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

**Washington,D.C. 20549**

**FORM 10-QSB**

**(Mark One)**

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

**Forthe quarterly period ended: September 30, 2006**

**OR**

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

**Forthe transition period from              to              **

**CommissionFile Number 000-50758**

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**VISTULA COMMUNICATIONS SERVICES, INC.**

(Exact name of smallbusiness issuer as specified in its charter)

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

 

**Suite 801, 405 ParkAvenue**

**New York, New York 10022**

(Address of principalexecutive offices and zip code)

**(212) 317-8900**

(Issuer’s telephonenumber)

Check whether the issuer (1) filed all reportsrequired to be filed by Section 13 or 15(d) of the Exchange Act during the past12 months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements for thepast 90 days. Yes x   No o

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

As of November 10, 2006, there were 66,964,898 sharesof common stock, $0.001 par value, of the registrant issued and outstanding.

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

 

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**VISTULA COMMUNICATIONS SERVICES, INC.**

**FORM 10-QSB**

**FOR THE THREE MONTHS ENDED SEPTEMBER30, 2006**
| Facing Page                                                                                                                       |   |   |   |
|-----------------------------------------------------------------------------------------------------------------------------------|--------|--------|--------|
|                                                                                                                              |   |   |   |
| Table of Contents                                                                                                                 |   |   |   |
|                                                                                                                              |   |   |   |
| PART I. FINANCIAL  INFORMATION(*):                                                                                                |   |   |   |
|                                                                                                                              |   |   |   |
| Item 1.  Financial Statements                                                                                                     |   |   |   |
|                                                                                                                              |   |   |   |
| Consolidated  Balance Sheets as of September 30, 2006 (unaudited) and December 31, 2005                                           |   |   |   |
|                                                                                                                              |   |   |   |
| Consolidated  Statements of Operations for the Three and Nine Months ended September 30,  2006 and September 30, 2005 (unaudited) |   |   |   |
|                                                                                                                              |   |   |   |
| Consolidated  Statements of Stockholders’ Equity (Deficit) for the Nine Months ended  September 30, 2006 (unaudited)         |   |   |   |
|                                                                                                                              |   |   |   |
| Consolidated  Statements of Cash Flows for the Nine Months ended September 30, 2006 and  September 30, 2005 (unaudited)           |   |   |   |
|                                                                                                                              |   |   |   |
| Notes to Unaudited 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  1. Legal Proceedings                                                                                                        |   |   |   |
|                                                                                                                              |   |   |   |
| Item 2. Unregistered Sales of Equity Securities                                                                                   |   |   |   |
|                                                                                                                              |   |   |   |
| Item 3. Defaults Upon Senior Securities                                                                                           |   |   |   |
|                                                                                                                              |   |   |   |
| Item 4. Submission of Matters to a Vote of Security  Holders                                                                      |   |   |   |
|                                                                                                                              |   |   |   |
| Item  5. Other Information                                                                                                        |   |   |   |
|                                                                                                                              |   |   |   |
| Item 6.  Exhibits                                                                                                                 |   |   |   |
|                                                                                                                              |   |   |   |
| SIGNATURES                                                                                                                        |   |   |   |

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(*)            Allof the financial statements contained in this Quarterly Report are unauditedwith the exception of the financial information at December 31, 2005, which hasbeen derived from our audited financial statements at that date and should beread in conjunction therewith. Our audited financial statements as of December31, 2005 and for the year then ended, and the notes thereto, can be found inour Annual Report on Form 10-KSB (File No. 000-50758), which was filed with theSecurities and Exchange Commission on March 31, 2006.

2

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** **

**PART I.FINANCIAL INFORMATION**

**Item 1.Financial Statements.**

***VISTULACOMMUNICATIONS SERVICES, INC.***Consolidated Balance Sheets as of September 30, 2006 andDecember 31, 2005
| ** **                                                                                                                                                                             | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------|------------|-----------------------------|------------|
| ** **                                                                                                                                                                             | ** ** | **(unaudited)**              | ** ** | **(audited)**               | ** ** |
| **ASSETS**                                                                                                                                                                             | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current assets:                                                                                                                                                                        |       |                         |       |                        |       |
| Cash and cash  equivalents                                                                                                                                                             |       | $                            | 547,188    |                        | $          | 553,127 |   |
| Accounts  receivable                                                                                                                                                                   |       | 169,443                      |       | 130,748                     |       |
| Prepaid expenses  and other current assets                                                                                                                                             |       | 393,381                      |       | 1,045,795                   |       |
| Total current  assets                                                                                                                                                                  |       | 1,110,012                    |       | 1,729,670                   |       |
|                                                                                                                                                                                   |       |                         |       |                        |       |
| Property and equipment,  net                                                                                                                                                           |       | 2,136,994                    |       | 2,362,373                   |       |
| Deferred financing  costs                                                                                                                                                              |       | 401,293                      |       | 613,742                     |       |
| Intangible assets                                                                                                                                                                      |       | 24,965,229                   |       | —                      |       |
| Other assets                                                                                                                                                                           |       | 30,198                       |       | 57,272                      |       |
| Total Assets                                                                                                                                                                           |       | $                            | 28,643,726 |                        | $          | 4,763,057 |   |
|                                                                                                                                                                                   |       |                         |       |                        |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY (DEFICIT)**                                                                                                                               | ** ** | ** **                   | ** ** | ** **                  | ** ** |
| Current liabilities:                                                                                                                                                                   |       |                         |       |                        |       |
| Accounts payable                                                                                                                                                                       |       | $                            | 1,143,466  |                        | $          | 398,841 |   |
| Accrued expenses                                                                                                                                                                       |       | 602,458                      |       | 628,154                     |       |
| Convertible  promissory note to related party                                                                                                                                          |       | 175,000                      |       | 175,000                     |       |
| Notes payable                                                                                                                                                                          |       | —                       |       | 870,000                     |       |
| Total current  liabilities                                                                                                                                                             |       | 1,920,924                    |       | 2,071,995                   |       |
| Convertible debentures                                                                                                                                                                 |       | 5,726,260                    |       | 5,424,902                   |       |
| Total  liabilities                                                                                                                                                                     |       | 7,647,184                    |       | 7,496,897                   |       |
|                                                                                                                                                                                   |       |                         |       |                        |       |
| Stockholders’ equity  (deficit):                                                                                                                                                  |       |                         |       |                        |       |
| Preferred stock,  $0.001 par value, 10,000,000 shares authorized; no shares issued and  outstanding                                                                                    |       | —                       |       | —                      |       |
| Common stock,  $0.001 par value, 200,000,000 shares authorized, 64,464,898 and 31,914,898  shares issued and outstanding as of September 30, 2006 and December 31, 2005,  respectively |       | 64,464                       |       | 31,914                      |       |
| Additional  paid-in capital                                                                                                                                                            |       | 51,540,309                   |       | 13,975,077                  |       |
| Deferred  compensation                                                                                                                                                                 |       | —                       |       | (13,422                     | )          |
| Accumulated  deficit                                                                                                                                                                   |       | (30,477,997                  | )          | (16,576,999                 | )          |
| Cumulative translation  adjustment                                                                                                                                                     |       | (130,234                     | )          | (150,410                    | )          |
| Total  stockholders’ equity (deficit)                                                                                                                                             |       | 20,996,542                   |       | (2,733,840                  | )          |
| Total Liabilities and  Stockholders’ Equity (Deficit)                                                                                                                             |       | $                            | 28,643,726 |                        | $          | 4,763,057 |   |

 

See accompanying notes to unaudited consolidatedfinancial statements.

3

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*** ***

***VISTULACOMMUNICATIONS SERVICES, INC***Consolidated Statements of Operations for theThree and Nine Months ended September 30, 2006 and 2005
| ** **                                             | ** ** | **Three Months Ended  September 30,** | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------------------------------------|------------|------------------------------------------------------|------------|-----------------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                             | ** ** | **2005**                                            | ** ** | **2006** | ** ** | **2005** | ** ** |
| ** **                                             | ** ** | **(unaudited)**                                      | ** ** | **(unaudited)**                                     | ** ** | **(unaudited)** | ** ** | **(unaudited)** | ** ** |
| Net revenues                                           |       | $                                                    | 191,999    |                                                | $          | 262,050 |   | $ | 749,337 |   | $ | 614,378 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Cost of revenues                                       |       | 491,132                                              |       | 301,120                                             |       | 1,166,736 |   | 719,955 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Gross margin  (loss)                                   |       | (299,133                                             | )          | (39,070                                             | )          | (417,399 | ) | (105,577 | ) |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Operating expenses:                                    |       |                                                 |       |                                                |       |   |   |   |   |
| Selling, general and  administrative                   |       | 5,501,623                                            |       | 4,536,424                                           |       | 12,398,107 |   | 7,654,878 |   |
| Research and  development                              |       | 98,016                                               |       | —                                              |       | 167,561 |   | — |   |
| Total operating  expenses                              |       | 5,599,639                                            |       | 4,536,424                                           |       | 12,565,668 |   | 7,654,878 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Loss from  operations                                  |       | (5,898,772                                           | )          | (4,575,494                                          | )          | (12,983,067 | ) | (7,760,455 | ) |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Interest expense, net                                  |       | (304,055                                             | )          | (445,778                                            | )          | (917,931 | ) | (863,539 | ) |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Net loss                                               |       | $                                                    | (6,202,827 | )                                                   | $          | (5,021,272 | ) | $ | (13,900,998 | ) | $ | (8,623,994 | ) |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Weighted-average basic  and diluted shares outstanding |       | 63,695,757                                           |       | 26,192,848                                          |       | 47,118,162 |   | 25,327,068 |   |
|                                                   |       |                                                 |       |                                                |       |   |   |   |   |
| Basic and diluted net loss per common share            |       | $                                                    | (0.10      | )                                                   | $          | (0.19 | ) | $ | (0.30 | ) | $ | (0.34 | ) |

 

See accompanying notes to unaudited consolidatedfinancial statements.

4

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*** ***

***VISTULACOMMUNICATIONS SERVICES, INC.***Consolidated Statements of Stockholders’ Equity (Deficit)for theNine Months ended September 30, 2006(unaudited)
| ** **                                                               | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **       | ** ** | ** **      | ** ** | **Cumulative**         | ** ** | **Total**                 | ** ** | ** **  | ** ** |
|--------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|-----------------|------------|------------------------|------------|---------------------------|------------|-------------|------------|
| ** **                                                               | ** ** | **Common Stock** | ** ** | **Paid-in** | ** ** | **Deferred**   | ** ** | **Accumulated**  | ** ** | **Translation** | ** ** | **Stockholders’** | ** ** | **Comprehensive**         | ** ** |
| ** **                                                               | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Deficit**     | ** ** | **Adjustment**         | ** ** | **Equity (Deficit)** | ** ** | **Loss**    | ** ** |
| Balance, December 31,  2005                                              |       | 31,914,898            |       | $           | 31,914     |           | $          | 13,975,077       |       |            | $          | (13,422                | )          |                      | $          | (16,576,999 | )          |   | $ | (150,410 | ) |   |   | $ | (2,733,840 | ) |   |   |   |   |   |
| Application of deferred  compensation against additional paid-in capital |       |                  |       |        |       | (13,422        | )          |             | 13,422     |            |       |                   |       |                      |       |        |       |   | — |   |   |   |   |   |   |
| Issuance of common stock                                                 |       | 31,800,000            |       | 31,800      |       | 34,167,365     |       |             |       |            |       |                   |       |                      |       |        |       |   | 34,199,165 |   |   |   |   |   |   |
| Exercise of stock  options                                               |       | 750,000               |       | 750         |       | 74,250         |       |             |       |            |       |                   |       |                      |       |        |       |   | 75,000 |   |   |   |   |   |   |
| Issuance of stock  options                                               |       |                  |       |        |       | 2,694,249      |       |             |       |            |       |                   |       |                      |       |        |       |   | 2,694,249 |   |   |   |   |   |   |
| Issuance of warrants  pursuant to consulting agreement                   |       |                  |       |        |       | 231,945        |       |             |       |            |       |                   |       |                      |       |        |       |   | 231,945 |   |   |   |   |   |   |
| Issuance of warrants  pursuant to revolving credit facility              |       |                  |       |        |       | 410,845        |       |             |       |            |       |                   |       |                      |       |        |       |   | 410,845 |   |   |   |   |   |   |
| Net loss                                                                 |       |                  |       |        |       |           |       |             |       |            |       | (13,900,998            | )          |                      |       |        |       |   | (13,900,998 | ) |   |   | $ | (13,900,998 | ) |   |
| Change in cumulative  translation adjustment                             |       |                  |       |        |       |           |       |             |       |            |       |                   |       |                      | 20,176     |        |       |   | 20,176 |   |   |   | 20,176 |   |   |
| Balance, September 30, 2006                                              |       | 64,464,898            |       | $           | 64,464     |           | $          | 51,540,309       |       |            | $          | —                 |       |                      | $          | (30,477,997 | )          |   | $ | (130,234 | ) |   |   | $ | 20,996,542 |   |   |   | $ | (13,880,822 | ) |   |

 

See accompanying notes to unaudited consolidatedfinancial statements.

5

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*** ***

***VISTULACOMMUNICATIONS SERVICES, INC***Consolidated Statements of Cash Flows for theNine Months ended September 30, 2006 and 2005
| ** **                                                                                                | ** ** | **Nine Months Ended September 30,** | ** **  |
|-----------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------|-------------|
| ** **                                                                                                | ** ** | **2006**                                                | ** **  | **2005** | ** ** |
| ** **                                                                                                | ** ** | **(unaudited)**                                         | ** **  | **(unaudited)** | ** ** |
| Cash flows from  operating activities:                                                                    |       |                                                    |        |   |   |
| Net loss                                                                                                  |       | $                                                       | (13,900,998 | ) | $ | (8,623,994 | ) |
| Adjustments to  reconcile net loss to net cash used in operating activities:                              |       |                                                    |        |   |   |
| Depreciation and  amortization                                                                            |       | 1,782,515                                               |        | 97,150 |   |
| Non-cash expense  pursuant to financial advisory agreements                                               |       | 1,875,000                                               |        | — |   |
| Non-cash  compensation expense                                                                            |       | 2,694,249                                               |        | 2,566,896 |   |
| Non-cash issuance  of common stock pursuant to distribution and marketing agreement                       |       | —                                                  |        | 1,000,000 |   |
| Non-cash interest  expense                                                                                |       | 513,857                                                 |        | 467,474 |   |
| Issuance of  warrant pursuant to consulting agreement                                                     |       | 231,945                                                 |        | 29,913 |   |
| Issuance of  warrant pursuant to revolving credit facility                                                |       | 410,845                                                 |        | — |   |
| Changes in assets  and liabilities:                                                                       |       |                                                    |        |   |   |
| (Increase)  decrease in:                                                                                  |       |                                                    |        |   |   |
| Accounts  receivable                                                                                      |       | (30,121                                                 | )           | (46,983 | ) |
| Prepaid expenses  and other current assets                                                                |       | 307,391                                                 |        | (918,755 | ) |
| Increase  (decrease) in:                                                                                  |       |                                                    |        |   |   |
| Accounts payable                                                                                          |       | 722,800                                                 |        | 481,906 |   |
| Accrued expenses                                                                                          |       | (38,779                                                 | )           | (546,579 | ) |
| Net cash used in  operating activities                                                                    |       | (5,431,296                                              | )           | (5,492,972 | ) |
|                                                                                                      |       |                                                    |        |   |   |
| Cash flows from  investing activities:                                                                    |       |                                                    |        |   |   |
| Purchases of  property and equipment                                                                      |       | (195,716                                                | )           | (408,701 | ) |
| Purchase of  software and intellectual property                                                           |       | (8,800,000                                              | )           | — |   |
| Net cash used in  investing activities                                                                    |       | (8,995,716                                              | )           | (408,701 | ) |
|                                                                                                      |       |                                                    |        |   |   |
| Cash flows from  financing activities:                                                                    |       |                                                    |        |   |   |
| Net proceeds from  issuance of common stock                                                               |       | 15,244,165                                              |        | 3,000 |   |
| Proceeds from  bridge revolving credit agreement                                                          |       | 1,250,000                                               |        | — |   |
| Proceeds from  exercise of stock options                                                                  |       | 75,000                                                  |        | — |   |
| Proceeds from  issuance of convertible debentures and warrants, net of deferred financing  costs          |       | —                                                  |        | 7,452,874 |   |
| Payment on bridge  revolving credit agreement                                                             |       | (1,250,000                                              | )           | — |   |
| Payment on notes  payable                                                                                 |       | (870,000                                                | )           | — |   |
| Payments on due  to stockholder                                                                           |       | —                                                  |        | (801,630 | ) |
| Payment of  capital lease obligation                                                                      |       | —                                                  |        | (500,000 | ) |
| Net cash provided  by financing activities                                                                |       | 14,449,165                                              |        | 6,154,244 |   |
|                                                                                                      |       |                                                    |        |   |   |
| Effect of exchange rates  on cash                                                                         |       | (28,092                                                 | )           | (14,379 | ) |
|                                                                                                      |       |                                                    |        |   |   |
| Net (decrease) increase  in cash and cash equivalents                                                     |       | (5,939                                                  | )           | 238,192 |   |
| Cash and cash  equivalents, beginning of period                                                           |       | 553,127                                                 |        | 3,221 |   |
|                                                                                                      |       |                                                    |        |   |   |
| Cash and cash  equivalents, end of period                                                                 |       | $                                                       | 547,188     |   | $ | 241,413 |   |
|                                                                                                      |       |                                                    |        |   |   |
| **Supplemental disclosure of cash  flow information:**                                                    | ** ** | ** **                                              | ** **  | ** ** | ** ** |
| ** **                                                                                                | ** ** | ** **                                              | ** **  | ** ** | ** ** |
| Cash paid for  interest                                                                                   |       | $                                                       | 448,227     |   | $ | 433,042 |   |
|                                                                                                      |       |                                                    |        |   |   |
| Cash paid for  taxes                                                                                      |       | $                                                       | —      |   | $ | — |   |
|                                                                                                      |       |                                                    |        |   |   |
| **Supplemental disclosure of  non-cash financing activities:**                                            | ** ** | ** **                                              | ** **  | ** ** | ** ** |
|                                                                                                      |       |                                                    |        |   |   |
| Issuance of  common stock pursuant to financial advisory agreement                                        |       | $                                                       | 1,875,000   |   | $ | — |   |
|                                                                                                      |       |                                                    |        |   |   |
| Issuance of  common stock warrant pursuant to consulting agreement                                        |       | $                                                       | 231,945     |   | $ | — |   |
|                                                                                                      |       |                                                    |        |   |   |
| Issuance of  common stock warrant pursuant to revolving credit facility                                   |       | $                                                       | 410,845     |   | $ | — |   |
|                                                                                                      |       |                                                    |        |   |   |
| Issuance of  common stock pursuant to purchase of software and intellectual property                      |       | $                                                       | 17,080,000  |   | $ | — |   |
|                                                                                                      |       |                                                    |        |   |   |
| Reclass of  prepaid royalties to purchase of intangible asset                                             |       | $                                                       | 399,189     |   | $ | — |   |
|                                                                                                      |       |                                                    |        |   |   |
| Company expenses  paid directly by and returned directly to stockholder                                   |       | $                                                       | 75,000      |   | $ | — |   |
|                                                                                                      |       |                                                    |        |   |   |
| Issuance of  common stock pursuant to capital lease obligation                                            |       | $                                                       | —      |   | $ | 324,874 |   |
|                                                                                                      |       |                                                    |        |   |   |
| Issuance of note  payable pursuant to capital lease obligation                                            |       | $                                                       | —      |   | $ | 970,000 |   |
|                                                                                                      |       |                                                    |        |   |   |
| Issuance of  common stock pursuant to debenture conversions                                               |       | $                                                       | —      |   | $ | 1,355,056 |   |
|                                                                                                      |       |                                                    |        |   |   |
| Issuance of  common stock warrants in connection with convertible debenture financing                     |       | $                                                       | —      |   | $ | 184,844 |   |
|                                                                                                      |       |                                                    |        |   |   |
| Reduction in fixed  assets and related indebtedness pursuant to modification of asset purchase  agreement |       | $                                                       | —      |   | $ | 200,000 |   |

 

See accompanying notes to unaudited consolidatedfinancial statements.

6

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**VISTULA COMMUNICATIONS SERVICES, INC.**

**NOTES TOUNAUDITED CONSOLIDATED FINANCIAL STATEMENTSSeptember 30, 2006**

**(1)           Basis ofPresentation**

The accompanying unaudited consolidated financialstatements of Vistula Communications Services, Inc. (“Vistula” or the “Company”)have been prepared in accordance with accounting principles generally acceptedin the United States (GAAP) for interim financial information and with theinstructions to Form 10-QSB and Item 310 of Regulation S-B. Accordingly, theydo not include all of the information and footnotes required by GAAP forcomplete financial statements. In the opinion of management, all adjustments(consisting of normal recurring accruals) considered necessary for the fairpresentation of the results for the interim periods have been included. Thepreparation of financial statements in conformity with GAAP requires managementto make estimates and assumptions that affect the amounts reported in thefinancial statements and accompanying notes. Interim results are notnecessarily indicative of results to be expected for the entire fiscal yearending December 31, 2006. These unaudited financial statements should be readin conjunction with the Company’s audited annual financial statements for thefiscal year ended December 31, 2005 and the footnotes thereto. Those auditedfinancial statements are included in the Company’s Annual Report on Form10-KSB, which was filed with the Securities and Exchange Commission (SEC) onMarch 31, 2006.

The Company uses the United States dollar as itsreporting currency. The British pound is the functional currency of itswholly-owned subsidiary, Vistula Limited. The South African rand is thefunctional currency of its 60% owned subsidiary, Vistula CommunicationsServices SA (Pty) Ltd. Assets and liabilities of the Company’s internationaloperations are translated into U.S. dollars at exchange rates that are ineffect on the balance sheet date and equity accounts are translated athistorical exchange rates. Income and expense items are translated at averageexchange rates which are in effect during the period. Translation adjustmentsare accumulated in other comprehensive loss as a separate component ofstockholders’ equity in the consolidated balance sheet. Transaction gains(losses) were immaterial for the three- and nine- month periods ended September30, 2006 and September 30, 2005.

In the event that the Company is not successful inimplementing its business plan, or does not raise third-party capital, theCompany will have to curtail certain expenditures, seek additional financingfrom one of its principal stockholders, or both in order to sustain operations.One of the Company’s principal stockholders has historically provided workingcapital advances and has caused a lender to issue letters of credit in favor ofcertain vendors and personally guaranteed advances drawn under a revolvingcredit agreement entered in March 2006. While the stockholder is not obligatedto provide these working capital advances to the Company, or to providepersonal guarantees with respect to credit facilities of the Company, or tocause a lender to issue standby letters of credit in favor of its vendors, theCompany expects that the stockholder will continue to provide funds foroperations in 2006 and into 2007, as and if needed, until such time that theCompany’s operations are self-sustaining or the Company raises additionalexternal capital, as the case may be. As described in Note 9, in March 2006 andApril 2006 the Company received a total of $1.25 million in net proceeds undera revolving credit agreement. As described in Note 15, in May 2006 the Companyreceived net proceeds of approximately $15.2 million from the sale of units,each unit consisting of one share of common stock and eight-tenths of onewarrant to acquire one share of common stock.

The consolidated financial statements shown for theperiod ended September 30, 2006 have been prepared on a going concern basiswhich contemplates the realization of assets and the satisfaction of liabilitiesin the normal course of business. As shown in the accompanying consolidatedfinancial statements, the Company incurred a net loss of $13,900,998 for thenine-month period ended September 30, 2006 and had an accumulated deficit of$30,477,997 at September 30, 2006. Further, the Company had cash of $547,188and a working capital deficit at September 30, 2006 of $810,912. These factorsamong others may indicate that the Company will be unable to continue as agoing concern.

7

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The consolidated financial statements do not includeany adjustments relating to the recoverability of assets and satisfaction ofliabilities that might be necessary should the Company be unable to continue asa going concern. The Company’s continuation as a going concern is dependent uponits ability to generate sufficient cash flow to meet its obligations on atimely basis, to comply with the terms of its financing arrangements, to obtainadditional financing as may be required, and ultimately to attainprofitability. To address these issues, the Company is consulting withfinancial advisors to examine short-term borrowing alternatives. The Companywill also continue to target and contract with telecommunications companies inorder to build cash flow from operations and to execute its business plan.  The Company is continuously examining thedevelopment and implementation of cost controls to conserve cash.  Further, as described in Note 17, during thefourth quarter the Company has recognized revenues and has received cashpayments from agreements entered into with Telstra Europe Limited. However,there is no assurance that the Company will be able to generate sufficientfunds to continue as a going concern.

Expenditures for research and development of productsare expensed as incurred.

Certain amounts from the three- and nine-month periodsended September 30, 2005 have been reclassified to conform with the currentpresentation.

**(2)          Stock-Based Compensation**

Effective January 1, 2006, the Company adopted thefair value recognition provisions of Statement of Financial AccountingStandards (“SFAS”) No. 123(R),*Share-BasedPayment* (“SFAS 123R”), using the modified-prospective-transitionmethod. Under this transition method, compensation cost recognized for thefirst nine months of 2006 includes: (a) compensation cost for all stock-basedpayments granted, but not yet vested as of January 1, 2006, based on thegrant-date fair value estimated in accordance with the original provisions ofSFAS No. 123, *Accounting for Stock BasedCompensation*, and (b) compensation cost for all stock-based paymentsgranted subsequent to January 1, 2006, based on the grant-date fair valueestimated in accordance with the provisions of SFAS 123R. Results for priorperiods have not been restated. For stock options granted to non-employees, theCompany recognizes compensation expense in accordance with the requirements ofEmerging Issues Task Force (“EITF”) No. 96-18, *Accountingfor Equity Instruments That Are Issued to Other Than Employees for Acquiring,or in Conjunction with Selling, Goods or Services*. EITF 96-18requires that companies recognize compensation expense based on the estimatedfair value of options granted to non-employees over their vesting period, whichis generally the period during which services are rendered by suchnon-employees. The fair value of unvested non-employee stock awards isre-measured at each reporting period.

Prior to January 1, 2006, consistent with theprovisions of Accounting Principles Board Opinion No. 25, *Accounting for Stock Issued to Employees* (“APB25”), the Company recorded deferred compensation in the stockholders’ deficitsection of the consolidated balance sheet when stock options were granted at anexercise price that was less than the fair value of the underlying common stockat the date of grant. These amounts were recognized as stock-based compensationexpense over the vesting period. Effective January 1, 2006, as provided in SFAS123R, the Company has reversed the unamortized deferred compensation for theunvested portions of stock option grants awarded prior to the effective date ofSFAS 123R, applying the balance to additional paid-in capital.

*Stock Incentive Plan.  *In February 2004, theboard of directors adopted the 2004 Stock Incentive Plan (the “Plan”). The Planinitially covered 6,000,000 shares of the Company’s common stock issuable uponexercise of incentive stock options and non-statutory stock options and inconnection with grants of restricted stock. The Plan was amended by the Boardon June 3, 2005 to, among other things, increase the number of shares availablefor options or restricted stock grants from 6,000,000 to 8,000,000. Theshareholders of the Company approved the amendment to the Plan on July 14,2005. On December 23, 2005, the board of directors approved an increase, from8,000,000 to 15,000,000, in the number of shares of common stock authorizedunder the Plan, on April 11 and 12, 2006 the board of directors approved anadditional increase, from 15,000,000 to 18,000,000, and on June 21, 2006 theboard of directors approved an additional increase, from 18,000,000 to20,000,000, in the number of shares of common stock authorized under the Plan.The shareholders of the Company ratified these amendments to the Plan on July17, 2006.

The Board has the authority to select the employees,officers, directors, consultants and advisors to whom options are granted anddetermine the terms of each option, including (i) the number of shares of

8

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commonstock subject to the option, (ii) when the option becomes exercisable, (iii)the option exercise price, which must be at least 100% (110% in the case ofincentive stock options granted to a stockholder owning in excess of 10% of theCompany’s common stock) of the fair market value of the common stock as of thedate of grant and (iv) the duration of the option, which may be up to 10 yearsor, in the case of incentive stock options issued to a stockholder owning inexcess of 10% of the Company’s common stock, five years.

As a result of the January 1, 2006 adoption of SFAS123R and stock compensation expense related to options granted tonon-employees, the Company recognized $375,993, and $421,172 in stock-basedcompensation expense for the three- and nine-month periods ended September 30,2006, respectively.

The following tablesummarizes amounts charged to expense for stock-based compensation related toemployee and director stock option grants and stock-based compensation recordedin connection with stock options and restricted stock awards granted tonon-employee consultants:
| ** **                                                                 | ** ** | **Three Months  Ended  September 30, 2006** | ** ** | **Nine Months  Ended  September 30, 2006** | ** ** |
|----------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| ** **                                                                 | ** ** | ** **                                                 | ** ** | ** **                                                | ** ** |
| Employee and  director stock option grants:                                |       |                                                       |       |                                                      |       |
|                                                                       |       |                                                       |       |                                                      |       |
|  Selling,  general and administrative                                 |       | $                                                          | 1,942,906  |                                                      | $          | 2,273,077 |   |
|                                                                       |       | 1,942,906                                                  |       | 2,273,077                                                 |       |
|                                                                       |       |                                                       |       |                                                      |       |
| Non-employee  consultants stock option grants and restricted stock awards: |       |                                                       |       |                                                      |       |
|                                                                       |       |                                                       |       |                                                      |       |
|  Selling,  general and administrative                                 |       | 375,993                                                    |       | 421,172                                                   |       |
|                                                                       |       | 375,993                                                    |       | 421,172                                                   |       |
|                                                                       |       |                                                       |       |                                                      |       |
| Total stock-based  compensation                                            |       | $                                                          | 2,318,899  |                                                      | $          | 2,694,249 |   |

 

The following table illustrates the effect on net lossand net loss per share had the Company applied the fair value recognitionprovisions of SFAS 123R in the first three quarters of 2005. For purposes ofthis pro-forma disclosure, the value of the options is estimated using the Black-Scholesoption-pricing model and amortized to expense over the options’ vestingperiods. 
| ** **                                                                   | ** ** | **Three Months  Ended  September 30, 2005** | ** ** | **Nine Months  Ended  September 30, 2005** | ** ** |
|------------------------------------------------------------------------------|------------|------------------------------------------------------------|------------|-----------------------------------------------------------|------------|
| Net loss as  reported                                                        |       | $                                                          | (5,021,272 | )                                                         | $          | (8,623,994 | ) |
| Add: Stock  compensation expense included in net loss                        |       | 1,802,459                                                  |       | 2,199,459                                                 |       |
| Deduct: Stock  compensation expense determined under fair value based method |       | (2,116,747                                                 | )          | (2,599,663                                                | )          |
| Pro-forma net  loss                                                          |       | $                                                          | (5,335,560 | )                                                         | $          | (9,024,198 | ) |
|                                                                         |       |                                                       |       |                                                      |       |
| Basic and  diluted net loss per common share:                                |       |                                                       |       |                                                      |       |
| As reported                                                                  |       | $                                                          | (0.19      | )                                                         | $          | (0.34 | ) |
| Pro-forma                                                                    |       | $                                                          | (0.20      | )                                                         | $          | (0.36 | ) |

 

9

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The fair value of eachstock award is estimated on the grant date using the Black-Scholesoption-pricing model based on the assumptions noted in the following table:
| ** **               | ** ** | **Nine Months Ended  September 30,** | ** ** |
|--------------------------|------------|-----------------------------------------------------|------------|
| ** **               | ** ** | **2006**                                            | ** ** | **2005** | ** ** |
| Volatility               |       | 80                                                  | %          | 80 | % |
| Risk-free  interest rate |       | 4.29 - 5.04                                         | %          | 3.98 - 4.05 | % |
| Expected life  (years)   |       | 5                                                   |       | 5 |   |
| Dividend                 |       | None                                                |       | None |   |

 

Volatility is determined based on the Company’sestimate of fluctuation in its common stock price and its review of comparablepublic company data due to the limited amount of time that the Company’s commonstock has been publicly traded. The expected life of stock options granted isbased on the Company’s estimate of when options will be exercised in the futureas there have been limited stock option exercises to date. The expected life isgenerally applied to one group as a whole as the Company does not expectsubstantially different exercise or post-vesting termination behavior amongstits employee population. The risk-free interest rate is based on the U.S.Treasury yield curve in effect at the time of grant commensurate with theexpected life assumption.

On July 28, 2006, the Company granted Jared Taylor,who became Chief Financial Officer on August 1, 2006, an incentive stock optionto purchase up to 200,000 shares of the Company’s common stock.  Theoption has an exercise price of $0.65 per share, representing the fair marketvalue of our common stock, on the date of grant. The option vests in four equalannual installments of 50,000 shares commencing on the first anniversary dateof the date of option grant and thereafter on each subsequent anniversaryof the date of option grant until fully vested. The options will accelerate infull upon a change of control of the Company (as defined in his optionagreement).

On April 12, 2006, theCompany granted stock options to purchase 1,270,000 shares of common stock tocertain consultants, employees, and directors as detailed below:

| Employee, Consultant or Director | ** ** | **Shares** | ** ** |
|-------------------------------------------------|------------|------------|------------|
|                                            |       |       |       |
| Adam Bishop                                     |       | 150,000    |       |
|                                            |       |       |       |
| Ian Cope                                        |       | 50,000     |       |
|                                            |       |       |       |
| Olympic  Corporate Holdings Limited*            |       | 100,000    |       |
|                                            |       |       |       |
| Nick Topham                                     |       | 50,000     |       |
|                                            |       |       |       |
| George R. Vaughn                                |       | 20,000     |       |
|                                            |       |       |       |
| Executive  Management Services Limited*         |       | 800,000    |       |
|                                            |       |       |       |
| Anthony  Warrender                              |       | 50,000     |       |
|                                            |       |       |       |
| J. Marcus Payne                                 |       | 50,000     |       |
|                                            |       |       |       |
|                                            |       | 1,270,000  |       |

 

----

*                    J.Marcus Payne, one of the Company’s directors, is a director of OlympicCorporate Holdings Limited.  Rupert Galliers-Pratt, the Company’sChairman, President and Chief Executive Officer, holds indirect voting andinvestment control over shares held by Executive Management Services Limited.

10

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All of the options have an exercise price of $1.25 pershare and an expiration date of April 12, 2016. The options were granted ascompensation for consulting, employment or director services, as applicable.The options became vested as to 25% of the total number of option shares uponshareholder ratification of the increase in the number of shares authorizedunder the Company’s 2004 Stock Incentive Plan to at least 18,000,000 shares,which occurred on July 17, 2006. Thereafter, the options will become vested asto an additional 6.25% of the total number of option shares in quarterlyinstallments beginning on September 30, 2006.

On April 11, 2006, the Company granted stock optionsto J. Keith Markley to purchase 3,052,000 shares of common stock.  Mr. Markley was also granted on that day anoption to purchase 948,000 shares of common stock contingent upon the approvalby the Company’s stockholders of an increase in the number of shares availablefor options on restricted stock grants to at least 16,000,000 shares.  As per the amendment to Mr. Markley’semployment described in Note 7, a portion of his option to purchase 948,000shares of commons stock which entitled him to purchase 500,000 shares wascancelled.  The remaining 448,000 sharessubject to this option have an exercise price of $1.18 per share and anexpiration date of April 11, 2016.  Eachoption vests with respect to one-sixth of the total number of shares subject tothe option six months after the date of grant. Each option continues to vestwith respect to an additional one thirty-sixth of the total number of sharessubject to the option on a monthly basis thereafter until fully vested. Theoptions will accelerate in full upon a change of control of the Company or atermination without cause (as defined in the employment agreement).

OnDecember 23, 2005, the Company granted stock options to purchase 6,350,000shares of common stock to certain consultants, employees, and directors asdetailed below:

| Employee, Consultant or Director | ** ** | **Shares** | ** ** |
|-------------------------------------------------|------------|------------|------------|
|                                            |       |       |       |
| Adam Bishop                                     |       | 750,000    |       |
|                                            |       |       |       |
| Ian Cope                                        |       | 250,000    |       |
|                                            |       |       |       |
| Olympic  Corporate Holdings Limited*            |       | 500,000    |       |
|                                            |       |       |       |
| Nick Topham                                     |       | 250,000    |       |
|                                            |       |       |       |
| George R. Vaughn                                |       | 100,000    |       |
|                                            |       |       |       |
| Executive  Management Services Limited*         |       | 4,000,000  |       |
|                                            |       |       |       |
| Anthony  Warrender                              |       | 250,000    |       |
|                                            |       |       |       |
| J. Marcus Payne                                 |       | 250,000    |       |
|                                            |       |       |       |
|                                            |       | 6,350,000  |       |

----

*                    J.Marcus Payne, one of the Company’s directors, is a director of OlympicCorporate Holdings Limited.  Rupert Galliers-Pratt, the Company’sChairman, President and Chief Executive Officer, holds indirect voting andinvestment control over shares held by Executive Management Services Limited.

All of the stock options have an exercise price of$1.50 per share and an expiration date of December 23, 2015.  The stock options were granted ascompensation for consulting, employment or

11

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directorservices, as applicable.  The optionsbecame vested as to 25% of the total number of option shares upon stockholderratification of the increase in the number of shares authorized under theCompany’s 2004 Stock Incentive Plan to at least 15,000,000, which occurred onJuly 17, 2006. Thereafter, the options will become vested as to an additional6.25% of the total number of option shares in quarterly installments beginningon September 30, 2006.

As the stock options granted on April 12, 2006(1,270,000 shares), April 11, 2006 (948,000 shares, less 500,000 sharescancelled) and December 23, 2005 (6,350,000 shares) were contingent uponstockholder approval of an increase in the number of shares authorized underthe Company’s 2004 Stock Incentive Plan, which occurred on July 17, 2006, theseamounts have been reflected as stock options granted during the three-monthperiod ending September 30, 2006 in accordance with the provisions of SFAS123R.

The Company is using the straight-line attributionmethod to recognize stock-based compensation expense. The amount of stock-basedcompensation recognized during a period is based on the value of the portion ofthe awards that are ultimately expected to vest. SFAS 123R requires forfeituresto be estimated at the time of grant and revised, if necessary, in subsequentperiods if actual forfeitures differ from those estimates. The term “forfeitures”is distinct from “cancellations” or “expirations” and represents only theunvested portion of the surrendered option. The Company has applied an annualforfeiture rate of 0% to all unvested options as of September 30, 2006 as theCompany believes that forfeitures to date are not representative of likelyfuture forfeitures. This analysis will be re-evaluated quarterly and theforfeiture rate will be adjusted as necessary. Ultimately, the actual expenserecognized over the vesting period will be for only those shares that vest.

Using the Black-Scholes option-pricing model, theweighted average grant-date fair value of options granted during the ninemonths ended September 30, 2006 was $0.77 and the weighted average grant-date fair value of the options grantedduring the nine months ended September 30, 2005 was $0.45.

A summary of stock optionactivity as of September 30, 2006, and changes during the nine- month periodthen ended, is presented below:
| ** **                                           | ** ** | **Options  Outstanding** | ** ** | **Weighted-  average  Exercise Price** | ** ** | **Weighted-average  Remaining  Contracted Term in  Years** | ** ** | **Aggregate  Intrinsic  Value (1)** | ** ** |
|------------------------------------------------------|------------|--------------------------|------------|---------------------------------------------|------------|----------------------------------------------------------------------|------------|------------------------------------------|------------|
|                                                 |       |                     |       |                                        |       |                                                                 |       |                                     |       |
| Outstanding at December  31, 2005                    |       | 5,153,000                |       | $                                           | 0.31       |                                                                 |       |                                     |       |   |
| Granted                                              |       | 12,660,000               |       | $                                           | 1.35       |                                                                 |       |                                     |       |   |
| Cancelled                                            |       | (2,700,000               | )          | $                                           | 0.43       |                                                                 |       |                                     |       |   |
| Exercised                                            |       | (750,000                 | )          | $                                           | 0.10       |                                                                 |       |                                     |       |   |
| Outstanding at  September 30, 2006                   |       | 14,363,000               |       | $                                           | 1.24       |                                                                 | 9.3        |                                     | $          | 796,360 |   |
| Exercisable at $0.05 at  September 30, 2006          |       | 15,000                   |       | $                                           | 0.05       |                                                                 | 2.6        |                                     | $          | 9,150 |   |
| Exercisable at $0.45 at  September 30, 2006          |       | 1,780,750                |       | $                                           | 0.45       |                                                                 | 8.8        |                                     | $          | 373,958 |   |
| Exercisable at $1.18 at  September 30, 2006          |       | 100,000                  |       | $                                           | 1.18       |                                                                 | 9.5        |                                     | $          | — |   |
| Exercisable at $1.25 at  September 30, 2006          |       | 410,625                  |       | $                                           | 1.25       |                                                                 | 9.5        |                                     | $          | — |   |
| Exercisable at $1.30 to  $1.42 at September 30, 2006 |       | 438,334                  |       | $                                           | 1.32       |                                                                 | 9.3        |                                     | $          | — |   |
| Exercisable at $1.50 at September 30, 2006           |       | 2,053,125                |       | $                                           | 1.50       |                                                                 | 9.2        |                                     | $          | — |   |

----

(1)             Theaggregate intrinsic value in this table was calculated based on the positivedifference between the closing market price of the Company’s common stock atthe end of the respective period ($0.66) and the exercise price of theunderlying options.

12

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During the nine-months ended September 30, 2006, thetotal intrinsic value of options exercised (i.e., the difference between themarket price at date of exercise and the price paid by the employee to exercisethe options) was $937,500 and the total amount of cash received from exerciseof these options was $75,000. The total grant-date fair value of stock optionsthat vested during the three- and nine-months ended September 30, 2006 was$2,037,013 and $2,124,013, respectively.

As of September 30, 2006, there was approximately$6,484,840 of total unrecognized compensation cost related to unvestedshare-based awards. This cost is expected to be recognized over a weighted averageperiod of 2.4 years. The Company expects 9,565,166 shares subject to unvestedoptions to vest in the future.

**(3)           IncomeTaxes**

The Company accounts for income taxes in accordancewith SFAS No. 109, *Accounting for IncomeTaxes*(“SFAS 109”). Under SFAS 109, deferred tax assets orliabilities are computed based on the difference between the financialstatement 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 to period.The Company did not record a provision for federal, state or foreign incometaxes for the nine-month periods ended September 30, 2006 and 2005 because theCompany has experienced losses since inception. The Company has not recorded abenefit for deferred tax assets as their realizability is uncertain.

**(4)           BalanceSheet Detail**

Prepaidexpenses and other current assets at September 30, 2006 and December 31, 2005consisted of the following:
| ** **                        | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|-----------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                              |       |                         |       |                        |       |
| Value added tax                   |       | $                            | 118,326    |                        | $          | 77,043 |   |
| Insurance                         |       | 77,200                       |       | 44,610                      |       |
| Rent                              |       | 72,722                       |       | 62,736                      |       |
| Prepaid call  termination charges |       | 68,256                       |       | 44,446                      |       |
| Non-trade  receivables            |       | 47,330                       |       | 164,472                     |       |
| Professional  fees                |       | —                       |       | 121,694                     |       |
| Software                          |       | —                       |       | 77,436                      |       |
| Prepaid  royalties                |       | —                       |       | 399,899                     |       |
| Maintenance  agreement            |       | —                       |       | 40,370                      |       |
| Other                             |       | 9,547                        |       | 13,089                      |       |
|                              |       | $                            | 393,381    |                        | $          | 1,045,795 |   |

 

Other assets consisted of the following at September30, 2006 and December 31, 2005:
| ** **                | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|---------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                      |       |                         |       |                        |       |
| Call termination  charges |       | $                            | 23,010     |                        | $          | 21,145 |   |
| Legal deposit             |       | 4,941                        |       | 4,540                       |       |
| Rent                      |       | —                       |       | 29,522                      |       |
| Other                     |       | 2,247                        |       | 2,065                       |       |
|                      |       | $                            | 30,198     |                        | $          | 57,272 |   |

 

13

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Accrued expenses at September 30, 2006 and December31, 2005 consisted of the following:
| ** **                   | ** ** | **September 30,  2006** | ** ** | **December 31,  2005** | ** ** |
|------------------------------|------------|------------------------------|------------|-----------------------------|------------|
|                         |       |                         |       |                        |       |
| Professional  fees           |       | $                            | 469,495    |                        | $          | 313,897 |   |
| Termination  costs           |       | 40,097                       |       | 60,924                      |       |
| Interest                     |       | 26,881                       |       | 17,693                      |       |
| Travel                       |       | 25,491                       |       | 33,415                      |       |
| Repairs and  maintenance     |       | 15,047                       |       | —                      |       |
| Printing                     |       | 5,530                        |       | 14,655                      |       |
| Payroll and  payroll-related |       | —                       |       | 141,983                     |       |
| Rent                         |       | —                       |       | 8,514                       |       |
| Directors’ fees         |       | —                       |       | 20,200                      |       |
| Other                        |       | 19,917                       |       | 16,873                      |       |
|                         |       | $                            | 602,458    |                        | $          | 628,154 |   |

 

**(5)          Comprehensive Loss**

For the three- and nine-month periods ended September30, 2006 and 2005, the components of other comprehensive loss consisted of theCompany’s net loss and foreign currency translation adjustments. Comprehensiveloss was $6,190,106 and $5,026,320 for the three months ended September 30,2006 and 2005, respectively. Comprehensive loss was $13,880,822 and $8,650,423for the nine months ended September 30, 2006 and 2005, respectively.

**(6)           Net LossPer Share**

Basic net loss per share is computed by dividing netloss for the period by the weighted average number of common shares outstandingduring the period. Diluted net loss per share is computed by dividing net lossby the weighted average number of common shares outstanding during the periodplus the dilutive effect of potential common stock equivalents then outstanding.As there was a net loss for the three-and nine-month periods ended September30, 2006, 14,363,000 outstanding stock options, 24,778,725 outstandingwarrants, and 8,399,999 common shares obtainable upon exercise of theconversion feature of the convertible debentures were excluded from thecalculation of diluted earnings per share because they were anti-dilutive. Asthere was a net loss for the three- and nine-month periods ending September 30,2005, 4,868,000 outstanding stock options, 9,302,500 outstanding warrants, and8,633,333 common shares obtainable upon exercise of the conversion feature ofthe convertible debentures were excluded from the calculation of dilutedearnings per share because they were anti-dilutive.

**(7)          Employment Agreements**

On April 11, 2006, the Company entered into anemployment agreement with J. Keith Markley relating to Mr. Markley’s employmentas its chief executive officer. On August 1, 2006, the Company entered into anamendment of the employment agreement in connection with a reorganization ofthe Company’s management positions (see Note 16). Pursuant to the amendment Mr.Markley resigned as the Company’s chief executive officer and agreed to serveas the president of Vistula USA, Inc., a wholly-owned US subsidiary of theCompany. Under the amended employment agreement, the Company pays Mr. Markleyan annual base salary of $290,000 and provides him with customaryemployment-related benefits.

14

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The amendment also provides that, in addition to theexisting severance benefits already contained in his employment agreement, inthe event he voluntarily terminates his employment prior to a change of control(as defined in the amendment) or in the event that the Company elects toterminate his employment as a result of his repeated failure to comply withreasonable directions and instructions of the Company’s chief executive officeror board of directors in connection with the performance of his duties andresponsibilities under his employment agreement prior to a change of control,the Company will be required to make severance payments to him equivalent tothe base salary he would have received had his employment continued and tocontinue to provide medical benefits, in each case for a period of twelvemonths following termination of his employment. In the event the Companyterminates Mr. Markley’s employment without cause, the Company will be requiredto make severance payments equivalent to the base salary he would have receivedhad his employment continued and to continue to provide medical benefits, ineach case for a period of twelve months following the termination, if hisemployment is terminated in his first year of employment and in each case for aperiod of eighteen months if his employment is terminated at any time after hisfirst year of employment.

The original employment agreement provided for thegrant to Mr. Markley of two non-qualified stock options to purchase shares ofcommon stock, one exercisable for 3,052,000 shares and the other exercisablefor 948,000 shares, with the latter option grant subject to the ratification bystockholders at the next annual meeting of an increase in the number of sharesavailable under the Amended and Restated 2004 Stock Incentive Plan to at least16,000,000 shares, which ratification occurred on July 17, 2006. The Company’scompensation committee approved these grants on April 11, 2006, and fixed theexercise price per share at $1.18, representing the fair market value of theCompany’s common stock on the date of grant based on the previous day’s closingprice.  In the amendment, Mr. Markleyalso agreed to waive his rights to exercise that portion of his outstandingoption to purchase 948,000 shares of common stock granted to him on April 11,2006 which entitles him to purchase 500,000 shares of common stock. Mr. Markleywill retain the right to purchase up to 448,000 shares of common stock underthat option. In the amendment, Mr. Markley also agreed to waive any claims hemight have against the Company in connection with his change in position withthe Company.

Each option vests with respect to one-sixth of thetotal number of shares subject to the option six months after the date of grant(April 11, 2006). Each option continues to vest with respect to an additionalone thirty-sixth of the total number of shares subject to the option on amonthly basis thereafter until fully vested. The options will accelerate infull upon a change of control of the Company or a termination without cause (asdefined in the employment agreement).

Mr. Markley has agreed not to engage, during hisemployment and for a period equal to the longer of (a) one year following thetermination of his employment or (b) the period for which he is entitled toseverance payments following the termination of his employment, in anyactivities competitive with the Company in the United States or any foreignterritory where the Company or any of its subsidiaries are conducting business.Mr. Markley also agreed, during that period, not to solicit any of the Company’semployees or the employees of its subsidiaries to leave the Company or tosolicit any of the Company’s clients to terminate or curtail their businessrelationships with the Company.

Effective August 1, 2006, Jared Taylor was appointedas the Company’s Chief Financial Officer, Treasurer and Secretary following theresignation of George Vaughn of Vaughn & Associates, P.C., who was servingin these capacities under a consulting agreement between the Company and Vaughn& Associates, P.C. Mr. Taylor was promoted from his prior position ofManager of Accounting and Administration, a position he held since he joinedthe Company in July 2005. In connection with Mr. Taylor’s promotion to the roleof chief financial officer, the Company has agreed to pay Mr. Taylor an annualbase salary of $125,000 and to grant him an incentive stock option to purchaseup to 200,000 shares of the Company’s common stock.  The option has an exercise price of $0.65 pershare, representing the fair market value of the Company’s common stock on thedate of grant (July 28, 2006). The option vests in four equal annualinstallments of 50,000 shares commencing on the first anniversary date of thedate of option grant and thereafter on each subsequent anniversary of the dateof option grant until fully vested. The option shall become fully vested upon achange of control (as defined in his option agreement).

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On January 5,2006, the Company entered into an employment agreement with Ian Cope relatingto Mr. Cope’s employment as its chief operations officer. Under theemployment agreement, the Company will pay Mr. Cope an annual base salaryof $140,000 and provide him with certain employment-related benefits. Inaddition, the employment agreement provides that the Company will grantMr. Cope an incentive stock option to purchase 250,000 shares of theCompany’s common stock with an exercise price equal to $1.42 per share; 50,000of those shares subject to the option vested immediately and the remaining200,000 shares subject to the option will vest in four equal annualinstallments of 50,000 shares beginning on January 5, 2007. The option issubject to the terms and conditions of the Company’s Amended and Restated 2004Stock Incentive Plan. The employment agreement also provides that ifMr. Cope is terminated without cause, the Company will pay him his basesalary for three months.

OnFebruary 28, 2006, the Company finalized an agreement with Mark Scullyresolving matters relating to his cessation of employment as president andchief executive officer of Vistula USA, one of the Company’s wholly-ownedsubsidiaries, on November 2, 2005. In connection with a mutual release ofclaims, the Company paid Mr. Scully $50,000 in severance and issued to him750,000 shares of common stock in respect of the exercise of an outstandingoption issued under the Company’s Amended and Restated 2004 Stock IncentivePlan.

**(8)           RelatedParty Transactions**

On March 10, 2006, on behalf of the Company, theCompany’s Chairman, Rupert Galliers-Pratt (the “Chairman”), advanced $75,000directly to an escrow agent, allowing the Company to fulfill a contractualcommitment in the normal course of business. The deposit was returned to theChairman in full on March 27, 2006.

**(9)         Commitmentsand Contingencies**

Since its inception, the Company has sustained itsoperations through funding provided by the Company’s  Chairman, as well as contributed services bythe Chairman and other stockholders, and debt and equity financings. TheChairman has made various advances to the Company from a credit facilityestablished in the name of the Chairman, as well as other of the Chairman’spersonal assets. The Company may obtain future advances from the Chairman fromboth the credit facility and the Chairman’s other personal assets in order tomeet certain working capital needs. The Chairman may also cause the lenderunder the credit facility to issue standby letters of credit in favor of one ormore of the Company’s vendors to secure the Company’s obligations to suchvendor or vendors. While the Chairman is not obligated to provide theseadvances to the Company or to cause the lender to issue standby letters ofcredit in favor of the Company’s vendors, the Company expects the Chairman tocontinue providing funds for operations in 2006 as and if needed, until suchtime that the Company raises additional external capital. In the absence ofexternal capital, the Company will continue to be dependent on the Chairman tofund existing operations and provide growth capital. Although the Companyraised a substantial amount of capital from third parties during the ninemonths ended September 2006, (see Note 15), there can be no assurances that theCompany can continue to raise such capital on acceptable terms, if at all.

On January 27, 2006, the Company entered into aFinancial Advisory Agreement (the “Agreement”) with Indigo Ventures LLC (“Indigo”)in which the Company agreed to appoint Indigo as its financial advisor toadvise, consult with, and assist the Company in various matters which mayinclude:

·                  areview of the Company’s business, operations and financial condition, includingadvising the Company on capitalization structures;

·                  advicerelating to general capital-raising matters;

·                  recommendationsrelating to specific business operations, transactions and joint ventures;

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·                  adviceregarding future financings involving the Company or any of the Company’saffiliates’ debt or equity securities; and

·                  assistancein connection with the due diligence review of any significant acquisitiontransactions proposed by the Company during the term of the agreement.

In consideration for these services, the Companyagreed to pay Indigo a cash fee of $20,000 per month in arrears, increasing to$30,000 per month beginning in the first month following the consummation of asignificant debt or equity financing from which the Company obtains grossproceeds of at least $5 million. Following the May 2006 financing described inNote 15, the monthly cash fee payable to Indigo increased to $30,000.  Also, the Company issued to Indigo 1,500,000restricted shares of common stock, which shares vested on June 7, 2006 upon theclosing of the acquisition of the software and intellectual property describedin Note 14.  The shares the Companyissued to Indigo are restricted shares and may not be sold, assigned ortransferred by Indigo for a one (1) year period beginning on January 27, 2006and ending on January 27, 2007.

On March 30, 2006 the Company entered into a revolvingcredit agreement with Indigo Investments I LLC that provided for up to$5,000,000 in advances to be available to the Company. Upon the closing of thiscredit facility, $1,000,000 was advanced to the Company and an additional$250,000 was advanced under the credit agreement in April 2006. Additionaladvances under the credit facility were dependent upon the Company’s accountsreceivable balances and adherence to certain covenants as described in thecredit agreement. Outstanding principal under this credit facility was subjectto interest at a rate of 1.5% per month, increasing to 2.5% per month in theevent of a default by the Company under the credit agreement. In addition, theCompany paid the lender a 2.25% commitment fee on the total amount of thecredit facility and issued the lender a five-year warrant to purchase up to500,000 shares of common stock at an exercise price of $1.50 per share. Theexercise price of the warrant is subject to adjustment in certaincircumstances. The revolving credit agreement was terminated at September 30,2006.

All outstanding principal and interest on the creditfacility plus the commitment fee became due and payable on May 22, 2006, whichwas the earlier of (i) September 30, 2006, or (ii) the closing of the sale of aminimum of $6,000,000 of the Company’s equity securities. As the financingclosed prior to September 30, 2006, the Company also paid the lender an earlyrepayment fee equal to 2.25% of the total amount of the credit facility. Therights of the lender under the credit facility are junior to those of theoutstanding convertible debentures. Advances drawn under this agreement wereguaranteed by the Company’s Chairman.

A portion of the cash received from the sale of unitsconsisting of common stock and warrants described in Note 15, was used on May24, 2006, to pay down the credit facility in its entirety including allinterest accrued, commitment fees, and early repayment fees.  Also, the sale of units consisting of commonstock and warrants described in Note 15, resulted in an anti-dilutionadjustment to the exercise price of the outstanding warrants described above.Such adjustment reduced the exercise price of such warrants from $1.50 to $1.34per share of common stock and increased the number of exercisable sharesrelated to such warrants from 500,000 to 559,701.

**(10)        Indemnification**

As permitted under Delaware law, the Company hasagreements with its directors whereby it indemnifies them for certain events oroccurrences while they are, or were serving, at the Company’s request as adirector (or in any other capacity). The term of the indemnification period isthe director’s lifetime. The maximum potential amount of future payments theCompany could be required to make under these indemnification agreements isunlimited; however, the Company has a director and officer insurance policypursuant to which the Company may recover all or a portion of amounts it paysto directors under their indemnification agreements. As a result of itsinsurance policy coverage, the Company believes the estimated fair value ofthese indemnification agreements is minimal.

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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 distributors, agents, or customers, in connection with any patent,copyright, trademark, trade secret or other intellectual property infringementclaim by any third party with respect to the Company’s products. The term ofthese indemnification agreements is generally perpetual. The maximum potentialamount of future payments the Company could be required to make under theseindemnification agreements is often capped at a dollar figure. In addition, theCompany has agreed to indemnify the investors in the private placementfinancings described in Note 12 and 15 against certain losses arising under theSecurities Act for misleading statements or omissions by the Company containedin a registration statement or prospectus relating to securities being sold bysuch investors. 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.

**(11)        Convertible Promissory Note to Related Party**

On July 2, 2004, the Company entered into a notesubscription agreement with the J. Rothschild Assurance Self Invested PersonalPension Plan No. 2, the sole beneficiary of which is the Company’s Chairman,Rupert Galliers-Pratt. The note subscription agreement was amended and restatedon August 11, 2004. Under the amended and restated note subscription agreement,the Company issued and sold to Mr. Galliers-Pratt’s pension plan convertiblepromissory notes in the principal amounts of $125,000 and $50,000 on July 12,2004 and on August 11, 2004, respectively. 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. On August 11, 2005, the pension plan confirmed its earlier agreement toextend the maturity date of both promissory notes until December 31, 2005. OnDecember 15, 2005, the pension plan confirmed its earlier agreement to extendthe maturity date of both promissory notes until June 30, 2006.  On June 30, 2006, the pension plan confirmedits earlier agreement to extend the maturity date of both promissory notesuntil December 31, 2006.

**(12)        Convertible Debentures and Warrant Financing**

On February 18, 2005 and March 4, 2005, the Companyissued and sold convertible debentures and warrants to certain sophisticatedinstitutional and accredited individual investors pursuant to a securitiespurchase agreement between the Company and the investors. In the two closingsof the private placement under the securities purchase agreement, the Companysold convertible debentures in the aggregate principal amount of $8,400,000,convertible into common stock of the Company at $0.75 per share, and warrantsto purchase an aggregate of 8,400,000 shares of common stock, at an exercise priceof $1.00 per share. These warrants expire five years after the issue date.

The debentures accrue interest daily at a rate of 8%per annum, which interest is payable quarterly on each March 31, June 30,September 30 and December 31 following the issue date. The final interestpayment is due on the date of maturity of the debentures, the third anniversaryof the issue date. In addition, on any date on which all or a portion of theprincipal of a debenture is converted, all unpaid interest having accrued onsuch principal at the time of such conversion will become immediately payable.The Company is not permitted to prepay any portion of the principal amount ofany of the debentures without the prior consent of the holder thereof.

The debentures are convertible at the option of theholders into shares of common stock at any time at an initial conversion priceof $0.75 per share. Except in the case of certain designated issuances, in theevent the Company issues shares of common stock or common stock equivalents(i.e., securities convertible into, or exercisable or exchangeable for, sharesof common stock) at a price per share (or in the case of common stockequivalents, a conversion, exercise or exchange price per share) below the thenapplicable conversion price of the debentures, the conversion price of thedebentures will be reduced to that lower price per share. Issuances that willnot result in adjustment to the conversion price include issuances toemployees, consultants, directors or officers pursuant to a stock or optionplan adopted by the Company’s board of directors, securities issued uponconversion of other securities outstanding prior to the

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date ofissuance of the warrants, warrants issued in connection with obtaining bankfinancing, common stock issued in connection with the settlement of claims, andsecurities issued in connection with acquisitions, joint ventures or otherstrategic transactions.

The Company has agreed to certain restrictions underthe terms of the debentures, including a prohibition on the payment of cashdividends to stockholders while any of the debentures are outstanding. Upon theoccurrence of an event of default under the debentures, an amount equal to (i)130% of the then outstanding principal amount, plus any accrued and unpaidinterest thereon, or (ii) the product of the then outstanding principal amount,plus any accrued and unpaid interest thereon, times the ratio obtained bydividing the conversion price of the debentures and the market price of theCompany’s common stock, whichever is greater, will, at the holder’s option,become immediately due and payable in cash along with any other amounts, costs,expenses or liquidated damages then due in respect of such debentures. Theratio referred to in clause (ii) is to be calculated based on the conversionprice in effect on the date of such default or the date the accelerated amountis paid in full (whichever is less), and the market price of the Company’scommon stock on the date of such default or the date the accelerated amount ispaid in full (whichever is greater, such market price to be determined inaccordance with the terms of the debenture). Upon an event of a default, theinterest rate on the debentures will also be increased to 18% per annum.

Events of default under the debentures include failureto pay any amounts under the debentures when due, a material default under theCompany’s other agreements with the investors or default in the Company’sobligations under mortgage, credit facility or similar agreements, a materialinaccuracy in the representations and warranties made to the investors inconnection with the convertible debenture and warrant financing, and theinitiation of voluntary or involuntary bankruptcy proceedings against theCompany.

Of the $8,400,000 aggregate principal amount ofconvertible debentures sold, through September 30, 2006, $2,100,000 principalamount has been converted into 2,799,993 shares of common stock, reducing theamount of interest required to be paid in future periods, with $6,300,000 inprincipal remaining outstanding at September 30, 2006.  In the Company’s consolidated balance sheetat September 30, 2006, the remaining principal of $6,300,000 has been reducedby unamortized debt discount of $573,740.

The common stock purchase warrants issued to theinvestors are exercisable at an initial exercise price of $1.00. The warrantshave an expiration date of five years after the date of issuance. They containa cashless exercise provision whereby the holder may pay the exercise price byhaving the Company withhold upon exercise shares having a fair market valueequal to the applicable aggregate exercise price if after the first anniversaryof the date of issuance of the warrant there is no effective registration statementregistering, or no current prospectus available for, the resale of the sharesissuable upon the exercise of the warrants. In the event this provision is usedwith respect to an exercise, the Company would receive no proceeds from thesale of its common stock in connection with such exercise.  The warrants were initially exercisable foran aggregate 8,400,000 shares of common stock. As of September 30, 2006, theCompany had issued 3,190,499 shares upon exercise of warrants, all inconnection with the warrant exercise agreements described below.

The exercise price is subject to adjustment in theevent of certain issuances of new securities. Specifically, except in the caseof certain designated issuances, if the Company issues shares of common stock orcommon stock equivalents (i.e., securities convertible into, or exercisable orexchangeable for, shares of the Company’s common stock) at a price per share(or in the case of common stock equivalents, a conversion, exercise or exchangeprice per share) below the then applicable exercise price of the warrants, theexercise price of the warrants will be reduced to that lower price per share.In the event of such an adjustment, the number of shares for which the warrantsare exercisable will be increased such that the aggregate exercise price of thewarrants after the adjustment will equal the aggregate exercise priceimmediately prior to the adjustment. Issuances that will not result inadjustment to the exercise price include issuances to employees, consultants,directors or officers pursuant to a stock or option plan adopted by the Company’sboard of directors, securities issued upon conversion of other securitiesoutstanding prior to the date of issuance of the warrants, warrants issued inconnection with obtaining bank financing,

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commonstock issued in connection with the settlement of claims, and securities issuedin connection with acquisitions, joint ventures or other strategictransactions.

In connection with the two closings of the privateplacement, the Company paid placement fees in the aggregate amount of $802,500to the placement agent. At the second closing, the Company also issued to theplacement agent a warrant to purchase up to 802,500 shares of common stock atan initial exercise price of $1.00 per share. The warrant, which expires onMarch 4, 2010, is on substantially the same terms as the warrants issued to theinvestors in the private placement.

The Company registered for resale under the SecuritiesAct of 1933, as amended (the “Securities Act”), the shares underlying thedebentures and warrants pursuant to a registration statement on Form SB-2, asamended (File No. 333-123815). The registration statement was declaredeffective on May 3, 2005.

*Warrant Exercise Agreements. *In October 2005, theCompany entered into several warrant exercise agreements with holders ofwarrants issued in the private placement that closed in the first quarter of2005. Pursuant to these agreements, the Company issued to these holders newcommon stock purchase warrants exercisable for a number of shares equal to thenumber of shares they purchased upon exercise of the warrants issued to them inthe private placement. These new warrants have an exercise price of $1.50 pershare. The Company received aggregate proceeds of $3,190,499 in connection withthe exercise of the prior warrants, and issued new warrants, which expire fiveyears after the issue date, to purchase an aggregate of 3,190,499 shares ofcommon stock (plus an additional warrant, which expires five years after theissue date, to purchase 159,525 shares of common stock to a placement agent whoassisted with the transaction). The shares of common stock underlying thesewarrants have been registered for resale with the Securities and ExchangeCommission pursuant to a registration statement on Form SB-2 (File No.333-130808). This registration statement was declared effective on January 31,2006.

**(13)        Distribution and Marketing Agreement**

On August 11, 2004, the Company entered into adistribution and marketing agreement with NetYantra Inc. (“NetYantra US”) andNetYantra India Pvt. Ltd. (“NetYantra India”, with NetYantra US and NetYantraIndia being hereinafter referred to collectively as “NetYantra”) pursuant towhich NetYantra granted to the Company the exclusive worldwide rights (otherthan in India where NetYantra is headquartered and subject to certain existingdistribution agreements) to market and distribute the V-CubeTM IP-PBX softwareplatform developed by NetYantra to Tier 1 carriers, telecommunicationsequipment manufacturers, internet service providers, large corporations, SMEsand other business entities and individual retail customers. Under thisagreement, the Company paid NetYantra $400,000 and was required to payNetYantra fifty percent of certain net revenues that the Company derived fromthe distribution of the V-CubeTM platform.

In addition, the agreement stated that in the eventthat the Company’s common stock was quoted or traded on a stock market on orbefore the first anniversary of the agreement, the Company would issue toNetYantra shares of the Company’s common stock having a market value of$1,000,000 based on the opening price of the Company’s common stock on thefirst day of trading (or, at the Company’s option, pay to NetYantra a cashpayment of $1,000,000 instead of issuing such shares). On July 21, 2005, publictrading in the Company’s common stock began jointly on the OTC Bulletin Boardand the Pink Sheets Electronic Quotation Service under the trading symbol “VSTL.”  The opening sale was at a price of $2.00 pershare. The Company issued 500,000 shares of its common stock to NetYantra incompliance with the agreement.

On May 1, 2006, the Company executed and delivered anAsset Purchase Agreement with NetYantra relating to the V-CubeTM IP-PBX softwareplatform. See Note 14.  The distributionand marketing agreement was terminated upon the closing of the acquisition ofthe V-CubeTM platform and associated intellectual property under the AssetPurchase Agreement on June 7, 2006.

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**(14)         Purchaseof Software and Intellectual Property**

On June 7, 2006, the Company completed theacquisition of certain assets of NetYantra for an aggregate purchase priceof  $8.8 million in cash, 14 million shares of the Company’s common stock(the “Share Consideration”) and the outstanding prepaid amount ($399,189) forroyalties due on future net revenues that was paid under the terms of the distributionand marketing agreement described in Note 13 above. The acquisition was madepursuant to an Asset Purchase Agreement by and among Vistula, NetYantra US andNetYantra India dated April 28, 2006, as amended on May 11, 2006 andfurther amended on June 7, 2006 (the “Purchase Agreement”).  In accordance with the terms of the PurchaseAgreement, 10,068,833 shares of the Share Consideration were issued toNetYantra US at the closing. The remaining shares comprising the ShareConsideration were issued to NetYantra US on July 19, 2006 following anincrease in the Company’s authorized common stock by its stockholders at theannual meeting of stockholders held on July 17, 2006. The acquired assetsinclude NetYantra’s VoIP IP-PBX platform software and associated intellectualproperty. The Company had previously distributed this software as its V-CubeTMVoIP IP-PBX platform offering under a Distribution and Marketing Agreement withNetYantra.

The terms of the Purchase Agreement required theCompany and NetYantra to use commercially reasonable efforts to negotiate andexecute within sixty (60) days following the closing of the acquisition alicense and revenue agreement, a services agreement and an executive employmentagreement.  Also, the terms of thePurchase Agreement prohibit, during the term of the services agreement and for12 months thereafter,  the Company andNetYantra from soliciting for hire, directly or indirectly, an employee,subcontractor or consultant of the other party, without that other party’swritten consent.

On August 3, 2006, the Company and NetYantra agreed toa 30 day extension to negotiate and execute a license and revenue agreement, aservices agreement, and an executive employment agreement.  Although the services agreement has not beenformally executed as of the date of this Form 10-QSB, NetYantra has beenperforming services for the Company since June 8, 2006.  The Company made a cash payment in October2006 to NetYantra US of $294,048 for the services provided from June 8, 2006through September 30, 2006.  This amountwas accrued as of September 30, 2006.

In connection with the Purchase Agreement, the Companyentered into a Registration Rights Agreement dated as of June 7, 2006 withNetYantra US (the “Registration Rights Agreement”) which provides NetYantra USwith certain registration rights with respect to the shares being issued toNetYantra US pursuant to the Purchase Agreement (“Registrable Securities”).Under the terms of the Registration Rights Agreement, if at any time after theearlier of (i) the second anniversary of the date of that agreement or (ii) thedate on which a persons or persons acting in concert who are not shareholdersof the Company as at the date of that agreement acquire in a transaction orseries of related transactions an aggregate of at least thirty percent (30%) ofthe then outstanding shares of common stock of the Company, the Companyreceives a request from NetYantra US that it requests a registration withrespect to the Registrable Securities then outstanding, then the Company shallas soon as practicable, and in any event within forty-five (45) days after thedate such request is given by NetYantra US, file a registration statement underthe Securities Act, covering all Registrable Securities then outstanding.NetYantra US also has the right to request that the Registrable Securities beregistered if the Company proposes to register any of its stock or othersecurities under the Securities Act in connection with the public offering ofsuch securities solely for cash.

The Company recorded the acquisition of the V-CubeTMIP-PBX platform software and associated intellectual property as an intangibleasset in June 2006 at a total of $26,279,189 ($8.8 million in cash, 14 millionshares at $1.22 per share, and the outstanding prepaid royalty amount of$399,189).  The Company has determinedthat the asset will be amortized over a five year estimated useful lifebeginning on July 1, 2006, which coincides with the first V-CubeTM productlaunch by one of the Company’s customers. At September 30, 2006 the net carrying value of this intangible assetwas $24,965,229.  Amortization expensefor the three- and nine-months ended September 30, 2006 was $1,313,960.

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 **(15)        Stock and Warrant Purchase Agreement**

On May 22, 2006, the Company entered into a stock andwarrant purchase agreement with 23 accredited investors whereby the Companysold 16,300,000 units consisting of one share of common stock and eight-tenthsof one warrant to acquire one share of common stock. The effective purchaseprice of the units was $1.00 per unit. In exchange for the units sold, theCompany received gross cash proceeds of $16,300,000. The Company issuedwarrants for 13,040,000 common stock shares, exercisable until May 22, 2011 atan exercise price of $1.00 per share.

CRT Capital Group LLC (“CRT”) acted as the placementagent in connection with the offering. The aggregate commissions payable to CRTin connection with the private placement were approximately $978,000. Inaddition, the Company issued warrants to the placement agent to purchase1,467,000 shares of common stock similar to those sold to the investors.

The Company realized net proceeds from the sale ofunits, after deducting placement agent fees and expenses, of approximately$15.2 million. The Company used a portion of these proceeds to purchase thesoftware and intellectual property rights of NetYantra’s V-CubeTM IP-PBXplatform as described in Note 14 ($8.8 million); pay the outstanding principal,interest and fees related to the revolving credit agreement with IndigoInvestments I LLC described in Note 9 ($1.5 million); and pay the outstandingprincipal and interest related to a promissory note for equipment ($0.8million).

The Company agreed to register the resale of theshares of common stock sold in the offering and issuable upon exercise of thewarrants. The Company was required to file the registration statement with theSecurities and Exchange Commission (“SEC”) within forty-five (45) days of theclosing and use its best efforts to cause the registration statement to bedeclared effective under the Securities Act no later than the earlier of (i)ninety (90) days (or in the case of a full review one hundred and twenty (120)days) after the closing date and (ii) the sixth (6th) business day followingthe date on which the Company is notified by the SEC that the registrationstatement will not be reviewed or is no longer subject to further review andcomments. The Company is required to use its best efforts to keep theregistration statement continuously effective under the Securities Act untilthe earlier of the date when all the registrable securities covered by theregistration statement have been sold or are freely saleable and the secondanniversary of the closing. In the event that the registration statement is nottimely filed or declared effective when due, or after effectiveness ceases toremain effective, the Company is obligated to make cash payments in the natureof liquidated damages up to a limit of 10% of the purchase price of theunits.  A registration statement wasfiled on June 30, 2006 and became effective on July 14, 2006.

**(16)         ManagementReorganization**

Effective August 1, 2006, the Company reorganized themanagement structure of Vistula and its wholly-owned subsidiaries, VistulaLimited and Vistula USA, Inc. As part of the reorganization, RupertGalliers-Pratt retained his position as Chairman and President of VistulaCommunications Services, Inc. and also serves as its Chief Executive Officer.Adam Bishop continues to serve as Chief Executive Officer of Vistula Limited,Vistula’s UK-based subsidiary and resigned as President of Vistula USA, Inc.,Vistula’s US operating company. Keith Markley has assumed the position ofPresident of Vistula USA, Inc., and resigned as Chief Executive Officer ofVistula. Mr. Markley will continue to serve on the Board of Directors ofVistula.  Jared Taylor was appointed theCompany’s Chief Financial Officer.

Mr. Galliers-Pratt has served as chairman of theCompany’s board of directors since its inception. He served as the Company’spresident and chief executive officer from the Company’s inception untilSeptember 1, 2004 and resumed service in those capacities on February 8, 2005until April 11, 2006 when he resigned as chief executive officer upon theappointment of Mr. Markley to that position. He also serves as chairman of theboard of directors of the Company’s wholly-owned subsidiaries, Vistula Limited,Vistula USA, Inc. and Cardlink Services Limited.

** (17)         Subsequent Events**

On October 11, 2006, the Company completed theacquisition of Goodman Blue Limited (“Goodman Blue”), a UK company whichdevelops software systems to automate the delivery of complex

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multi-tieredproducts through web portals that guide clients through sign-up, delivery,implementation and billing. The Company uses this software as an ordering andprovisioning portal for the V-CubeTM product and categorizes this software underthe descriptive name Order-to-Cash. The acquisition was made pursuant to ashare purchase agreement (the “Purchase Agreement”) with Scott Lee Goodwin (“Goodwin”),the sole stockholder of Goodman Blue. Pursuant to the Purchase Agreement, theCompany agreed to purchase all of the outstanding shares of Goodman Blue fromGoodwin (the “Shares”) for consideration consisting of 2,500,000 shares of theCompany’s common stock, $.001 par value per share subject to an option torequire the Company to repurchase the Shares for an aggregate purchase price of$2,500,000 in certain circumstances. In the event that Goodwin fails to delivernotice to the Company by 5:00 pm Eastern Standard Time on the tenth businessday following February 1, 2007 (or the next day which the Company’s commonstock is traded), any right for Goodwin to exercise the option shall be deemedto have lapsed. Under the terms of the Purchase Agreement, the Company grantedGoodwin certain piggy back registration rights with respect to the Shares.

At the time of the filing of this Form 10-QSB, theCompany was still evaluating the allocation of the acquisition purchase priceto intangibles and goodwill.

On October 12, 2006, the Company entered intoagreements with Telstra Europe Limited (“Telstra Europe”) relating to Vistula’sOrder-to-Cash (“O2C”) Managed Office software platform and the management ofcertain Telstra customer accounts utilizing the O2C software.  Under the agreements, Vistula has granted aglobal license to Telstra Europe for the O2C software for the managed serviceoffice marketplace and has recognized revenue and received cash payments ofapproximately $280,000 to date. In addition to the sale of the O2C software forthe managed service office marketplace, and beginning in October 2006, TelstraEurope has also outsourced the support and management of their O2C client baseto the Company for a minimum period of eighteen months at an annual rate ofapproximately $900,000.

**Item 2.****  Management’s Discussion and Analysisof Financial Condition and Results of Operations.**

**Introduction**

The following information should be read inconjunction with the financial statements and notes thereto in Part I, Item 1of this Quarterly Report and with Management’s Discussion and Analysis ofFinancial Condition and Results of Operations contained in our Annual Report onForm 10-KSB for the year ended December 31, 2005 (File No. 000-50758).

**Cautionary Statements**

We do not provide forecasts of our future financialperformance. However, from time to time, information provided by us orstatements made by our employees may contain “forward-looking” information thatinvolves 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 PrivateSecurities Litigation Reform Act of 1995. Forward-looking statements involvesubstantial 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-lookingstatements carefully because they: (1) discuss our future expectations; (2)contain projections of our future operating results or financial condition; or(3) state other “forward-looking” information. Various factors described below,as well as any other instances of cautionary language in this Quarterly Report,refer to or provide examples of risks, uncertainties and events that may causeour actual results to be materially different than the expectations describedin 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-lookingstatements included in this Quarterly Report are based on information availableto us on the date hereof, and we assume no obligation to update any suchforward-looking statements.

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Each forward-looking statement should be read inconjunction with the financial statements and notes thereto in Part I, Item 1of this Quarterly Report, this section, and Management’s Discussion andAnalysis of Financial Condition and Results of Operations contained in ourAnnual Report on Form 10-KSB for the year ended December 31, 2005 (FileNo.000-50758), including but not limited to the section therein entitled “FactorsAffecting Future Performance.”

In addition to the risks and uncertainties faced generallyby participants in the telecommunication industry, we face the following risksand uncertainties:

·                                          Wehave a limited operating history; therefore, we may not be able to accuratelyforecast future results and operating losses in future periods could be greaterthan expected.

·                                          Ifwe do not obtain a substantial amount of additional financing, we may have tocurtail or suspend operations.

·                                          Wemay continue to lose money on our operations.

·                                          Ifwe fail to establish the Vistula and Cardlink brands or to attract repeatcustomers, we may not be able to increase our revenues sufficiently to fund ouroperations.

·                                          Wehave only limited revenue of which a significant portion is derived from alimited number of contracts and customers. If we are unable to replacecontracts upon completion and maintain customer relationships, we could have asignificant decrease in our revenues that would negatively impact our results.

·                                          Wemay experience significant fluctuations in our results as a result ofuncertainties relating to our ability to generate additional revenues, manageour expenditures and other factors, certain of which are outside of ourcontrol.

·                                          Ourcontracts typically contain provisions giving customers the ability toterminate their contracts under various circumstances and we may not be able toreplace the revenues from such contracts that may have an adverse effect on ourrevenues and operating results.

·                                          Wemay not be able to promptly reduce expenses in response to any decrease in ourrevenues, which would result in lower net margins.

·                                          Ifwe are unable to collect receivables from development stage customers and othertelecommunications companies, our operating results may be materially harmed.

·                                          Theextent of our dependence on international operations may give rise to increasedmanagement challenges and could harm our results of operations.

·                                          Providingservices outside the United States carries the additional risk of currencyfluctuations and foreign exchange controls imposed by certain countries sincemany of our non-U.S. projects are undertaken in local currency.

·                                          Ourinability to anticipate or adapt to changes in technology may harm ourcompetitive position, reputation and opportunities for revenue growth.

·                                          Wemay not be able to hire or retain a sufficient number of qualified engineersand other employees to meet our customers’ needs or maintain the quality of ourservices.

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·                                          Futureacquisitions of new companies or technologies may result in disruption to ourbusiness and expose us to risks associated with acquisitions.

·                                          Theconsolidation of telecommunication service providers could adversely impact ourbusiness.

·                                          Governmentregulations may adversely affect our business.

·                                          Ifwe fail to retain our key personnel and attract and retain additional qualifiedpersonnel, we might not be able to meet our customers’ needs.

·                                          Themanagement of our finances and the quality and timeliness of our financialreporting may be adversely affected if we are unable to increase the size andcapabilities of our internal administrative and finance function as ourbusiness grows.

·                                          Wewill not be successful if we do not grow our customer base beyond our initialcustomers.

·                                          Ifwe do not respond rapidly to technological changes or to changes in industrystandards, our products and services could become obsolete.

·                                          Wewill not retain customers or attract new customers if we do not anticipate andmeet specific customer requirements and if our products and services do notadequately interoperate with our customers’ existing networks.

·                                          Ifwe fail to compete successfully, our ability to increase our revenues orachieve profitability will be impaired.

·                                          Ourbusiness is exposed to the general conditions of the telecommunications market.

·                                          Themarkets for wholesale voice services (particularly VoIP services) and pre-payproducts are new and evolving and, if these markets do not develop as expected,then it could have a material adverse effect on our business.

·                                          Intellectualproperty infringement claims against us or any of our subsidiaries, evenwithout merit, could require us to enter into costly licenses or deprive us ofthe technology we need.

·                                          Failureto protect our intellectual property rights could have a material adverseeffect on our business.

·                                          Ifour products contain defects, then our sales are likely to suffer, and we maybe exposed to legal claims.

·                                          Wemay be subject to litigation.

Because of the foregoing and other factors, we mayexperience material fluctuations in our future operating results on a quarterlyor annual basis which could materially adversely affect our business, financialcondition and operating results.

**Overview**

Vistula Communications Services, Inc. (“VCS”, the “Company”or “we”) currently has three wholly-owned subsidiaries: Vistula Limited (“Vistula”),Vistula USA, Inc. (“Vistula USA”) and Cardlink

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ServicesLimited (“Cardlink”), and has one subsidiary that is 60% owned, VistulaCommunications Services SA (Pty) Ltd. (“Vistula SA”). Through Vistula andVistula USA, we currently provide wholesale value-added telecommunicationsservices (including direct and partner voice routing services) to Tier 1 andTier 2 telecommunication carriers and transit operators. In the first quarterof 2005, through Vistula, Vistula USA, and Vistula SA we began to market our V-CubeTMVoice over Internet Protocol, or “VoIP,” IP-PBX software platform totelecommunications carriers, Internet service providers, or “ISPs,” largecorporations and small and medium enterprises, or “SMEs,” throughout the world.

Through our Cardlink subsidiary we plan to market anddistribute electronic top-up software, which enables prepayment for servicesprovided by mobile telephone operators, and associated services to Tier 1 andTier 2 telecommunications carriers and transit network operators throughout theworld. Cardlink has developed a software product suite that enables mobileoperators to electronically process prepayments from “pay-as-you-go” mobilephone customers.

On October 11, 2006, VCS acquired Goodman Blue Limited(“Goodman Blue”) which provides a software package that allows serviceproviders, of any kind, to deliver real-time, self-service and fully automated,provisioning, rating, billing, service management and reporting of telecom andother services.  For VCS and itscustomers, this software sits on the outside of V-CubeTM so that serviceproviders can create hands-off management of their customers’ billableactivity. The Goodman Blue solution is called Order-to-Cash (“O2C”).  VCS will be marketing O2C to V-CubeTM andnon-V-CubeTM clients. The particular benefit to VCS’s clients is that it allowsthem to address the high cost of sale issues common with relatively low-value,high-volume client bases requiring complex solutions.  See Recent Developments below and Note 17 tothe Company’s financial statements.

***Vistula, Vistula USA, and Vistula SA***

Vistula, Vistula USA, and Vistula SA are aggregatorsof wholesale telecommunications services to Tier 1 and Tier 2telecommunications carriers and transit network operators. Vistula, VistulaUSA, and Vistula SA are collectively referred to as the “Vistula Companies.”The Vistula Companies have switching facilities in London and Los Angeles andinterconnect agreements with suppliers and customers in these locations.Vistula is also leveraging its switched voice infrastructure (traditionallywholesale) to service off-net calls (phone calls that leave the Internet andneed to be delivered to traditional phones).

The Vistula Companies began to actively market ourV-CubeTM IP-PBX 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 existingPBX phone systems to provide VoIP capability without the need for significantinvestment in new hardware, will provide the Vistula Companies with a highlycompetitive VoIP solution.

On April 1, 2005, we 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 anticipate leveraging the marketing advantagesand customer relationships of Telstra Europe to provide us with regular monthlyrevenue. On July 3, 2006, Telstra Europe commenced IP-PBX services to itscustomers using the hosted V-CubeTM IP-PBX platform.

Cardlink was first acquired by Rupert Galliers-Prattand certain members of his family in April 2003. VCS acquired Cardlink throughthe share exchange completed in March 2004. Cardlink will offer an electronictop-up, or “ETU”, software product suite which will enable mobile operators toelectronically process prepayments from “pay-as-you-go” customers. Cardlink’sproducts will allow these customers to “electronically top-up” their accountswith the mobile operator. We believe that the market for these prepaymentservices is expanding both in the developed and in the underdeveloped regionsin the world

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and webelieve that Cardlink’s ETU product will be of value as new mobile operatorsthroughout the world seek to adopt this technology.

We believe that the potential for providing ETUservices in markets where the adoption and use of mobile telephony is growingrapidly will create opportunities and long-term growth potential for Cardlink.We intend that Cardlink will typically receive a percentage of the total mobilerevenues transacted through the Cardlink system. As a result, Cardlink will bea beneficiary of any increase in mobile telephony revenues without anyinvestment of capital in building infrastructure. We currently expect to usethird parties to provide necessary software updates, maintenance and supportfor these activities.

**Recent Developments**

On October 11, 2006, we completed the acquisition ofGoodman Blue Limited (“Goodman Blue”), a UK company which develops software toautomate the delivery of complex multi-tiered products through web portals thatguide clients through sign-up, delivery, implementation and billing. VCS usesthis software as an ordering and provisioning portal for the V-CubeTM productand categorizes this software under the descriptive name Order-to-Cash. Theacquisition was made pursuant to a share purchase agreement (the “PurchaseAgreement”) with Scott Lee Goodwin (“Goodwin”), the sole stockholder of GoodmanBlue. Pursuant to the Purchase Agreement, we agreed to purchase all of theoutstanding shares of Goodman Blue from Goodwin (the “Shares”) forconsideration consisting of 2,500,000 shares of our common stock, $.001 parvalue per share subject to an option to require us to repurchase the Shares foran aggregate purchase price of $2,500,000 in certain circumstances. In theevent that Goodwin fails to deliver notice to the Company by 5:00 pm EasternStandard Time on the tenth business day following February 1, 2007 (or the nextday which the Company’s common stock is traded), any right for Goodwin toexercise the option shall be deemed to have lapsed. We issued these shares ofcommon stock in reliance on the exemption from registration afforded by Section4(2) of the Securities Act for transactions by an issuer not involving anypublic offering.  Under the terms of thePurchase Agreement, we granted Goodwin certain piggyback registration rightswith respect to the Shares.

On July 17, 2006, the stockholders of the Company approvedan amendment to the Company’s Certificate of Incorporation to increase to200,000,000 the number of shares of common stock, par value $.001, the Companyis authorized to issue (the “Amendment”). The Amendment became effective onJuly 18, 2006 upon the filing of the Amendment with the Delaware Secretary ofState’s office.

On July 17, 2006, the stockholders of the Companyratified an amendment to the Company’s 2004 Stock Incentive Plan to increasethe number of shares available for issuance thereunder to 20,000,000 shares.

On June 7, 2006, we purchased NetYantra’s VoIP IP-PBXplatform software and associated intellectual property. We previouslydistributed this software as the V-CubeTM VoIP IP-PBX platform offering under adistribution and marketing agreement with NetYantra. The V-CubeTM VoIP IP-PBXplatform enables telecom carriers and internet service providers to offer abroad range of IP telephony services from simple IP telephone calls to videoconferencing to their customers.  Thepurchase price for the software and associated intellectual property was $8.8million in cash, 14 million shares of our common stock, and $399,189 in prepaidroyalties. See Note 14.

On May 22, 2006, we completed a private placement ofunits with 23 accredited investors whereby we sold 16,300,000 units consistingof one share of common stock and eight-tenths of one warrant to acquire oneshare of common stock.  The effectivepurchase price of the units was $1.00 per unit. In exchange for the units sold, we received gross proceeds of$16,300,000.  The warrants areexercisable until May 22, 2011 at an exercise price of $1.00 per share.  See Note 15.

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**Critical Accounting Policies**

Our consolidated financial statements are prepared inaccordance with accounting principles generally accepted in the United States.These accounting principles require us to make certain estimates, judgments andassumptions. We believe that the estimates, judgments and assumptions uponwhich we rely are reasonable based upon information available to us at the timethat these estimates, judgments and assumptions are made. These estimates,judgments and assumptions can affect the reported amounts of assets andliabilities as of the date of the financial statements, as well as the reportedamounts of revenues and expenses during the periods presented. Those estimatesand judgments are based on management’s historical experience, the terms ofexisting agreements, our observance of trends in the industry, information thatwe obtain from our customers and outside sources, and on various otherassumptions that management believes to be reasonable and appropriate under thecircumstances, the results of which form the basis for making judgments aboutthe carrying values of assets and liabilities that are not readily apparentfrom other sources. To the extent there are material differences between theseestimates, judgments or assumptions and actual results, our financialstatements will be affected.

We believe that the following accounting policiesreflect our more significant judgments and estimates used in the preparation ofour financial statements.

*Revenue Recognition*.   Our revenue is derived primarily from feescharged to terminate voice services over our network. We recognize suchrevenue, net of reserves, when persuasive evidence of a sales arrangementexists, delivery has occurred or services have been rendered, the sales priceis fixed and determinable and collectibility is reasonably assured. We reservefor potential billing disputes at the time revenue is recognized or the disputeis known. Such disputes can result from disagreements with customers regardingthe duration, destination or rates charged for each call. These revenueallowances are based on estimates derived from factors that include, but are notlimited to, historical results, analysis of credits issued, current economictrends and changes in demand. Amounts billed in advance of the service monthare recorded as deferred revenue and recognized as revenue as the underlyingservices are rendered.

Reciprocal compensation is the amount paid by onecarrier to complete particular calls on another local exchange carrier’snetwork. Reciprocal compensation paid to and received from other carriers isbased on contractual fixed rate per minute charges. We apply the receipt ofreciprocal compensation against the cost of reciprocal compensation and reflectthe net amount as either revenue (receipts greater than costs) or expense(costs greater than receipts) at each settlement date.

We have entered into transactions such as buying,selling, swapping or exchanging capacity to complete and complement ournetwork. In general, these transactions represent the exchange of productiveassets not held for sale in the ordinary course of business and, as such, donot result in the culmination of the earnings process. Accordingly, we do notrecognize any revenue for these types of transactions. We account for theexchange of a non-monetary asset based on the recorded amount of thenon-monetary asset relinquished with no gain or loss recognized in accordancewith Accounting Principles Board (APB) Opinion No. 29, *Accounting for Non-Monetary Transactions*.

*Stock-Based Compensation*.Commencing on January 1, 2006 we began applying the provisions of Statement ofFinancial Accounting Standards (SFAS) No. 123R, *Share Based Payment*, or SFAS 123R, in accounting forstock-based compensation. SFAS 123R requires measurement of the cost ofemployee services received in exchange for an award of equity instruments basedon the grant-date fair value of the award. That cost is recognized over theperiod during which an employee is required to provide service in exchange forthe award (usually the vesting period). Prior to January 1, 2006, we followedAccounting Principles Board (APB), Opinion No. 25, *Accounting for Stock Issued to Employees*, or APB 25, andrelated interpretations, in accounting for our stock-based compensation plans,rather than the alternative fair-value method provided for under SFAS No. 123, *Accounting for Stock-Based Compensation*,or SFAS 123. In the notes to our financial statements, we provide pro-formadisclosures in accordance with SFAS 123. We account for transactions in whichservices are received from non-employees in exchange for equity instrumentsbased on the fair value of such services received or of the equity instrumentsissued, whichever is more reliably measured, in accordance with SFAS 123 andthe Emerging Issues Task Force (EITF) Issue 96-18, *Accounting for Equity Instruments That Are Issued to Other than Employeesfor Acquiring, or in Conjunction with Selling, Goods or Services*, orEITF 96-18.

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Accounting for equity instruments granted or sold byus under APB 25, SFAS 123, SFAS 123R and EITF 96-18 requires fair-valueestimates of the equity instrument granted or sold. If our estimates of thefair value of these equity instruments are too high or too low, our expensesmay be over- or understated. For equity instruments granted or sold in exchangefor the receipt of goods or services, we estimate the fair value of the equityinstruments based upon consideration of factors that we deem to be relevant atthat time. Because shares of our common stock were not publicly traded prior toJuly 21, 2005, market factors historically considered in valuing stock andstock option grants included comparative values of public companies discountedfor the risk and limited liquidity provided for in the shares we are issuing;prior valuations of stock grants and the effect of events that occurred betweenthe time of such grants; economic trends; and the comparative rights andpreferences of the security being granted compared to the rights andpreferences of our other outstanding equity.

Prior to July 21, 2005, the fair value of our commonstock was determined by our board of directors contemporaneously with thegrant. In the absence of a public trading market for our common stock, ourboard of directors considered numerous objective and subjective factors indetermining the fair value of our common stock. At the time of option grantsand other stock issuances, our board of directors considered the status ofprivate and public financial markets; valuations of comparable private andpublic companies; the likelihood of achieving a liquidity event such as aninitial public offering; our existing financial resources; our anticipatedcontinuing operating losses and increased spending levels required to meet ourbusiness plan; dilution to common stockholders from anticipated futurefinancings; and a general assessment of future business risks.

*Impairmentof Long Lived Assets**.* In accordancewith Statement of Financial Accounting Standards No. 144, *Accountingfor the Impairment or Disposal of Long-lived Assets*, the Companyreviews its long-lived assets whenever events or changes in circumstancesindicate that the carrying amount of such assets may not be recoverable. If thecarrying amount of an asset or group of assets exceeds its net realizablevalue, the asset will be written down to its fair value.

*Intangible Assets*.Intangible assets are carried at cost less accumulated amortization, which iscalculated on a straight-line basis over their estimated economic life. TheCompany reviews intangible assets for impairment whenever events or changes incircumstances indicate that the carrying amount may not be recoverable.

**Results of Operations**

Net revenues for the three-month period endedSeptember 30, 2006 were $191,999 which represents a decrease of $70,051 (26.7%)over the $262,050 in net revenues for the three-month period ended September30, 2005. Net revenues for the nine-month period ended September 30, 2006 were$749,337 which represents an increase of $134,959 (22.0%) over the $614,378 innet revenues for the nine-month period ended September 30, 2005. The decreasein the three-month period ended September 30, 2006 is primarily attributable tothe loss of one wholesale revenue traffic route in our UK operations offset byincreases in wholesale revenues from other UK customers.  The increase in the nine-month period endedSeptember 30, 2006 is primarily attributable to an increase in wholesalerevenues from UK customers.  Minimalrevenue has been recognized to date for the V-CubeTM product offering althoughwe commenced the V-CubeTM product offering in the UK and Argentina during thethree-month period ended September 30, 2006.

Cost of revenues for the three-month period endedSeptember 30, 2006 were $491,132, an increase of 63.1% over the $301,120 in thethree-month period ended September 30, 2005. Cost of revenues for thenine-month period ended September 30, 2006 were $1,166,736, an increase of62.1% over the $719,955 in the nine-month period ended September 30, 2005. Theincrease for the three-month period ended September 30, 2006 is primarily dueto increased engineering costs associated with commencing our VoIP productoffering and the increased cost of our co-location facilities in both theUnited States and the United Kingdom, net of a decrease in engineering costsassociated with wholesale traffic.  Theincrease for the nine-month period ended September 30, 2006 is primarily due toincreased engineering costs associated with commencing our VoIP productoffering; an increase in wholesale revenues and the cost of co-location

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facilitiesin both the United States and the United Kingdom, net of a decrease inengineering costs associated with wholesale traffic.  Both increases for the three- and nine-monthperiods ended September 30, 2006 over the respective periods in 2005 are net ofengineering costs classified as costs of revenue.  For the three- and nine-month periods endedSeptember 30, 2006 engineering costs associated with the V-CubeTM product of$196,039 were classified as costs of revenue compared to $0 in the respectiveperiods in 2005.  The engineering costsassociated with the V-CubeTM product include internal staffing costs and supportservices provided by NetYantra under a services agreement discussed in Note 14.For the three-month period ended September 30, 2006 engineering costsclassified as costs of revenue associated with wholesale traffic of $34,968decreased 44.7% as compared to the same period in fiscal 2005, and engineeringcosts classified as costs of revenue associated with wholesale traffic for thenine-month period ended September 30, 2006 of $140,560 decreased 32.2% comparedto the same period in fiscal 2005.  Boththree and nine month decreases in engineering costs associated with wholesaletraffic are primarily due to reductions in personnel costs.

Selling, general and administrative costs for thethree-month period ended September 30, 2006 were $5,501,623, an increase of21.3% over the $4,536,424 for the three-month period ended September 30, 2005.Selling, general and administrative costs for the nine-month period endedSeptember 30, 2006 were $12,398,107, an increase of 62.0% over the $7,654,878for the nine-month period ended September 30, 2005. During the three-monthperiod ended September 30, 2006, our most significant increase was theamortization of an intangible asset of $1,313,959 over the same period in 2005,which was offset by a non-cash reduction for the three months ended September30, 2006 over the same period in 2005 of $1.0 million due to the issuance of500,000 shares to NetYantra at $2.00 per share in 2005 as discussed in Note 13.  We also incurred increases in operationalexpenses due to the growing needs of the business, including compensation ofadditional employees and consultants, investment banking fees, and increasedtravel and entertainment expenses associated with our VoIP product offering,net of decreases in professional services, marketing, and repairs andmaintenance expenses.

During the nine-month period ended September 30, 2006,we incurred non-cash expenses of $1,875,000 as a result of the issuance ofcommon stock to a financial advisory firm as partial compensation for itsservices to us, $231,945 as a result of the issuance of a warrant to afinancial advisory firm as partial compensation for its services to us, and$410,845 as a result of the issuance of a warrant to the lender as partialcompensation for the revolving credit facility described in Note 9, which wasfully repaid during the nine-month period ended September 30, 2006. We alsoexperienced an increase in amortization of an intangible asset of $1,313,959over the same period in 2005, offset by a non-cash reduction for the ninemonths ended September 30, 2006 over the same period in 2005 of $1.0 milliondue to the issuance of 500,000 shares to NetYantra at $2.00 per share in 2005as discussed in Note 13. In addition, we incurred increases in expenses for thenine-month period ended September 30, 2006 associated with our periodic publiccompany filing requirements including professional and consulting fees, publicand investor relations fees, public company recordkeeping costs, insurance, andprinting. We also incurred increases in operational expenses due to the growingneeds of the business including compensation of additional employees andconsultants, expenses relating to maintenance and support agreements ofpurchased telecommunications equipment, marketing and engineering activitiesrelated to our VoIP product offering, increased rental costs for ourfacilities, and fees for the establishment of a credit facility, net of adecrease in investment banking fees and in travel and entertainment expenses.

During the three- and nine-month periods endedSeptember 30, 2006, we incurred research and development costs of $98,016 and$167,561, respectively.  During thethree- and nine-month periods ended September 30, 2005, there were no researchand development costs incurred.  Researchand development costs, primarily personnel costs, relate to softwaredevelopment of potential products expected to be offered to our current andprospective customers.

Interest expense, net for the three-month period endedSeptember 30, 2006 of $304,055 decreased 31.8% compared to $445,778 for thethree-month period ended September 30, 2005. Interest expense, net for thenine-month period ended September 30, 2006 of $917,931 increased 6.3% over the$863,539 for the nine-month period ended September 30, 2005. During thethree-month period ended September 30, 2006 interest expense, net decreasedover the respective period in fiscal 2005 primarily due to a lower level of

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debt asthe result of $2.1 million of convertible debentures being converted in late2005, and an increase in interest income earned on cash balances from therevolving credit facility described in Note 9 and from proceeds obtained fromthe stock and warrant purchase agreement described in Note 15.  During the nine-month period ended September30, 2006 the increase in interest expense, net is attributable to interestexpense on the revolving credit facility described in Note 9, together withincreased convertible debenture interest due to the debentures beingoutstanding for the entire nine-month period ended September 30, 2006.

The non-cash expense for employee compensation forstock options for the three-month periods ended September 30, 2006 andSeptember 30, 2005 was $1,942,906 and $1,802,459, respectively.  The non-cash expense for employeecompensation for stock options for the nine-month periods ended September 30,2006 and September 30, 2005 was $2,273,077 and $2,199,459, respectively.  The non-cash expense for non-employeecompensation for stock options for the three-month periods ended September 30,2006 and September 30, 2005 was $375,993 and $367,437, respectively.  The non-cash expense for non-employeecompensation for stock options for the nine-month periods ended September 30,2006 and September 30, 2005 was $421,172 and $367,437, respectively.

       For the three-month period ended September30, 2006, we incurred a net loss of $6,202,827 or $0.10 net loss per commonshare, basic and diluted.  For thenine-month period ended September 30, 2006, we incurred a net loss of$13,900,998 or $0.30 net loss per common share, basic and diluted.

**Liquidity And Capital Resources**

As of September 30, 2006, we had cash and cashequivalents of approximately $547,000 and a working capital deficit ofapproximately $811,000. This represents a decrease in cash and cash equivalentsof approximately $6,000 from December 31, 2005 and an increase in the workingcapital deficit of approximately $469,000 from that at December 31, 2005. Sinceour inception through September 30, 2006, we have generated losses ofapproximately $30,478,000. Accounts receivable were approximately $169,000 atSeptember 30, 2006, an increase of approximately $39,000 from December 31,2005. Accounts payable and accrued liabilities at September 30, 2006 increasedapproximately $719,000 from December 31, 2005.

We have made cash expenditures for capital equipmentfrom our inception until September 30, 2006 of approximately $11,637,000, inconnection with the purchase of telecommunications equipment necessary to beginour business.

On May 22, 2006, we entered into a stock and warrantpurchase agreement with 23 accredited investors whereby we sold 16,300,000units. Each unit consists of one share of our common stock and eight-tenths ofone warrant to acquire one share of common stock and was sold at a purchaseprice of $1.00 per unit. In exchange for the units sold, we received gross cashproceeds of $16,300,000. The warrants are exercisable until May 2011 at anexercise price of $1.00 per share.

The exercise price of these warrants is subject toadjustment in the event of certain issuances of new securities. Except in thecase of certain designated issuances, if we issue shares of common stock orcommon stock equivalents (i.e., securities convertible into, or exercisable orexchangeable for, shares of our common stock) at a price per share (or in thecase of common stock equivalents, a conversion, exercise or exchange price pershare) below the then applicable exercise price of the warrants, the exerciseprice will be reduced to that lower price per share.  Upon each such adjustment, the number ofshares for which the warrants are exercisable shall be adjusted to the numberof shares determined by multiplying the exercise price in effect immediatelyprior to such adjustment by the number of shares for which the warrants areexercisable immediately prior to such adjustment and dividing the productthereof by the exercise price resulting from such adjustment. Issuances thatwill not result in adjustment to the exercise price include issuances toemployees, directors or officers pursuant to a stock or option plan adopted byour board of directors, the issuance of common stock upon the exercise orconversion of other securities outstanding prior to the date of issuance of thewarrants, the issuance of warrants to the placement agent and the issuance ofcommon stock upon exercise of the placement agent’s warrants.

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CRT Capital Group LLC (“CRT”) acted as the placementagent in connection with the offering. The aggregate commissions payable to CRTin connection with the private placement were approximately $978,000. Inaddition, we issued warrants to the placement agent to purchase 1,467,000shares of common stock at an exercise price of $1.00, which may be exercisedthrough May 22, 2009. These warrants contain a cashless exerciseprovision.  In the event these warrantsare exercised pursuant to the cashless exercise provision, we would receive noproceeds from the issuance of our common stock in connection with suchexercise. The exercise price is subject to adjustment (as defined in thewarrant) in the event of certain issuances of new securities. Upon each suchadjustment of the exercise price under the warrant, the number of shares ofcommon stock acquirable upon exercise of the warrant shall be adjusted to thenumber of shares determined by multiplying the exercise price in effectimmediately prior to such adjustment by the number of shares of Common Stockacquirable upon exercise of the warrant immediately prior to such adjustmentand dividing the product thereof by the exercise price resulting from suchadjustment. In the event of such an adjustment, the number of shares for whichthe warrants are exercisable will be increased such that the aggregate exerciseprice of the warrants after the adjustment will equal the aggregate exerciseprice immediately prior to the adjustment. Issuances that will not result inadjustment to the exercise price include issuances to employees, consultants,directors or officers pursuant to a stock or option plan adopted by our boardof directors, securities issued upon conversion of other securities outstandingprior to the date of issuance of the warrants, warrants issued in connectionwith obtaining bank financing, common stock issued in connection with thesettlement of claims up to an aggregate of 500,000 shares, and securitiesissued in connection with acquisitions, joint ventures or other strategictransactions.

We realized net proceeds from the sale of units, afterdeducting placement agent fees and expenses, of approximately $15.2 million. Weused a portion of these proceeds to purchase the software and intellectualproperty rights of NetYantra’s V-Cube IP-PBX platform as described below ($8.8million); paid the outstanding principal, interest and fees related to therevolving credit agreement with Indigo Investments I LLC described in Note 9($1.5 million); and paid the outstanding principal and interest related to apromissory note for equipment ($0.8 million). We will need to obtain additional financing in order to sustain ouroperations.

On May 1, 2006, we executed and delivered an AssetPurchase Agreement with NetYantra relating to the V-CubeTM IP-PBX softwareplatform. On June 7, 2006, we completed the acquisition of the V-CubeTM IP-PBXsoftware and related intellectual property for $8.8 million in cash and10,068,833 shares of common stock, with the remaining 3,931,167 shares ofcommon stock being issued on July 19, 2006, as permitted by the secondamendment to the purchase agreement.  Theterms of this agreement are described in Note 14.

As of September 30, 2006, we have $6,300,000 principalamount of 8% convertible debentures outstanding, out of the original $8,400,000principal amount issued in March 2005. For financial reporting purposes, the remaining principal of $6,300,000has been reduced by unamortized debt discount of approximately $574,000. Thedebentures accrue interest daily at a rate of 8% per annum, which interest ispayable quarterly on each March 31, June 30, September 30 and December 31following the issue date. The final interest payment is due on the date ofmaturity of the debentures, the third anniversary of the issue date. Inaddition, on any date on which all or a portion of the principal of a debentureis converted, all unpaid interest having accrued on such principal at the timeof such conversion will become immediately payable. We are not permitted to prepayany portion of the principal amount of any of the debentures without the priorconsent of the holder thereof.

The debentures are convertible at the option of theholders into shares of our common stock at any time at an initial conversionprice of $0.75 per share. Except in the case of certain designated issuances,in the event we issue shares of common stock or common stock equivalents (i.e.,securities convertible into, or exercisable or exchangeable for, shares of ourcommon stock) at a price per share (or in the case of common stock equivalents,a conversion, exercise or exchange price per share) below the then applicableconversion price of the debentures, the conversion price of the debentures willbe reduced to that lower price per share. Issuances that will not result inadjustment to the conversion price include issuances to employees, consultants,directors or officers pursuant to a stock or option plan adopted by our boardof directors, securities issued upon conversion of other securities outstandingprior to the date of issuance of

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thewarrants, warrants issued in connection with obtaining bank financing, commonstock issued in connection with the settlement of claims, and securities issuedin connection with acquisitions, joint ventures or other strategictransactions.

We have agreed to certain restrictions under the termsof the debentures, including a prohibition on the payment of cash dividends toour stockholders while any of the debentures are outstanding. Upon theoccurrence of an event of default under the debentures, an amount equal to (i)130% of the then outstanding principal amount, plus any accrued and unpaidinterest thereon, or (ii) the product of the then outstanding principal amount,plus any accrued and unpaid interest thereon, times the ratio obtained bydividing the conversion price of the debentures and the market price of ourcommon stock, whichever is greater, will, at the holder’s option, becomeimmediately due and payable in cash along with any other amounts, costs, expensesor liquidated damages then due in respect of such debentures. The ratioreferred to in clause (ii) is to be calculated based on the conversion price ineffect on the date of such default or the date the accelerated amount is paidin full (whichever is less), and the market price of our common stock on thedate of such default or the date the accelerated amount is paid in full(whichever is greater, such market price to be determined in accordance withthe terms of the debenture). Upon an event of a default, the interest rate onthe debentures will also be increased to 18% per annum.

Events of default under the debentures include failureto pay any amounts under the debentures when due, a material default under ourother agreements with the investors or default in our obligations undermortgage, credit facility or similar agreements, a material inaccuracy in therepresentations and warranties we made to the investors in connection with theconvertible debenture and warrant financing, and the initiation of voluntary orinvoluntary bankruptcy proceedings against us.

Through September 30, 2006, $2,100,000 in outstandingprincipal amount of convertible debentures has been converted into 2,799,993shares of common stock, reducing the amount of interest required to be paid infuture periods.

The common stock purchase warrants issued to theinvestors are exercisable at an initial exercise price of $1.00. The warrantshave an expiration date of five years after the date of issuance. They containa cashless exercise provision whereby the holder may pay the exercise price byhaving us withhold upon exercise shares having a fair market value equal to theapplicable aggregate exercise price if after the first anniversary of the dateof issuance of the warrant there is no effective registration statementregistering, or no current prospectus available for, the resale of the sharesissuable upon the exercise of the warrants. In the event this provision is usedwith respect to an exercise, we would receive no proceeds from the sale of ourcommon stock in connection with such exercise. The warrants were initiallyexercisable for an aggregate 8,400,000 shares of our common stock. As ofSeptember 30, 2006, we had issued 3,190,499 shares upon exercise of warrants,all in connection with the warrant exercise agreements described below. Theexercise price is subject to adjustment in the event of certain issuances ofnew securities. Specifically, except in the case of certain designatedissuances, if we issue shares of common stock or common stock equivalents(i.e., securities convertible into, or exercisable or exchangeable for, sharesof our common stock) at a price per share (or in the case of common stockequivalents, a conversion, exercise or exchange price per share) below the thenapplicable exercise price of the warrants, the exercise price of the warrantswill be reduced to that lower price per share. In the event of such anadjustment, the number of shares for which the warrants are exercisable will beincreased such that the aggregate exercise price of the warrants after theadjustment will equal the aggregate exercise price immediately prior to theadjustment. Issuances that will not result in adjustment to the exercise priceinclude issuances to employees, consultants, directors or officers pursuant toa stock or option plan adopted by our board of directors, securities issuedupon conversion of other securities outstanding prior to the date of issuanceof the warrants, warrants issued in connection with obtaining bank financing,common stock issued in connection with the settlement of claims, and securitiesissued in connection with acquisitions, joint ventures or other strategictransactions.

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 warrant, which expires on March 4, 2010, is onsubstantially the same terms as the warrants issued to the investors in theprivate placement.

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We have registered for resale under the Securities Actthe shares underlying the debentures and warrants pursuant to a registrationstatement on Form SB-2, as amended, (File No. 333-123815). The registrationstatement was declared effective on May 3, 2005.

In October 2005, we entered into several WarrantExercise Agreements with holders of warrants issued in the private placementthat closed in the first quarter of 2005. Pursuant to these agreements, weissued to these holders new common stock purchase warrants exercisable for anumber of shares equal to the number of shares they purchased upon exercise ofthe warrants issued to them in the private placement. These new warrants havean exercise price of $1.50 per share. We received aggregate proceeds of$3,190,499 in connection with the exercise of the prior warrants, and issuednew warrants, which expire five years after the issue date, to purchase anaggregate of 3,190,499 shares of our common stock (plus an additional warrant,which expires five years after the issue date, to purchase 159,525 shares ofcommon stock to a placement agent who assisted with the transaction). Theshares of common stock underlying these warrants have been registered forresale with the Securities and Exchange Commission pursuant to a registrationstatement on Form SB-2 (File No. 333-130808). This registration statement wasdeclared effective on January 31, 2006.

We expect that we will need to raise additional debtor equity financing to pay the required interest and principal payments underthe convertible debentures issued in our private placement.

On May 23, 2006, we paid the remaining principalamount ($770,000) and any unpaid interest originally payable pursuant to apromissory note for an aggregate principal amount of $1,170,000 issued in March2005 in connection with our purchase of certain telecommunications equipment(including two Sonus Networks switches) from MRS.

We do not believe that our available cash and cashequivalents, including the cash proceeds from the recently completed privateplacement described above, will be sufficient to meet our working capitalrequirements, including the funding of operating losses, and capitalexpenditure requirements for our next fiscal year. Previously, our primarysources of capital have been the revenues generated from interconnectagreements with our customers, debt and equity financings, and advances made byone of our principal stockholders from a credit facility established in thename of the stockholder and other of the stockholder’s personal assets.

In the event that we do not succeed in implementingour business plan, and do not otherwise raise additional third-party capital,we will have to curtail certain expenditures, seek additional financing fromour principal stockholder, or both in order to sustain operations. As notedabove, the principal stockholder has historically provided working capitaladvances. While the stockholder is not obligated to provide these workingcapital advances to us, we expect the stockholder to continue providing fundsfor operations 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.

** **

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**Other Arrangements and Obligations**

On December 13, 2005, we entered into a Consultant,Representative and Professional Services Agreement with QuestTelecommunications, Inc. (“Quest”). Under this agreement, we have appointedQuest as an independent advisor and our exclusive representative in thegeographic areas of Vietnam, Cambodia, Malaysia and Turkey (and any other areasto which we and Quest agree in writing). Within these geographic areas, Questwill (i) assist in structuring and establishing business relationships,including introducing us and the V-CubeTM IP-PBX software platform to potentialpartners, distributors, licensees and/or purchasers, and (ii) provide projectmanagement services relating to business operations, including developingrevenue targets, establishing technical support capability, facilitatingtechnical support delivery, and monitoring license fee reconciliation. Questwill also act as our agent for the V-CubeTM to consumers from, but residingoutside, the geographic area covered by this agreement (except for consumersresiding in territories for which we or any of our affiliates have granted orhereafter grant exclusive distribution or agency rights). Under this agreement,we paid Quest $50,000 in consideration for Quest’s assistance relating to theexecution by us and Saigon Post and Telecommunications Services Corporation (“SPT”)of a memorandum of understanding and pilot license agreement with respect tothe V-CubeTM. The memorandum of understanding, which we entered into onSeptember 20, 2005, contemplates that, following legal and technical evaluationof the V-CubeTM platform by SPT, SPT and the Company will negotiate and enterinto an agreement with respect to the deployment and commercialization of theV-CubeTM platform in Vietnam. The pilot license agreement, which we entered intoon October 15, 2005, permitted SPT to use the V-CubeTM platform for evaluationand testing purposes on a royalty-free basis from November 15, 2005 throughFebruary 15, 2006. We entered into a distribution and marketing agreement withSPT with respect to the V-CubeTM on July 3, 2006.  Upon signing this agreement, we are obligatedto issue to Quest 300,000 shares of our common stock and to pay to Quest$150,000 in cash, plus a continuing commission of thirty percent of the licensefees we receive from SPT in connection with the licensing and distribution ofthe V-CubeTM in the above-mentioned geographic areas (net of sales, use andvalue added taxes, if any, payable by us in connection with such license fees).

On January 27, 2006, we entered into a FinancialAdvisory Agreement (the “Agreement”) with Indigo Ventures LLC (“Indigo”) inwhich we agreed to appoint Indigo as our financial advisor to advise, consultwith, and assist us in various matters which may include:

·                  areview of our business, operations and financial condition, including advisingus on capitalization structures;

·                  advicerelating to general capital raising matters;

·                  recommendationsrelating to specific business operations, transactions and joint ventures;

·                  adviceregarding future financings involving our or any of our affiliates’ debt or equitysecurities; and

·                  assistancein connection with the due diligence review of any significant acquisitiontransactions proposed by us during the term of the agreement.

In consideration for these services, we have agreed topay Indigo a cash fee of $20,000 per month in arrears, increasing to $30,000per month beginning in the first month following the consummation by us of asignificant debt or equity financing from which we obtain gross proceeds of atleast $5 million. Following the May 2006 financing described in Note 15, themonthly cash fee payable to Indigo increased to $30,000.  Also, we issued to Indigo 1,500,000restricted shares of our common stock, which shares vested on May 22, 2006 uponthe closing of the financing described in Note 15. The shares we issued toIndigo are restricted shares and may not be sold, assigned or transferred byIndigo for a one (1) year period beginning on January 27, 2006 and ending on January27, 2007. If we terminate the Agreement as a result of a material breach ofthis Agreement by Indigo, we will have the right and option to repurchase fiftypercent (50%) of all of the then unvested shares at a purchase price of $0.001per share.

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*Guaranty of Vistula Limited.  *One of our subsidiaries,Vistula, had agreed to unconditionally guarantee the obligations of one of ourprincipal stockholders under a $3,000,000 credit facility established in thename of the stockholder. This guarantee was released by the financialinstitution on March 27, 2006.

**Item 3.****   Controls andProcedures.**

Evaluationof Disclosure Controls and Procedures

Based on Company management’s evaluation (with theparticipation of the Company’s principal executive officer and principalfinancial officer), as of the end of the period covered by this report, theCompany’s principal executive officer and principal financial officer haveconcluded that the Company’s disclosure controls and procedures (as defined inRules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended, (the “Exchange Act”)) are effective to ensure that informationrequired to be disclosed by the Company in reports that it files or submitsunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in Securities and Exchange Commission rules andforms.

It should be noted that any system of controls,however well designed and operated, can provide only reasonable, and notabsolute, assurance that the objectives of the system are met. In addition, thedesign of any control system is based in part upon certain assumptions aboutthe likelihood of future events. Because of these and other inherentlimitations of control systems, there can be no assurance that any design willsucceed in achieving its stated goals under all potential future conditions,regardless of how remote.

Changesin Internal Control over Financial Reporting

The Company’s management, in connection with itsevaluation of internal controls (with the participation of the Company’sprincipal executive officer and principal financial officer), did not identifyany change in internal control over the financial reporting process thatoccurred during the Company’s third fiscal quarter of 2006 that would havematerially affected, or would have been reasonably likely to materially affect,the Company’s internal control over financial reporting.

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**PART II.                OTHER INFORMATION**

**Item1:  Legal Proceedings**

None.

**Item2.  Unregistered Sales of EquitySecurities**

None.

**Item3.  Defaults Upon Senior Securities**

None.

**Item4.  Submission of Matters to a Vote ofSecurity Holders**

We held our Annual Meetingof Stockholders at the offices of Foley Hoag LLP, 155 Seaport Boulevard,Boston, Massachusetts on July 17, 2006.

(i)            Thestockholders elected five directors to serve until the next Annual Meeting ofStockholders. The stockholders present in person or by proxy cast the followingnumbers of votes in connection with the election of directors, resulting in theelection of all nominees:

| Nominee               | ** ** | **Votes For** | ** ** | **Votes  Withheld** | ** ** |
|-----------------------|------------|---------------|------------|---------------------|------------|
| Rupert Galliers-Pratt |       | 44,614,649    |       | 0                   |       |
| J. Marcus Payne       |       | 44,614,649    |       | 0                   |       |
| Anthony Warrender     |       | 44,614,649    |       | 0                   |       |
| John Keith Markley    |       | 44,579,649    |       | 35,000              |       |
| Jack Early            |       | 44,614,649    |       | 0                   |       |

 

(ii)           Thestockholders of the Company approved an amendment to the Company’s Certificateof Incorporation to increase to 200,000,000 the number of shares of commonstock, par value $.001, the Company is authorized to issue (the “Amendment”).There were 44,358,649 votes cast for the proposal; 256,000 votes were castagainst the proposal; 0 votes abstained; and there were no broker non-votes.The Amendment became effective on July 18, 2006 upon the filing of theAmendment with the Delaware Secretary of State’s office.

(iii)          Thestockholders of the Company ratified an amendment to the Company’s 2004 StockIncentive Plan to increase the number of shares available for issuancethereunder to 20,000,000 shares.  Therewere 40,062,707 votes cast for the proposal; 259,500 votes were cast againstthe proposal; 0 votes abstained; and there were no broker non-votes.

(iv)          Thestockholders ratified the appointment of PKF, Certified Public Accountants, AProfessional Corporation, as the Company’s independent registered publicaccounting firm for the 2006 fiscal year. There were 44,614,649 votes cast forthe proposal; 0 votes were cast against the proposal; 0 votes abstained; andthere were no broker non-votes.

**Item5.  Other Information**

** **None.

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**Item 6. Exhibits**

**     (a) Exhibits.**
|                     | ** ** | ** **                                                                                                                                                                                                                                             | ** ** | ** **                        | ** ** | **Incorporated by Reference** |
|---------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------|------------|-------------------------------|
| **Exhibit  Number** | ** ** | **Exhibit Description**                                                                                                                                                                                                                           | ** ** | **Filed with  this Form  10-QSB** | ** ** | **Form**                      | ** ** | **Filing Date** | ** ** | **Exhibit No.** |
| 3.1                 |       | Certificate of Incorporation filed with the Delaware  Secretary of State on September 22, 2003                                                                                                                                                         |       |                              |       | Form 10-SB                    |   | May 12, 2004 |   | 3.1 |
| 3.2                 |       | Certificate of Amendment of Certificate of  Incorporation filed with the Delaware Secretary of State on January 23, 2004                                                                                                                               |       |                              |       | Form 10-SB                    |   | May 12, 2004 |   | 3.2 |
| 3.3                 |       | Certificate of Amendment of Certificate of  Incorporation filed with the Delaware Secretary of State on March 4, 2004                                                                                                                                  |       |                              |       | Form 10-SB                    |   | May 12, 2004 |   | 3.3 |
| 3.4                 |       | Certificate of Amendment of Certificate of  Incorporation filed with the Delaware Secretary of State on July 18, 2006                                                                                                                                  |       |                              |       | Form 8-K                      |   | July 20, 2006 |   | 3.1 |
| 3.5                 |       | Bylaws adopted on September 22, 2003                                                                                                                                                                                                                   |       |                              |       | Form 10-SB                    |   | May 12, 2004 |   | 3.4 |
| 10.1                |       | Amended and Restated 2004 Stock Incentive Plan                                                                                                                                                                                                         |       |                              |       | DEF 14A                       |   | June 27, 2006 |   |   |
| 10.2                |       | Amendment to Employment Agreement of John Keith  Markley dated August 1, 2006                                                                                                                                                                          |       |                              |       | Form 8-K                      |   | August 3, 2006 |   | 10.1 |
| 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.                        |       | X                                 |       |                          |   |   |   |   |
| 31.2                |       | Certification by Jared P. Taylor 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.                              |       | X                                 |       |                          |   |   |   |   |
| 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. |       | X                                 |       |                          |   |   |   |   |
| 32.2                |       | Certification by Jared P. Taylor pursuant to  Section 1350, Chapter 63 of Title 18, United States Code, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, relating to  Vistula Communications Services, Inc.       |       | X                                 |       |                          |   |   |   |   |

 

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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: November 14, 2006 | By:                                   | /s/ Rupert Galliers-Pratt |
|                    |                                  | Rupert Galliers-Pratt |
|                    |                                  | Chief Executive Officer |

 

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