | **2003** | ** ** |
|------------------------------|------------|----------|------------|----------|------------|
|                         |       |     |       |     |       |
| Audit Fees (Note  1)         |       | $        | 582,261    |     | $          | 475,868 |   |
| Audit-Related  Fees (Note 2) |       | 0        |       | 0        |       |
| Tax Fees (Note  3)           |       | 12,220   |       | 8,500    |       |
| All Other Fees  (Note 4)     |       | 0        |       | 0        |       |
|                         |       |     |       |     |       |
| Total Fees                   |       | $        | 594,481    |     | $          | 484,368 |   |

 

NOTES TO PRECEDING TABLE

 

1.               Auditfees represent fees billed for professional services provided in connectionwith the audit of our annual financial statements, reviews of our quarterlyfinancial statements, audit services

 

49

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provided inconnection with statutory and regulatory filings for those years and auditservices provided in connection with securities registration and/or otherissues resulting from that process.

2.               Audit-relatedfees represent fees billed primarily for assurance and related servicesreasonably related to the performance of the audit or reviews of our financialstatements.

3.               Taxfees principally represent fees billed for tax preparation.

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

 

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**PART IV**

 

**ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULESAND REPORTS ON FORM 8-K**

 

(a)(1) Thefollowing consolidated financial statements of Telesource International, Inc.and Subsidiaries are included in Part II, Item 8:

 

FinancialStatements:

 

ConsolidatedBalance Sheets—December 31, 2004 and 2003

 

ConsolidatedStatements of Operations—Years Ended December 31, 2004, 2003 and 2002

 

ConsolidatedStatements of Cash Flows—Years Ended December 31, 2004, 2003 and 2002

 

Consolidated Statements of Stockholders’ Equity andComprehensive Loss—Years Ended December 31, 2004, 2003 and 2002

 

Notes toConsolidated Financial Statements

 

(a)(2) The following financial statement schedules areincluded in this Form 10-K report:

 

None.

 

(b) Reports onForm 8-K:

 
| **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**                   |

 

51

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| 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** |
|   |   |                                                                                                                                                                                                                               |
| 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 *                                                                                                                                                                       |

 

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| 32.2 |   | Section 1350  Certification Chief Financial Officer * |
|------|--------|-------------------------------------------------------|

 

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*                 Filed herewith

**          Previously filed

 

**ITEM15(a)(3). EXECUTIVE COMPENSATION PLANS AND ARRANGEMENTS**

 

The followingexecutive compensation plans and arrangements are listed incorporated by referencein this Form 10-K:

 

Employment Contract between Nidal Z. Zayed andTelesource International, Inc.

Telesource International, Inc. 2000 Incentive StockOption Plan

Telesource International, Inc. 2000 Non-QualifiedStock Option Plan

Telesource International, Inc. 2000 Non-EmployeeDirector Stock Option Plan

 

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**SIGNATURES**

 

PURSUANT TO THE REQUIREMENTSOF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, THE REGISTRANTHAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNEDTHEREUNTO DULY AUTHORIZED.

 
|   |           | **TELESOURCE INTERNATIONAL, INC.** |
|--------|----------------|------------------------------------|
|   |           |                               |     (Registrant) |
|   |           |                               |   |
| Date   | March 15, 2006 |                               | /s/ Nidal Zayed |   |
|   |           |                               | Nidal Zayed |
|   |           |                               | President and Chief Executive Officer |

 

 

PURSUANT TO THE REQUIREMENTSOF THE SECURITIES EXCHANGE ACT OF 1934, THIS REPORT HAS BEEN SIGNED BELOW BYTHE FOLLOWING PERSONS ON BEHALF OF THE REGISTRANT AND IN THE CAPACITIESINDICATED ON July 6, 2004.

 
| /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/ Weston Marsh   |   |   | Director                             |
| Weston Marsh       |   |   |                                 |
|               |   |   |                                 |
|               |   |   | Director                             |
| Ibrahim Ibrahim    |   |   |                                 |
|               |   |   |                                 |
| /s/ Greg Grosvenor |   |   | Chief Financial Officer              |
| Greg Grosvenor     |   |   |                                 |
|               |   |   |                                 |
|               |   |   |                                 |

 

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