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

**Washington,D.C. 20549**

 

**FORM 10-QSB/A**

(Amendment No 1)

**(Mark One)**

 
| **ý** | ** ** | **QUARTERLY REPORT UNDER  SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                                      |
|------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|       |       |                                                                                                                                                                                                                                                                                                                                                  |
| ** ** | ** ** | **For  the quarterly period ended: March 31, 2005**                                                                                                                                                                                                                                                                                              |
|       |       |                                                                                                                                                                                                                                                                                                                                                  |
|       |       | **OR**                                                                                                                                                                                                                                                                                                                                                |
|       |       |                                                                                                                                                                                                                                                                                                                                                  |
| **o**      | ** ** | **TRANSITION REPORT PURSUANT TO  SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934**                                                                                                                                                                                                                                               |
|       |       |                                                                                                                                                                                                                                                                                                                                                  |
| ** ** | ** ** | **For the transition period from                             to                          ** |

 

**CommissionFile Number 000-50758**

 

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**VISTULACOMMUNICATIONS SERVICES, INC.**

(Exact name of registrant asspecified in its charter)

 
| **Delaware**                                                    | ** ** | **20-0734966**                   |
|-----------------------------------------------------------------|------------|----------------------------------|
| (State or other jurisdiction of  incorporation or organization) |       | (IRS EmployerIdentification No.) |
|                                                            |       |                             |
| **Suite 801, 405 Park Avenue**                             |
| **New York, New York 10022**                                    |
| (Address of  principal executive offices and zip code)          |
| ** **                                                      |
| **(212) 317-8900**                                              |
| (Registrant’s  telephone number, including area code)      |

 

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Actduring the preceding 12 months (or for such shorter period that the registrantwas required to file such reports), and (2) has been subject to suchfiling requirements for the past 90 days.            Yes   ý          No   o

 

As of May 12, 2005, there were 25,179,406shares of common stock, $0.001 par value, of the registrant issued andoutstanding.

 

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

 

 

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**VISTULACOMMUNICATIONS SERVICES, INC.**

 

**FORM 10-QSB**

 

**FOR THETHREE MONTHS ENDED MARCH 31, 2005**

 
| Facing Page       |                                                                                                                       |
|-------------------|----------------------------------------------------------------------------------------------------------------------------|
|              |                                                                                                                       |
| Table of Contents |                                                                                                                       |
|              |                                                                                                                       |
| PART I.      | FINANCIAL  INFORMATION(*):                                                                                                 |   |
|              |                                                                                                                       |
|              | Item 1.                                                                                                                    | Financial Statements |   |
|              |                                                                                                                       |
|              | Consolidated  Balance Sheets as of March 31, 2005 (unaudited) and December 31,  2004                             |   |
|              |                                                                                                                       |   |
|              | Consolidated  Statements of Operations for the Three Months ended March 31, 2005 and  March 31, 2004 (unaudited) |   |
|              |                                                                                                                       |   |
|              | Consolidated  Statements of Stockholders’ Deficit for the Three Months ended March 31,  2005 (unaudited)         |   |
|              |                                                                                                                       |   |
|              | Consolidated  Statements of Cash Flows for the Three Months ended March 31, 2005 and  March 31, 2004 (unaudited) |   |
|              |                                                                                                                       |   |
|              | Notes  to Consolidated Financial Statements                                                                                |   |
|              |                                                                                                                       |
|              | Item  2.                                                                                                                   | Management’s  Discussion and Analysis of Financial Condition and Results of Operations |   |
|              |                                                                                                                       |   |   |
|              | Item 3.                                                                                                                    | Controls and  Procedures |   |
|              |                                                                                                                       |   |
| PART II.     | OTHER INFORMATION                                                                                                          |   |
|              |                                                                                                                       |
|              | Item 6.                                                                                                                    | Exhibits |   |
|              |                                                                                                                       |   |   |
| SIGNATURES        |                                                                                                                       |
|                   |                                                                                                                            |  |  |  |

 

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(*)                                 All of thefinancial statements contained in this Quarterly Report are unaudited with theexception of the financial information at December 31, 2004, which hasbeen derived from our audited financial statements at that date and should beread in conjunction therewith. Our audited financial statements as of December 31,2004 and for the year then ended, and the notes thereto, can be found in ourAnnual Report on Form 10-KSB (File No. 000-50758), which was filedwith the Securities and Exchange Commission on March 31, 2005.

 

2

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**PART I.  FINANCIAL INFORMATION**

 

**Item 1.  Financial Statements.**

 

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

Consolidated Balance Sheets as of March 31, 2005 and

December 31, 2004

 
| ** **                                                                                                                                                                                  | ** ** | **March 31,  2005** | ** ** | **December 31,  2004** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **(Unaudited)**          | ** ** | ** **                  | ** ** |
| **ASSETS**                                                                                                                                                                                  | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                             | ** ** | ** **               | ** ** | ** **                  | ** ** |
| Cash and cash equivalents                                                                                                                                                                   |       | $                        | 4,016,774  |                        | $          | 3,221 |   |
| Restricted cash                                                                                                                                                                             |       | 200,020                  |       | —                      |       |
| Accounts receivable                                                                                                                                                                         |       | 38,980                   |       | 55,991                      |       |
| Prepaid expenses and other current assets                                                                                                                                                   |       | 251,984                  |       | 228,870                     |       |
| Total current assets                                                                                                                                                                        |       | 4,507,758                |       | 288,082                     |       |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| Property and equipment, net                                                                                                                                                                 |       | 2,000,292                |       | 1,997,621                   |       |
| Deferred financing costs                                                                                                                                                                    |       | 1,085,405                |       | —                      |       |
|                                                                                                                                                                                        |       |                     |       |                        |       |
|                                                                                                                                                                                        |       | $                        | 7,593,455  |                        | $          | 2,285,703 |   |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| **LIABILITIES  AND STOCKHOLDERS’ DEFICIT**                                                                                                                                             |       |                     |       |                        |       |
| Current liabilities:                                                                                                                                                                        |       |                     |       |                        |       |
| Accounts payable                                                                                                                                                                            |       | $                        | 237,951    |                        | $          | 537,660 |   |
| Accrued expenses                                                                                                                                                                            |       | 469,390                  |       | 1,044,343                   |       |
| Due to stockholder                                                                                                                                                                          |       | —                   |       | 801,630                     |       |
| Convertible promissory note to related  party                                                                                                                                               |       | 175,000                  |       | 175,000                     |       |
| Note payable                                                                                                                                                                                |       | 1,174,290                |       | —                      |       |
| Total current liabilities                                                                                                                                                                   |       | 2,056,631                |       | 2,558,633                   |       |
| Capital lease obligation                                                                                                                                                                    |       | —                   |       | 1,971,167                   |       |
| Convertible debentures                                                                                                                                                                      |       | 6,845,087                |       | —                      |       |
| Stockholders’ deficit:                                                                                                                                                                 |       |                     |       |                        |       |
| Common stock, $0.001 par value, 100,000,000  shares authorized, 25,179,406 and 24,454,406 shares issued and outstanding as  of March 31, 2005 and December 31, 2004, respectively |       | 25,179                   |       | 24,454                      |       |
| Additional paid-in capital                                                                                                                                                                  |       | 4,743,487                |       | 2,608,581                   |       |
| Deferred compensation                                                                                                                                                                       |       | (200,500                 | )          | (399,000                    | )          |
| Accumulated deficit                                                                                                                                                                         |       | (5,805,916               | )          | (4,394,997                  | )          |
| Cumulative translation adjustment                                                                                                                                                           |       | (70,513                  | )          | (83,135                     | )          |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| Total stockholders’ deficit                                                                                                                                                            |       | (1,308,263               | )          | (2,244,097                  | )          |
|                                                                                                                                                                                        |       |                     |       |                        |       |
| ** **                                                                                                                                                                                  |       | $                        | 7,593,455  |                        | $          | 2,285,703 |   |

 

See accompanying notes to unaudited consolidated financial statements.

 

3

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

ConsolidatedStatements of Operations for the

Three Months ended March 31, 2005 and 2004

 
| ** **                                             | ** ** | **Three Months Ended  March 31,** | ** ** |
|--------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                             | ** ** | **2005**                               | ** ** | **2004** | ** ** |
|                                                   |       | **(unaudited)**                        |       | **(unaudited)** |   |
| Net revenues                                           |       | $                                      | 122,198    |   | $ | 986,626 |   |
|                                                   |       |                                   |       |   |   |
| Cost of revenues                                       |       | 254,488                                |       | 956,521 |   |
|                                                   |       |                                   |       |   |   |
| Gross margin                                           |       | (132,290                               | )          | 30,105 |   |
|                                                   |       |                                   |       |   |   |
| Selling, general and administrative  expenses          |       | 1,147,898                              |       | 408,777 |   |
|                                                   |       |                                   |       |   |   |
| Loss from operations                                   |       | (1,280,188                             | )          | (378,672 | ) |
|                                                   |       |                                   |       |   |   |
| Interest expense, net                                  |       | (130,731                               | )          | (28,824 | ) |
|                                                   |       |                                   |       |   |   |
| Net loss                                               |       | $                                      | (1,410,919 | ) | $ | (407,496 | ) |
|                                                   |       |                                   |       |   |   |
| Weighted-average basic and diluted shares  outstanding |       | 24,591,350                             |       | 23,885,000 |   |
|                                                   |       |                                   |       |   |   |
| Basic and diluted net loss per common share            |       | $                                      | (0.06      | ) | $ | (0.02 | ) |

 

**See accompanying notes to unaudited consolidated financial statements.**

 

4

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

ConsolidatedStatements of Stockholders’ Deficit for the

ThreeMonths ended March 31, 2005

**(unaudited)**

 
| ** **                                      | ** ** | **Common  Stock** | ** ** | **Additional  Paid-in  Capital** | ** ** | **Deferred  Compensation** | ** ** | **Accumulated  Deficit** | ** ** | **Cumulative  Translation  Adjustment** | ** ** | **Total  Stockholders’  Deficit** | ** ** | **Comprehensive  Loss** | ** ** |
|-------------------------------------------------|------------|-------------------|------------|----------------------------------|------------|----------------------------|------------|--------------------------|------------|-----------------------------------------|------------|----------------------------------------|------------|-------------------------|------------|
| ** **                                      | ** ** | **Shares**        | ** ** | **Amount**                       |
| Balance,  December 31, 2004                |       | 24,454,406        |       | $                                | 24,454     |                       | $          | 2,608,581                |       | $                                       | (399,000   | )                                      | $          | (4,394,997              | )          | $ | (83,135 | ) | $ | (2,244,097 | ) |   |   |
| Issuance  of common stock                       |       | 725,000           |       | 725                              |       | 324,149                    |       |                     |       |                                    |       |                                   |       | 324,874                 |       |   |   |
| Amortization  of deferred stock compensation    |       |              |       |                             |       |                       |       | 198,500                  |       |                                    |       |                                   |       | 198,500                 |       |   |   |
| Issuance  of warrants on convertible debentures |       |              |       |                             |       | 1,780,844                  |       |                     |       |                                    |       |                                   |       | 1,780,844               |       |   |   |
| Issuance  of stock options                      |       |              |       |                             |       | 29,913                     |       |                     |       |                                    |       |                                   |       | 29,913                  |       |   |   |
| Net  loss                                       |       |              |       |                             |       |                       |       |                     |       | (1,410,919                              | )          |                                   |       | (1,410,919              | )          | $ | (1,410,919 | ) |
| Change  in cumulative translation adjustment    |       |              |       |                             |       |                       |       |                     |       |                                    |       | 12,622                                 |       | 12,622                  |       | 12,622 |   |
| Balance,  March 31, 2005                   |       | 25,179,406        |       | $                                | 25,179     |                       | $          | 4,743,487                |       | $                                       | (200,500   | )                                      | $          | (5,805,916              | )          | $ | (70,513 | ) | $ | (1,308,263 | ) | $ | (1,398,297 | ) |

 

See accompanying notes to unaudited consolidated financial statements.

 

5

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

ConsolidatedStatements of Cash Flows for the

ThreeMonths ended March 31, 2005 and 2004

 
| ** **                                                                                      | ** ** | **Three Months Ended March 31,** | ** ** |
|-------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                      | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| ** **                                                                                      | ** ** | **(unaudited)**                       | ** ** | **(unaudited)** | ** ** |
| Cash flows from operating activities:                                                           |       |                                  |       |   |   |
| Net loss                                                                                        |       | $                                     | (1,410,919 | ) | $ | (407,496 | ) |
| Adjustments to reconcile net loss to net  cash provided by (used in) operating activities:      |       |                                  |       |   |   |
| Depreciation                                                                                    |       | 12,243                                |       | 9,828 |   |
| Payment of Company expenses by stockholders  recorded as a capital contribution                 |       | —                                |       | 52,293 |   |
| Non cash compensation expense                                                                   |       | 198,500                               |       | — |   |
| Non cash interest expense                                                                       |       | 100,096                               |       | 28,833 |   |
| Issuance of stock options pursuant to  consulting agreement                                     |       | 29,913                                |       | — |   |
| Contribution of services by stockholder                                                         |       | —                                |       | 27,500 |   |
| Changes in assets and liabilities:                                                              |       |                                  |       |   |   |
| (Increase) decrease in:                                                                         |       |                                  |       |   |   |
| Accounts receivable                                                                             |       | 17,011                                |       | (203,416 | ) |
| Prepaid expenses and other current assets                                                       |       | (23,114                               | )          | 73,945 |   |
| Increase (decrease) in:                                                                         |       |                                  |       |   |   |
| Accounts payable                                                                                |       | (299,709                              | )          | 122,371 |   |
| Accrued expenses                                                                                |       | (574,953                              | )          | 363,345 |   |
| Net cash provided by (used in) operating  activities                                            |       | (1,950,932                            | )          | 67,203 |   |
|                                                                                            |       |                                  |       |   |   |
| Cash flows from investing activities:                                                           |       |                                  |       |   |   |
| Purchases of property and equipment                                                             |       | (18,333                               | )          | (59,383 | ) |
| Net cash used in investing activities                                                           |       | (18,333                               | )          | (59,383 | ) |
|                                                                                            |       |                                  |       |   |   |
| Cash flows from financing activities:                                                           |       |                                  |       |   |   |
| Payments on due to stockholder                                                                  |       | (801,630                              | )          | — |   |
| Settlement of capital lease obligation                                                          |       | (500,000                              | )          | — |   |
| Increase in restricted cash                                                                     |       | (200,020                              | )          | — |   |
| Proceeds from issuance of convertible  debentures and warrants, net of deferred financing costs |       | 7,468,427                             |       | — |   |
| Net cash provided by financing activities                                                       |       | 5,966,777                             |       | — |   |
|                                                                                            |       |                                  |       |   |   |
| Effect of exchange rates on cash                                                                |       | 16,041                                |       | (5,609 | ) |
|                                                                                            |       |                                  |       |   |   |
| Net increase in cash and cash equivalents                                                       |       | 4,013,553                             |       | 2,211 |   |
| Cash and cash equivalents, beginning of  period                                                 |       | 3,221                                 |       | 88,644 |   |
|                                                                                            |       |                                  |       |   |   |
| Cash and cash equivalents, end of period                                                        |       | $                                     | 4,016,774  |   | $ | 90,855 |   |
|                                                                                            |       |                                  |       |   |   |
| **Supplemental  disclosure of cash flow information:**                                          |       |                                  |       |   |   |
| ** **                                                                                      |       |                                  |       |   |   |
| Cash paid for interest                                                                          |       | $                                     | 61,600     |   | $ | — |   |
|                                                                                            |       |                                  |       |   |   |
| Cash paid for taxes                                                                             |       | $                                     | —     |   | $ | — |   |
|                                                                                            |       |                                  |       |   |   |
| **Supplemental  disclosure of non cash financing activities:**                                  |       |                                  |       |   |   |
|                                                                                            |       |                                  |       |   |   |
| Issuance of common stock pursuant to  capital lease obligation                                  |       | $                                     | 324,874    |   | $ | — |   |
|                                                                                            |       |                                  |       |   |   |
| Issuance of note payable pursuant to  capital lease obligation                                  |       | $                                     | 1,170,000  |   | $ | — |   |
|                                                                                            |       |                                  |       |   |   |
| Issuance of common stock warrants in  connection with convertible debenture financing           |       | $                                     | 184,844    |   | $ | — |   |

 

See accompanying notes to unaudited consolidated financial statements.

 

6

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**VISTULA COMMUNICATIONS SERVICES, INC.**

 

**NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**

**March 31, 2005**

 

**(1)****                                ****Basis of Presentation**

 

Theaccompanying unaudited consolidated financial statements of VistulaCommunications Services, Inc. (“Vistula” or the “Company”) have beenprepared in accordance with accounting principles generally accepted in theUnited States (GAAP) for interim financial information and with theinstructions to Form 10-QSB and Article 10 of Regulation S-X.Accordingly, they do not include all of the information and footnotes requiredby GAAP for complete financial statements. In the opinion of management, alladjustments (consisting of normal recurring accruals) considered necessary forthe fair presentation of the results for the interim periods have beenincluded. The preparation of financial statements in conformity with GAAPrequires management to make estimates and assumptions that affect the amountsreported in the financial statements and accompanying notes. Interim resultsare not necessarily indicative of results to be expected for the entire fiscalyear ending December 31, 2005. These unaudited financial statements shouldbe read in conjunction with the audited financial statements and related notesthereto included in the Company’s audited annual financial statements for thefiscal year ended December 31, 2004. Those audited financial statementsare included in the Company’s Annual Report on Form 10-KSB, which has beenfiled with the Securities and Exchange Commission (SEC).

 

The Company uses the UnitedStates dollar as its reporting currency. The British pound is the functionalcurrency of its wholly owned subsidiaries. Assets and liabilities of theCompany’s international operations are translated into U.S. dollars at exchangerates that are in effect on the balance sheet date and equity accounts aretranslated at historical exchange rates. Income and expense items are translated at average exchange rates whichare in effect during the year. Translation adjustments are accumulated in other comprehensive loss as aseparate component of stockholders’ deficit in the consolidated balance sheet.Transaction gains (losses) were immaterial for the three-month periods ended March 31,2005 and 2004.

 

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

 

Statementof Financial Accounting Standard (SFAS) No. 123, *Accounting for Stock-Based Compensation*requiresthe measurement of the fair value of stock options and warrants to be includedin the statement of operations or disclosed in the notes to financialstatements.  The Company has determinedthat it will continue to account for stock-based compensation for employeesunder Accounting Principles Board (APB) Opinion No. 25, *Accounting for Stock Issued to Employees,*andelect the disclosure-only alternative under SFAS No. 123, as amended byStatement of Financial Accounting Standard (SFAS) No. 148,*Accounting for Stock-Based Compensation*.

 

Common stock options grantedhave been valued using the Black-Scholes option pricing model prescribed bySFAS No. 123. There were no stock options granted to employees during thethree months ended March 31, 2005. The weighted average assumptions usedfor stock options granted during 2004 are as follows:

 
| Risk-free interest rate |   | 3.95    | %      |
|-------------------------|--------|---------|--------|
| Expected dividend yield |   | 0       |   |
| Expected lives          |   | 5 years |   |
| Expected volatility     |   | 80      | %      |

 

7

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The following table illustrates the effect on netloss and loss per share if the fair value based method had been applied to alloutstanding and unvested awards for each of the three-month periods endedMarch 31, 2005 and 2004, respectively:

 
| ** **                                                                    | ** ** | **Three months  ended March 31,** | ** ** |
|-------------------------------------------------------------------------------|------------|-----------------------------------|------------|
| ** **                                                                    | ** ** | **2005**                          | ** ** | **2004** | ** ** |
|                                                                          |       |                              |       |   |   |
| Net loss as reported                                                          |       | $                                 | (1,410,919 | ) | $ | (407,496 | ) |
| Stock compensation expense included in net  loss                              |       | 198,500                           |       | — |   |
| Stock compensation expense determined using  fair value method for all awards |       | (241,458                          | )          | — |   |
| Pro forma net loss                                                            |       | $                                 | (1,453,877 | ) | $ | (407,496 | ) |
|                                                                          |       |                              |       |   |   |
| Loss per share (Basic and Diluted): as  reported                              |       | $                                 | (0.06      | ) | $ | (0.02 | ) |
| Pro forma                                                                     |       | $                                 | (0.06      | ) | $ | (0.02 | ) |

 

Inaccordance with Emerging Issues Task Force (EITF) 96-18,*Accounting for Equity Instruments that are Issued toOther than Employees for Acquiring, or in Connection with Selling, Goods orServices*, the Company records compensation expense equal to the fairvalue of the options granted to non-employees over the vesting period, which isgenerally the period of service.  InMarch 2005 the Company issued 100,000 stock options pursuant to a consultingagreement.  The options were valued at$29,913 using the Black-Scholes option pricing model and charged to selling,general and administrative expense for the three month period ending March 31,2005.

 

On December 16,2004, the Financial Accounting Standards Board issued SFAS No. 123(revised 2004) (“SFAS No. 123R”), *Share-Based Payment*,which is a revision of SFAS No. 123, *Accounting for Stock-BasedCompensation*. SFAS No 123R supersedes APB No. 25 and amendsSFAS No. 95, *Statement of Cash Flows*.Generally, the approach in SFAS No. 123R is similar to the approachdescribed in SFAS No. 123. However, SFAS No. 123R requires allshare-based payments to employees, including grants of employee stock options,to be recognized in the statement of operations based on their fair values atthe date of grant. Pro forma disclosure is no longer an alternative. SFAS No. 123Rmust be adopted in fiscal periods beginning after December 15, 2005. Earlyadoption will be permitted in periods in which financial statements have notyet been issued. The Company expects to adopt SFAS No. 123R on January 1,2006.

 

SFAS No. 123Rpermits public companies to adopt its requirements using one of two methods. A “modifiedprospective” method in which compensation cost is recognized beginning with theeffective date (a) based on the requirements of SFAS No. 123R for allshare-based payments granted after the effective date and (b) based on therequirements of SFAS No. 123 for all awards granted to employees prior tothe effective date of SFAS No. 123R that remain unvested on the effectivedate. A “modified retrospective” method which includes the requirements of themodified prospective method described above, but also permits entities torestate based on the amounts previously recognized under SFAS No. 123 forpurposes of pro forma disclosures either (a) all prior periods presentedor (b) prior interim periods of the year of adoption. The Company has yetto determine which method to use in adopting SFAS No. 123R.

 

As permittedby SFAS No. 123, the Company currently accounts for share-based paymentsto employees using APB No. 25’s intrinsic value method. Accordingly, theadoption of SFAS No. 123R’s fair value method may have a significantimpact on the Company’s results of operations, although it will have no impacton the Company’s overall financial position. The impact of adoption of SFAS No. 123Rcannot be predicted at this time because it will depend on levels ofshare-based payments granted in the future. However, had the Company adoptedSFAS No. 123R in prior periods, the impact of that standard would haveapproximated the impact of SFAS No. 123 as described in the disclosure ofpro forma net loss and net loss per share in Note 2 to the Company’s financialstatements. The Company is currently evaluating the impact of the adoption ofSFAS No. 123R on its financial position and results of operations,including the valuation methods and support for the assumptions that underliethe valuation of the awards.

 

**(3)****                                ****Income Taxes**

 

TheCompany accounts for income taxes in accordance with Statement of FinancialAccounting Standard (SFAS) No. 109, *Accountingfor Income Taxes*. Under SFAS No. 109, deferred tax assets orliabilities are computed based on the difference between the financialstatements and income tax basis of assets and liabilities, and net operatingloss carryforwards, using the enacted tax rates. Deferred income tax expense orbenefit is based on changes in the asset or liability from period toperiod.   The Company did not recorda provision for federal, state or foreign income taxes for the three-monthperiods ended March 31, 2005 and 2004 because the Company has experiencedlosses since inception. The Company has not recorded a benefit for deferred taxassets as their realizability is uncertain.

 

**(4)****                                ****Balance Sheet Detail**

 

Restrictedcash represents amounts deposited with a bank in support of an irrevocablestandby letter of credit issued by the bank. The letter of credit has an expiration date of June 15, 2005 atwhich time these amounts will become unrestricted, unless the letter of creditis extended.

 

Prepaidexpenses and other current assets at March 31, 2005 and December 31,2004 consisted of the following:

 
| ** **                       | ** ** | **March 31,  2005** | ** ** | **December 31,****2004** | ** ** |
|----------------------------------|------------|--------------------------|------------|-------------------------------|------------|
|                             |       |                     |       |                          |       |
| Prepaid royalties                |       | $                        | 150,000    |                          | $          | 150,000 |   |
| Prepaid equipment rent           |       | 62,756                   |       | 41,707                        |       |
| Prepaid call termination charges |       | 24,446                   |       | 28,756                        |       |
| Other                            |       | 14,782                   |       | 8,407                         |       |
|                             |       | $                        | 251,984    |                          | $          | 228,870 |   |

 

8

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Otherassets at March 31, 2005 represents deferred financing costs in connectionwith the Company’s issuance of convertible debentures as described in Note 15,which costs are being amortized over the life of the convertible debentures.

 

Accruedexpenses at March 31, 2005 and December 31, 2004 consisted of thefollowing:

 
| ** **                  | ** ** | **March 31,  2005** | ** ** | **December 31,****2004** | ** ** |
|-----------------------------|------------|--------------------------|------------|-------------------------------|------------|
|                        |       |                     |       |                          |       |
| Payroll and payroll-related |       | $                        | 227,892    |                          | $          | 167,500 |   |
| Professional fees           |       | 125,785                  |       | 573,323                       |       |
| Travel                      |       | 30,335                   |       | 107,767                       |       |
| Printing                    |       | 24,443                   |       | 50,764                        |       |
| VAT payable                 |       | 14,823                   |       | 47,024                        |       |
| Directors’ fees        |       | 5,522                    |       | 59,346                        |       |
| Rent                        |       | —                   |       | 25,848                        |       |
| Other                       |       | 40,590                   |       | 12,771                        |       |
|                        |       | $                        | 469,390    |                          | $          | 1,044,343 |   |

 

**(5)****                                ****Comprehensive Loss**

 

Forthe three-month periods ended March 31, 2005 and 2004, the components of othercomprehensive loss consisted of the Company’s net loss and foreign currencytranslation adjustments.  Comprehensiveloss was $1,398,297 and $408,613 for the three months ended March 31, 2005and 2004, respectively.

 

**(6)****                                ****Net Loss Per Share**

 

Basicnet loss per share is computed by dividing net loss for the period by theweighted average number of common shares outstanding during the period.  Diluted net loss per share is computed bydividing net loss by the weighted average number of common shares outstandingduring the period plus the dilutive effect of outstanding stock options.  As there was a net loss for the three-monthperiod ending March 31, 2005, 3,125,000 outstanding stock options, 9,202,500outstanding warrants, and 11,200,000 common shares obtainable uponexercise of the conversion feature of the convertible debentures were excluded from the calculation ofdiluted earnings per share because they were anti-dilutive. There were nostock options outstanding for any other period presented.

 

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**(7)****                                ****Stock Incentive Plan**

 

InFebruary 2004, the board of directors adopted the 2004 Stock IncentivePlan (the “Plan”). Under the Plan, the Company may grant incentive stockoptions, non-statutory stock options and restricted stock that aggregate6,000,000 shares of the Company’s common stock. The Board has the authority toselect the employees, officers, directors, consultants and advisors to whomoptions 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 exerciseprice, which, in the case of incentive stock options, must be at least 100%(110% in the case of incentive stock options granted to a stockholder owning inexcess of 10% of the Company’s common stock) of the fair market value of thecommon stock as of the date of grant and (iv) the duration of the option,which may be up to 10 years or provided that incentive stock options issued toa stockholder owning in excess of 10% of the Company’s common stock, may nothave a term of more than five years.

 

Optionsfor a total of 4,825,000 shares have been granted under the Plan. On June 30, 2004 two employeesterminated their employment with the Company.  As a result, 1,500,000options were forfeited.  Pursuant to an employment agreement, anotheremployee has a contractual right to the grant of these options. TheCompany has treated these 1,500,000 options as outstanding at March 31,2005 for the purposes of calculating stock compensation expense.  On October 19, 2004, the Company granted 2,000,000 optionsto purchase common stock to its then newly-appointed chief executive officer.The options have an exercise price of $.10 per share and were fully vested upongrant.  In February 2005 this officerresigned and agreed to relinquish 1,800,000 options in exchange for a right toexercise all or any part of the remaining 200,000 options for a period of 12months from termination.  As a result, asof March 31, 2005, there were outstanding under the plan options to purchase anaggregate 3,125,000 shares of common stock.

 

TheCompany has reflected pre-tax charges to earnings in the three-month periodended March 31, 2005 of $198,500, for the compensation value of theoptions granted.  At March 31, 2005,an additional $200,500 of deferred compensation remains on the accompanyingbalance sheet that will be amortized over future periods as the underlying stockoptions vest.

 

**(8)****                                ****Employment Agreements**

 

InJanuary 2004, the Company entered into employment and non-competitionagreements with three key individuals. The agreements were amended and restated in May 2004.  These agreements have initial terms thatbegin on January 1, 2004 and end between March 2005 andJune 2005 and may be renewed for successive annual terms if both theCompany and the employee agree in writing. The agreements provide for annual salaries totaling $300,000, as well asbonuses totaling $285,000 if certain Company performance goals are achieved asdefined in the agreement.  As ofMarch 31, 2005 no bonuses have been accrued as such goals have not beenmet.  If the Company elects to terminatethe employees without cause, the employees are entitled to receive severancepayments equal to six months of their salaries. Two of the employees resigned as of June 30, 2004.

 

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**(9)****                                ****Related Party Transactions**

 

Contributed Services

 

During the year endedDecember 31, 2004 certain stockholders contributed services to theCompany. Pursuant to Staff Accounting Bulletin Topic 5T (SAB.T.5T), the Companyrecorded compensation of $27,500 for the three-month period endedMarch 31, 2004, with corresponding credits recorded in additional paid-incapital.  There were no contributedservices during the three month period ending March 31, 2005.

 

Expenses Paid By Stockholder

 

During 2004, the Chairmanpaid certain legal, accounting and operating expenses on behalf of theCompany.  Pursuant to SAB.T.5T, expensesnot expected to be repaid of approximately $52,000 were recorded as expense andcharged to additional paid-in capital for the three-month period endedMarch 31, 2004. Expenses that were expected to be repaid of $14,579 areincluded in due to stockholder at March 31, 2004. The amounts due tostockholder do not bear interest.  TheChairman did not pay any Company expense during the three month period endingMarch 31, 2005.

 

**(10)****                         ****Asset Purchase**

 

In January 2004, the Company signed anagreement to purchase certain equipment from another entity in exchange for$2,000,000, less any fees, costs and expenses incurred by the Company tore-certify or re-license such assets by June 30, 2004. The agreement wasamended on May 5, 2004. As a result of the amendment, the purchase pricefor the equipment was $1,670,000 and 725,000 shares of common stock having avalue of approximately $325,000. On March 15, 2005, the agreement wasfurther amended, at which time the Company completed the purchase of thisequipment.  In consideration for theequipment purchased, the Company paid $500,000 in March 2005, issued725,000 shares of common stock, and issued a promissory note for the balancedue of $1,170,000.  The promissory notebears interest at 8.25% per annum and is payable monthly in arrears.  Principal payments of $150,000 are due onSeptember 30, 2005 and December 31, 2005, with the balance of theprincipal ($870,000) due on March 15, 2006.

 

Through March 15, 2005,the Company accounted for the agreement as a capital lease in accordance withStatement of Financial Accounting Standard (SFAS) No. 13 *Accounting for Leases*andreflected the liability as a capital lease obligation. As of March 15,2005, the obligation has been included in the consolidated balance sheet underthe caption “Long-term obligation.”

 

TheCompany originally recorded the present value of the minimum lease payments asan asset of $1,855,835.  The equipmentwas not placed in service as of March 31, 2005.  The future minimum lease payments related tothe capital lease was $2,000,000, which included $144,165 related tointerest.  The Company recorded $27,997 and$28,833 related to interest expense on the capital lease for the three-monthperiods ended March 31, 2005 and 2004, respectively.  The Company does not have any minimumsublease rental income related to the capital lease.  There were no contingent rentals during thethree month period ended March 31, 2005.

 

TheCompany has deemed the May 5, 2004 amendment described above to be amodification of the lease pursuant to SFAS No. 13.  As of May 5, 2004, the balance of theasset and associated capital lease obligation was adjusted by an amount equalto the difference between the present value of the future minimum leasepayments under the modified agreement and the present balance of theobligation, with no resulting gain or loss recognized.  Under certain circumstances, the cash portionof the obligation was convertible into the Company’s common stock, at thelessor’s option.  The Company accountedfor the conversion feature associated with the capital lease obligationincluded in the May 2004 amendment pursuant to EITF Issue No. 98-5, *Accounting for Convertible Securities with BeneficialConversion Features or Contingently Adjustable Conversion Ratios*,whereby the Company measured the beneficial conversion feature on the amendmentdate, but did not record any charge until the contingencies were resolved.  Upon completion of the purchase inMarch 2005, the conversion feature expired, therefore no charge wasrecorded.  The promissory note does notinclude a conversion feature.

 

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**(11)****                         ****Commitments andContingencies**

 

From its inception through the closings of the convertible debenturesdescribed in Note 14, the Company sustained its operations through fundingprovided by the Chairman, as well as contributed services by the Chairman andother stockholders. The Chairman has made various advances to the Company froma $3,000,000 credit facility established in the name of the Chairman, as wellas from other of the Chairman’s personal assets. The credit facility wasestablished by the Chairman in February of 2003 and was first drawn uponby the Chairman in May of 2003. Borrowings are payable by the Chairman upondemand.  Interest accrues at the bank’sbase rate plus 2% for the first $300,000 of borrowings and at the bank’s baserate plus 5% on all additional borrowings. Under the credit facility, the lender may issue standby letters of creditfor the benefit of third parties at the request of the Chairman. Theobligations of the Chairman under the credit facility are secured by certainproperty in which the Chairman has a beneficial interest. As of April 30,2005, the Chairman has drawn approximately $262,000 under this facility to payexpenses incurred and accrued by the Company and its affiliates. Seven lettersof credit in the aggregate amount of $1,271,000 have been issued by the lenderunder the credit facility of which $508,000 have been issued in favor ofvendors to the Company and its affiliates at the request of the Chairman. As ofApril 30, 2005, approximately $355,000 was undrawn and available under thecredit facility and $2,645,000 was outstanding. The Company may obtain futureadvances from the Chairman from both the credit facility and the Chairman’sother personal assets in order to meet certain working capital needs. TheChairman may also cause the lender under the credit facility to issue standbyletters of credit in favor of one or more of the Company’s vendors to securethe Company’s obligations to such vendor or vendors. While the Chairman is notobligated to provide these advances to the Company or to cause the lender toissue standby letters of credit in favor of the Company’s vendors, the Companyexpects the Chairman to continue providing funds for operations in 2005 as andif needed. In the absence of the Company raising additional external capital,the Company will continue to be dependent on the Chairman to fund existingoperations and provide growth capital. There can be no assurances that theCompany can raise such capital on acceptable terms, if at all.

 

The credit facility is secured by certain property in which theChairman has a beneficial interest. The credit facility is guaranteed by theCompany’s wholly owned subsidiary, Vistula Limited. The lender under the creditfacility requested that Vistula Limited provide the guarantee as a condition toproviding the facility since it was anticipated that a portion of the drawingsunder the facility would be advanced to, or used to pay expenses of, VistulaLimited. Vistula shall be required to perform its obligations under theguarantee in the event that the Chairman fails to pay to the lender any amountspayable under the credit facility when due. The maximum amount of futurepayments the guarantor could be required to make under the guarantee is$3,000,000, plus interest, fees, costs and expenses payable to the lender underthe credit facility. The guarantee shall continue in effect until all of theobligations and liabilities of the Chairman under the credit facility have beenpaid or satisfied in full. The Company has no recourse provisions that wouldenable it to recover monies from third parties with respect to amounts it isrequired to pay under the guarantee. The Company does not have any collateralit could obtain to recover amounts paid under the guarantee. The Company has evaluatedthe fair value of the guarantee in accordance with Financial AccountingStandards Board Interpretation Number 45 (FIN 45) and determined the value tobe immaterial to the financial statements and, as a result, no liability hasbeen recorded.

 

The Company maintains a letter of credit totaling 80,000 pounds(converted to $150,320 as of March 31, 2005) for the benefit of a customer.  The holder can draw against the letter of creditin the event of default. The Company is required to maintain a cash balance ofat least $200,000 as of March 31, 2005 for funding of the letter of creditpursuant to the agreement.  This amountis included as restricted cash in the consolidated balance sheet atMarch 31, 2005.

 

Shortly afterthe first closing of the private placement described in Note 11, the Companyreceived a letter on behalf of Kevin Dann & Partners (“KDP”), a placementagent we had retained prior to our engagement of IndiGo Securities, LLC asplacement agent, demanding a placement fee of $227,000.  The letter also included a claim that KDPwould be entitled to additional fees in the event of future closings.  In the Company’s response to this letter, theCompany denied any such liability to KDP.

 

**(12)****                          Indemnification**

 

As permitted under Delaware law, the Company hasagreements whereby it indemnifies its officers and directors for certain eventsor occurrences while the officer or director is, or was serving, at theCompany’s request in such capacity. The term of the indemnification period isfor the officer or director’s lifetime. The maximum potential amount of futurepayments the Company could be required to make under these indemnificationagreements is unlimited; however, the Company has a Director and 

 

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Officerinsurance policy pursuant to which the Company may recover all or a portion ofamounts it pays to directors or officers under their indemnificationagreements. As a result of its insurance policy coverage, the Company believesthe estimated fair value of these indemnification agreements is minimal.

 

The Company enters into standard indemnificationagreements in the ordinary course of its business. Pursuant to theseagreements, the Company indemnifies, holds harmless, and agrees to reimbursethe indemnified party for losses suffered or incurred by the indemnified party,generally business partners, debenture holders, agents, or customers, inconnection with any patent, copyright, trademark, trade secret or otherintellectual property infringement claim by any third party with respect to theCompany’s products. The term of these indemnification agreements is generallyperpetual. The maximum potential amount of future payments the Company could berequired to make under these indemnification agreements is often capped at adollar figure. The Company has never incurred costs to defend lawsuits orsettle claims related to these indemnification agreements. As a result, theCompany believes the estimated fair value of these agreements is minimal.

 

**(13)****                         ****Notes Payable**

** **

On July 2, 2004, the Company entered into a note subscriptionagreement with the J. Rothschild Assurance Self Invested Personal Pension PlanNo. 2, the sole beneficiary of which is the Company’s Chairman, chiefexecutive officer and president, Mr. Rupert Galliers-Pratt. The notesubscription agreement was amended and restated on August 11, 2004. Underthe amended and restated note subscription agreement, the Company issued andsold to Mr. Galliers-Pratt’s pension plan a convertible promissory note inthe principal amount of $125,000 on July 12, 2004 and the Company issuedand sold to the pension plan a convertible promissory note in the principalamount of $50,000 on August 11, 2004. Both convertible promissory noteshave a one-year term, accrue interest at the rate of 7% per annum and areconvertible into shares of the Company’s common stock at the price of $1.50 pershare.

 

**(14)****                          ConvertibleDebentures**

** **

On February 18, 2005 and March 4,2005, the Company completed a private placement of convertible debentures andwarrants to a group of sophisticated institutional and individual investors. Inthe private placement, the Company sold convertible debentures in the aggregateprincipal amount of $8,400,000 and warrants to purchase an aggregate of8,400,000 shares of its common stock. The Company paid placement fees to theplacement agent in the aggregate amount of $802,500 and also issued to theplacement agent a warrant to purchase up to 802,500 shares of the Company’s commonstock at an initial exercise price of $1.00 per share. The debentures accrueinterest daily at a rate of 8% per annum, which interest is payable quarterly oneach March 31, June 30, September 30 and December 31following the issue date.  The finalinterest payment is due on the date of maturity of the debentures, the third 

 

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anniversary of the issue date.

 

In connection with the debenture financingtransaction, the Company issued warrants to the placement agent topurchase 802,500 shares of the Company’s common stock at an exercise priceof $1.00 per each common stock share. The Company determined the value of the warrant to be $184,844 using theBlack-Scholes pricing model and the following assumptions: risk freeinterest rate, 3.9%; expected divided yield, 0; expected life, 5 years; andexpected volatility, 80%.  The Company recorded this transactionas deferred financing fees.  Inaddition, the Company paid legal expenses and broker fees of $931,573, whichhave been recorded as deferred financing fees. The deferred financing fees are being amortized to investment feesexpense using the straight-line method through the maturity date of thedebentures.

 

In connection with the debenture financingtransaction, the Company issued 8,400,000 warrants to the investors topurchase shares of the Company’s common stock at an exercise price of $1.00 pereach common stock share.  The Company determined the value of the warrantto be $1,933,108 using the Black-Scholes pricing model and the followingassumptions: risk free interest rate, 3.9%; expected divided yield,  0;expected life, 5 years; and expected volatility, 80%.  TheCompany allocated value to the debt and the warrant based on their relativefair values in accordance with Accounting Principles Board Opinion No. 14,*Accounting for Convertible Debt and Debt Issuedwith Stock Purchase Warrants,* resulting in an allocation of$1,596,000 to the warrants.  The warrantswere recorded as a discount to the debenture and a credit toadditional paid-in capital.  This discount is amortized to interestexpense using the effective interest rate method through the maturity date ofthe debentures.  Asof March 31, 2005, the unamortized portion of the discount was$1,554,913.

 

After allocation of the proceeds between thedebentures and the warrants, the Company considered whether the conversionterms of the debenture result in a beneficial conversion feature, pursuant toEmerging Issue Task Force Nos. 98-5 and 00-27. The Company determined that there was not a beneficial conversionfeature.

 

For both of the Black-Scholes computationsdescribed above, the Company used $ 0.45 as the fair value of its commonstock.  Because there is no currenttrading market for the Company’s common stock, management’s determination offair value was based on an independent appraisal.

 

**(15)****                          Distributionand Marketing Agreement**

** **

On August 11, 2004, the Company entered into a distribution andmarketing agreement with NetYantra Inc. and NetYantra India Pvt. Ltd.(collectively, “NetYantra”) pursuant to which NetYantra grants to the Companythe exclusive worldwide rights (other than in India where NetYantra isheadquartered and subject to certain existing distribution agreements) tomarket and distribute the V-CubeTM IP-PBX software platform to Tier 1 carriers,telecommunications equipment manufacturers, internet service providers, largecorporations, SMEs and other business entities and individual retail customers.Under the distribution and marketing agreement, in consideration for themarketing and distribution rights granted to the Company by NetYantra, theCompany paid NetYantra $150,000 (the “Initial Payment”) and is required to:

 

•                PayNetYantra the amount of $250,000 (the “Second Payment”) on the day immediatelyfollowing the first anniversary of the signing of the agreement; and

 

•                PayNetYantra fifty percent of certain net revenues that the Company derives fromthe distribution of the V-CubeTM platform.

 

Amounts paid by the Companypursuant to the Initial Payment and the Second Payment are creditable againstfuture royalty commitments.  Accordingly,the Company recorded the amount paid pursuant to the Initial Payment, and willrecord the amount due pursuant to the Second Payment, as prepaid royalties andwill expense such prepaid amounts as royalties accrue.  Should the Company fail to make any of thesepayments, NetYantra may terminate the agreement.

 

In addition, in the eventthat the Company’s common stock is quoted or traded on a stock market on orbefore the first anniversary of the agreement, the Company must also issue toNetYantra shares of the Company’s common stock having a market value of$1,000,000 based on the opening price of the 

 

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Company’s common stock onthe first day of trading (or, at the Company’s option, pay to NetYantra a cashpayment of $1,000,000 instead of issuing such shares). Should the Company failto issue these shares, or make the cash payment, NetYantra may terminate theagreement.  This payment, whether in theform of common stock or cash, is not creditable towards royalty commitments andwill be expensed when and if it becomes payable.

 

The Agreement is for aninitial term of five years. NetYantra may elect to terminate the exclusivitygranted to the Company under the Agreement after a period of two years for anyreason.

 

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**Item 2.  Management’s Discussion and Analysis ofFinancial Condition and Results of Operations.**

** **

**Introduction**

 

The following informationshould be read in conjunction with the financial statements and notes theretoin Part I, Item 1 of this Quarterly Report and with Management’sDiscussion and Analysis of Financial Condition and Results of Operationscontained in our Annual Report on Form 10-KSB for the year endedDecember 31, 2004 (File No. 000-50758).

 

**Cautionary Statements**

 

We do not provide forecastsof our future financial performance. However, from time to time, informationprovided by us or statements made by our employees may contain“forward-looking” information that involves risks and uncertainties.  In particular, statements contained in thisQuarterly Report that are not historical facts constitute forward-lookingstatements and are made under the safe harbor provisions of the Private SecuritiesLitigation Reform Act of 1995.  Forward-lookingstatements involve substantial risks and uncertainties.  You can identify these statements byforward-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 ourfuture operating results or financial condition; or (3) state other“forward-looking” information.  Variousfactors described below, as well as any other instances of cautionary languagein this Quarterly Report, refer to or provide examples of risks, uncertaintiesand events that may cause our actual results to be materially different thanthe expectations described in our forward-looking statements.  You should be aware that the occurrence ofany of the events or factors described below and elsewhere in this QuarterlyReport could materially and adversely affect our business.  All forward-looking statements included inthis Quarterly Report are based on information available to us on the datehereof, and we assume no obligation to update any such forward-lookingstatements.

 

Each forward-lookingstatement should be read in conjunction with the financial statements and notesthereto in Part I, Item 1 of this Quarterly Report, this section, andManagement’s Discussion and Analysis of Financial Condition and Results ofOperations contained in our Annual Report on Form 10-KSB for the yearended December 31, 2004 (File No.000-50758), including but not limited tothe section therein entitled “Factors Affecting Future Performance.”

 

In addition to the risks anduncertainties faced generally by participants in the telecommunicationindustry, we face the following risks and uncertainties:

 

•                                          We have a limited operating history and therefore, we may not be able toaccurately forecast future results and operating losses in future periods couldbe greater than expected.

 

•                                          If we do not obtain a substantial amount of additional financing, we mayhave to curtail or suspend operations.

 

•                                          We may continue to lose money on our operations.

 

•                                          If we fail toestablish the Vistula, V-CubeTM and Cardlink brands or to attract repeatcustomers, we may not be able to increase our revenues sufficiently to fund ouroperations.

 

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•                                          We currentlyderive a significant portion of revenue from a limited number of largecontracts and customers and, if we are unable to replace large contracts uponcompletion and maintain customer relationships, we could have a significantdecrease in our revenues that would negatively impact our results.

 

•                                          We mayexperience significant fluctuations in our results as a result of uncertaintiesrelating to our ability to generate additional revenues, manage ourexpenditures and other factors, certain of which are outside of our control.

 

•                                          Our contractstypically contain provisions giving customers the ability to terminate theircontracts under various circumstances and we may not be able to replace therevenues from such contracts that may have an adverse effect on our revenuesand operating results.

 

•                                          We may not be able to promptly reduce expenses in response to anydecrease in our revenues, which would result in lower net margins.

 

•                                          If we are unable to collect receivables from development stage customersand other telecommunications companies, our operating results may be materiallyharmed.

 

•                                          The extent of our dependence on international operations may give rise toincreased management challenges and could harm our results of operations.

 

•                                          Providing services outside the United States carries the additional riskof currency fluctuations and foreign exchange controls imposed by certaincountries since many of our non-U.S. projects are undertaken in local currency.

 

•                                          Our inability to anticipate or adapt to changes in technology may harmour competitive position, reputation and opportunities for revenue growth.

 

•                                          We may not be able to hire or retain a sufficient number of qualifiedengineers and other employees to meet our customers’ needs or maintain thequality of our services.

 

•                                          Future acquisitions of new companies or technologies may result indisruption to our business and expose us to risks associated with acquisitions.

 

•                                          The consolidation of telecommunication service providers could adverselyimpact our business.

 

•                                          Government regulations may adversely affect our business.

 

•                                          If we fail to retain our key personnel and attract and retain additionalqualified personnel, we might not be able to meet our customers’ needs.

 

•                                          Our internal controls and procedures need improvement.

 

•                                          The management of our finances and the quality and timeliness of ourfinancial reporting may be adversely affected if we are unable to increase thesize and capabilities of our internal administrative and finance function asour business grows.

 

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•                                          We will not be successful if we do not grow our customer base beyond ourinitial customers.

 

•                                          If we do not respond rapidly to technological changes or to changes inindustry standards, our products and services could become obsolete.

 

•                                          We will notretain customers or attract new customers if we do not anticipate and meetspecific customer requirements and if our products and services do notadequately interoperate with our customers’ existing networks.

 

•                                          If we fail tocompete successfully, our ability to increase our revenues or achieveprofitability will be impaired.

 

•                                          Our business isexposed to the general conditions of the telecommunications market.

 

•                                          The markets for wholesale voice services (particularly VoIP services) andpre-pay products are new and evolving and, if these markets do not develop asexpected, then it could have a material adverse effect on our business.

 

•                                          Intellectual property infringement claims against us or any of oursubsidiaries, even without merit, could require us to enter into costlylicenses or deprive us of the technology we need. Failure to protect ourintellectual property rights could have a material adverse effect on ourbusiness.

 

•                                          If our products contain defects, then our sales are likely to suffer, andwe may be exposed to legal claims.

 

•                                          We may be subject to litigation.

 

Becauseof the foregoing and other factors, we may experience material fluctuations inour future operating results on a quarterly or annual basis which couldmaterially adversely affect our business, financial condition and operatingresults.

 

**Overview**

 

Vistula CommunicationsServices, Inc. (“VCS”, the “Company” or “we”) currently has threesubsidiaries: Vistula Limited (“Vistula”), Vistula USA, Inc. (“VistulaUSA”) and Cardlink Services Limited (“Cardlink”).  Through Vistula and Vistula USA, we currentlyprovide wholesale value-added telecommunications services (including direct andpartner voice routing services) to Tier 1 and Tier 2 telecommunication carriersand transit operators. Beginning in the first quarter of 2005, through Vistulaand Vistula USA, we began to market the V-CubeTM Voice over Internet Protocol,or “VoIP”, IP-PBX software platform to telecommunications carriers, Internetservice providers, or “ISPs”, large corporations and small and mediumenterprises, or “SMEs”, throughout the world.

 

Through our Cardlinksubsidiary, which is currently inactive, we plan to market and distributeelectronic top-up software, which enables prepayment for services provided bymobile telephone operators, and associated services to Tier 1 and Tier 2telecommunications carriers and transit network operators throughout theworld.  Cardlink developed a softwareproduct suite that enabled mobile operators to electronically processprepayments from “pay-as-you-go” mobile phone customers.

 

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***Vistula and Vistula USA***

 

Vistula and Vistula USA are aggregators of wholesaletelecommunications services to Tier 1 and Tier 2 telecommunications carriersand transit network operators.  Vistulaand Vistula USA are collectively referred to as the “Vistula Companies.”  The Vistula Companies have switchingfacilities in London and Los Angeles and interconnect agreements with suppliersand customers in these locations.  Webelieve that the Vistula Companies are positioned to take advantage of thedisruption and uncertainty in the telecommunications sector over the past fewyears. The collapse of a significant number of competitive wholesale serviceproviders has meant that profit margins have improved significantly and webelieve the opportunity for well managed and well financed wholesale carrierssuch as the Vistula Companies is significant.

 

The Vistula Companies began to actively market theV-CubeTM IP-PBX software platform to carriers, transit network operators, largecorporations, and SMEs in the first quarter of 2005. We expect this multiplefeature VoIP platform, which will enable customers to convert their existingtraditional PBX phone systems to provide VoIP capability without the need forsignificant investment in new hardware, will provide the Vistula Companies witha highly competitive VoIP solution.

 

We recently entered into a distribution andmarketing agreement with Telstra Europe Limited, a U.K.-basedtelecommunications carrier. Under this agreement, we license Telstra Europe toprovide hosted IP-PBX services to its customers using the hosted V-CubeTM IP-PBXplatform. The agreement grants Telstra Europe an exclusive license to providethe hosted solution to its customers in the United Kingdom and Ireland for aperiod of five years. The monthly license fee payable by Telstra Europe to usis based on the number of individual users at the various Telstra Europecustomers who are using the VoIP services provided by Telstra Europe throughuse of the V-CubeTM platform. We hope to leverage the marketing advantages andcustomer relationships of Telstra Europe to provide us with regular monthlyrevenue.

 

***Cardlink***

 

Cardlink has been inactive since it was first acquired by Mr. Rupert Galliers-Pratt and certain members of his family in April 2003.  Following the acquisition of Cardlink by VCS through the share exchange completed in March 2004, VCS intends to reactivate and refocus the operations of Cardlink. Cardlink will offer an electronic top-up, or “ETU”, software product suite which will enable mobile operators to electronically process prepayments from “pay-as-you-go” customers.  Cardlink’s products will allow these customers to “electronically top-up” their accounts with the mobile operator.  We believe that the market for these prepayment services is expanding both in the developed and in the underdeveloped regions in the world and we believe that Cardlink’s ETU product will be of significant value as new mobile operators throughout the world seek to adopt this technology.

 

We believe that the potential for providing ETU services in markets where the adoption and use of mobile telephony is growing rapidly will create significant opportunities and long-term growth potential for Cardlink.  We intend that Cardlink will typically receive a percentage of the total mobile revenues transacted through the Cardlink system.  As a result, Cardlink will be a beneficiary of any increase in mobile telephony revenues without any investment of capital in building infrastructure.  We currently expect to use third parties to provide necessary software updates, maintenance and support for these activities.

 

**Critical Accounting Policies**

 

Our consolidated financial statements are preparedin accordance with accounting principles generally accepted in the UnitedStates. These accounting principles require us to make certain estimates, 

 

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judgments and assumptions.We believe that the estimates, judgments and assumptions upon which we rely arereasonable based upon information available to us at the time that theseestimates, judgments and assumptions are made. These estimates, judgments andassumptions can affect the reported amounts of assets and liabilities as of thedate of the financial statements, as well as the reported amounts of revenuesand expenses during the periods presented. Those estimates and judgments arebased on management’s historical experience, the terms of existing agreements,our observance of trends in the industry, information that we obtain from ourcustomers and outside sources, and on various other assumptions that managementbelieves to be reasonable and appropriate under the circumstances, the resultsof which form the basis for making judgments about the carrying values ofassets and liabilities that are not readily apparent from other sources.  To the extent there are material differencesbetween these estimates, judgments or assumptions and actual results, ourfinancial statements will be affected.

 

The significant accounting policy that we believe ismost critical in fully understanding and evaluating our reported financialresults is our policy regarding revenue recognition which is discussed indetail in our Annual Report on Form 10-KSB filed with the Securities andExchange Commission. We have reviewed and determined that our revenuerecognition policy remains our critical accounting policy for the three-monthperiod ended March 31, 2005. We did not make any changes to this policyduring this period.

 

For thecomputations described in Note 14 pertaining to the convertible debentures andwarrants, the Company used $0.45 as the fair value of its common stock.  Because there is no current trading marketfor the Company’s common stock, management’s determination of fair value wasbased on an independent appraisal.

 

**Results of Operations**

 

Revenues for the three-month period ended March 31, 2005 were $122,198 which represents a decrease of $864,428 from the comparable period in fiscal 2004. We believe this decrease is attributable both to the decline of the UK mobile market as a re-sellable wholesale route and to our inability to attract new wholesale business due to our lack of liquidity prior to the closings of our private placement of convertible debentures and warrants in the first quarter of 2005 as described in Note 14.  We expect to increase our revenues during the remainder of 2005 as the equipment described in Note 10 is placed into service.

 

Cost of revenues for the three-month period endedMarch 31, 2005 was $254,488, a 73% decrease as compared to the same periodin fiscal 2004. Engineering costs classified as cost of revenues for thethree-month period ended March 31, 2005 of $122,000 increased 155% ascompared to the same period in fiscal 2004 due to expenditures pertaining tothe establishment of the VoIP platform and initiating routing services in theU.S.

 

Selling, general and administrative costs increasedby 181% to $1,147,898 for the three-month period ended March 31, 2005 ascompared to the same period in fiscal 2004. During the three-month period endedMarch 31, 2005, we incurred $198,500 from the expensing of employee stockoptions granted under our Stock Incentive Plan that vested during the periodand $140,000 in expenses for financial advisory services provided by aninvestment banking firm. In addition, we have incurred approximately $230,000in legal and accounting expenses including substantial legal and accountingexpenses associated with the financing activities. We also incurred $118,000 intravel expenses related to the marketing activity for the V-CubeTM IP-PBXsoftware platform.

 

Depreciation and amortization expenses were $12,243 for the three-month period ending March 31, 2005.  Property and equipment are carried at cost. We provide for depreciation expense using the straight-line method over the estimated useful lives of the equipment of 3 to 5 years.

 

During the three month period ended March 31, 2005, we recorded $23,707 of interest expense related to capital lease obligations.

 

The charge for expensing non-cash employee compensation for stock options was $198,500 for the three-month period ended March 31, 2005. No stock options were awarded during the three-month period ended March 31, 2005.

 

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For the three-month period ended March 31, 2005, we incurred a loss of $1,410,919 or approximately $0.06 loss per common share, basic and diluted.

 

**Liquidity And Capital Resources**

 

As of March 31, 2005, we had cash and cash equivalents of approximately $4,017,000 and a working capital surplus of approximately $2,451,000.  This represents an increase in cash and cash equivalents of $4,014,000 from December 31, 2004 and an increase in working capital from a deficit of $2,271,000 at December 31, 2004. Since our inception through March 31, 2005, we have generated losses of approximately $5,675,000. Accounts receivable were approximately $39,000 at March 31, 2005, a decrease of approximately 30% from December 31, 2004.  Accounts payable, accrued expenses and due to stockholder decreased $1,676,292 from December 31, 2004 as a result of applying a portion of the proceeds received from the issuance of convertible debentures to the payment of these outstanding obligations.

 

We have made expenditures for capital equipment fromour inception until March 31, 2005 of approximately $245,000, purchasingthe telecommunications equipment necessary to begin our business. This amountexcludes the $1.8 million in telecommunications equipment acquired from MRSPartners LLC described further below.

 

On February 18, 2005 and March 4, 2005, wecompleted a private placement of convertible debentures and warrants to a groupof sophisticated institutional and individual investors. In the privateplacement, we sold convertible debentures in the aggregate principal amount of$8,400,000 and warrants to purchase an aggregate of 8,400,000 shares of ourcommon stock. We paid placement fees to the placement agent in the aggregateamount of $802,500 and we also issued to the placement agent a warrant topurchase up to 802,500 shares of our common stock at an initial exercise priceof $1.00 per share. The debentures accrue interest daily at a rate of 8% perannum, which interest is payable quarterly on each March 31, June 30,September 30 and December 31 following the issue date.  The final interest payment is due on the dateof maturity of the debentures, the third anniversary of the issue date.

 

On March 15, 2005 we completed the purchase ofcertain telecommunications equipment (including two Sonus Networks switches) fromMRS Partners LLC (“MRS Partners”) for $500,000 in cash, 725,000 shares of ourcommon stock and a promissory note for an aggregate principal amount of$1,170,000. Prior to the closing, we were leasing this equipment from MRSPartners. Under the terms of the promissory note, interest accrues daily at arate of 8.25% and is payable monthly in arrears. Principal repayments of$150,000 are payable on September 30, 2005 and December 31, 2005. Theremaining principal and any unpaid interest is payable on the first anniversaryof the closing of the purchase.

 

In the second quarter, we incurred additional charges from SonusNetworks relating to relicensing and recertifying the purchased equipment.  We believe that we are contractually entitledto reimbursement of at least a portion of these amounts from MRS Partners.  We have been in discussions with MRS Partnersregarding our claim to reimbursement and expect to withhold payments under thenote until such issue is resolved. However, there can be no assurance that this issue will be resolved, andin the event it is not resolved, MRS Partners may seek to accelerate allamounts owed under the note.

 

On August 11, 2004, we entered into adistribution and marketing agreement with NetYantra Inc. and NetYantraIndia Pvt. Ltd. (collectively, “NetYantra”) pursuant to which NetYantragrants to VCS the exclusive worldwide rights (other than in India whereNetYantra is headquartered and subject to certain existing distributionagreements) to market and distribute the V-CubeTM IP-PBX software platformdeveloped by NetYantra to Tier 1 carriers, telecommunications equipmentmanufacturers, internet service 

 

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providers, largecorporations, SMEs and other business entities and individual retail customers.Under this agreement, we will be required in the future to, among other things:

 

•                  pay NetYantrathe amount of $250,000 on the day immediately following the first anniversaryof the signing of the distribution and marketing agreement; and

 

•                  pay NetYantrafifty percent of certain net revenues that the Company derives from thedistribution of the V-CubeTM platform.

 

In addition, in the event that our common stock isquoted or traded on a stock market on or before the first anniversary of theagreement, we must also issue to NetYantra shares of our common stock having amarket value of $1,000,000 based on the opening price of our common stock onthe first day of trading (or, at our option, pay to NetYantra a cash payment of$1,000,000 instead of issuing such shares).

 

We expect to be able to pay the required interestand principal payments under the convertible debentures issued in our recentprivate placement and the promissory note issued to MRS Partners as part of theconsideration for the purchase of equipment from MRS Partners and the paymentsrequired under the NetYantra agreement, including the $1,000,000 payment (inthe event we are required to issue shares of our common stock having a marketvalue of $1,000,000 to NetYantra and we elect to make this payment in cashinstead of shares), from wholesale voice services and from the remainingproceeds from our recently completed convertible debenture and warrantfinancing.

 

We believe that our available cash and cashequivalents will be sufficient to meet our working capital requirements,including the funding of operating losses, and capital expenditure requirementsfor at least the current fiscal year, assuming that our business plan isimplemented successfully. Previously, our primary sources of capital had beenthe revenues generated from interconnect agreements with our customers andadvances made by one of our principal stockholders from a credit facilityestablished in the name of the stockholder and other of the stockholder’s personalassets.  In the event that we do notsucceed in implementing our business plan, and do not otherwise raisethird-party capital, we will have to curtail certain expenditures, seekadditional financing from our principal stockholder, or both in order to sustainoperations.  As noted above, theprincipal stockholder has historically provided working capital advances, andhas caused the lender to issue letters of credit in favor or certain vendors.While the stockholder is not obligated to provide these working capitaladvances to us or to cause the lender to issue standby letters of credit infavor of our vendors, we expect the stockholder to continue providing funds foroperations in 2005 as and if needed, until such time that our operations areself-sustaining or we raise additional external capital, as the case may be.

 

Our plans for growth and expansion will require theneed for additional capital in the future. As a result, we may have to relyupon the issuance of additional debt or equity securities in order to continueto grow our business as well as to fund the negative cash flow we haveexperienced to date, and may experience in the future, as a result of theseactivities. If additional funds are raised through the issuance of equitysecurities, our existing stockholders may experience significant dilution. Inthe absence of achieving profitable operations in future periods, obtainingadditional capital through asset sales, securing a revolving credit facility,debt or equity offerings, or a combination of the foregoing, we may encounterliquidity difficulties. No assurance can be given that we will be able to raiseadditional capital when needed, or at all, or that such capital, if available,will be on acceptable terms.

 

To date, inflation has not had a material impact onour financial results. There can be no assurance, however, that inflation willnot adversely affect our financial results in the future.

 

**Off-Balance SheetArrangements**

 

 One of our subsidiaries,Vistula has agreed to guarantee unconditionally the obligations of one of ourprincipal stockholders under a $3,000,000 credit facility established in thename of the stockholder. Vistula has agreed to provide this guaranty since thestockholder has to date advanced drawings under the credit facility to Vistulaand its affiliates and letters of credit have been issued under the facility infavor of vendors to Vistula and its affiliates to secure obligations of thoseentities to their vendors. In light of the circumstances surrounding the guaranty,including the fact that the obligations of the stockholder 

 

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under the credit facilityare secured by significant assets in which the stockholder has a beneficialinterest, we believe that the potential liability and obligations of Vistulaunder this guaranty are not reasonably likely to have a material current orfuture effect on our financial condition, results of operations, liquidity orcapital resources.

 

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****

 

**Item 3. Controls and Procedures.**

 

*ManagementEvaluation of Disclosure Controls and Procedures*

 

We maintaindisclosure controls and procedures, which are designed to provide reasonableassurance that information required to be disclosed in the reports we file orsubmit under the Securities Exchange Act of 1934, as amended, is recorded,processed, summarized and reported within the time periods specified in theSecurities and Exchange Commission’s rules and forms,and that such information is accumulated and communicated to our management,including our chief executive officer and chief financial officer, asappropriate, to allow timely decisions regarding required disclosure.  

 

Under thesupervision and with the participation of our chief executive officer and chieffinancial officer, our management has evaluated the effectiveness of ourdisclosure controls and procedures as of the end of the period covered by thisquarterly report. Based on that evaluation, our chief executive officer andchief financial officer have concluded that our disclosure controls andprocedures were effective as of March 31, 2005.  

 

During thecourse of this evaluation, our independent registered public accounting firm atthe time, Vitale, Caturano & Company,Ltd., advised us in connection with the completion of their audit for the 2004fiscal year that they had identified certain matters involving the operation ofour internal controls that they considered to be a material weakness.  A “material weakness” is a reportable condition in which the design or operationof one or more of the internal control components does not reduce to arelatively low level the risk that misstatements caused by errors or fraud inamounts that would be material in relation to the consolidated financialstatements being audited may occur and not be detected within a timely periodby employees in the normal course of performing their assigned functions.  

 

Thematerial weakness identified by Vitale, Caturano & Company, Ltd. related toour lack of full-time accounting and finance personnel and to a lack ofsophistication in our accounting systems, which required significant manual effortand lacked formal, documented procedures and controls over transactionreporting.  Both of these factors werethe result of the severe capital constraints we faced prior to the completionof our private financing in the first quarter of 2005.  Although we retained during the 2004 fiscalyear the services of a part-time Chief Financial Officer to assist inaccounting consideration and recording and the financial reporting process,Vitale, Caturano & Company,Ltd. noted delays in the communication of information and documentation to theChief Financial Officer.  While thesematters were not formally identified as a material weakness until very late inthe audit process, they were presumably present from our inception in early2003.  

 

Vitale,Caturano & Company,Ltd.’sconclusion that we needed to reassess our existing finance organizationresource requirements and re-evaluate the design and operating effectiveness ofcertain controls surrounding the financial statement close process was based onseveral adjustments that were made in the course of the audit process, some ofwhich occurred late in the audit process, and issues relating to the timelycommunication of information and documentation necessary to yield properaccounting consideration and recording. Among the issues identified oraddressed late in the audit process were accounting for stock optionarrangements, prepaid royalties, severance accruals, certain revenue contracts,reconciling and verifying shareholder loans, cutoff of accounts payable, andpreparing complete financial statements with footnote disclosures.  

 

NotwithstandingVitale, Caturano & Company,Ltd.’s identificationof a material weakness in our internal controls, our management, including ourchief executive officer and chief financial officer, concluded that thepresence of this material weakness did not necessitate a conclusion that ourdisclosure controls and procedures were not effective as of March 31, 2005.  In arriving at this conclusion, ourmanagement considered the following factors:  

 

•      Vitale, Caturano & Company, Ltd.’s conclusions regarding the presence of a material weaknesswere based largely on delays they experienced in the communication ofinformation and documentation during the course of their audit, not due to anyobserved deficiency in our ability to make timely disclosures as required bythe Securities and Exchange Commission.  

 

•      Despite the presence of the material weakness, we filed ourannual report for the 2004 fiscal year and this quarterly report within thetime periods specified by the Securities and Exchange Commission.  

 

•      Vitale, Caturano & Company, Ltd. issued its Report of Independent Registered Public Accounting Firm, which isincluded in our annual report on Form 10-KSB for the 2004 fiscal year, without qualification.  

 

•      During the quarter ended March 31, 2005, we implemented automated accounting softwarefor our U.S. operations, following the recommendation of our Chief FinancialOfficer made in the fourth quarter of 2004.  

 

*Changes inInternal Controls Over Financial Reporting*

 

As notedabove, during the quarter ended March 31, 2005, we implemented automated accounting softwarefor our U.S. operations.  We believe thatthis constituted a change in our internal control over financial reporting andhas materially affected, or is reasonably likely to materially affect, ourinternal control over financial reporting.  

 

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**PART II.****                                               ****OTHER INFORMATION**

 

**Item 6.  Exhibits**

 

**(a) Exhibits.**

 
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                                                                                                                                                           |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|                |       |                                                                                                                                                                                                                                                   |
| 31.1*               |       | 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.                        |
| 31.2*               |       | Certification by George R.  Vaughn 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.                             |
| 32.1*               |       | 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. |
| 32.2*               |       | Certification by George R.  Vaughn 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.      |

 

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*Filed herewith.

 

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**SIGNATURES**

 

In accordance with the requirements of the ExchangeAct, the registrant caused this report to be signed on its behalf by theundersigned, thereunto duly authorized.

 
|                    | Vistula  Communications Services, Inc. |
|-------------------------|---------------------------------------------|
|                    |                                        |
| Date:  January 30, 2006 | By:                                         | /s/  RUPERT GALLIERS-PRATT |   |
|                    |                                        | Rupert  Galliers-Pratt |
|                    |                                        | Chief  Executive Officer |

 

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