**U.S.
      SECURITIES AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**




**FORM
      10-QSB**




**(Mark
      One)**




**x** **** **QUARTERLY
      REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF
      1934**




**For
      the quarterly period ended: June 30, 2007**




**OR**




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




**For
      the transition period from
              
to**




**Commission
      File Number 000-50758**







**VISTULA
      COMMUNICATIONS SERVICES, INC.**


(Exact
      name of small business issuer as specified in its charter)




**Delaware**
            
            **20-0734966**(State
                or other jurisdiction of
              incorporation
                or organization)
            
            (IRS
                Employer
              Identification
                No.)




**Suite
      801, 405 Park Avenue**


**New
      York, New York 10022**


(Address
      of principal executive offices and zip code)




**(212)
      317-8900**


(Issuer’s
      telephone number)




Check
      whether the issuer (1) filed all reports required to be filed by Section 13
      or
      15(d) of the Exchange Act during the past 12 months (or for such shorter period
      that the registrant was required to file such reports), and (2) has been subject
      to such filing requirements for the past 90 days. Yes x No o




Indicate
      by check mark whether the registrant is a shell company (as defined in Rule
      12b-2 of the Exchange Act) Yes o No x




As
      of
      August 13, 2007 there were 66,964,898 shares of common stock, $0.001 par value,
      of the registrant issued and outstanding.




Transitional
      Small Business Disclosure Format ( *Check
      one* ): Yes o No x












**VISTULA
      COMMUNICATIONS SERVICES, INC.**




**FORM
      10-QSB**




**FOR
      THE SIX MONTHS ENDED JUNE 30, 2007**




Facing
                PageTable
                of ContentsPART
                I. FINANCIAL INFORMATION(*):Item
                1. Financial Statements
            1Consolidated
                Balance Sheets as of June 30, 2007 (unaudited) and December 31,
                2006
            1Consolidated
                Statements of Operations for the Three and Six Months ended June
                30, 2007
                and June 30, 2006 (unaudited)
            2Consolidated
                Statements of Stockholders’ Equity for the Six Months ended June 30, 2007
                (unaudited)
            3Consolidated
                Statements of Cash Flows for the Six Months ended June 30, 2007 and
                June
                30, 2006 (unaudited)
            4Notes
                to Unaudited Consolidated Financial Statements
            5Item
                2. Management’s Discussion and Analysis of Financial Condition and Results
                of Operations
            18Item
                3. Controls and Procedures
            29PART
                II. OTHER INFORMATIONItem
                1. Legal Proceedings
            30Item
                2. Unregistered Sales of Equity Securities
            30Item
                3. Defaults Upon Senior Securities
            30Item
                4. Submission of Matters to a Vote of Security Holders
            30Item
                5. Other Information
            30Item
                6. Exhibits
            31SIGNATURES
            32





(*)  All
      of
      the financial statements contained in this Quarterly Report are unaudited with
      the exception of the financial information at December 31, 2006, which has
      been
      derived from our audited financial statements at that date and should be read
      in
      conjunction therewith. Our audited financial statements as of December 31,
      2006
      and for the year then ended, and the notes thereto, can be found in our Annual
      Report on Form 10-KSB (File No. 000-50758), which was filed with the Securities
      and Exchange Commission on April 17, 2007.









**PART
      I. FINANCIAL INFORMATION**




**Item
      1. Financial Statements.**




***VISTULA
      COMMUNICATIONS SERVICES, INC.***


Consolidated
      Balance Sheets as of June 30, 2007 and


December
      31, 2006




**June
                30,**
              **2007**
            
            **December 31,**
              **2006****(unaudited)**
            
            **(audited)****ASSETS**Current
                assets:Cash
            
            $
            57,510
            
            $
            195,223Accounts
                receivable
            
            
            36,244
            
            
            157,517Prepaid
                expenses and other current assets
            
            
            358,579
            
            
            313,352Assets
                held for sale
            
            
            —
            
            
            110,527Total
                current assets
            
            
            452,333
            
            
            776,619Property
                and equipment, net
            
            
            393,438
            
            
            444,999Deferred
                financing costs
            
            
            315,440
            
            
            330,476Intangible
                assets
            
            
            22,794,173
            
            
            25,629,870Other
                assets
            
            
            51,305
            
            
            20,254Total
                Assets
            
            $
            24,006,689
            
            $
            27,202,218**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            1,048,526
            
            $
            1,039,875Accrued
                expenses
            
            
            1,433,130
            
            
            1,379,113Shares
                subject to put option
            
            
            2,500,000
            
            
            2,500,000Deferred
                revenue
            
            
            —
            
            
            160,685Convertible
                promissory note to related party
            
            
            175,000
            
            
            175,000Notes
                payable
            
            
            83,496
            
            
            204,073Convertible
                debt
            
            
            6,045,124
            
            
            —Total
                current liabilities
            
            
            11,285,276
            
            
            5,458,746Convertible
                debt
            
            
            2,128,561
            
            
            5,830,634Total
                liabilities
            
            
            13,413,837
            
            
            11,289,380Stockholders’
                equity:Preferred
                stock, $0.001 par value, 10,000,000 shares authorized; no shares
                issued
                and outstanding
            
            
            —
            
            
            —Common
                stock, $0.001 par value, 200,000,000 shares authorized, 66,964,898
                shares
                issued and outstanding as of June 30, 2007 and December 31,
                2006
            
            
            66,964
            
            
            66,964Additional
                paid-in capital
            
            
            53,270,529
            
            
            52,089,738Accumulated
                deficit
            
            
            (42,592,316
            )
            
            (36,107,104
            )Cumulative
                translation adjustment
            
            
            (152,325
            )
            
            (136,760
            )Total
                stockholders’ equity
            
            
            10,592,852
            
            
            15,912,838Total
                Liabilities and Stockholders’ Equity
            
            $
            24,006,689
            
            $
            27,202,218




See
      accompanying notes to unaudited consolidated financial statements.




1




***VISTULA
      COMMUNICATIONS SERVICES, INC***


Consolidated
      Statements of Operations for the


Three
      and
      Six Months ended June 30, 2007 and 2006




**Three Months Ended**
              **June 30,**
            
            **Six Months Ended**
              **June 30,****2007**
            
            **2006**
            
            **2007**
            
            **2006****(unaudited)**
            
            **(unaudited)**
            
            **(unaudited)**
            
            **(unaudited)**RevenuesTelecommunications
            
            $
            23,780
            
            $
            237,919
            
            $
            75,716
            
            $
            557,338Contracted
                services
            
            
            241,032
            
            
            —
            
            
            475,571
            
            
            —Total
                Revenues
            
            
            264,812
            
            
            237,919
            
            
            551,287
            
            
            557,338Cost
                of revenuesTelecommunications
            
            
            83,251
            
            
            324,091
            
            
            186,399
            
            
            675,604Contracted
                services
            
            
            162,971
            
            
            —
            
            
            294,163
            
            
            —Total
                cost of revenues
            
            
            246,222
            
            
            324,091
            
            
            480,562
            
            
            675,604Gross
                margin (loss)
            
            
            18,590
            
            
            (86,172
            )
            
            70,725
            
            
            (118,266
            )Operating
                expenses:Selling,
                general and administrative
            
            
            1,314,162
            
            
            2,972,772
            
            
            2,775,638
            
            
            6,604,862Depreciation
                and amortization
            
            
            1,461,746
            
            
            130,643
            
            
            2,943,912
            
            
            260,509Research
                and development
            
            
            20,845
            
            
            22,034
            
            
            86,816
            
            
            100,658Total
                operating expenses
            
            
            2,796,753
            
            
            3,125,449
            
            
            5,806,366
            
            
            6,966,029Loss
                from operations
            
            
            (2,778,163
            )
            
            (3,211,621
            )
            
            (5,735,641
            )
            
            (7,084,295
            )Interest
                expense, net
            
            
            (438,889
            )
            
            (298,773
            )
            
            (749,571
            )
            
            (613,876
            )Net
                loss
            
            $
            (3,217,052
            )
            $
            (3,510,394
            )
            $
            (6,485,212
            )
            $
            (7,698,171
            )Weighted-average
                basic and diluted shares outstanding
            
            
            66,964,898
            
            
            43,985,250
            
            
            66,964,898
            
            
            38,691,681Basic
                and diluted net loss per common share
            
            $
            (0.05
            )
            $
            (0.08
            )
            $
            (0.10
            )
            $
            (0.20
            )




See
      accompanying notes to unaudited consolidated financial statements.





2




***VISTULA
      COMMUNICATIONS SERVICES, INC.***


Consolidated
      Statements of Stockholders’ Equity for the


Six
      Months ended June 30, 2007


(unaudited)




************
              
              ****************************
              
              **Additional**********
              
              ************
              
              **Cumulative**********
              
              **Total**********
              
              ************************
              
              **Common Stock**********
              
              **Paid-in**********
              
              **Accumulated**********
              
              **Translation**********
              
              **Stockholders’**********
              
              **Comprehensive**************
              
              **Shares**********
              
              **Amount**********
              
              **Capital**********
              
              **Deficit**********
              
              **Adjustment**********
              
              **Equity (Deficit)**********
              
              **Loss**********Balance,
                  December 31, 2006
              
              
              66,964,898
              
              $
              66,964
              
              $
              52,089,738
              
              $
              (36,107,104
              )
              $
              (136,760
              )
              $
              15,912,838Amortization
                  of stock compensation
              
              
              
              
              
              
              
              
              736,983
              
              
              
              
              
              
              
              
              736,983Issuance
                  of warrants and transfer of shares on convertible
                  notes
              
              
              
              
              
              
              
              
              443,808
              
              
              
              
              
              
              
              
              443,808Net
                  loss
              
              
              
              
              
              
              
              
              
              
              
              (6,485,212
              )
              
              
              
              
              (6,485,212
              )
              $
              (6,485,212
              )Change
                  in cumulative translation adjustment
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (15,565
              )
              
              (15,565
              )
              
              (15,565
              )Balance,
                  June 30, 2007
              
              
              66,964,898
              
              $
              66,964
              
              $
              53,270,529
              
              $
              (42,592,316
              )
              $
              (152,325
              )
              $
              10,592,852
              
              $
              (6,500,777
              )




See
      accompanying notes to unaudited consolidated financial statements.




3




***VISTULA
      COMMUNICATIONS SERVICES, INC***


Consolidated
      Statements of Cash Flows for the


Six
      Months ended June 30, 2007 and 2006




**Six Months Ended June 30,****2007**
            
            **2006****(unaudited)**
            
            **(unaudited)**Cash
                flows from operating activities:Net
                loss
            
            $
            (6,485,212
            )
            $
            (7,698,171
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Depreciation
                and amortization
            
            
            2,943,912
            
            
            260,509Non-cash
                expense pursuant to financial advisory agreements
            
            
            —
            
            
            1,875,000Non-cash
                compensation expense
            
            
            736,983
            
            
            375,350Non-cash
                interest expense
            
            
            417,595
            
            
            326,094Issuance
                of warrant pursuant to consulting agreement
            
            
            —
            
            
            231,945Issuance
                of warrant pursuant to revolving credit facility
            
            
            —
            
            
            410,845Changes
                in assets and liabilities:Decrease
                in:Accounts
                receivable
            
            
            122,502
            
            
            28,825Prepaid
                expenses and other current assets
            
            
            22,138
            
            
            294,918Increase
                (decrease) in:Accounts
                payable
            
            
            (137,433
            )
            
            319,991Accrued
                expenses
            
            
            177,940
            
            
            (64,985
            )Deferred
                revenue
            
            
            (157,598
            )
            
            —Net
                cash used in operating activities
            
            
            (2,359,173
            )
            
            (3,639,679
            )Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            (32,920
            )
            
            (72,265
            )Purchase
                of software and intellectual property
            
            
            —
            
            
            (8,800,000
            )Net
                cash used in investing activities
            
            
            (32,920
            )
            
            (8,872,265
            )Cash
                flows from financing activities:Proceeds
                from convertible notes
            
            
            2,500,000
            
            
            —Capitalized
                finance fees
            
            
            (115,700
            )
            
            —Net
                proceeds from issuance of common stock
            
            
            —
            
            
            15,244,165Proceeds
                from bridge revolving credit agreement
            
            
            —
            
            
            1,250,000Proceeds
                from exercise of stock options
            
            
            —
            
            
            75,000Payment
                on bridge revolving credit agreement
            
            
            —
            
            
            (1,250,000
            )Payment
                on notes payable
            
            
            (123,123
            )
            
            (870,000
            )Net
                cash provided by financing activities
            
            
            2,261,177
            
            
            14,449,165Effect
                of exchange rates on cash
            
            
            (6,797
            )
            
            (22,119
            )Net
                (decrease) increase in cash
            
            
            (137,713
            )
            
            1,915,102Cash,
                beginning of period
            
            
            195,223
            
            
            553,127Cash,
                end of period
            
            $
            57,510
            
            $
            2,468,229**Supplemental
                disclosure of cash flow information:**Cash
                paid for interest
            
            $
            263,935
            
            $
            319,427Cash
                paid for taxes
            
            $
            —
            
            $
            —**Supplemental
                disclosure of non-cash financing activities:**Issuance
                of common stock warrants in connection with convertible debt
                financing
            
            $
            27,617
            
            $
            —Transfer
                of shares
            
            $
            416,191
            
            $
            —Issuance
                of common stock pursuant to financial advisory agreement
            
            $
            —
            
            $
            1,875,000Issuance
                of common stock warrant pursuant to consulting agreement
            
            $
            —
            
            $
            231,945Issuance
                of common stock warrant pursuant to revolving credit
                facility
            
            $
            —
            
            $
            410,845Issuance
                of common stock pursuant to purchase of software and intellectual
                property
            
            $
            —
            
            $
            12,283,976Reclass
                of prepaid royalties to purchase of intangible asset
            
            $
            —
            
            $
            399,189Company
                expenses paid directly by and returned directly to
                stockholder
            
            $
            —
            
            $
            75,000




See
      accompanying notes to unaudited consolidated financial statements.




4





**VISTULA
      COMMUNICATIONS SERVICES, INC.**




**NOTES
      TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**


**June
      30, 2007**




**(1)          
      Basis of Presentation**




The
      accompanying unaudited consolidated financial statements of Vistula
      Communications Services, Inc. (“Vistula” or the “Company”) have been
      prepared in accordance with accounting principles generally accepted in the
      United States (GAAP) for interim financial information and with the instructions
      to Form 10-QSB and Item 310 of Regulation S-B. Accordingly, they do
      not include all of the information and footnotes required by GAAP for complete
      financial statements. In the opinion of management, all adjustments (consisting
      of normal recurring accruals) considered necessary for the fair presentation
      of
      the results for the interim periods have been included. The preparation of
      financial statements in conformity with US GAAP requires management to make
      estimates and assumptions that affect the amounts reported in the financial
      statements and accompanying notes. Interim results are not necessarily
      indicative of results to be expected for the entire fiscal year ending
      December 31, 2007. These unaudited financial statements should be read in
      conjunction with the Company’s audited annual financial statements for the
      fiscal year ended December 31, 2006 and the footnotes thereto. Those
      audited financial statements are included in the Company’s Annual Report on
      Form 10-KSB, which was filed with the Securities and Exchange Commission
      (the “SEC”) on April 17, 2007.




The
      consolidated financial statements include the accounts of Vistula Communications
      Services, Inc., Vistula Limited, Goodman Blue Limited, Vistula USA, Inc.,
      Vistula Communications Services (Pty) Ltd., Cardlink Services Limited and
      Vistula Telecom Limited collectively the “Company”. All significant intercompany
      transactions and balances have been eliminated in consolidation.




The
      Company uses the United States dollar as its reporting currency. The British
      pound is the functional currency of its wholly-owned subsidiaries, Vistula
      Limited and Goodman Blue Limited. Assets and liabilities of the Company’s
      international operations are translated into U.S. dollars at exchange rates
      that
      are in effect on the balance sheet date and equity accounts are translated
      at
      historical exchange rates. Income and expense items are translated at average
      exchange rates which are in effect during the period. Translation adjustments
      are accumulated in other comprehensive loss as a separate component of
      stockholders’ equity in the consolidated balance sheet.




*Going
      Concern*




The
      report of the Company’s independent registered public accounting firm on its
      audited consolidated financial statements as of December 31, 2006 and for
      the year then ended included a discussion on the Company’s ability to continue
      as a going concern. The consolidated financial statements shown for the period
      ended June 30, 2007, have been prepared on a going concern basis which
      contemplates the realization of assets and the satisfaction of liabilities
      in
      the normal course of business. As shown in the accompanying consolidated
      financial statements, the Company incurred a net loss of $6,485,212 for the
      six
      month period ended June 30, 2007 and had an accumulated deficit of $42,592,316
      at June 30, 2007. Further, the Company had cash of $57,510 and a working capital
      deficit at June 30, 2007 of $10,832,943. These factors among others indicate
      that the Company will be unable to continue as a going concern.




5




The
      consolidated financial statements do not include any adjustments relating to
      the
      recoverability of assets and satisfaction of liabilities that might be necessary
      should the Company be unable to continue as a going concern. The Company's
      continuation as a going concern is dependent upon its ability to generate
      sufficient cash flow to meet its obligations on a timely basis, to comply with
      the terms of its financing arrangements, to obtain additional financing as
      may
      be required, and ultimately to attain profitability. To address these issues
      in
      part, the Company raised $2,500,000 in gross proceeds on April 6, 2007 from
      a
      convertible note and warrant financing and entered into an amended licensing
      arrangement with Telstra Europe Limited which provided approximately $300,000
      in
      July 2007. These funds have been used to satisfy a portion of the Company’s
      outstanding payables, to provide some working capital related to the anticipated
      launch of the V-CubeTM product through a United Kingdom distributor, Northamber
      PLC (“Northamber”) and to enable the Company to continue to operate into the
      third quarter of 2007. However, as of the date of this filing, the Company
      has
      not launched its V-CubeTM product through the Northamber arrangement and does not
      anticipate generating revenue from the Northamber arrangement until the fourth
      quarter of 2007. As of the date of this filing, the Company has not paid the
      interest that was due on June 30, 2007 to the holders of the convertible
      debentures. The Company has not yet established an ongoing source of revenues
      sufficient to cover its operating costs and allow it to continue as a going
      concern. The Company’s management is in the process of attempting to secure
      additional funds to remedy the now expected cash shortfall for the third fiscal
      quarter and anticipates the availability of these funds by September 1, 2007.
      Management is in negotiations concerning a new licensing arrangement for the
      Company’s V-CubeTM product which may help meet the Company’s short term cash
      requirements until longer term arrangements can be obtained. Also, as
      discussed in the Liquidity and Capital Resources section of the Management
      Discussion and Analysis of Item 2, the Company has been implementing cost
      controls and negotiating discounts and deferrals of payments owed to creditors
      and will need to continue to do so, in order to conserve cash. However, there
      is
      no assurance that the Company will be able to complete the new V-CubeTM licensing
      arrangement described above, identify sufficient savings from its implementation
      of cost controls and ultimately generate sufficient revenue from the sales
      of
      its V-CubeTM product by Northamber or otherwise to continue as a going concern.
      The ability of the Company to continue as a going concern is dependent upon
      its
      ability to successfully accomplish the plans described above and eventually
      secure other sources of funding and attain profitable operations.





*Recent
      Accounting Pronouncements*





In
      February 2007, the Financial Accounting Standards Board (FASB) issued SFAS
      No.
      159, *The
      Fair Value Option for Financial Assets and Financial Liabilities - Including
      an
      Amendment to FASB Statement No. 115* (SFAS
      159). SFAS 159 permits entities to choose to measure many financial instruments
      and certain other items at fair value. SFAS 159 is effective for financial
      statements issued for fiscal years beginning after November 15, 2007. Earlier
      adoption is permitted as of the beginning of a fiscal year that begins on or
      before November 15, 2007, provided that the entity also elects to apply the
      provisions of SFAS 157. The Company is currently evaluating the effect of this
      standard on its future reported financial position and results of
      operations.





In
      September 2006, the FASB issued SFAS No. 157, *Fair
      Value Measurements* (SFAS
      157), to define fair value, establish a framework for measuring fair value
      in
      generally accepted accounting principles and expand disclosures about fair-value
      measurements. SFAS 157 is effective for financial statements issued for fiscal
      years beginning after November 15, 2007 and interim periods within those fiscal
      years, with earlier application allowed. The Company is currently evaluating
      the
      effect of this standard on its future reported financial position and results
      of
      operations.





*Reclassification*





Certain
      amounts from the three- and six-month period ended June 30, 2006 have been
      reclassified to conform with the current presentation.





**(2)**
            **Stock-Based
                Compensation**




Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      Statement of Financial Accounting Standards (“SFAS”) No. 123(R), *Share-Based
      Payment* (“SFAS
      123R”), using the modified-prospective-transition method. Under this transition
      method, compensation cost recognized for the period ended June 30, 2007
      includes: (a) compensation cost for all stock-based payments granted, but not
      yet vested as of January 1, 2006, based on the grant-date fair value estimated
      in accordance with the original provisions of SFAS No. 123, *Accounting
      for Stock Based Compensation* ,
      and (b)
      compensation cost for all stock-based payments granted subsequent to January
      1,
      2006, based on the grant-date fair value estimated in accordance with the
      provisions of SFAS 123R. For stock options granted to non-employees, the Company
      recognizes compensation expense in accordance with the requirements of Emerging
      Issues Task Force (“EITF”) No. 96-18, *Accounting
      for Equity Instruments That Are Issued to Other Than Employees for Acquiring,
      or
      in Conjunction with Selling, Goods or Services* .
      EITF
      96-18 requires that companies recognize compensation expense based on the
      estimated fair value of options granted to non-employees over their vesting
      period, which is generally the period during which services are rendered by
      such
      non-employees. The fair value of unvested non-employee stock awards is
      re-measured at the end of each reporting period.




6




*Stock
      Incentive Plan*




** In
      February 2004, the board of directors adopted the 2004 Stock Incentive Plan
      (the
“Plan”). Under the Company Amended and Restated 2004 Stock Incentive Plan, the
      Company is authorized to issue up to 20,000,000 shares of common stock pursuant
      to options and restricted stock grants.




The
      Board
      has the authority to select the employees, officers, directors, consultants
      and
      advisors to whom options are granted and determine the terms of each option,
      including (i) the number of shares of common stock subject to the option, (ii)
      when the option becomes exercisable, (iii) the option exercise price, which
      must
      be at least 100% (110% in the case of incentive stock options granted to a
      stockholder owning in excess of 10% of the Company’s common stock) of the fair
      market value of the common stock as of the date of grant and (iv) the duration
      of the option, which may be up to 10 years or, in the case of incentive stock
      options issued to a stockholder owning in excess of 10% of the Company’s common
      stock, five years.




As
      a
      result of the adoption of SFAS 123R the Company recognized $736,983 in
      stock-based compensation expense for the six months ended June 30,
      2007.




The
      following table summarizes amounts charged to expense for stock-based
      compensation related to employee and director stock option grants and
      stock-based compensation recorded in connection with stock options and
      restricted stock awards granted to non-employee consultants:


****
              
              **Three Months Ended**
                **June 30,**
              
              **Six Months Ended**
                **June 30,****2007**
              
              **2006**
              
              **2007**
              
              **2006****(unaudited)**
              
              **(unaudited)**
              
              **(unaudited)**
              
              **(unaudited)**Employee
                  and director stock option grants:Selling,
                  general and administrative
              
              $
              382,529
              
              $
              270,068
              
              $
              747,288
              
              $
              330,174Non-employee
                  consultants stock option grants and restricted stock
                  awards:Selling,
                  general and administrative *
              
              $
              (3,269
              )
              $
              22,516
              
              $
              (10,305
              )
              $
              45,176Total
                  stock-based compensation
              
              $
              379,260
              
              $
              292,584
              
              $
              736,983
              
              $
              375,350




*
      The
      amount recognized for non-employee consultants is a result of the re-measurement
      of the fair value using the Black-Scholes option-pricing model at the end of
      the
      reporting period. The result is an adjustment to the expense recognized since
      the date of the option grant to the end of the reporting period for the unvested
      portion of the option grants. As a tranche of options vest each tranche is
      re-measured and adjusted as of the vesting date and is not re-measured or
      adjusted after the vesting date.




7




The
        fair
        value of each stock award is estimated on the grant date using the Black-Scholes
        option-pricing model based on the assumptions noted in the following
        table:
  **Six
                  Months Ended**
                **June 30,****2007**
              
              **2006**Volatility
              
              
              80
              %
              
              80
              %Risk-free
                  interest rate
              
              
              4.58 –
                  4.92
              %
              
              4.29 –
                  5.04
              %Expected
                  life (years)
              
              
              5
              
              
              5Dividend
              
              
              None
              
              
              NoneForfeiture
                  rate
              
              
              None
              
              
              None
  Volatility
        is determined based on the Company’s estimate of fluctuation in its common stock
        price and its review of comparable public company data due to the limited
        amount
        of time that the Company’s common stock has been publicly traded. The expected
        life of stock options granted is based on the Company’s estimate of when options
        will be exercised in the future as there have been limited stock option
        exercises to date. The expected life is generally applied to one group as
        a
        whole as the Company does not expect substantially different exercise or
        post-vesting termination behavior amongst its employee population. The risk-free
        interest rate is based on the U.S. Treasury yield curve in effect at the
        time of
        grant commensurate with the expected life assumption.
  The
        Company is using the straight-line attribution method to recognize stock-based
        compensation expense. The amount of stock-based compensation recognized during
        a
        period is based on the value of the portion of the awards that are ultimately
        expected to vest. SFAS 123R requires forfeitures to be estimated at the time
        of
        grant and revised, if necessary, in subsequent periods if actual forfeitures
        differ from those estimates. The term “forfeitures” is distinct from
“cancellations” or “expirations” and represents only the unvested portion of the
        surrendered option. The Company has applied an annual forfeiture rate of
        0% to
        all unvested options as of June 30, 2007 as the Company believes that
        forfeitures to date are not representative of likely future forfeitures.
        This
        analysis will be re-evaluated quarterly and the forfeiture rate will be adjusted
        as necessary. Ultimately, the actual expense recognized over the vesting
        period
        will be for only those shares that vest.
  Using
        the
        Black-Scholes option-pricing model, the weighted average grant date fair
        value
        of options granted during the six months ended June 30, 2007 and 2006 was
        $0.05
        and $0.79, respectively.
  A
        summary
        of stock option activity as of June 30, 2007, and changes during the six-month
        period then ended, is presented below:
  **Options**
                **Outstanding**
              
              **Weighted-average**
                **Exercise Price**
              
              **Weighted-average**
                **Remaining**
                **Contracted Term in**
                **Years**
              
              **Aggregate**
                **Intrinsic**
                **Value**Outstanding
                  at December 31, 2006
              
              
              11,712,300
              
              $
              1.24
              
              
              8.9
              
              $
              2,850Granted
              
              
              1,805,000Expired
              
              
              (591,250
              )Outstanding
                  at June 30, 2007
              
              
              12,926,050
              
              $
              1.09
              
              
              8.6
              
              $
              2,680Exercisable
                  at $0.05 at June 30, 2007
              
              
              15,000
              
              $
              0.05
              
              
              1.8
              
              $
              300Exercisable
                  at $0.06 at June 30, 2007
              
              
              238,000
              
              $
              0.06
              
              
              9.9
              
              $
              2,380Exercisable
                  at $0.11 at June 30, 2007
              
              
              50,000
              
              $
              0.11
              
              
              9.9
              
              $
              —Exercisable
                  at $0.32 at June 30, 2007
              
              
              28,750
              
              $
              0.32
              
              
              9.6
              
              $
              —Exercisable
                  at $0.45 at June 30, 2007
              
              
              1,677,000
              
              $
              0.45
              
              
              8.0
              
              $
              —Exercisable
                  at $1.18 to $1.50 at June 30, 2007
              
              
              5,248,050
              
              $
              1.40
              
              
              8.6
              
              $
              —
  8
  On
        May
        11, 2007, Douglas Benedict was elected by the Company’s board of directors as a
        director of the Company. Mr. Benedict serves on the Company’s audit committee,
        compensation committee and nominating committee of the board of directors.
        Mr.
        Benedict serves as chairman of the compensation committee. Mr. Benedict was
        granted a non-statutory stock option to purchase up to 250,000 shares of
        the
        Company’s common stock. The option has an exercise price of $0.11 per share,
        representing the fair market value of the Company’s common stock on the date of
        grant. On the date of grant, the option was exercisable with respect to 50,000
        shares of common stock purchasable thereunder and will vest and become
        exercisable with respect to the remaining shares of common stock purchasable
        thereunder in quarterly installments of 50,000 shares such that the option
        will
        be fully vested on the first anniversary of the date of grant (such quarterly
        installments to vest on the quarterly anniversary date of the date of grant).
        The option shall immediately become exercisable with respect to all shares
        purchasable thereunder upon a change of control of the company.
 
 On
        May
        16, 2007, we entered into a consulting agreement with Jack Early relating
        to Mr.
        Early’s serving as the Company’s chief operating officer. The consulting
        agreement provides for the grant to Mr. Early of a non-statutory stock option
        to
        purchase up to 250,000 shares of the Company’s common stock. The exercise price
        per share is $0.06, which represented the closing price of the Company’s common
        stock on May 15, 2007 as reported on the Over-the-Counter Bulletin Board.
        The
        option is exercisable for five years from the date of grant and shall vest
        and
        become exercisable with respect to 150,000 shares of common stock on December
        31, 2007 and shall vest and become exercisable with respect to the remaining
        100,000 shares of common stock on December 31, 2008, provided, in each case,
        that Mr. Early is an officer or director of the Company on such vesting date.
        Mr. Early resigned as a director and chief operating officer in August 2007.
        See
        Note 15.
 
 The
        Company also granted options to purchase up to 1,270,000 shares of common
        stock
        on May 23, 2007 to certain officers and employees. Two employees left the
        Company and their options terminated in accordance with the terms of their
        option agreements and one employee refused the option grant. Therefore a
        total
        of 80,000 options were terminated. The options were granted as compensation
        for
        employment and as incentive to remain employed with the Company. All of these
        options have an exercise price of $0.06 per share which represents the closing
        price of the Company’s common stock on May 23, 2007 as reported on the
        Over-the-Counter Bulletin Board and an expiration date of May 23, 2017. On
        the
        date of grant, the options were exercisable with respect to 20% of the total
        option shares purchasable thereunder. The remaining options become fully
        vested
        on December 31, 2007. All of the above options will accelerate in full upon
        a
        change of control. The options granted are evidenced by the Company’s standard
        form of the incentive stock option agreement.
 
 There
        were no options exercised during the six months ended June 30, 2007. During
        the
        six months ended June 30, 2006, the total intrinsic value of options exercised
        (i.e., the difference between the market price at exercise and the price
        paid by
        the employee to exercise the options) was $937,500 and the total amount of
        cash
        received from exercise of these options was $75,000. The total grant-date
        fair
        value of stock options that vested during the three and six months ended
        June
        30, 2007 was $24,705 and $76,385, respectively.
 
 As
        of
        June 30, 2007, there was approximately $2,920,839 of total unrecognized
        compensation cost related to unvested share-based awards. This cost is expected
        to be recognized over a weighted average period of 3.5 years. The Company
        expects 5,669,250 unvested options to vest in the future.
 9
  **(3)          
        Income Taxes**
  The
        Company accounts for income taxes in accordance with Statement of Financial
        Accounting Standard (SFAS) No. 109, *Accounting
        for Income Taxes* (“SFAS
        109”). Under SFAS 109, deferred tax assets or liabilities are computed based
        on
        the difference between the financial statements and income tax basis
        of
        assets and liabilities, and net operating loss carryforwards, using the enacted
        tax rates. Deferred income tax expense or benefit is based on changes in
        the
        asset or liability from period to period. The Company did not record a provision
        for federal, state or foreign income taxes for the three- and six-month periods
        ended June 30, 2007 and 2006 because the Company has experienced losses since
        inception. The Company has not recorded a benefit for deferred tax assets
        as
        their realizability is uncertain.
  **(4)          
        Balance Sheet Detail**
  Accrued
        expenses at June 30, 2007 and December 31, 2006 consisted of the
        following:
  **June
                  30,**
                **2007**
              
              **December 31,**
                **2006**(unaudited)
              
              (unaudited)Payroll
                  and payroll related
              
              $
              485,376
              
              $
              384,257Professional
                  fees
              
              
              443,846
              
              
              598,820Interest
              
              
              232,901
              
              
              158,743Value
                  added tax
              
              
              78,174
              
              
              51,660Termination
                  costs
              
              
              60,777
              
              
              90,040Directors’
                  fees
              
              
              37,440
              
              
              12,300Travel
              
              
              36,015
              
              
              34,331Repairs
                  and maintenance
              
              
              —
              
              
              15,047Printing
              
              
              —
              
              
              10,750Other
              
              
              58,601
              
              
              23,165$
              1,433,130
              
              $
              1,379,113
  **(5)** **Intangible
        Assets**
  The
        Company recorded the acquisition of the V-CubeTM IP-PBX platform software and
        associated intellectual property as an intangible asset in June 2006 amounting
        to $26,279,189 ($8,800,000 in cash, 14,000,000 shares at $1.22 per share,
        and
        the outstanding prepaid royalty amount of $399,189). The asset is being
        amortized over a five year estimated useful life beginning on July 1, 2006,
        which coincides with the first V-CubeTM product launch by one of the Company’s
        customers. At June 30, 2007 the net carrying value of this intangible asset
        was
        $21,023,351. Amortization expense for the three- and six-month periods ended
        June 30, 2007 was approximately $1,314,000 and $2,628,000,
        respectively.
 
 The
        acquired assets include NetYantra’s VoIP IP-PBX platform software and associated
        intellectual property. The Company had previously distributed this software
        as
        its V-CubeTM VoIP IP-PBX platform offering under a Distribution and Marketing
        Agreement with NetYantra.
  The
        terms
        of the Purchase Agreement required the Company and NetYantra to use commercially
        reasonable efforts to negotiate and execute within sixty (60) days following
        the
        closing of the acquisition a license and revenue agreement, a services agreement
        and an executive employment agreement.  Although
        a mutually satisfactory services agreement was not executed, NetYantra had
        been
        performing services for the Company since June 7, 2006. As of June 30, 2007
        the
        Company had made cash payments of $743,968 for the services provided by
        NetYantra and for services provided from June 7, 2006 through March 31, 2007
        by
        one of the authors of the V-Cube who was also a principal of NetYantra. Of
        the
        total amount paid, $280,000 was paid directly to the author and principal
        on
        April 25, 2007 as the Company was informed that NetYantra’s operations had been
        closed.
 
 10
  The
        Company recorded the acquisition of the Order-to-Cash (“O2C”) software as an
        intangible asset in October 2006 amounting to $2,077,777, including acquisition
        costs of $62,643. The O2C asset is being amortized over a five year estimated
        useful life beginning on October 11, 2006 (see Note 10). At June 30, 2007
        the
        net carrying value of the O2C intangible asset was $1,770,822. Amortization
        expense for the three- and six-month periods ended June 30, 2007 was
        approximately $104,000 and $208,000, respectively.
 
 In
        accordance with SFAS No. 144, intangible assets must be tested at least annually
        for impairment at the reporting unit level. If an indication of impairment
        exists, the Company is required to determine if the intangible assets implied
        fair value is less than the carrying value in order to determine the amount,
        if
        any, of the impairment loss required to be recorded. Impairment indicators
        include, among other conditions, cash flow deficits, a historic or anticipated
        decline in revenue or operating profits, adverse legal or regulatory
        developments and/or a material decrease in the fair value of some or all
        of the
        assets. The Company performs the required impairment tests on an annual basis
        in
        conjunction with the Company’s fiscal year end. Due to certain indicators of
        impairment during the second quarter of 2007 (see Note 1), management has
        performed an analysis of its intangible assets and determined that an impairment
        charge is not required at June 30, 2007. Because management believes these
        indicators still exist, it is continuing to review the carrying value of
        intangible assets. Intangible assets are being amortized over their estimated
        useful lives.
 
 **(6)** **Comprehensive
        Loss**
  For
        the
        three- and six-month periods ended June 30, 2007 and 2006, the components
        of
        other comprehensive loss consisted of the Company’s net loss and foreign
        currency translation adjustments. Comprehensive loss was $3,228,618 and
        $3,511,724 for the three months ended June 30, 2007 and 2006, respectively.
        Comprehensive loss was $6,500,777 and $7,690,716 for the six months ended
        June
        30, 2007 and 2006, respectively.
 
 **(7)          
        Net Loss Per Share**
  Basic
        net
        loss per share is computed by dividing net loss for the period by the weighted
        average number of common shares outstanding during the period. Diluted net
        loss
        per share is computed by dividing net loss by the weighted average number
        of
        common shares outstanding during the period plus the dilutive effect of
        convertible debt and outstanding stock options. As there was a net loss for
        the
        three- and six-month periods ending June 30, 2007, 12,926,050 outstanding
        stock
        options, 28,678,725 outstanding warrants, 8,399,999 common shares obtainable
        upon exercise of the conversion feature of the convertible debentures and
        2,500,000 common shares obtainable upon exercise of the conversion feature
        of
        the convertible notes were excluded from the calculation of diluted earnings
        per
        share because they were anti-dilutive. As there was a net loss for the three-and
        six-month periods ended June 30, 2006, 5,755,000 outstanding stock options
        (excluding 6,350,000 options granted on December 23, 2005, 948,000 options
        granted on April 11, 2006, later reduced to 448,000, and 1,270,000 granted
        on
        April 12, 2006, all pending shareholder ratification of an amendment to the
        2004
        Stock Incentive Plan, which was approved on July 17, 2006), 24,778,725
        outstanding warrants, and 8,399,999 common shares obtainable upon exercise
        of
        the conversion feature of the convertible debentures were excluded from the
        calculation of diluted earnings per share because they were
        anti-dilutive.
  **(8)         Convertible
        Debentures and Warrant Financing**
  On
        February 18, 2005 and March 4, 2005, the Company sold convertible debentures
        maturing three years from issuance in the aggregate principal amount of
        $8,400,000, convertible into common stock of the Company at $0.75 per share,
        and
        warrants to purchase an aggregate of 8,400,000 shares of common stock, at
        an
        exercise price of $1.00 per share to accredited investors. Of the $8,400,000
        aggregate principal amount of convertible debentures sold, through June 30,
        2007, $2,100,000 in outstanding principal has been converted into 2,799,993
        shares of common stock, reducing the amount of interest required to be paid
        in
        future periods, with $6,300,000 in principal remaining outstanding at June
        30,
        2007. In the Company’s consolidated balance sheet at June 30, 2007, the
        remaining principal of $6,300,000 has been reduced by unamortized debt discount
        of $254,876.
 
 11
  The
        debentures accrue interest daily at a rate of 8% per annum, which interest
        is
        payable quarterly on each March 31, June 30, September 30 and December 31
        following the issue date. The Company is not permitted to prepay any portion
        of
        the principal amount of any of the debentures without the prior consent of
        the
        holder thereof. The debentures are convertible at the option of the holders
        into
        shares of common stock at any time at an initial conversion price of $0.75
        per
        share. Except in the case of certain exempted issuances, in the event the
        Company issues shares of common stock or common stock equivalents (i.e.,
        securities convertible into, or exercisable or exchangeable for, shares of
        common stock) at a price per share (or in the case of common stock equivalents,
        a conversion, exercise or exchange price per share) below the then applicable
        conversion price of the debentures, the conversion price of the debentures
        will
        be reduced to that lower price per share. The Company has agreed to certain
        restrictions under the terms of the debentures, including a prohibition on
        the
        payment of cash dividends to stockholders while any of the debentures are
        outstanding. Upon the occurrence of an event of default under the debentures,
        an
        amount equal to (i) 130% of the then outstanding principal amount, plus any
        accrued and unpaid interest thereon, or (ii) the product of the then outstanding
        principal amount, plus any accrued and unpaid interest thereon, times the
        ratio
        obtained by dividing the conversion price of the debentures and the market
        price
        of the Company’s common stock, whichever is greater, will, at the holder’s
        option, become immediately due and payable in cash along with any other amounts,
        costs, expenses or liquidated damages then due in respect of such debentures.
        Upon an event of a default, the interest rate on the debentures will also
        be
        increased to 18% per annum. The Company requested waivers from the debenture
        holders for the payment due on June 30, 2007 to be deferred until August
        15,
        2007. As of the date of this filing, the Company has not received any executed
        waivers from the debenture holders.
  The
        common stock purchase warrants issued to the investors are exercisable at
        an
        initial exercise price of $1.00. The warrants have an expiration date of
        five
        years after the date of issuance. They contain a cashless exercise provision
        whereby the holder may pay the exercise price by having the Company withhold
        upon exercise shares having a fair market value equal to the applicable
        aggregate exercise price if after the first anniversary of the date of issuance
        of the warrant there is no effective registration statement registering,
        or no
        current prospectus available for, the resale of the shares issuable upon
        the
        exercise of the warrants. In the event this provision is used with respect
        to an
        exercise, the Company would receive no proceeds from the sale of its common
        stock in connection with such exercise. The warrants were initially exercisable
        for an aggregate 8,400,000 shares of common stock. As of June 30, 2007, the
        Company had issued 3,190,499 shares upon exercise of warrants, all in connection
        with the warrant exercise agreements described below.
  The
        exercise price is subject to adjustment in the event of certain issuances
        of new
        securities. Specifically, except in the case of certain exempted issuances,
        if
        the Company issues shares of common stock or common stock equivalents (i.e.,
        securities convertible into, or exercisable or exchangeable for, shares of
        the
        Company’s common stock) at a price per share (or in the case of common stock
        equivalents, a conversion, exercise or exchange price per share) below the
        then
        applicable exercise price of the warrants, the exercise price of the warrants
        will be reduced to that lower price per share. In the event of such an
        adjustment, the number of shares for which the warrants are exercisable will
        be
        increased such that the aggregate exercise price of the warrants after the
        adjustment will equal the aggregate exercise price immediately prior to the
        adjustment. In connection with the two closings of the private placement,
        the
        Company paid $802,500 in fees and issued a warrant to purchase up to 802,500
        shares of common stock (exercisable at $1.00 per share) to the placement
        agent.
  *Warrant
        Exercise Agreements.* In
        October 2005, the Company entered into several warrant exercise agreements
        with
        holders of warrants issued in the private placement that closed in the first
        quarter of 2005. Pursuant to these agreements, the Company issued to these
        holders new common stock purchase warrants exercisable for a number of shares
        equal to the number of shares they purchased upon exercise of the warrants
        issued to them in the private placement. These new warrants have an exercise
        price of $1.50 per share. The Company received aggregate proceeds of $3,190,499
        in connection with the exercise of the prior warrants, and issued new warrants,
        which expire five years after the issue date, to purchase an aggregate of
        3,190,499 shares of common stock (plus an additional warrant with an exercise
        price of $1.50, which
        expires five years after the issue date, to purchase 159,525 shares of common
        stock to a placement agent who assisted with the transaction). The shares
        of
        common stock underlying these warrants have been registered for resale with
        the
        SEC. As a condition for each debenture holder executing a waiver for the
        April
        6, 2007 financing as discussed herein, the Company agreed to reduce the exercise
        price of the replacement warrants to $1.00 per share and provide the same
        anti-dilution protection as contained in the warrants issued in connection
        with
        the debenture financing.
 
 12
  **(9) Stock
        and
        Warrant Purchase Agreement**
  On
        May
        22, 2006, the Company sold 16,300,000 units consisting of one share of common
        stock and eight-tenths of one warrant to acquire one share of common stock
        to
        accredited investors. The effective purchase price of the units was $1.00
        per
        unit. In exchange for the units sold, the Company received gross cash proceeds
        of $16,300,000. The Company issued warrants for 13,040,000 common stock shares,
        exercisable until May 22, 2011 at an exercise price of $1.00 per share. In
        connection with the private placement, the Company paid $978,000 in fees
        and
        issued 1,467,000 common stock warrants (exercisable at $1.00 per share) to
        the
        placement agent.
  The
        Company realized net proceeds from the sale of units, after deducting placement
        agent fees and expenses, of approximately $15,200,000. The Company used
        $8,800,000 of these proceeds to purchase the software and intellectual property
        rights of NetYantra’s V-CubeTM IP-PBX platform as described in Note 5.
  The
        Company agreed to register the resale of the shares of common stock sold
        in the
        offering and issuable upon exercise of the warrants. A registration statement
        was filed on June 30, 2006 and initially became effective on July 14, 2006.
        The
        Company is required to use its best efforts to keep the registration statement
        continuously effective under the Securities Act until the earlier of the
        date
        when all the registrable securities covered by the registration statement
        have
        been sold or are freely saleable and the second anniversary of the closing.
        In
        the event that the registration statement ceases to remain effective, the
        Company is obligated to make cash payments in the nature of liquidated damages
        up to a limit of 10% of the purchase price of the units.
  **(10)         Business
        Acquisition**
  On
        October 11, 2006, the Company acquired all outstanding shares of Goodman
        Blue
        Limited, a UK company, from its sole shareholder, Scott Lee Goodwin (“Goodwin”),
        for 2,500,000 common shares, subject to an option on the part of Goodwin
        to
        require the Company to repurchase the shares at $1.00 per share. On February
        12,
        2007, the Company and Goodwin amended the share purchase agreement to provide
        that: (i) Goodwin shall have the option to require the Company to
        purchase 1,400,000 of the Consideration Shares for $1,400,000 (the “First Put
        Option”); and (ii) Goodwin shall have the option to require the Company to
        purchase 1,100,000 of the Consideration Shares for $1,100,000 (the “Second Put
        Option”). The time for exercise of the First Put Option and Second Put
        Option was deferred until the period beginning on December 1, 2007 and ending
        on
        December 31, 2007 in consideration of the payment to Goodwin of approximately
        $110,000 and the engagement of Goodwin for consulting services to be provided
        to
        the Company’s subsidiary, Goodman Blue Limited. The terms of the Company's
        currently outstanding notes prohibit the redemption of shares of the
        Company's common stock without the note holders consent. Also see Note
        5.
  
 13
  **(11)        
          Commitments and Contingencies**
  On
          December 13, 2005, the Company entered into a Consultant, Representative
          and
          Professional Services Agreement with Quest Telecommunications, Inc. (“Quest”).
          Under this agreement, the Company appointed Quest as an independent advisor
          and
          the Company’s exclusive representative in the geographic areas of Vietnam,
          Cambodia, Malaysia and Turkey (and any other areas to which the Company
          and
          Quest agree in writing). Under this agreement, the Company paid Quest
          $50,000 in consideration for Quest’s assistance
          relating to the execution by the Company and Saigon Post and Telecommunications
          Services Corporation (“SPT”) of a memorandum of understanding and pilot license
          agreement with respect to the V-CubeTM. The Company entered into a distribution
          and marketing agreement with SPT with respect to the V-CubeTM on July 3, 2006.
          Upon signing this agreement, the Company is obligated to issue to Quest
          300,000
          shares of the Company’s common stock and to pay to Quest $150,000 in cash, plus
          a continuing commission of thirty percent of the license fees received
          from SPT
          in connection with the licensing and distribution of the V-CubeTM in the
          above-mentioned geographic areas (net of sales, use and value added taxes,
          if
          any, payable by the Company in connection with such license fees). Although
          the
          agreement with SPT has been signed, the Company does not expect to pay
          the
          $150,000 in cash or continuing commission of thirty percent of the license
          fees
          received from SPT due to SPT’s indication to enter into license purchase and
          maintenance agreement in lieu of the distribution and marketing agreement
          and a
          reported delay in SPT’s ability to launch the product due to the local
          government’s approval process, therefore the $150,000 due has not been recorded
          in the financial statements.
 
 **(12)        
        Indemnification**
  As
        permitted under Delaware law, the Company has agreements with its directors
        whereby it indemnifies them for certain events or occurrences while they
        are, or
        were serving, at the Company’s request as a director (or in any other capacity).
        The term of the indemnification period is the director’s lifetime. The maximum
        potential amount of future payments the Company could be required to make
        under
        these indemnification agreements is unlimited; however, the Company has a
        director and officer insurance policy pursuant to which the Company may recover
        all or a portion of amounts it pays to directors under their indemnification
        agreements. As a result of its insurance policy coverage, the Company believes
        the estimated fair value of these indemnification agreements is
        minimal.
  The
        Company enters into standard indemnification agreements in the ordinary course
        of its business. Pursuant to these agreements, the Company indemnifies, holds
        harmless, and agrees to reimburse the indemnified party for losses suffered
        or
        incurred by the indemnified party, generally distributors, agents, or customers,
        in connection with any patent, copyright, trademark, trade secret or other
        intellectual property infringement claim by any third party with respect
        to the
        Company’s products. The term of these indemnification agreements is generally
        perpetual. The maximum potential amount of future payments the Company could
        be
        required to make under these indemnification agreements is often capped at
        a
        dollar figure. In addition, the Company has agreed to indemnify the investors
        in
        the convertible debenture financing described in Notes 8, 9 and 14 against
        certain losses. The Company has never incurred costs to defend lawsuits or
        settle claims related to these indemnification agreements. As a result, the
        Company believes the estimated fair value of these agreements is
        minimal.
  **(13)        
        Convertible Promissory Note to Related Party**
  On
        July
        2, 2004, the Company entered into a note subscription agreement with the
        J.
        Rothschild Assurance Self Invested Personal Pension Plan No. 2, the sole
        beneficiary of which is the Company’s Chairman, chief executive officer and
        president, Rupert Galliers-Pratt. The note subscription agreement was amended
        and restated on August 11, 2004. Under the amended and restated note
        subscription agreement, the Company issued and sold to Mr. Galliers-Pratt’s
        pension plan convertible promissory notes in the principal amounts of $125,000
        and $50,000 on July 12, 2004 and on August 11, 2004, respectively. Both
        convertible promissory notes have a one year term, accrue interest at the
        rate
        of 7% per annum and are convertible into shares of the Company’s common stock at
        the price of $1.50 per share. On August 11, 2005, the pension plan confirmed
        its
        earlier agreement to extend the maturity date of both promissory notes until
        December 31, 2005. On December 15, 2005, the pension plan confirmed its earlier
        agreement to extend the maturity date of both promissory notes until June
        30,
        2006. On June 30, 2006, the pension plan confirmed its earlier agreement
        to
        extend the maturity date of both promissory notes until December 31, 2006.
        On
        December 31, 2006, the pension plan confirmed its earlier agreement to extend
        the maturity date of both promissory notes until June 30, 2007. On July 30,
        2007, the pension plan confirmed its earlier agreement to extend the maturity
        date of both promissory notes until December 31, 2007.
 
 14
 
 **(14)       
        Convertible Notes**
 
 On
        April
        6, 2007, the Company completed a private placement of convertible notes and
        warrants pursuant to a securities purchase agreement (the “Securities Purchase
        Agreement”) with certain accredited investors (the “Investors”). The Investors
        purchased convertible notes in the aggregate principal amount of $2,500,000
        and
        warrants to purchase up to an aggregate of 2,500,000 shares of the Company’s
        common stock. The private placement resulted in gross proceeds of $2,500,000.
        The investors also received an aggregate of 5,000,000 shares of the Company’s
        common stock, which shares were transferred from Executive Management Services
        Limited (“EMS”), an entity of which Mr. Galliers-Pratt, is a beneficiary, to the
        investors, EMS received no consideration for the transfer. The Company has
        accounted for the transfer of shares by EMS to the investors using SFAS 123R
        and
        Staff Accounting Bulletin No. 107, *Share-Based
        Payment* (“SAB
        107”), whereby a principal stockholder, in this case Mr. Galliers-Pratt through
        his interest at EMS, pays an expense for the Company as a type of pecuniary
        interest which benefits the Company in a transaction involving financial
        instruments with both equity and debt financing arrangements. The Company
        has
        recorded the value of the shares transferred as additional paid-in capital
        and
        as a discount to the convertible notes and amortizes the discount in accordance
        with the Company’s critical accounting policy on convertible debt.
  The
        Company granted each of the Investors a participation right whereby they
        may
        each elect to purchase all or a portion of securities sold in certain future
        financings. The participation right expires on the first anniversary of the
        closing date.
  The
        Company also granted each Investor the right to exchange all or some of its
        notes for securities offered in certain future financings. In the event of
        this
        exchange right is asserted in connection with such a future financing, the
        Company would be required to issue to the Investor requesting the exchange
        a
        number of new securities offered in such financing determined by dividing
        the
        outstanding principal amount of the note being exchanged (plus accrued interest
        or other fees owed to such Investor) by the price at which the new securities
        are being sold in such financing. This exchange right expires on the first
        anniversary of the closing date.
  Under
        the
        terms of the Securities Purchase Agreement, the Company is prohibited from
        engaging in certain types of financing transactions. In particular, for a
        period
        of 45 days after the date the initial registration statement covering the
        shares
        underlying the notes and warrants is first declared effective by the SEC
        (which
        the Company must file pursuant to a Registration Rights Agreement, as further
        described herein), the Company may not issue shares of common stock or common
        stock equivalents except pursuant to conversion or exercise of convertible
        securities or outstanding rights to acquire common stock that were outstanding
        on or prior to the closing date. Also, until such time as no Investor holds
        any
        of the notes, warrants or shares of common stock underlying the notes or
        warrants, the Company may not issue securities that are convertible into,
        exchangeable or exercisable for, or include the right to receive additional
        shares of the Company’s common stock at a conversion, exercise or exchange
        price, as applicable, that is (i) determined based on the market price of
        the
        Company’s common stock at any time after the issuance of such securities, or
        (ii) is subject to reset upon the occurrence of events directly or indirectly
        related to the Company’s business or the market for the Company’s common stock.
        The Company is also prohibited from entering into any agreement providing
        for
        the sale of securities at a price determined at a future time.
  The
        notes
        issued to the Investors on April 6, 2007 accrue interest daily at an rate
        of 12%
        per annum, which interest is payable quarterly on each March 31, June 30,
        September 30 and December 31 beginning on September 30, 2007. The final interest
        payment is due on the date of maturity of the note, April 6, 2009. In addition,
        on any date on which all or a portion of the principal of a note is converted,
        all unpaid interest having accrued on such principal at the time of such
        conversion will become immediately payable. The Company is not permitted
        to
        prepay any portion of the principal amount of any of the notes without the
        prior
        consent of the holder thereof. These notes are junior to the Company’s currently
        outstanding 8% convertible debentures due in February and March
        2008.
 
 15
 
 The
        notes
        are convertible at the option of the holders into shares of the Company’s common
        stock at any time at an initial conversion price of $1.00 per share. Except
        in
        the case of certain exempted issuances, in the event the Company issues shares
        of common stock or common stock equivalents (i.e., securities convertible
        into,
        or exercisable or exchangeable for, shares of the Company’s common stock) at a
        price per share (or in the case of common stock equivalents, a conversion,
        exercise or exchange price per share) below the then applicable conversion
        price
        of the notes, the conversion price of the notes will be reduced to that lower
        price per share.
  If,
        after
        the effectiveness of the registration statement, the market price for any
        period
        of 20 consecutive trading days exceeds $2.50 and the average daily trading
        volume for the Company’s common stock for such period exceeds 100,000 shares,
        the Company may, subject to certain conditions, force the holders of the
        notes
        to immediately convert all or any part of the then outstanding principal
        amount
        at the then-effective conversion price.
  If,
        after
        the first year anniversary of the issuance of the notes, there is an effective
        registration statement and for a period of 20 consecutive trading days, the
        daily trading volume for the Company’s common stock exceeds 100,000 shares per
        trading day, the Company may, subject to certain conditions, redeem all or
        any
        part of the then outstanding principal amount of the notes for cash in an
        amount
        equal to the sum of (i) 150% of the then outstanding principal amount of
        the
        note, (ii) accrued but unpaid interest and (iii) all liquidated damages and
        other amounts due in respect of the note.
  The
        Company has agreed to certain restrictions under the terms of the notes,
        including a prohibition on the payment of cash dividends to the Company’s
        stockholders while any of the notes are outstanding. Upon the occurrence
        of an
        event of default under the notes, an amount equal to (i) 130% of the then
        outstanding principal amount, plus any accrued and unpaid interest thereon,
        or
        (ii) the product of the then outstanding principal amount, plus any accrued
        and
        unpaid interest thereon, times the ratio obtained by dividing the conversion
        price of the notes and the market price of the Company’s common stock, whichever
        is greater, will, at the holder’s option, become immediately due and payable in
        cash along with any other amounts, costs, expenses or liquidated damages
        then
        due in respect of such notes. The ratio referred to in clause (ii) is to
        be
        calculated based on the conversion price in effect on the date of such default
        or the date the accelerated amount is paid in full (whichever is less), and
        the
        market price of the Company’s common stock on the date of such default or the
        date the accelerated amount is paid in full (whichever is greater, such market
        price to be determined in accordance with the terms of the notes). Upon an
        event
        of a default, the interest rate on the notes will also be increased to 18%
        per
        annum.
  Events
        of
        default under the notes include failure to pay any amounts under the notes
        when
        due, a material default under other agreements with the Investors or default
        in
        the Company’s obligations under mortgage, credit facility or similar agreements,
        a material inaccuracy in the representations and warranties the Company made
        to
        the Investors in connection with the Financing, and the initiation of voluntary
        or involuntary bankruptcy proceedings against the Company.
  The
        common stock purchase warrants issued to the Investors on April 6, 2007 are
        exercisable for an aggregate of 2,500,000 shares of the Company’s common stock
        at an initial exercise price of $1.00. The warrants have an expiration date
        of
        five years after the date of issuance, or April 6, 2012. They contain a cashless
        exercise provision whereby the holder may pay the exercise price by having
        the
        Company withhold upon exercise shares having a fair market value equal to
        the
        applicable aggregate exercise price if after the first anniversary of the
        date
        of issuance of the warrant there is no effective registration statement
        registering, or no current prospectus available for, the resale of the shares
        issuable upon the exercise of the warrants. In the event this provision is
        used
        with respect to an exercise, the Company would receive no proceeds from the
        sale
        of the Company’s common stock in connection with such exercise.
 
 16
 
 The
          exercise price is subject to adjustment in the event of certain issuances
          of new
          securities. Specifically, except in the case of certain designated issuances,
          if
          the Company issues shares of common stock or common stock equivalents (i.e.,
          securities convertible into, or exercisable or exchangeable for, shares
          of the
          Company’s common stock) at a price per share (or in the case of common stock
          equivalents, a conversion,
          exercise or exchange price per share) below the then applicable exercise
          price
          of the warrants, the exercise price of the warrants will be reduced to
          that
          lower price per share. In the event of such an adjustment, the number of
          shares
          for which the warrants are exercisable will be increased such that the
          aggregate
          exercise price of the warrants after the adjustment will equal the aggregate
          exercise price immediately prior to the adjustment. Issuances that will
          not
          result in adjustment to the exercise price include issuances to employees,
          consultants, directors or officers pursuant to a stock or option plan adopted
          by
          the Company’s board of directors, securities issued upon conversion of other
          securities outstanding prior to the date of issuance of the warrants, warrants
          issued in connection with obtaining bank financing, common stock issued
          in
          connection with the settlement of claims up to a maximum aggregate of 500,000
          shares, securities issued in connection with acquisitions, joint ventures
          or
          other strategic transactions and securities issued under agreements executed
          by
          the Company prior to the date of the Securities Purchase Agreement and
          disclosed
          in the Company’s reports filed with the SEC since January 1, 2006.
  If,
        after
        the effectiveness of the registration statement, (i) the market price for
        any
        period of 20 consecutive trading days exceeds $2.50, (ii) the average daily
        trading volume for the Company’s common stock for such period exceeds 100,000
        shares and (iii) the Investor is not in possession of any information that
        constitutes, or might constitute, material non-public information which was
        provided by us, then the Company may, within 1 trading day of the end of
        such
        period, call for cancellation of all or any portion of the warrants for which
        a
        notice of exercise has not yet been delivered for consideration equal to
        $0.001
        per share.
  The
        Company agreed to register for resale under the Securities Act of 1933, as
        amended, the shares underlying the notes and warrants and the bonus shares
        pursuant to a Registration Rights Agreement between the Company and the
        Investors dated April 6, 2007. On May 7, 2007, the Company filed with the
        SEC a
        registration statement covering the resale of a number of shares of common
        stock
        equal to 120% of the shares issuable upon conversion and exercise in full
        of the
        notes and warrants as of the date of filing of the registration statement
        plus
        the bonus shares. Pursuant to the Registration Rights Agreement, the
        registration statement covering these shares had to be declared effective
        by the
        SEC no later than August 4, 2007. The registration statement was not declared
        effective within the timeframe specified by the Registration Rights Agreement
        and as a result the Company may be required to pay liquidated damages equal
        to
        1.5% per month (but pro-rated on a daily basis for any period of less than
        a
        full month) of the aggregate purchase price of the notes and warrants until
        the
        registration statement is declared effective. The Company received a comment
        letter from the SEC dated as of June 6, 2007. As of the date of this filing,
        the
        Company has not responded to the SEC’s comment letter. The Company will need to
        respond to the SEC’s comment letter and resolve any comments with the SEC before
        the registration statement can be declared effective.
  If,
        at
        any time, the number of shares issuable upon conversion and exercise in full
        of
        the notes and warrants exceeds 100% of the number of shares then registered
        (e.g., due to adjustments in the conversion price of the notes or exercise
        price
        of the warrants), the Company will be required to file an additional
        registration statement covering the excess shares. The Company will have
        to file
        the additional registration statement on the earliest practicable date, and
        the
        additional registration statement must be declared effective by the SEC not
        later than the 60 th calendar
        day, following the date the 100% threshold is exceeded. If the Company does
        not
        file the registration statement or the registration statement is not declared
        effective within these time frames, the Company will be required to pay to
        the
        liquidated damages as described in the preceding paragraph.
  In
        connection with the closing of the convertible note and warrant financing,
        the
        Company paid placement agent fees in the amount of $56,000 in cash and warrants
        to purchase 1,400,000 shares of the Company’s common stock
        at
        $1.00 per share, which warrants expire in five years. The Company agreed
        to
        indemnify the principal placement agent from claims arising in relation to
        the
        services it provides to the Company.
  17
  **(15)        
          Subsequent Events**
 
 On
          July
          5, 2007 the Company and Telstra Europe Limited entered into an agreement
          which
          amended the terms of the distribution and marketing agreement with regard
          to the
          Company’s V-CubeTM product entered into on April 1, 2005. The license from the
          Company to Telstra ceased being exclusive and was expanded to include MyPortal
          and MyService software developed by the Company. The agreement also resolved
          claims and counterclaims made by the parties. Pursuant to the agreement,
          a one
          time license fee of approximately $300,000 was paid to the Company by
          Telstra.
 
 Effective
          August 6, 2007, Mr. J. Marcus Payne and Mr. Jack Early resigned from the
          board
          of directors of the Company.  Mr. Early also resigned as the Company’s
          chief operating officer effective August 6, 2007. Effective August 7, 2007,
          Mr.
          Jared Taylor resigned from his positions as chief financial officer, secretary
          and treasurer of the Company.
  Effective
          August 8, 2007, Mr. Rupert Galliers-Pratt was appointed the Company’s interim
          chief financial officer. Effective August 9, 2007, Mr. Ian Cope was appointed
          as
          the Company’s chief operating officer.
  **Item
          2.** **** **Management’s
          Discussion and Analysis of Financial Condition and Results of
          Operations.**
  **Introduction**
  The
          following information should be read in conjunction with the financial
          statements and notes thereto in Part I, Item 1 of this Quarterly Report and
          with Management’s Discussion and Analysis of Financial Condition and Results of
          Operations contained in our Annual Report on Form 10-KSB for the year ended
          December 31, 2006 (File No. 000-50758).
  **Cautionary
          Statements**
  We
          do not
          provide forecasts of our future financial performance. However, from time
          to
          time, information provided by us or statements made by our employees may
          contain
“forward-looking” information that involves risks and uncertainties. In
          particular, statements contained in this Quarterly Report that are not
          historical facts constitute forward-looking statements and are made under
          the
          safe harbor provisions of the Private Securities Litigation Reform Act
          of 1995.
          Forward-looking statements involve substantial risks and uncertainties.
          You can
          identify these statements by forward-looking words such as “may”, “will”,
“expect”, “anticipate”, “believe”, “estimate”, “continue”, and similar words.
          You should read forward-looking statements carefully because they:
          (1) discuss our future expectations; (2) contain projections of our
          future operating results or financial condition; or (3) state other
“forward-looking” information. Various factors described below, as well as any
          other instances of cautionary language in this Quarterly Report, refer
          to or
          provide examples of risks, uncertainties and events that may cause our
          actual
          results to be materially different than the expectations described in our
          forward-looking statements. You should be aware that the occurrence of
          any of
          the events or factors described below and elsewhere in this Quarterly Report
          could materially and adversely affect our business. All forward-looking
          statements included in this Quarterly Report are based on information available
          to us on the date hereof, and we assume no obligation to update any such
          forward-looking statements.
  Each
          forward-looking statement should be read in conjunction with the financial
          statements and notes thereto in Part I, Item 1 of this Quarterly Report,
          this section, and Management’s Discussion and Analysis of Financial Condition
          and Results of Operations contained in our Annual Report on Form 10-KSB for
          the year ended December 31, 2006 (File No. 000-50758), including but not
          limited to the section therein entitled “Factors Affecting Future
          Performance.”
  18
  In
          addition to the risks and uncertainties faced generally by participants
          in the
          telecommunication industry, we face the following risks and
          uncertainties:
 
 ·
                If
                    we do not obtain a substantial amount of additional funding and/or
                    concessions from creditors, we may have to curtail or suspend
                    operations.
 
 ·
                To
                    date we have not realized any revenue from our arrangement with
                    a
                    distributor in the United Kingdom which was expected to be a
                    major source
                    of revenue and there is no assurance that we will ever realize
                    revenue
                    from this arrangement.
  ·
                The
                    markets for VoIP services are new and evolving and, if these markets
                    do not develop as expected, then it could have a material adverse
                    effect
                    on our business.
  ·
                We
                    may not be able to accurately forecast future
                    results.
  ·
                We
                    may continue to lose money on our
                    operations.
 
 ·
                If
                    we fail to establish the Vistula and Goodman Blue brands or to
                    attract
                    repeat customers, we may not be able to increase our revenues
                    sufficiently
                    to fund our operations.
 
 ·
                We
                    currently derive a significant portion of revenue from a limited
                    number of
                    contracts and customers, and if we are unable to replace contracts
                    upon
                    completion and maintain customer relationships, we could have
                    a
                    significant decrease in our revenues which would negatively impact
                    our
                    results.
 
 ·
                We
                    may experience significant fluctuations in our results as a result
                    of
                    uncertainties relating to our ability to generate additional
                    revenues,
                    manage our expenditures and other factors, certain of which are
                    outside of
                    our control.
 
 ·
                Our
                    contracts typically contain provisions giving customers the ability
                    to
                    terminate their contracts under various circumstances and we
                    may not be
                    able to replace the revenues from such contracts which may have
                    an adverse
                    effect on our revenues and operating
                    results.
 
 ·
                We
                    may not be able to promptly reduce expenses in response to any
                    decrease in
                    our revenues, which would result in lower net
                    margins.
 
 ·
                If
                    we are unable to collect receivables from development stage customers
                    and
                    other telecommunications companies, our operating results may
                    be
                    materially harmed.
 
 ·
                The
                    extent of our dependence on international operations may give
                    rise to
                    increased management challenges and could harm our results of
                    operations.
 
 ·
                Providing
                    services outside the United States carries the additional risk
                    of currency
                    fluctuations and foreign exchange controls imposed by certain
                    countries
                    since many of our non-U.S. projects are undertaken in local
                    currency.
 
 ·
                Our
                    inability to anticipate or adapt to changes in technology may
                    harm our
                    competitive position, reputation and opportunities for revenue
                       growth.
 
 ·
                We
                    may not be able to hire or retain a sufficient number of qualified
                    engineers and other employees to meet our customers’ needs or maintain the
                    quality of our services.
  19
  ·
                Future
                    acquisitions of new companies or technologies may result in disruption
                    to
                    our business and expose us to risks associated with
                    acquisitions.
 
 ·
                The
                    consolidation of telecommunication service providers could adversely
                    impact our business.
 
 ·
                Government
                    regulations may adversely affect our
                    business.
 
 ·
                If
                    we fail to retain our key personnel and attract and retain additional
                    qualified personnel, we might not be able to meet our customers’
                    needs.
 
 ·
                The
                    management of our finances and the quality and timeliness of
                    our financial
                    reporting may be adversely affected if we are unable to increase
                    the size
                    and capabilities of our internal administrative and finance function
                    as
                    our business grows.
 
 ·
                The
                    registration statement filed pursuant to the convertible note
                    financing
                    closed on April 6, 2007 was not declared effective by the SEC
                    under the
                    timeframe permitted in the Registration Rights Agreement and we
                    may incur liquidated damages as a result.
 
 ·
                We
                    will not be successful if we do not grow our customer base beyond
                    our
                    initial customers.
 
 ·
                If
                    we do not respond rapidly to technological changes or to changes
                    in
                    industry standards, our products and services could become
                    obsolete.
 
 ·
                We
                    will not retain customers or attract new customers if we do not
                    anticipate
                    and meet specific customer requirements and if our products and
                    services
                    do not adequately interoperate with our customers’ existing
                    networks.
 
 ·
                If
                    we fail to compete successfully, our ability to increase our
                    revenues or
                    achieve profitability will be
                    impaired.
 
 ·
                Our
                    business is exposed to the general conditions of the telecommunications
                    market.
  ·
                Intellectual
                    property infringement claims against us or any of our subsidiaries,
                    even
                    without merit, could require us to enter into costly licenses
                    or deprive
                    us of the technology we need.
 
 ·
                Failure
                    to protect our intellectual property rights could have a material
                    adverse
                    effect on our business.
 
 ·
                If
                    our products contain defects, then our sales are likely to suffer,
                    and we
                    may be exposed to legal claims.
 
 ·
                Compliance
                    with changing corporate governance and public disclosure regulations
                    may
                    result in additional expense.
  ·
                Our
                    executive officers, directors and principal stockholders have
                    substantial
                    holdings, which could delay or prevent a change in corporate
                    control
                    favored by our other stockholders.
  20
  ·
                Our
                    common stock could be further diluted as the result of the issuance
                    of
                    additional shares of common stock, convertible securities, warrants
                    or
                    options.
 
 ·
                We
                    may be subject to litigation.
 
 Because
          of the foregoing and other factors, we may experience material fluctuations
          in
          our future operating results on a quarterly or annual basis which could
          materially adversely affect our business, financial condition and operating
          results.
  **Overview**
  Vistula
          Communications Services, Inc. (“VCS”, the “Company” or “we”) has four
          wholly-owned subsidiaries: Vistula Limited (“Vistula”), Vistula USA, Inc.
          (“Vistula USA”), Goodman Blue Limited (“Goodman Blue”) and Cardlink Services
          Limited (“Cardlink”), and has one subsidiary that is 60% owned, Vistula
          Communications Services SA (Pty) Ltd. (“Vistula SA”) (of these, principal
          operations are carried out through Vistula, Vistula USA and Goodman Blue
          as the
          other subsidiaries are dormant). Through Vistula and Goodman Blue we currently
          provide value-added telecommunications services (including direct and partner
          voice routing services) to Tier 1 and Tier 2 telecommunication carriers
          and
          transit operators. Beginning in the first quarter of 2005, through Vistula,
          Vistula USA, and Vistula SA we began to market our V-Cube Ô Voice
          over Internet Protocol, or “VoIP,” IP-PBX software platform to
          telecommunications carriers, ISPs, large corporations and SMEs, throughout
          the
          world. The V-CubeTM platform is a uniquely feature-rich IP-PBX, that facilitates
          full contact communication services including voice, video, conferencing,
          call
          center, multi/sub-domain and unified messaging across both enterprise and
          public
          networks.
 
 We
          expect
          to dissolve Cardlink and Vistula SA by the end of 2007. Since its acquisition
          by
          VCS in March 2004, Cardlink has been inactive. Vistula SA has not generated
          any
          revenue.
 
 **Critical
          Accounting Policies**
  Our
          consolidated financial statements are prepared in accordance with accounting
          principles generally accepted in the United States. These accounting principles
          require us to make certain estimates, judgments and assumptions. We believe
          that
          the estimates, judgments and assumptions upon which we rely are reasonable
          based
          upon information available to us at the time that these estimates, judgments
          and
          assumptions are made. These estimates, judgments and assumptions can affect
          the
          reported amounts of assets and liabilities as of the date of the financial
          statements, as well as the reported amounts of revenues and expenses during
          the
          periods presented. Those estimates and judgments are based on management’s
          historical experience, the terms of existing agreements, our observance
          of
          trends in the industry, information that we obtain from our customers and
          outside sources, and on various other assumptions that management believes
          to be
          reasonable and appropriate under the circumstances, the results of which
          form
          the basis for making judgments about the carrying values of assets and
          liabilities that are not readily apparent from other sources. To the extent
          there are material differences between these estimates, judgments or assumptions
          and actual results, our financial statements will be affected.
 
 We
          believe that the following accounting policies reflect our more significant
          judgments and estimates used in the preparation of our financial statements.
  **Revenue
          Recognition.** Our
          revenue is derived primarily from fees charged to terminate voice services
          over
          our network and contracted services to support software licenses. We recognize
          such revenue, net of reserves, when persuasive evidence of a sales arrangement
          exists, delivery has occurred or services have been rendered, the sales
          price is
          fixed and determinable and collectibility is reasonably assured. We reserve
          for
          potential billing disputes at the time revenue is recognized or the dispute
          is
          known. Such disputes can result from disagreements with customers regarding
          the
          duration, destination or rates charged for each call. These revenue allowances
          are based on estimates derived from factors that include, but are not limited
          to, historical results, analysis of credits issued, current economic trends
          and
          changes in demand. Amounts billed in advance of the service month are recorded
          as deferred revenue and recognized as revenue as the underlying services
          are
          rendered.
  21
  Reciprocal
          compensation is the amount paid by one carrier to complete particular calls
          on
          another local exchange carrier’s network. Reciprocal compensation paid to and
          received from other carriers is based on contractual fixed rate per minute
          charges. We apply the receipt of reciprocal compensation against the cost
          of
          reciprocal compensation and reflect the net amount as either revenue (receipts
          greater than costs) or expense (costs greater than receipts) at each settlement
          date.
 
 We
          have
          entered into transactions such as buying, selling, swapping or exchanging
          capacity to complete and complement our network. In general, these transactions
          represent the exchange of productive assets not held for sale in the ordinary
          course of business and, as such, do not result in the culmination of the
          earnings process. Accordingly, we do not recognize any revenue for these
          types
          of transactions. We account for the exchange of a non-monetary asset based
          on
          the recorded amount of the non-monetary asset relinquished with no gain
          or loss
          recognized in accordance with Accounting Principles Board (APB) Opinion
          No. 29, *Accounting
          for Non-Monetary Transactions* .
 
 **Convertible
          Debt.** The
          Company applies Accounting Principles Board Opinion Number 14 (“APB 14”), *Accounting
          for Convertible Debt and Debt Issued with Stock Purchase
          Warrants* ,
          when
          recording debt with conversion features and when issuing warrants to purchase
          its common stock. When debt is issued which is convertible to equity at
          the
          option of the holder, no portion of the proceeds is accounted for as
          attributable to the conversion feature, and is recorded as a liability.
          The
          warrants to purchase the Company's stock have been determined to be detachable
          warrants as the holder of the debt and warrants may convert the debt or
          exercise
          the warrant without affecting the other instrument. The fair-value of the
          warrants issued is determined as of the date of the issuance by using a
          Black-Scholes pricing model. The value is then used as a discount to the
          convertible debt and is amortized to interest expense over the term of
          the
          convertible debt to the maturity date, or is accelerated proportionally
          if the
          debt is converted at the option of the holder prior to the maturity date.
 
 **Stock-Based
          Compensation.** ** Commencing
          on January 1, 2006 we began applying the provisions of Statement of Financial
          Accounting Standards (SFAS) No. 123R, *Share
          Based Payment* ,
          or SFAS
          123R, in accounting for stock-based compensation. SFAS 123R requires measurement
          of the cost of employee services received in exchange for an award of equity
          instruments based on the grant-date fair value of the award. That cost
          is
          recognized over the period during which an employee is required to provide
          service in exchange for the award (usually the vesting period). Prior to
          January
          1, 2006, we followed Accounting Principles Board (APB), Opinion No. 25, *Accounting
          for Stock Issued to Employees* ,
          or APB
          25, and related interpretations, in accounting for our stock-based compensation
          plans, rather than the alternative fair-value method provided for under
          SFAS No.
          123, *Accounting
          for Stock-Based Compensation* ,
          or SFAS
          123. We account for transactions in which services are received from
          non-employees in exchange for equity instruments based on the fair value
          of such
          services received or of the equity instruments issued, whichever is more
          reliably measured, in accordance with SFAS 123R and the Emerging Issues
          Task
          Force (EITF) Issue 96-18, *Accounting
          for Equity Instruments That Are Issued to Other than Employees for Acquiring,
          or
          in Conjunction with Selling, Goods or Services* ,
          or EITF
          96-18.
  Accounting
          for equity instruments granted or sold by us under APB 25, SFAS 123, SFAS
          123R
          and EITF 96-18 requires fair-value estimates of the equity instrument granted
          or
          sold. If our estimates of the fair value of these equity instruments are
          too
          high or too low, our expenses may be over- or understated. For equity
          instruments granted or sold in exchange for the receipt of goods or services,
          we
          estimate the fair value of the equity instruments based upon consideration
          of
          factors that we deem to be relevant at that time. Because shares of our
          common
          stock were not publicly traded prior to July 21, 2005, market factors
          historically considered in valuing stock and stock option grants included
          comparative values of public companies discounted for the risk and limited
          liquidity provided for in the shares we are issuing; prior valuations of
          stock
          grants and the effect of events that occurred between the time of such
          grants;
          economic trends; and the comparative rights and preferences of the security
          being granted compared to the rights and preferences of our other outstanding
          equity.
  22
  Prior
          to
          July 21, 2005, the fair value of our common stock was determined by our
          board of
          directors contemporaneously with the grant. In the absence of a public
          trading
          market for our common stock, our board of directors considered numerous
          objective and subjective factors in determining the fair value of our common
          stock. At the time of option grants and other stock issuances, our board
          of
          directors considered the status of private and public financial markets;
          valuations of comparable private and public companies; the likelihood of
          achieving a liquidity event such as an initial public offering; our existing
          financial resources; our anticipated continuing operating losses and increased
          spending levels required to meet our business plan; dilution to common
          stockholders from anticipated future financings; and a general assessment
          of
          future business risks.
  **Impairment
          of Long Lived Assets.** In
          accordance with Statement of Financial Accounting Standards No. 144, *Accounting
          for the Impairment or Disposal of Long-lived Assets* ,
          the
          Company reviews its long-lived assets whenever events or changes in
          circumstances indicate that the carrying amount of such assets may not
          be
          recoverable. If the carrying amount of an asset or group of assets exceeds
          its
          net realizable value, the asset will be written down to its fair value.
 
 **Intangible
          Assets.** Intangible assets are carried at cost less accumulated amortization, which
          is
          calculated on a straight-line basis over their estimated economic life.
          The
          Company reviews intangible assets for impairment whenever events or changes
          in
          circumstances indicate that the carrying amount may not be
          recoverable.
 
 **Recently
          Issued Accounting Pronouncements**
  In
          February 2007, the Financial Accounting Standards Board (FASB) issued SFAS
          No.
          159, *The
          Fair Value Option for Financial Assets and Financial Liabilities - Including
          an
          Amendment to FASB Statement No. 115* (SFAS
          159). SFAS 159 permits entities to choose to measure many financial instruments
          and certain other items at fair value. SFAS 159 is effective for financial
          statements issued for fiscal years beginning after November 15, 2007. Earlier
          adoption is permitted as of the beginning of a fiscal year that begins
          on or
          before November 15, 2007, provided that the entity also elects to apply
          the
          provisions of SFAS 157. The Company is currently evaluating the effect
          of this
          standard on its future reported financial position and results of
          operations.
 
 In
          September 2006, the FASB issued SFAS No. 157, *Fair
          Value Measurements* (SFAS
          157), to define fair value, establish a framework for measuring fair value
          in
          generally accepted accounting principles and expand disclosures about fair-value
          measurements. SFAS 157 is effective for financial statements issued for
          fiscal
          years beginning after November 15, 2007 and interim periods within those
          fiscal
          years, with earlier application allowed. The Company is currently evaluating
          the
          effect of this standard on its future reported financial position and results
          of
          operations.
 
 **Results
          of Operations**
 
 Net
          revenues for the three-month period ended June 30, 2007 were $264,812 which
          represents an increase of $26,893 (11.3%) over the $237,919 in net revenues
          for
          the three-month period ended June 30, 2006. Net revenues for the six-month
          period ended June 30, 2007 were $551,287 which represents a decrease of
          $6,051
          (1.1%) over the $557,338 in net revenues for the six-month period ended
          June 30,
          2006. The increase for the three-month period ended June 30, 2007 is primarily
          attributable to an increase in contracted services of $241,032 for support
          services in relation to our Order-to-Cash (“O2C”) software, which was not
          acquired until October of 2006. The increase was offset by a decrease in
          wholesale traffic of $214,139 due to our cash position which limited our
          ability
          to pay vendors who in turn would not provide traffic routes which would
          allow us
          to generate traffic for revenue purposes. The decrease for the six-month
          period
          ended June 30, 2007 is primarily attributable to wholesale traffic termination
          which decreased by $481,622 due to our cash position which limited our
          ability
          to pay vendors who in turn would not provide traffic routes which would
          allow us
          to generate traffic for revenue purposes. The decrease in wholesale traffic
          was
          mostly offset by an increase in revenue from contracted services for the
          six-month period ended June 30, 2007 of $475,571 for services provided
          under a
          contract agreement to support our O2C software portal. The revenue increase
          recorded for software licenses, as included in revenues from telecommunications,
          of $21,821 is mainly attributable to a single sale for use of our O2C software
          license.
  23
  Cost
          of
          revenues for the three-month period ended June 30, 2007 were $246,222,
          a
          decrease of 24.0% over the $324,091 in the three-month period ended June
          30,
          2006. Cost of revenues for the six-month period ended June 30, 2007 were
          $480,562, a decrease of 28.9% over the $675,604 in the six-month period
          ended
          June 30, 2006. The decrease for the three-month period ended June 30, 2007
          is
          primarily attributable to a reduction in wholesale traffic of $243,022
          due to
          our cash position which limited our ability to pay vendors who in turn
          would not
          provide traffic routes which would allow us to generate traffic. The decrease
          in
          costs of wholesale traffic was mostly offset by an increase in costs experienced
          from contracted services for the three-month period ended June 30, 2007
          of
          $162,971 for services provided under a contract agreement to support our
          O2C
          software portal. Engineering costs classified as cost of revenues pertaining
          to
          wholesale traffic for the period ended June 30, 2007 of $0 decreased by
          $42,606
          (100 %) as compared to the same period in fiscal 2006. The decrease is
          mainly
          due to expenditures pertaining to staff support of the wholesale business.
          The
          decrease for the six-month period ended June 30, 2007 is primarily attributable
          to a reduction in wholesale traffic of $491,387 due to our cash position
          which
          limited our ability to pay vendors who in turn would not provide traffic
          routes
          which would allow us to generate traffic. The decrease in costs of wholesale
          traffic was mostly offset by an increase in costs experienced from contracted
          services for the six-month period ended June 30, 2007 of $294,163 for services
          provided under a contract agreement to support our O2C software portal.
          Engineering costs classified as cost of revenues pertaining to wholesale
          traffic
          for the period ended June 30, 2007 of $32,080 decreased by 53,727 (62.6%)
          as
          compared to the same period in fiscal 2006. The decrease is mainly due
          to
          expenditures pertaining to staff support of the wholesale business.
  Gross
          margin (loss) increased to 7.0% for the three-month period ended June 30,
          2007
          from (36.2%) for the same period ended June 30, 2006. Gross margin (loss)
          increased to 12.8% for the six-month period ended June 30, 2007 from (21.2%)
          for
          the same period ended June 30, 2006. The increase for the three-months
          ended
          June 30, 2007 is primarily due to contracted services being provided by
          the
          staff of Goodman Blue to support the software license contract sold to
          a third
          party. The reduction in staff levels for the wholesale traffic business
          also
          contributed to the increase in margin. The increase for the six-months
          ended
          June 30, 2007 is primarily due to contracted services being provided by
          the
          staff of Goodman Blue to support the software license contract sold to
          a third
          party. The reduction in staff levels for the wholesale traffic business
          also
          contributed to the increase in margin.
 
 Selling,
          general and administrative costs for the three-month period ended June
          30, 2007
          were $1,314,162, a decrease of 57.3% over the $3,074,975 for the three-month
          period ended June 30, 2006. Selling, general and administrative costs for
          the
          six-month period ended June 30, 2007 were $2,775,638, a decrease of 60.0%
          over
          the $6,604,862 for the six-month period ended June 30, 2006. During the
          three-month period ended June 30, 2007, we incurred increased compensation
          for
          employees due to non-cash options expenses. Non-cash expenses, excluding
          depreciation and amortization discussed below, decreased by $231,945 as
          a result
          of the issuance of a warrant to a financial advisory firm as compensation
          for
          its services to us, and decreased $410,845 as a result of the issuance
          of a
          warrant to the lender as partial compensation for a revolving credit facility
          which was fully repaid in the three-months ending June 30, 2006. Other
          decreases
          experienced were in expenses related to support fees for a consumer IP
          product
          no longer in use, consulting fees, investment fees, promotional and marketing
          fees, professional fees, rent, repairs and maintenance fees, and travel
          expenses. During the six-month period ended June 30, 2007, we incurred
          increased
          compensation for employees due to non-cash options expenses. Non-cash decreases
          were due to the one time issuance of 1,500,000 shares per the Indigo advisory
          agreement for $1,875,000 in the first quarter of 2006 as described below
          under *Other
          Arrangements and Obligations* .
  Depreciation
          and amortization expenses for the three-month period ended June 30, 2007
          were
          $1,461,746, an increase of 5,039.8% over the $130,643 in fiscal 2006.
          Depreciation and amortization expenses for the six-month period ended June
          30,
          2007 were $2,943,912, an increase of 1,030.0% over the $260,509 in fiscal
          2006.
          During the three-month period ended June 30, 2007, we recorded decreased
          depreciation for equipment which was impaired as of December 31, 2006.
          During
          the three- and six-month periods ended June 30, 2007, we recorded amortization
          expenses for the purchase of our V-CubeTM software as described in Note 5 to the
          financial statements included in Item 1 which did not begin to be amortized
          until July 1, 2006, and the acquisition of our O2C software as described
          in Note
          5 to the financial statements included in Item 1, which did not begin to
          be
          amortized until October 11, 2006.
  24
  Amortization
          expense for the intangible assets held at June 30, 2007 was approximately
          $1,418,000 and $2,836,000 for the three- and six-month periods ending June
          30,
          2007, respectively. In accordance with FASB 144, with consideration of
          delays in
          the launch of the distribution of the V-CubeTM product under the Northamber
          arrangement, and due to certain indicators of impairment during the second
          quarter of 2007 (see Note 1), management has performed an analysis of its
          intangible assets and determined that an impairment charge is not required
          at
          June 30, 2007. Because management believes these indicators still exist,
          it is
          continuing to review the carrying value of intangible assets throughout
          the
          third quarter.
  Research
          and development expenses for the three-month period ended June 30, 2007
          were
          $20,845, a decrease of 5.4% compared to the $22,034 in the same period
          of fiscal
          2006. Research and development expenses for the six-month period ended
          June 30,
          2007 were $86,816, a decrease of 13.8% compared to the $100,658 in the
          same
          period of fiscal 2006. During the three-month period ended June 30, 2007,
          we
          incurred research and development expenses for the MyService portal development
          for the V-CubeTM product and for the MyOrder portal development work for the O2C
          software which will simplify the ordering and billing process for our customers.
          The O2C portal will work along-side the V-CubeTM platform and allow an automated
          sign-up and delivery process for customers which we expect to enable us
          to
          sign-up a significantly greater number of users each month in comparison
          to the
          more manual process of customer installations without the portal. During
          the
          six-month period ended June 30, 2007, we incurred research and development
          expenses for the MyService portal development for the V-CubeTM product and for
          the MyOrder portal development work for the O2C software which will simplify
          the
          ordering and billing process for our customers. The O2C portal will work
          along-side the V-CubeTM platform and allow an automated sign-up and delivery
          process for customers which we expect to enable us to sign-up a significantly
          greater number of users each month in comparison to the more manual process
          of
          customer installations without the portal.
  Interest
          expense, net for the three-month period ended June 30, 2007 of $399,890
          increased 33.8% compared to $298,773 for the three-month period ended June
          30,
          2006. Interest expense, net for the six-month period ended June 30, 2007
          of
          $710,572 increased 15.8% over the $613,876 for the six-month period ended
          June
          30, 2006. During the three-month period ended June 30, 2007 interest expense,
          net increased over the respective period in fiscal 2006 primarily due to
          our
          convertible notes issued on April 6, 2007 and the associated expense related
          to
          the amortization of the capitalized finance fees and discounted debt for
          the
          convertible notes as described in Note 14 to the financial statements included
          in Item 1.  During the six-month period ended June 30, 2007 interest
          expense, net increased over the respective period in fiscal 2006 primarily
          due
          to our convertible notes issued on April 6, 2007 and the associated expense
          related to the amortization of the capitalized finance fees and discounted
          debt
          for the convertible notes as described in Note 14 to the financial statements
          included in Item 1.
 
 During
          the three-month period ended June 30, 2007 net interest expense of approximately
          $400,000 was comprised of amortization of capitalized finance fees, amortization
          of the debt discount for the debentures and convertible notes held, interest
          on
          the convertible debentures as per the terms stated in Note 8 to the financial
          statements included in Item 1, interest on the convertible notes as per
          the
          terms stated in Note 14 to the financial statements included in Item 1.
          During
          the six-month period ended June 30, 2007 net interest expense of approximately
          $711,000 was comprised of amortization of capitalized finance fees, amortization
          of the debt discount for the debentures and convertible notes held, interest
          on
          the convertible debentures as per the terms stated in Note 8 to the financial
          statements included in Item 1, interest on the convertible notes as per
          the
          terms stated in Note 14 to the financial statements included in Item 1.
  25
  For
          the
          three-month period ended June 30, 2007, we incurred a loss of $3,217,052
          or
          $0.05 loss per common share, basic and diluted, as compared to a loss of
          $3,510,394 or $0.08 loss per common share, basic and diluted, for the
          three-month period ended June 30, 2006.  For
          the
          six-month period ended June 30, 2007, we incurred a loss of $6,485,212
          or $0.10
          loss per common share, basic and diluted, as compared to a loss of $7,698,171
          or
          $0.20 loss per common share, basic and diluted, for the six-month period
          ended
          June 30, 2006.
  **Liquidity
          And Capital Resources**
  Since
          our
          inception, we have sustained our operations through loans, debt and equity
          financings, funding provided by our Chairman and contributed services by
          our
          Chairman and other stockholders.
  As
          of
          June 30, 2007, we had cash and cash equivalents of approximately $58,000
          and a
          working capital deficit of approximately $10,833,000. This represents a
          decrease
          in cash and cash equivalents of approximately $138,000 from December 31,
          2006 and an increase in the working capital deficit of approximately $6,151,000
          from that at December 31, 2006. Approximately $6,045,000 of the increase in
          working capital deficit is due to the convertible debentures from February
          and
          March 2005 being recorded as current liabilities as they mature in February
          and
          March 2008. Since our inception through June 30, 2007, we have generated
          losses
          of approximately $42,592,000. Accounts receivable were approximately $36,000
          at
          June 30, 2007, a decrease of approximately $121,000 from December 31, 2006.
          Accounts payable and accrued expenses at June 30, 2007 increased approximately
          $63,000 from December 31, 2006, which excludes a $2,500,000 liability
          recorded for shares subject to a put option as described in Note 10 to
          the
          financial statements in Item 1.
  During
          the three- and six-month periods ended June 30, 2007 and 2006 no services
          were
          contributed to the Company by our stockholders.
 
 *Convertible
          Debenture and Warrant Financing.* On
          February 18, 2005 and March 4, 2005, we sold convertible debentures maturing
          three years from issuance in the aggregate principal amount of $8,400,000,
          convertible into common stock of the Company at $0.75 per share, and warrants
          to
          purchase an aggregate of 8,400,000 shares of our common stock, at an exercise
          price of $1.00 per share to accredited investors.
  The
          debentures accrue interest daily at a rate of 8% per annum, which interest
          is
          payable quarterly on each March 31, June 30, September 30 and December
          31
          following the issue date. The interest payments due on December 31, 2006
          and on
          March 31, 2007 were not paid until April 9, 2007. We received a waiver
          from each
          of the holders of the debentures for any late fee due or possible event
          of
          default in connection with the two late payments of interest. See Note
          8 to the
          financial statements included in Item 1. The Company requested waivers
          from the
          debenture holders for the payment due on June 30, 2007 to be deferred until
          August 15, 2007. As of the date of this filing, the Company has not received
          executed waivers from the debenture holders.
  Through
          May 18, 2007, $2,100,000 in outstanding principal amount of convertible
          debentures has been converted into 2,799,993 shares of common stock, reducing
          the amount of interest required to be paid in future periods.
  *Acquisition
          of Goodman Blue.* On
          October 11, 2006, VCS acquired 100% of the outstanding shares of Goodman
          Blue
          for consideration consisting of 2,500,000 shares of our common stock being
          issued to Scott Goodwin, the sole shareholder of Goodman Blue, subject
          to an
          option to require the Company to repurchase the shares of common stock
          for an
          aggregate purchase price of $2,500,000. We recorded the total purchase
          price of
          $2,562,643, which includes acquisition costs of $62,643, as intangible
          assets
          for the O2C software of $2,077,777 and as several customer contracts which
          were
          valued at $484,866. Management determined that the O2C asset will be amortized
          over a five year estimated useful life beginning on October 11, 2006. At
          June
          30, 2007 the net carrying value of this O2C intangible asset was $1,770,822.
          Amortization expense for the three- and six-months ended June 30, 2007
          was
          approximately $104,000 and $208,000, respectively. We have recorded the
          acquisition of Goodman Blue as a liability of $2,500,000 at June 30, 2007,
          in
          the expectation that Goodwin will require the Company to repurchase the
          shares.
          The purchase agreement, as amended, provides that: (i) Goodwin shall have
          the
          option to require us to purchase 1,400,000 of the consideration shares
          for
          $1,400,000 (the “First Put Option”); and (ii) Goodwin shall have the option to
          require us to purchase 1,100,000 of the consideration shares for $1,100,000
          (the
“Second Put Option”). The time for exercise of the First Put Option and Second
          Put Option has been deferred until the period beginning on December 1,
          2007 and
          ending on December 31, 2007 in consideration of the payment to Goodwin
          of
          approximately $110,000 and the engagement of Goodwin for consulting services
          to
          be provided to the Company’s subsidiary, Goodman Blue Limited. The terms of our
          currently outstanding notes prohibit the redemption of shares of our common
          stock without the debt holders consent.
  26
  As
          of
          June 30, 2007, Goodman Blue is obligated to pay approximately $83,000 in
          principal amount under a Small Firms Loan Guarantee Scheme from HSBC Bank
          plc.
          The loan accrues interest at a rate of 3.0% above the lender’s base interest
          rate of 5.5% as at June 30, 2007, and is payable in equal monthly installments
          of approximately $21,000 (which is exclusive of interest) until November
          7,
          2007, the maturity date. The loan is guaranteed by the Secretary of State
          in the
          United Kingdom and the borrower pays a guarantee premium at an annual rate
          of 2%
          on the loan to the Secretary of State.
  *Convertible
          Note and Warrant Financing.* As
          discussed in Note 14 to the financial statements in Item 1, on April 6,
          2007 we
          completed a convertible note and warrant financing for gross proceeds of
          $2,500,000. Most of these proceeds have been used in part for payments
          due to
          existing creditors and funding our working capital needs. In the event
          that the
          Company is not successful in implementing its business plan, or does not
          raise
          additional third-party capital, the Company will have to curtail certain
          expenditures and seek additional financing in order to sustain operations.
          See *Budget
          and Financial Forecasts for the Remainder of 2007* below
          for a more detailed explanation of the Company’s cash position.
  During
          the three- and six-month periods ended June 30, 2007 and 2006 no services
          were
          contributed to the Company by our stockholders. We have made cash expenditures
          for capital equipment and software from our inception until June 30, 2007
          of
          approximately $11,673,000 purchasing the telecommunications equipment necessary
          to operate our business, including the cash payment of $8,800,000 pursuant
          to
          the purchase of the V-CubeTM software and intellectual property, as described in
          Note 5 to the financial statements included in Item 1.
 
 To
          date,
          inflation has not had a material impact on our financial results. There
          can be
          no assurance, however, that inflation will not adversely affect our financial
          results in the future.
 
 *Budget
          and Financial Forecasts for the Remainder of 2007*
  The
          following disclosure includes certain statements, budgets, estimates,
          projections and other forward-looking statements with respect to the anticipated
          future performance of Vistula Communications Services, Inc. The statements,
          budgets, estimates, projections and other forward-looking statements, which
          have
          not been reviewed or examined by the Company’s independent auditors, are based
          upon various assumptions by management made on a reasonable basis and in
          good
          faith that may not prove to be correct. Such assumptions are inherently
          subject
          to significant uncertainties and contingencies, many of which are beyond
          the
          Company’s control. No assurance is given, that the Company can or will attain
          such results. Actual results are likely to vary, perhaps materially, from
          the
          Company’s projections due, at least in part, to the Company’s risks and
          uncertainties set forth above.
  In
          the
          course of their due diligence, the purchasers of the Company’s convertible notes
          and warrants discussed with the Company’s management the planned use of proceeds
          and the plan for operating the Company subsequent to the closing. These
          purchasers were provided with budgetary information and financial forecasts
          which were included in the disclosure schedules incorporated into the definitive
          investment documentation and filed with the Company’s Form 8-K dated April 9,
          2007 which reported on the closing of that transaction.
  27
  Budgetary
          information contemplated that the gross proceeds of the sale of the convertible
          notes and warrants would be $3,000,000 rather than the $2,500,000 actually
          raised and that the closing would have occurred before the end of the first
          quarter of 2007 rather than at the end of the first week of the second
          quarter.
          As a result of these variances and the continuing negotiation by management
          with
          trade creditors and service providers to extend payment terms and/or grant
          discounts and compromise obligations, the Company is in the process of
          reformulating and adjusting the operating budget and financial forecasts
          for the
          remainder of 2007.
  The
          Company believes that, irrespective of the actual adjustments made, the
          material
          implications of the budget are as follows:
  ·
                  Following
                      the closing and the payment of expenses associated with the
                      financing,
                      payments totaling $1,243,000 were made on past due interest
                      on the
                      Company’s 8% convertible debentures ($254,800), past due trade payables
                      and taxes in the United States and the United Kingdom, and
                      current amounts
                      due, such as payroll. The remaining cash has been used in part
                      to pay
                      negotiated rates with other creditors for outstanding balances
                      and for
                      ongoing operational
                      requirements;
  ·
                  The
                      Company had expected to incur selling, general and administrative
                      expenses
                      of approximately $1,300,000 in each of the remaining quarters
                      of 2007, and
                      management has made reductions of and continues to work towards
                      reductions
                      in the monthly incurred expenses and continues to negotiate
                      with creditors
                      for delayed payments and possible forgiveness of amounts
                      outstanding;
  ·
                  The
                      Company previously expected to generate net revenues of approximately
                      $830,000, $2,900,000 and $3,000,000 in the second, third and
                      fourth
                      quarters of 2007, respectively and as a result of such revenue
                      generation
                      expected to have net cash positions of approximately $0, $1,000,000
                      and
                      $2,500,000 at the end of the second, third and fourth quarters
                      of 2007,
                      respectively. No revenues have been generated from the distribution
                      of the
                      V-CubeTM
                      product under the arrangement with Northamber as of the date
                      of this
                      filing. However, the Company generated approximately $265,000
                      in revenues
                      during the second quarter of 2007 and now expects to generate
                      net revenues
                      of approximately $840,000 and $1,332,000 in the third and fourth
                      quarters
                      of 2007,****respectively;
                      and
  ·
                Despite
                    the anticipated generation of revenues and anticipated reduction
                    of
                    expenses, for financial reporting purposes, the Company would
                    continue to
                    show net losses in each of these three quarters of 2007 and for
                    the year
                    as a whole due to primarily non-cash items of
                    loss.
  As
          of the
          date of this filing, the Company has not launched distribution of its V-CubeTM
product through Northamber and as a result the budget for the third and
          fourth
          quarters of 2007 has been adversely affected. The Company does not expect
          to
          launch the V-CubeTM product under the Northamber arrangement until September 2007
          and therefore the Company does not expect to generate revenues from this
          arrangement until the fourth quarter of 2007 and such revenues will be
          limited
          in amount. The majority of the revenues budgeted for the third and fourth
          quarters of 2007 are expected to be generated from contracted services
          and
          licensing of product unrelated to the distribution of the V-CubeTM product under
          the Northamber arrangement. Management is actively seeking interim funding
          for
          operations until adequate revenues are generated. The failure to generate
          such
          revenue in the amount and in the timeframe contemplated in the forecast
          has
          directly and adversely effected the Company’s ability to continue its operations
          and management expects that the Company will need to raise additional funds
          and
          obtain further accommodations from trade creditors and service providers
          or it
          will have to cease operations. With the termination of exclusivity under
          the
          licensing agreement with Telstra, management is in negotiations to enter
          into a
          new licensing arrangement for the V-CubeTM product which may help meet the
          Company’s short term cash requirements until sufficient revenue can be generated
          from the Northamber distribution agreement. However, there is no guarantee
          in
          the amount or timing of obtaining additional funds and if the Company is
          unable
          to obtain additional funds it will have to cease its operations.
  28
 
 **Other
          Arrangements and Obligations**
  *V-CubeTM
          Distribution Arrangements*
 
 On
          February 2, 2007, Vistula Limited signed a distribution agreement with
          Northamber to sell its IP-PBX solutions to customers of Northamber in the
          United
          Kingdom. Northamber will offer a hosted IP-PBX product using our V-CubeTM
platform. The hosted IP-PBX product will be sold via Northamber's network
          of
          6,000 distributors and master agents in the UK. Under the agreement, we
          will
          host the service and provide Tier 2 and Tier 3 level support to Northamber's
          distributors and customers. Northamber is a long established and large
          trade-only distributor of IT products and equipment in the UK. The Company
          expected the revenues from this distribution to be a significant provider
          of
          operational cash for our business. However, as of the date of this filing,
          the
          Company has not launched the V-CubeTM product through the Northamber distributor
          agreement and has not realized any revenue as a result of this distribution
          agreement.
 
 *Financial
          Advisory Services*
  The
          Company entered into a financial advisory agreement on January 30, 2007
          with
          Indigo Ventures LLC ("Indigo") for a bridge financing. In connection with
          the
          convertible note and warrant financing, Indigo agreed to terminate the
          January
          30, 2007 financial advisory agreement and waive any fees under that agreement
          in
          return for reimbursement of legal and travel expenses of $49,182 and for
          the
          Company’s acknowledgement that $117,000 in connection with services previously
          rendered under the advisory agreement entered into on January 27, 2006
          remain
          outstanding and that this amount is payable upon the earlier of (i) the
          sale of
          the company, (ii) a capital raise of at least $5,000,000 or (iii) the date
          when
          the Company has sufficient cash flow available from its operations.
 
 **Subsequent
          Events**
 
 On
          July
          5, 2007 the Company and Telstra Europe Limited entered into an agreement
          which
          amended the terms of the distribution and marketing agreement with regard
          to the
          Company’s V-CubeTM product entered into on April 1, 2005. The license from the
          Company to Telstra ceased being exclusive and was expanded to include MyPortal
          and MyService software developed by the Company. The agreement also resolved
          claims and counterclaims made by the parties. Pursuant to the agreement,
          a one
          time license fee of approximately $300,000 was paid to the Company by
          Telstra.
 
 Effective
          August 6, 2007, Mr. J. Marcus Payne and Mr. Jack Early resigned from the
          board
          of directors of the Company.  Mr. Early also resigned as the Company’s
          chief operating officer effective August 6, 2007. Effective August 7, 2007,
          Mr.
          Jared Taylor resigned from his positions as chief financial officer, secretary
          and treasurer of the Company.
  Effective
          August 8, 2007, Mr. Rupert Galliers-Pratt was appointed the Company’s interim
          chief financial officer. Effective August 9, 2007, Mr. Ian Cope was appointed
          as
          the Company’s chief operating officer.
  **Item
          3.** **** **Controls
          and Procedures.**
  Evaluation
          of Disclosure Controls and Procedures
  Based
          on
          Company management’s evaluation (with the participation of the Company’s
          principal executive officer and principal financial officer), as of the
          end of
          the period covered by this report, the Company’s principal executive officer and
          principal financial officer have concluded that the Company’s disclosure
          controls and procedures (as defined in Rules 13a-15(e) and
          15d-15(e) under the Securities Exchange Act of 1934, as amended, (the
“Exchange Act”)) are effective to ensure that information required to be
          disclosed by the Company in reports that it files or submits under the
          Exchange
          Act is recorded, processed, summarized and reported within the time periods
          specified in Securities and Exchange Commission rules and
          forms.
  29
  It
          should
          be noted that any system of controls, however well designed and operated,
          can
          provide only reasonable, and not absolute, assurance that the objectives
          of the
          system are met. In addition, the design of any control system is based
          in part
          upon certain assumptions about the likelihood of future events. Because
          of these
          and other inherent limitations of control systems, there can be no assurance
          that any design will succeed in achieving its stated goals under all potential
          future conditions, regardless of how remote.
  Changes
          in Internal Control over Financial Reporting
  The
          Company’s management, in connection with its evaluation of internal controls
          (with the participation of the Company’s principal executive officer and
          principal financial officer), did not identify any change in internal control
          over the financial reporting process that occurred during the Company’s first
          two fiscal quarters of 2007 that would have materially affected, or would
          have
          been reasonably likely to materially affect, the Company’s internal control over
          financial reporting.
 
 Subsequent
          to June 30, 2007, the Company’s chief financial officer resigned and has been
          replaced on an interim basis by the chief executive officer. Management
          is
          currently formulating its plans to appoint or retain a chief financial
          officer
          on a permanent basis.
  **PART II.               
          OTHER INFORMATION**
  **Item
          1: Legal Proceedings**
  None.
  **Item
          2. Unregistered Sales of Equity Securities**
  None.
  **Item
          3. Defaults Upon Senior Securities**
  None.
  **Item
          4. Submission of Matters to a Vote of Security Holders**
  None.
  **Item
          5.  Other Events**
  None.
  30
  **Item
          6. Exhibits**
  **(a) Exhibits.**
  **Incorporated by Reference****Exhibit**
                  **Number**
                
                **Exhibit Description**
                
                **Filed with**
                  **this Form**
                  **10-QSB**
                
                **Form**
                
                **Filing Date**
                
                **Exhibit No.**4.1
                
                Form
                    of 12% Convertible Note
                
                
                
                Form 8-K
                
                April
                    9, 2007
                
                4.14.2
                
                Form
                    of Common Stock Purchase Warrant
                
                
                
                Form 8-K
                
                April
                    9, 2007
                
                4.210.1
                
                Securities
                    Purchase Agreement dated April 6, 2007
                
                
                
                Form 8-K
                
                April
                    9, 2007
                
                10.110.2
                
                Registration
                    Rights Agreement dated April 6, 2007
                
                
                
                Form 8-K
                
                April
                    9, 2007
                
                10.210.3
                
                Placement
                    Agent Agreement dated March 16, 2007
                
                
                
                Form 8-K
                
                April
                    9, 2007
                
                10.310.4
                
                Placement
                    Agent Agreement dated April 5, 2007
                
                
                
                Form 8-K
                
                April
                    9, 2007
                
                10.410.5
                
                Escrow
                    Agreement dated April 6, 2007
                
                
                
                Form 8-K
                
                April
                    9, 2007
                
                10.510.6
                
                Purchase
                    Agreement dated March 24, 2007
                
                
                
                Form 10-KSB
                
                April
                    17, 2007
                
                10.6010.7
                
                Consulting
                    Agreement, dated May 16, 2007, between Vistula Communications
                    Services,
                    Inc. and Jack Early
                
                
                
                Form 8-K
                
                May
                    17, 2007
                
                10.131.1
                
                Certification
                    by Rupert Galliers-Pratt pursuant to Rule 13a-14(a) and
                    15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
                    Act of 2002, relating to Vistula Communications
                    Services, Inc.
                
                X31.2
                
                Certification
                    by Rupert Galliers-Pratt pursuant to Rule 13a-14(a) and
                    15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
                    Act of 2002, relating to Vistula Communications
                    Services, Inc.
                
                X32.1
                
                Certification
                    by Rupert Galliers-Pratt pursuant to Section 1350, Chapter 63 of
                    Title 18, United States Code, as adopted pursuant to Section 906 of
                    the Sarbanes-Oxley Act of 2002, relating to Vistula Communications
                    Services, Inc.
                
                X32.2
                
                Certification
                    by Rupert Galliers-Pratt pursuant to Section 1350, Chapter 63 of
                    Title 18, United States Code, as adopted pursuant to Section 906 of
                    the Sarbanes-Oxley Act of 2002, relating to Vistula Communications
                    Services, Inc.
                
                X
  31
 
 **SIGNATURES**
  In
          accordance with the requirements of the Exchange Act, the registrant caused
          this
          report to be signed on its behalf by the undersigned, thereunto duly
          authorized.
  Vistula
                    Communications Services, Inc.Date:
                    August 20, 2007
                By:
                /s/
                    RUPERT GALLIERS-PRATTRupert
                    Galliers-PrattChief
                    Executive Officer
  32