10QSB
      1
      a06-9960_110qsb.htm QUARTERLY REPORT PURSUANT TO SECTIONS 13 OR 15(D)




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


**Washington,
      D.C. 20549**




**FORM 10-QSB**




**(Mark
      One)**




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




**For
      the quarterly period ended: March 31, 2007**




**OR**




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




**For
      the transition period from __________ to
      __________**




**Commission
      File Number 000-50758**





**VISTULA
      COMMUNICATIONS SERVICES, INC.**


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




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




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




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




As
      of
      May 18, 2007, there were 66,964,898 shares of common stock, $0.001 par
      value, of the registrant issued and outstanding.




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









**VISTULA
      COMMUNICATIONS SERVICES, INC.**




**FORM 10-QSB**




**FOR
      THE THREE MONTHS ENDED MARCH 31, 2007**


Table
        of
Contents
  Facing
                  PagePART
                  I.
              FINANCIAL
                  INFORMATION(*):
              3Item
                  1.
              Financial
                  Statements
              3Consolidated
                  Balance Sheets as of March 31, 2007 (unaudited) and December 31,
                  2006
              3Consolidated
                  Statements of Operations for the Three Months ended March 31, 2007
                  and
                  March 31, 2006 (unaudited)
              4Consolidated
                  Statements of Stockholders’ Equity for the Three Months ended March 31,
                  2007 (unaudited)
              5Consolidated
                  Statements of Cash Flows for the Three Months ended March 31, 2007
                  and
                  March 31, 2006 (unaudited)
              6Notes
                  to Unaudited Consolidated Financial Statements
              7Item
                  2.
              Management’s
                  Discussion and Analysis of Financial Condition and Results of
                  Operations
              21Item
                  3.
              Controls
                  and Procedures
              35PART
                  II.
              OTHER
                  INFORMATION
              35Item
                  5.
              Other
                  Events
              36Item
                  6.
              Exhibits
              36SIGNATURES
              
              37





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




2




**PART I.
      FINANCIAL INFORMATION**




**Item
      1. Financial Statements.**




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


Consolidated
      Balance Sheets as of March 31, 2007 and


December 31,
      2006




**March 31,**
              **2007**
            
            **December 31,**
              **2006****(unaudited)**
            
            **(audited)****ASSETS**Current
                assets:Cash
                and cash equivalents
            
            $
            1,880
            
            $
            195,223Accounts
                receivable
            
            
            185,554
            
            
            157,517Prepaid
                expenses and other current assets
            
            
            371,621
            
            
            313,352Assets
                held for sale
            
            
            —
            
            
            110,527Total
                current assets
            
            
            559,055
            
            
            776,619Property
                and equipment, net
            
            
            399,503
            
            
            444,999Deferred
                financing costs
            
            
            259,660
            
            
            330,476Intangible
                assets
            
            
            24,212,021
            
            
            25,629,870Other
                assets
            
            
            20,289
            
            
            20,254Total
                Assets
            
            $
            25,450,528
            
            $
            27,202,218**LIABILITIES
                AND STOCKHOLDERS’ EQUITY**Current
                liabilities:Accounts
                payable
            
            $
            1,633,071
            
            $
            1,039,875Accrued
                expenses
            
            
            2,043,602
            
            
            1,379,113Shares
                subject to put option
            
            
            2,500,000
            
            
            2,500,000Deferred
                revenue
            
            
            —
            
            
            160,685Convertible
                promissory note to related party
            
            
            175,000
            
            
            175,000Notes
                payable
            
            
            163,542
            
            
            204,073Convertible
                debentures
            
            
            5,936,911
            
            
            —Total
                current liabilities
            
            
            12,452,126
            
            
            5,458,746Convertible
                debentures
            
            
            —
            
            
            5,830,634Total
                liabilities
            
            
            12,452,126
            
            
            11,289,380Stockholders’
                equity:Preferred
                stock, $0.001 par value, 10,000,000 shares authorized; no shares
                issued
                and outstanding
            
            
            —
            
            
            —Common
                stock, $0.001 par value, 200,000,000 shares authorized, 66,964,898
                shares
                issued and outstanding
            
            
            66,964
            
            
            66,964Additional
                paid-in capital
            
            
            52,447,461
            
            
            52,089,738Accumulated
                deficit
            
            
            (39,375,264
            )
            
            (36,107,104
            )Cumulative
                translation adjustment
            
            
            (140,759
            )
            
            (136,760
            )Total
                stockholders’ equity
            
            
            12,998,402
            
            
            15,912,838Total
                Liabilities and Stockholders’ Equity
            
            $
            25,450,528
            
            $
            27,202,218




See
      accompanying notes to unaudited consolidated financial statements.




3




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


Consolidated
      Statements of Operations for the


Three
      Months ended March 31, 2007 and 2006




**Three Months Ended**
              **March 31,****2007**
            
            **2006****(unaudited)**
            
            **(unaudited)**Revenues:Telecommunications
            
            $
            51,936
            
            $
            319,419Contracted
                services
            
            
            234,539
            
            
            —Total
                revenues
            
            
            286,475
            
            
            319,419Cost
                of revenues:Telecommunications
            
            
            103,148
            
            
            351,513Contracted
                services
            
            
            131,192
            
            
            —Total
                cost of revenues
            
            
            234,340
            
            
            351,513Gross
                margin (loss)
            
            
            52,135
            
            
            (32,094
            )Operating
                expenses:Selling,
                general and administrative expenses
            
            
            1,461,476
            
            
            3,734,401Depreciation
                and amortization
            
            
            1,482,166
            
            
            27,555Research
                and development
            
            
            65,971
            
            
            78,624Total
                operating expenses
            
            
            3,009,613
            
            
            3,840,580Loss
                from operations
            
            
            (2,957,478
            )
            
            (3,872,674
            )Interest
                expense, net
            
            
            (310,682
            )
            
            (315,103
            )Net
                loss
            
            $
            (3,268,160
            )
            $
            (4,187,777
            )Weighted-average
                basic and diluted shares outstanding
            
            
            66,964,898
            
            
            33,339,898Basic
                and diluted net loss per common share
            
            $
            (0.05
            )
            $
            (0.13
            )




See
      accompanying notes to unaudited consolidated financial statements.




4


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


Consolidated
      Statements of Stockholders’ Equity for the


Three
      Months ended March 31, 2007


(unaudited)




**Common Stock**
            
            **Additional**
              **Paid-in**
            
            **Accumulated**
            
            **Cumulative**
              **Translation**
            
            **Total**
              **Stockholders’**
            
            **Comprehensive****Shares**
            
            **Amount**
            
            **Capital**
            
            **Deficit**
            
            **Adjustment**
            
            **Equity**
            
            **Loss**Balance,
                December 31, 2006
            
            
            66,964,898
            
            $
            66,964
            
            $
            52,089,738
            
            $
            (36,107,104
            )
            $
            (136,760
            )
            $
            15,912,838Amortization
                of stock compensation
            
            
            
            
            
            
            
            
            357,723
            
            
            
            
            
            
            
            
            357,723Net
                loss
            
            
            
            
            
            
            
            
            
            
            
            (3,268,160
            )
            
            
            
            
            (3,268,160
            )
            $
            (3,268,160
            )Change
                in cumulative translation adjustment
            
            
            
            
            
            
            
            
            
            
            
            
            
            
            (3,999
            )
            
            (3,999
            )
            
            (3,999
            )Balance,
                March 31, 2007
            
            
            66,964,898
            
            $
            66,964
            
            $
            52,447,461
            
            $
            (39,375,264
            )
            $
            (140,759
            )
            $
            12,998,402
            
            $
            (3,272,159
            )




See
      accompanying notes to unaudited consolidated financial statements.




5


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


Consolidated
      Statements of Cash Flows for the


Three
      Months ended March 31, 2007 and 2006




**Three Months Ended March 31,****2007**
            
            **2006****(unaudited)**
            
            **(unaudited)**Cash
                flows from operating activities:Net
                loss
            
            $
            (3,268,160
            )
            $
            (4,187,777
            )Adjustments
                to reconcile net loss to net cash (used in) operating
                activities:Depreciation
                and amortization
            
            
            1,482,166
            
            
            128,865Non-cash
                expense pursuant to financial advisory agreement
            
            
            —
            
            
            1,875,000Non-cash
                compensation expense
            
            
            357,723
            
            
            82,766Non-cash
                interest expense
            
            
            177,093
            
            
            169,697Company
                expenses paid by stockholder recorded as due to
                stockholder
            
            
            —
            
            
            75,000Changes
                in assets and liabilities:(Increase)
                decrease in:Accounts
                receivable
            
            
            (25,083
            )
            
            (692
            )Prepaid
                expenses and other current assets
            
            
            31,689
            
            
            352,721Increase
                (decrease) in:Accounts
                payable
            
            
            611,610
            
            
            295,455Accrued
                expenses
            
            
            638,189
            
            
            29,375Deferred
                revenue
            
            
            (156,359
            )
            
            —Net
                cash used in operating activities
            
            
            (151,132
            )
            
            (1,179,590
            )Cash
                flows from investing activities:Purchases
                of property and equipment
            
            
            —
            
            
            (55,010
            )Net
                cash used in investing activities
            
            
            —
            
            
            (55,010
            )Cash
                flows from financing activities:Payment
                on notes payable
            
            
            (40,719
            )
            
            (100,000
            )Proceeds
                from revolving credit agreement
            
            
            —
            
            
            1,000,000Proceeds
                from exercise of stock options
            
            
            —
            
            
            75,000Payments
                on due to stockholder
            
            
            —
            
            
            (75,000
            )Net
                cash (used in) provided by financing activities
            
            
            (40,719
            )
            
            900,000Effect
                of exchange rates on cash
            
            
            (1,492
            )
            
            2,807Net
                decrease in cash and cash equivalents
            
            
            (193,343
            )
            
            (331,793
            )Cash
                and cash equivalents, beginning of period
            
            
            195,223
            
            
            553,127Cash
                and cash equivalents, end of period
            
            $
            1,880
            
            $
            221,334**Supplemental
                disclosure of cash flow information:**Cash
                paid for interest
            
            $
            5,201
            
            $
            149,838Cash
                paid for taxes
            
            $
            —
            
            $
            —**Supplemental
                disclosure of non-cash investing and financing
                activities:**Assets
                held for sale in exchange for prepaid services
            
            $
            92,116
            
            $
            —Issuance
                of common stock pursuant to financial advisory agreement
            
            $
            —
            
            $
            1,875,000




See
      accompanying notes to unaudited consolidated financial statements.




6




**VISTULA
      COMMUNICATIONS SERVICES, INC.**




**NOTES
      TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS**


**March 31,
      2007**




**(1)          
      Basis of Presentation**




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




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




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




*Going
      Concern*




The
      report of the Company’s independent registered public accounting firm on its
      audited consolidated financial statements as of December 31, 2006 and for
      the year then ended included a discussion on the Company’s ability to continue
      as a going concern. The consolidated financial statements shown for the period
      ended March 31, 2007, have been prepared on a going concern basis which
      contemplates the realization of assets and the satisfaction of liabilities
      in
      the normal course of business. As shown in the accompanying consolidated
      financial statements, the Company incurred a net loss of $3,268,160 for the
      period ended March 31, 2007 and had an accumulated deficit of $39,375,264
      at March 31, 2007. Further, the Company had cash of $1,880 and a working
      capital deficit at March 31, 2007 of $11,893,071. These factors among
      others may indicate that the Company will be unable to continue as a going
      concern.




The
        consolidated financial statements do not include any adjustments relating
        to the
        recoverability of assets and satisfaction of liabilities that might be necessary
        should the Company be unable to continue as a going concern. The Company's
        continuation as a going concern is dependent upon its ability to generate
        sufficient cash flow to meet its obligations on a timely basis, to comply
        with
        the terms of its financing arrangements, to obtain additional financing as
        may
        be required, and ultimately to attain profitability. To address these issues
        in
        part, the Company raised $2,500,000 in gross proceeds on April 6, 2007, which
        has been used to satisfy a portion of the Company’s then outstanding payables
        and to fund working capital requirements for the launch of the V-CubeTM product
        through a United Kingdom distributor, Northamber PLC
        (“Northamber”). See Note 15 to the financial statements in Item 1 for a
        description of this convertible note and warrant financing. The Company remains
        dependent upon Northamber to meet its forecasted sales figures to its customers
        for the balance of 2007, in order to meet the Company’s cash needs during
        this period. However, the Company no longer expects to generate revenue from
        the
        Northamber arrangement in the second fiscal quarter of 2007. In order for
        Northamber to be successful in meeting the forecast it provided to the Company,
        the Company must be able to support the demand for large volumes of new user
        installations from Northamber and its customers. As discussed in the
        Liquidity and Capital Resources section of the Management Discussion and
        Analysis of Item 2 the Company still anticipates that the majority of the
        revenue for the final three fiscal quarters of 2007 will be derived from
        the
        Northamber distribution agreement and that the Company will be able to
        develop and implement cost controls and successfully negotiate significant
        reductions and delayed payments of material amounts owed to creditors, in
        order
        to conserve cash. The Company’s management is in the process of attempting to
        raise additional capital to remedy the now expected cash shortfall for the
        second fiscal quarter and anticipates the availability of this capital by
        the
        middle of June 2007. However, there is no assurance that the Company will
        be
        able to generate sufficient funds from the sales by the distributor, identify
        sufficient savings from its development and implementation of cost controls
        to
        conserve cash, nor is there any guarantee in the amount or timing of
        successfully closing on additional capital to continue as a going
        concern.





7


*Recent
      Accounting Pronouncements*





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





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





In
      June
      2006, the FASB issued FASB Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes -an interpretation of FASB Statement No.
      109* (FIN
      48). The interpretation contains a two-step approach to recognizing and
      measuring uncertain tax positions accounted for in accordance with SFAS No.
      109, *Accounting
      for Income Taxes* .
      The
      first step is to evaluate the tax position for recognition by determining if
      the
      weight of available evidence indicates that it is more likely than not that
      the
      position will be sustained on audit, including resolution of related appeals
      or
      litigation processes, if any. The second step is to measure the tax benefit
      as
      the largest amount which is more than 50% likely of being realized upon ultimate
      settlement. FIN 48 is effective as of the beginning of the first fiscal
      year beginning after December 15, 2006. The Company does not believe
      adoption of FIN 48 will have a material impact on the Company’s consolidated
      financial statements.





*Reclassification*





Certain
      amounts from the three-month period ended March 31, 2006 have been
      reclassified to conform with the current presentation.










8




**(2)          
      Stock-Based Compensation**




Effective
      January 1, 2006, the Company adopted the fair value recognition provisions
      of
      Statement of Financial Accounting Standards (“SFAS”) No. 123(R), *Share-Based
      Payment* (“SFAS
      123R”), using the modified-prospective-transition method. Under this transition
      method, compensation cost recognized for the period ended March 31, 2007
      includes: (a) compensation cost for all stock-based payments granted, but not
      yet vested as of January 1, 2006, based on the grant-date fair value estimated
      in accordance with the original provisions of SFAS No. 123, *Accounting
      for Stock Based Compensation* ,
      and (b)
      compensation cost for all stock-based payments granted subsequent to January
      1,
      2006, based on the grant-date fair value estimated in accordance with the
      provisions of SFAS 123R. For stock options granted to non-employees, the Company
      recognizes compensation expense in accordance with the requirements of Emerging
      Issues Task Force (“EITF”) No. 96-18, *Accounting
      for Equity Instruments That Are Issued to Other Than Employees for Acquiring,
      or
      in Conjunction with Selling, Goods or Services* .
      EITF
      96-18 requires that companies recognize compensation expense based on the
      estimated fair value of options granted to non-employees over their vesting
      period, which is generally the period during which services are rendered by
      such
      non-employees. The fair value of unvested non-employee stock awards is
      re-measured at the end of each reporting period.




*Stock
      Incentive Plan*




** In
      February 2004, the board of directors adopted the 2004 Stock Incentive Plan
      (the
“Plan”). The Plan initially covered 6,000,000 shares of the Company’s common
      stock issuable upon exercise of incentive stock options and non-statutory stock
      options and in connection with grants of restricted stock. The Plan was amended
      by the Board on June 3, 2005 to, among other things, increase the number of
      shares available for options or restricted stock grants from 6,000,000 to
      8,000,000. The shareholders of the Company approved the amendment to the Plan
      on
      July 14, 2005. On December 23, 2005, the board of directors approved an
      increase, from 8,000,000 to 15,000,000, in the number of shares of common stock
      authorized under the Plan, on April 11 and 12, 2006 the board of directors
      approved an additional increase, from 15,000,000 to 18,000,000, and on June
      21,
      2006 the board of directors approved an additional increase, from 18,000,000
      to
      20,000,000, in the number of shares of common stock authorized under the Plan.
      The shareholders of the Company ratified these amendments to the Plan on July
      17, 2006.




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




As
      a
      result of the adoption of SFAS 123R the Company recognized $357,723 in
      stock-based compensation expense for the three months ended March 31,
      2007.




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





**Three-months**
              **Ended**
              **March
                31, 2007**
            
            **Three-months**
              **Ended**
              **March
                31, 2006**Employee
                and director stock option grants:Selling,
                general and administrative
            
            $
            364,759
            
            $
            60,103Non-employee
                consultants stock option grants andrestricted
                stock awards:Selling,
                general and administrative *
            
            
            ($7,036
            )
            
            22,663Total
                stock-based compensation
            
            $
            357,723
            
            $
            82,766




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




9


The
      fair
      value of each stock award is estimated on the grant date using the Black-Scholes
      option-pricing model based on the assumptions noted in the following
      table:




**Three Months Ended**
              **March 31,****2007**
            
            **2006**Expected
                volatility
            
            
            80%
            
            
            80%Risk-free
                interest rate
            
            
            4.80%
            
            
            4.45%Expected
                life (years)
            
            
            5
            
            
            5Forfeitures
            
            
            0%
            
            
            0%Dividend
            
            
            None
            
            
            None




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




The
      Company is using the straight-line attribution method to recognize stock-based
      compensation expense. The amount of stock-based compensation recognized during
      a
      period is based on the value of the portion of the awards that are ultimately
      expected to vest. SFAS 123R requires forfeitures to be estimated at the time
      of
      grant and revised, if necessary, in subsequent periods if actual forfeitures
      differ from those estimates. The term “forfeitures” is distinct from
“cancellations” or “expirations” and represents only the unvested portion of the
      surrendered option. The Company has applied an annual forfeiture rate of 0%
      to
      all unvested options as of March 31, 2007 as the Company believes that
      forfeitures to date are not representative of likely future forfeitures. This
      analysis will be re-evaluated quarterly and the forfeiture rate will be adjusted
      as necessary. Ultimately, the actual expense recognized over the vesting period
      will be for only those shares that vest.




Using
      the
      Black-Scholes option-pricing model, the weighted average grant date fair value
      of options granted during the three months ended March 31, 2007 and 2006
      was $0.21 and $0.95, respectively.




A
      summary
      of stock option activity as of March 31, 2007, and changes during the
      three-month period then ended, is presented below:




**Options**
              **Outstanding**
            
            **Weighted-**
              **average**
              **Exercise Price**
            
            **Weighted-average**
              **Remaining**
              **Contracted Term in**
              **Years**
            
            **Aggregate**
              **Intrinsic**
              **Value**Outstanding
                at December 31, 2006
            
            
            11,712,300
            
            $
            1.24
            
            
            8.9
            
            $
            2,850Granted
            
            
            115,000Expired
            
            
            (201,250
            )Outstanding
                at March 31, 2007
            
            
            11,626,050
            
            $
            1.24
            
            
            8.7
            
            $
            900Exercisable
                at $0.05 at March 31, 2007
            
            
            15,000
            
            $
            0.05
            
            
            2.1
            
            $
            900Exercisable
                at $0.32 at March 31, 2007
            
            
            28,750
            
            $
            0.32
            
            
            9.9Exercisable
                at $0.45 at March 31, 2007
            
            
            1,727,000
            
            $
            0.45
            
            
            8.4Exercisable
                at $1.18 to $1.50 at March 31, 2007
            
            
            4,955,967
            
            $
            1.41
            
            
            8.8




10


The
      Company granted options to purchase up to 115,000 shares of common stock to
      certain officers and employees. All of the options have an exercise price of
      $0.32 per share which represents the closing price of the Company’s common stock
      on February 2, 2007 as reported on the Over the Counter Bulletin Board and
      an
      expiration date of February 5, 2017. The options were granted as compensation
      for employment. The options are immediately exercisable with respect to 25%
      of
      the total option shares purchasable thereunder. Thereafter, the options will
      vest and become exercisable for an additional 25% on the last day of each year
      after the date of grant, so that the options shall be fully vested on the third
      anniversary of the date of grant. All of the above options will accelerate
      in
      full upon a change of control. The options granted are evidenced by the
      Company’s standard form of the incentive stock option agreement.





There
      were no options exercised during the three months ended March 31, 2007. During
      the three months ended March 31, 2006, the total intrinsic value of options
      exercised (i.e., the difference between the market price at exercise and the
      price paid by the employee to exercise the options) was $937,500 and the total
      amount of cash received from exercise of these options was $75,000. The total
      grant-date fair value of stock options that vested during the three months
      ended
      March 31, 2006 was $47,500.





As
      of
      March 31, 2007, there was approximately $3,226,984 of total unrecognized
      compensation cost related to unvested share-based awards. This cost is expected
      to be recognized over a weighted average period of 3.6 years. The Company
      expects 4,899,333 unvested options to vest in the future.




**(3)          
      Income Taxes**




The
      Company accounts for income taxes in accordance with Statement of Financial
      Accounting Standard (SFAS) No. 109, *Accounting
      for Income Taxes* (“SFAS
      109”). Under SFAS 109, deferred tax assets or liabilities are computed based on
      the difference between the financial statements and income tax basis of assets
      and liabilities, and net operating loss carryforwards, using the enacted tax
      rates. Deferred income tax expense or benefit is based on changes in the asset
      or liability from period to period. The Company did not record a provision
      for
      federal, state or foreign income taxes for the three-month periods ended
      March 31, 2007 and 2006 because the Company has experienced losses since
      inception. The Company has not recorded a benefit for deferred tax assets as
      their  realizability
      is uncertain.




**(4)          
      Balance Sheet Detail**




Accrued
      expenses at March 31, 2007 and December 31, 2006 consisted of the
      following:




**March 31,**
              **2007**
            
            **December 31,**
              **2006**Professional
                fees
            
            $
            736,164
            
            $
            598,820Payroll
                and payroll related
            
            
            610,137
            
            
            384,257Interest
            
            
            287,806
            
            
            158,743Due in
                relation to sale of contracts
            
            
            158,785
            
            
            —Value
                added tax
            
            
            69,237
            
            
            51,660Directors’
                fees
            
            
            50,425
            
            
            12,300Termination
                costs
            
            
            46,462
            
            
            90,040Travel
            
            
            39,606
            
            
            34,331Repairs
                and maintenance
            
            
            —
            
            
            15,047Printing
            
            
            —
            
            
            10,750Other
            
            
            44,980
            
            
            23,165$
            2,043,602
            
            $
            1,379,113




11




**(5)**  **Intangible
      Assets**




The
      Company recorded the acquisition of the V-CubeTM IP-PBX platform software and
      associated intellectual property as an intangible asset in June 2006 amounting
      to $26,279,189 ($8,800,000 in cash, 14,000,000 shares at $1.22 per share, and
      the outstanding prepaid royalty amount of $399,189). The asset is being
      amortized over a five year estimated useful life beginning on July 1, 2006,
      which coincides with the first V-CubeTM product launch by one of the Company’s
      customers. At March 31, 2007 the net carrying value of this intangible asset
      was
      $22,337,310. Amortization expense for the three-month period ended March 31,
      2007 was approximately $1,314,000.





The
      Company recorded the acquisition of the Order-to-Cash (“O2C”) software as an
      intangible asset in October 2006 amounting to $2,077,777, including acquisition
      costs of $62,643. The O2C asset is being amortized over a five year estimated
      useful life beginning on October 11, 2006. At March 31, 2007 the net carrying
      value of the O2C intangible asset was $1,874,711. Amortization expense for
      the
      three-month period ended March 31, 2007 was approximately $104,000.





In
      accordance with SFAS No. 142, intangible assets must be tested at least annually
      for impairment at the reporting unit level. If an indication of impairment
      exists, the Company is required to determine if the intangible assets implied
      fair value is less than the carrying value in order to determine the amount,
      if
      any, of the impairment loss required to be recorded. Impairment indicators
      include, among other conditions, cash flow deficits, a historic or anticipated
      decline in revenue or operating profits, adverse legal or regulatory
      developments and/or a material decrease in the fair value of some or all of
      the
      assets. The Company performs the required impairment tests on an annual basis
      in
      conjunction with the Company’s fiscal year end. Intangible assets are being
      amortized over their estimated useful lives.





**(6)**  **Comprehensive
      Loss**




For
      the
      three-month periods ended March 31, 2007 and 2006, the components of other
      comprehensive loss consisted of the Company’s net loss and foreign currency
      translation adjustments. Comprehensive loss was $3,272,159 and $4,178,992 for
      the three months ended March 31, 2007 and 2006, respectively.




**(7)          
      Net Loss Per Share**




Basic
      net
      loss per share is computed by dividing net loss for the period by the weighted
      average number of common shares outstanding during the period. Diluted net
      loss
      per share is computed by dividing net loss by the weighted average number of
      common shares outstanding during the period plus the dilutive effect of
      convertible debt and outstanding stock options. As there was a net loss for
      the
      three-month period ending March 31, 2007, 11,626,050 outstanding stock
      options, 24,778,725 outstanding warrants, and 8,399,999 common shares obtainable
      upon exercise of the conversion feature of the convertible debentures were
      excluded from the calculation of diluted earnings per share because they were
      anti-dilutive. As there was a net loss for the three-month period ending
      March 31, 2006, 8,803,000 outstanding stock options (including 6,350,000
      options the Company’s shareholders ratified by an amendment to the 2004 Stock
      Incentive Plan on July 17, 2006), 9,962,025 outstanding warrants, and 8,399,999
      common shares obtainable upon exercise of the conversion feature of the
      convertible debentures were excluded from the calculation of diluted earnings
      per share because they were anti-dilutive.




12


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




On
      February 18, 2005 and March 4, 2005, the Company sold convertible debentures
      maturing three years from issuance in the aggregate principal amount of
      $8,400,000, convertible into common stock of the Company at $0.75 per share,
      and
      warrants to purchase an aggregate of 8,400,000 shares of common stock, at an
      exercise price of $1.00 per share to accredited investors. Of
      the
      $8,400,000 aggregate principal amount of convertible debentures sold, through
      March 31, 2007, $2,100,000 in outstanding principal has been converted into
      2,799,993 shares of common stock, reducing the amount of interest required
      to be
      paid in future periods, with $6,300,000 in principal remaining outstanding
      at
      March 31, 2007. In the Company’s consolidated balance sheet at March 31, 2007,
      the remaining principal of $6,300,000 has been reduced by unamortized debt
      discount of $363,089.




The
      debentures accrue interest daily at a rate of 8% per annum, which interest
      is
      payable quarterly on each March 31, June 30, September 30 and December 31
      following the issue date. The Company is not permitted to prepay any portion
      of
      the principal amount of any of the debentures without the prior consent of
      the
      holder thereof. The debentures are convertible at the option of the holders
      into
      shares of common stock at any time at an initial conversion price of $0.75
      per
      share. Except in the case of certain exempted issuances, in the event the
      Company issues shares of common stock or common stock equivalents (i.e.,
      securities convertible into, or exercisable or exchangeable for, shares of
      common stock) at a price per share (or in the case of common stock equivalents,
      a conversion, exercise or exchange price per share) below the then applicable
      conversion price of the debentures, the conversion price of the debentures
      will
      be reduced to that lower price per share. The Company has agreed to certain
      restrictions under the terms of the debentures, including a prohibition on
      the
      payment of cash dividends to stockholders while any of the debentures are
      outstanding. Upon the occurrence of an event of default under the debentures,
      an
      amount equal to (i) 130% of the then outstanding principal amount, plus any
      accrued and unpaid interest thereon, or (ii) the product of the then outstanding
      principal amount, plus any accrued and unpaid interest thereon, times the ratio
      obtained by dividing the conversion price of the debentures and the market
      price
      of the Company’s common stock, whichever is greater, will, at the holder’s
      option, become immediately due and payable in cash along with any other amounts,
      costs, expenses or liquidated damages then due in respect of such debentures.
      Upon an event of a default, the interest rate on the debentures will also be
      increased to 18% per annum. The Company obtained waivers from the outstanding
      debenture holders which waived any event of default and any late fees, including
      those associated with interest payments due on December 31, 2006 and March
      31,
      2007, provided the Company paid the interest payments due on December 31, 2006
      and March 31, 2007, in full on or before April 13, 2007. The Company paid the
      interest payments on April 9, 2007.




The
      common stock purchase warrants issued to the investors are exercisable at an
      initial exercise price of $1.00. The warrants have an expiration date of five
      years after the date of issuance. They contain a cashless exercise provision
      whereby the holder may pay the exercise price by having the Company withhold
      upon exercise shares having a fair market value equal to the applicable
      aggregate exercise price if after the first anniversary of the date of issuance
      of the warrant there is no effective registration statement registering, or
      no
      current prospectus available for, the resale of the shares issuable upon the
      exercise of the warrants. In the event this provision is used with respect
      to an
      exercise, the Company would receive no proceeds from the sale of its common
      stock in connection with such exercise. The warrants were initially exercisable
      for an aggregate 8,400,000 shares of common stock. As of March 31, 2007, the
      Company had issued 3,190,499 shares upon exercise of warrants, all in connection
      with the warrant exercise agreements described below.




The
      exercise price is subject to adjustment in the event of certain issuances of
      new
      securities. Specifically, except in the case of certain exempted issuances,
      if
      the Company issues shares of common stock or common stock equivalents (i.e.,
      securities convertible into, or exercisable or exchangeable for, shares of
      the
      Company’s common stock) at a price per share (or in the case of common stock
      equivalents, a conversion, exercise or exchange price per share) below the
      then
      applicable exercise price of the warrants, the exercise price of the warrants
      will be reduced to that lower price per share. In the event of such an
      adjustment, the number of shares for which the warrants are exercisable will
      be
      increased such that the aggregate exercise price of the warrants after the
      adjustment will equal the aggregate exercise price immediately prior to the
      adjustment. In
      connection with the two closings of the private placement, the Company paid
      $802,500 in fees and issued a warrant to purchase up to 802,500 shares of common
      stock (exercisable at $1.00 per share) to the placement agent.




13


*Warrant
      Exercise Agreements.* In
      October 2005, the Company entered into several warrant
      exercise agreements with holders of warrants issued in the private placement
      that closed in the first quarter of 2005. Pursuant to these agreements, the
      Company issued to these holders new common stock purchase warrants exercisable
      for a number of shares equal to the number of shares they purchased upon
      exercise of the warrants issued to them in the private placement. These new
      warrants have an exercise price of $1.50 per share. The Company received
      aggregate proceeds of $3,190,499 in connection with the exercise of the prior
      warrants, and issued new warrants, which expire five years after the issue
      date,
      to purchase an aggregate of 3,190,499 shares of common stock (plus an additional
      warrant with an exercise price of $1.50, which expires five years after the
      issue date, to purchase 159,525 shares of common stock to a placement agent
      who
      assisted with the transaction). The shares of common stock underlying these
      warrants have been registered for resale with the SEC. As a
      condition for each debenture holder executing a waiver for the April 6, 2007
      financing as discussed herein, the Company agreed to reduce the exercise price
      of the replacement warrants to $1.00 per share and provide the same
      anti-dilution protection as contained in the warrants issued in connection
      with
      the debenture financing.




**(9)** **Purchase
      of Software and Intellectual Property**




On
      June
      7, 2006, the Company completed the acquisition of certain assets of NetYantra,
      Inc. (“NetYantra US”) and NetYantra India Pvt. Ltd. (“NetYantra India”, with
      NetYantra US and NetYantra India being hereinafter referred to collectively
      as
“NetYantra”) for an aggregate purchase price of $8,800,000 in cash, 14,000,000
      shares of the Company’s common stock (the “Share Consideration”) and the
      outstanding prepaid amount ($399,189) for royalties due on future net revenues
      that was paid under the terms of the distribution and marketing agreement that
      had previously been in place between the Company and NetYantra. The acquisition
      was made pursuant to an Asset Purchase Agreement by and among Vistula, NetYantra
      US and NetYantra India dated April 28, 2006, as amended on May 11, 2006 and
      further amended on June 7, 2006 (the “Purchase Agreement”). The acquired assets
      include NetYantra’s VoIP IP-PBX platform software and associated intellectual
      property. The Company had previously distributed this software as its V-CubeTM
VoIP IP-PBX platform offering under a Distribution and Marketing Agreement
      with
      NetYantra.




The
      terms
      of the Purchase Agreement required the Company and NetYantra to use commercially
      reasonable efforts to negotiate and execute within sixty (60) days following
      the
      closing of the acquisition a license and revenue agreement, a services agreement
      and an executive employment agreement. Also, the terms of the Purchase Agreement
      prohibit, during the term of the services agreement and for 12 months
      thereafter, the Company and NetYantra from soliciting for hire, directly or
      indirectly, an employee, subcontractor or consultant of the other party, without
      that other party’s written consent.




Although
      a mutually satisfactory services agreement has not yet been executed, NetYantra
      had been performing services for the Company since June 7, 2006. As of March
      31,
      2007 the Company had made cash payments of $463,968 for the services provided
      from June 7, 2006 through November 2006. As of March 31, 2007 $280,000 was
      accrued for services provided for December 2006 through March 31, 2007 and
      for
      services provided to the Company by one of the authors of the V-Cube who was
      also a principal of NetYantra, all of which was paid on April 25, 2007 to the
      author and principal who provided services as the Company was informed
      NetYantra’s operations had been closed. The Company continues to receive
      services provided by the principal and consultants under terms separately from
      NetYantra.




14


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




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




On
      May
      22, 2006, sold 16,300,000 units consisting of one share of common stock and
      eight-tenths of one warrant to acquire one share of common stock to accredited
      investors. The effective purchase price of the units was $1.00 per unit. In
      exchange for the units sold, the Company received gross cash proceeds of
      $16,300,000. The Company issued warrants for 13,040,000 common stock shares,
      exercisable until May 22, 2011 at an exercise price of $1.00 per share. In
      connection with the private placement, the Company paid $978,000 in fees and
      issued 1,467,000 common stock warrants (exercisable at $1.00 per share) to
      the
      placement agent.




The
      Company realized net proceeds from the sale of units, after deducting placement
      agent fees and expenses, of approximately $15,200,000. The Company used a
      portion of these proceeds to purchase the software and intellectual property
      rights of NetYantra’s V-CubeTM IP-PBX platform as described in Note 9
      ($8,800,000).




The
      Company agreed to register the resale of the shares of common stock sold in
      the
      offering and issuable upon exercise of the warrants. A registration statement
      was filed on June 30, 2006 and initially became effective on July 14, 2006.
      The
      Company is required to use its best efforts to keep the registration statement
      continuously effective under the Securities Act until the earlier of the date
      when all the registrable securities covered by the registration statement have
      been sold or are freely saleable and the second anniversary of the closing.
      In
      the event that the registration statement ceases to remain effective, the
      Company is obligated to make cash payments in the nature of liquidated damages
      up to a limit of 10% of the purchase price of the units.




**(11)** **Business
      Acquisition**




On
      October 11, 2006, the Company acquired all outstanding shares of Goodman Blue
      Limited, a UK company, from its sole shareholder, Scott Lee Goodwin (“Goodwin”),
      for 2,500,000 common shares, subject to an option on the part of Goodwin to
      require the Company to repurchase the shares at $1.00 per share. On February
      12,
      2007, the Company and Goodwin amended the share purchase agreement to provide
      that: (i) Goodwin shall have the option to require the Company to
      purchase 1,400,000 of the Consideration Shares for $1,400,000 (the “First Put
      Option”); and (ii) Goodwin shall have the option to require the Company to
      purchase 1,100,000 of the Consideration Shares for $1,100,000 (the “Second Put
      Option”). In
      response to a purported exercise of the First Put Option on April 25, 2007,
      since retracted, the parties reached a supplemental agreement deferring the
      time
      for exercise of the First Put Option and Second Put Option to the period
      beginning on December 1, 2007 and ending on December 31, 2007 in consideration
      of the payment to Goodwin of approximately $110,000 and the engagement of
      Goodwin for consulting services to be providedto the
      Company’s subsidiary, Goodman Blue Limited. The
      terms
      of our currently outstanding notes prohibit the redemption of shares of our
      common stock without the note holders consent.




15


The
      Company recorded the acquisition of the Order-to-Cash (“O2C”) software as an
      intangible asset in October 2006 amounting to $2,077,777, including acquisition
      costs of $62,643. At March 31, 2007 the net carrying value of the O2C intangible
      asset was $1,874,711. Amortization expense for the three-month period ended
      March 31, 2007 was approximately $104,000.




**(12)      
      Commitments and Contingencies**




On
      December 13, 2005, the Company entered into a Consultant, Representative and
      Professional Services Agreement with Quest Telecommunications, Inc. (“Quest”).
      Under this agreement, the Company appointed Quest as an independent advisor
      and
      the Company’s exclusive representative in the geographic areas of Vietnam,
      Cambodia, Malaysia and Turkey (and any other areas to which the Company and
      Quest agree in writing).  Under
      this agreement, the Company paid Quest $50,000 in consideration for Quest’s
      assistance relating to the execution by the Company and Saigon Post and
      Telecommunications Services Corporation (“SPT”) of a memorandum of understanding
      and pilot license agreement with respect to the V-CubeTM. The
      Company entered into a distribution and marketing agreement with SPT with
      respect to the V-CubeTM on July 3, 2006. Upon signing this agreement, the Company
      is obligated to issue to Quest 300,000 shares of the Company’s common stock and
      to pay to Quest $150,000 in cash, plus a continuing commission of thirty percent
      of the license fees received from SPT in connection with the licensing and
      distribution of the V-CubeTM in the above-mentioned geographic areas (net of
      sales, use and value added taxes, if any, payable by the Company in connection
      with such license fees). Although the agreement with SPT has been signed, the
      Company does not expect to pay the $150,000 in cash or continuing commission
      of
      thirty percent of the license fees received from SPT due to SPT’s indication to
      enter into license purchase and maintenance agreement in lieu of the
      distribution and marketing agreement and a reported delay in SPT’s ability to
      launch the product due to the local government’s approval process, therefore the
      $150,000 due has not been recorded in the financial statements.




**(13)        
      Indemnification**




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




The
      Company enters into standard indemnification agreements in the ordinary course
      of its business. Pursuant to these agreements, the Company indemnifies, holds
      harmless, and agrees to reimburse the indemnified party for losses suffered
      or
      incurred by the indemnified party, generally distributors, agents, or customers,
      in connection with any patent, copyright, trademark, trade secret or other
      intellectual property infringement claim by any third party with respect to
      the
      Company’s products. The term of these indemnification agreements is generally
      perpetual. The maximum potential amount of future payments the Company could
      be
      required to make under these indemnification agreements is often capped at
      a
      dollar figure. In addition, the Company has agreed to indemnify the investors
      in
      the convertible debenture financing described in Notes 8 and 10 against certain
      losses. The Company has never incurred costs to defend lawsuits or settle claims
      related to these indemnification agreements. As a result, the Company believes
      the estimated fair value of these agreements is minimal.




16


**(14)        
      Convertible Promissory Note to Related Party**




On
      July
      2, 2004, the Company entered into a note subscription agreement with the J.
      Rothschild Assurance Self Invested Personal Pension Plan No. 2, the sole
      beneficiary of which is the Company’s Chairman, chief executive officer and
      president, Rupert Galliers-Pratt. The note subscription agreement was amended
      and restated on August 11, 2004. Under the amended and restated note
      subscription agreement, the Company issued and sold to Mr. Galliers-Pratt’s
      pension plan convertible promissory notes in the principal amounts of $125,000
      and $50,000 on July 12, 2004 and on August 11, 2004, respectively. Both
      convertible promissory notes have a one year term, accrue interest at the rate
      of 7% per annum and are convertible into shares of the Company’s common stock at
      the price of $1.50 per share. On August 11, 2005, the pension plan confirmed
      its
      earlier agreement to extend the maturity date of both promissory notes until
      December 31, 2005. On December 15, 2005, the pension plan confirmed its earlier
      agreement to extend the maturity date of both promissory notes until June 30,
      2006. On June 30, 2006, the pension plan confirmed its earlier agreement to
      extend the maturity date of both promissory notes until December 31, 2006.
      On
      December 31, 2006, the pension plan confirmed its earlier agreement to extend
      the maturity date of both promissory notes until June 30, 2007.




**(15)       
      Subsequent Events**





*Private
      Placement*




On
      April
      6, 2007, the Company completed a private placement of convertible notes and
      warrants pursuant to a securities purchase agreement (the “Securities Purchase
      Agreement”) with certain accredited investors (the “Investors”). The Investors
      purchased convertible notes in the aggregate principal amount of $2,500,000
      and
      warrants to purchase up to an aggregate of 2,500,000 shares of the Company’s
      common stock. The private placement resulted in gross proceeds of $2,500,000. The
      investors will also receive an aggregate of 5,000,000 shares of our common
      stock, which shares will be transferred from Executive Management Services
      Limited (“EMS”), an entity of which Mr. Galliers-Pratt, is a beneficiary, to the
      investors, EMS is receiving no consideration for the transfer. It is an event
      of
      default under the terms of the convertible notes if these 5,000,000 shares
      were
      not delivered to the investors by April 27, 2007. These shares have been
      released from a European custodian and sent to EMS' business office in the
      British Virgin Islands for processing and will be transferred to the investors
      immediately upon receipt by the Company’s counsel. The Company has notified the
      investors of these delays in effecting the transfer.




The
      Company granted each of the Investors a participation right whereby they may
      each elect to purchase all or a portion of securities sold in certain future
      financings. The participation right expires on the first anniversary of the
      closing date.




The
      Company also granted each Investor the right to exchange all or some of its
      notes for securities offered in certain future financings. In the event of
      this
      exchange right is asserted in connection with such a future financing, the
      Company would be required to issue to the Investor requesting the exchange
      a
      number of new securities offered in such financing determined by dividing the
      outstanding principal amount of the note being exchanged (plus accrued interest
      or other fees owed to such Investor) by the price at which the new securities
      are being sold in such financing. This exchange right expires on the first
      anniversary of the closing date.




Under
      the
      terms of the Securities Purchase Agreement, the Company is prohibited from
      engaging in certain types of financing transactions. In particular, for a period
      of 45 days after the date the initial registration statement covering the shares
      underlying the notes and warrants is first declared effective by the SEC (which
      the Company must file pursuant to a Registration Rights Agreement, as further
      described herein), the Company may not issue shares of common stock or common
      stock equivalents except pursuant to conversion or exercise of convertible
      securities or outstanding rights to acquire common stock that were outstanding
      on or prior to the closing date. Also, until such time as no Investor holds
      any
      of the notes, warrants or shares of common stock underlying the notes or
      warrants, the Company may not issue securities that are convertible into,
      exchangeable or exercisable for, or include the right to receive additional
      shares of the Company’s common stock at a conversion, exercise or exchange
      price, as applicable, that is (i) determined based on the market price of the
      Company’s common stock at any time after the issuance of such securities, or
      (ii) is subject to reset upon the occurrence of events directly or indirectly
      related to the Company’s business or the market for the Company’s common stock.
      The Company is also prohibited from entering into any agreement providing for
      the sale of securities at a price determined at a future time.




17


The
      notes
      issued to the Investors on April 6, 2007 accrue interest daily at an rate of
      12%
      per annum, which interest is payable quarterly on each March 31, June 30,
      September 30 and December 31 beginning on September 30, 2007. The final interest
      payment is due on the date of maturity of the note, April 6, 2009. In addition,
      on any date on which all or a portion of the principal of a note is converted,
      all unpaid interest having accrued on such principal at the time of such
      conversion will become immediately payable. The Company is not permitted to
      prepay any portion of the principal amount of any of the notes without the
      prior
      consent of the holder thereof. These notes are junior to the Company’s currently
      outstanding 8% convertible debentures due in February and March
      2008.




The
      notes
      are convertible at the option of the holders into shares of the Company’s common
      stock at any time at an initial conversion price of $1.00 per share. Except
      in
      the case of certain exempted issuances, in the event the Company issues shares
      of common stock or common stock equivalents (i.e., securities convertible into,
      or exercisable or exchangeable for, shares of the Company’s common stock) at a
      price per share (or in the case of common stock equivalents, a conversion,
      exercise or exchange price per share) below the then applicable conversion
      price
      of the notes, the conversion price of the notes will be reduced to that lower
      price per share.




If,
      after
      the effectiveness of the registration statement, the market price for any period
      of 20 consecutive trading days exceeds $2.50 and the average daily trading
      volume for the Company’s common stock for such period exceeds 100,000 shares,
      the Company may, subject to certain conditions, force the holders of the notes
      to immediately convert all or any part of the then outstanding principal amount
      at the then-effective conversion price.




If,
      after
      the first year anniversary of the issuance of the notes, there is an effective
      registration statement and for a period of 20 consecutive trading days, the
      daily trading volume for the Company’s common stock exceeds 100,000 shares per
      trading day, the Company may, subject to certain conditions, redeem all or
      any
      part of the then outstanding principal amount of the notes for cash in an amount
      equal to the sum of (i) 150% of the then outstanding principal amount of the
      note, (ii) accrued but unpaid interest and (iii) all liquidated damages and
      other amounts due in respect of the note.




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




Events
      of
      default under the notes include failure to pay any amounts under the notes
      when
      due, a material default under other agreements with the Investors or default
      in
      the Company’s obligations under mortgage, credit facility or similar agreements,
      a material inaccuracy in the representations and warranties the Company made
      to
      the Investors in connection with the Financing, and the initiation of voluntary
      or involuntary bankruptcy proceedings against us.




18


The
      common stock purchase warrants issued to the Investors on April 6, 2007 are
      exercisable for an aggregate of 2,500,000 shares of the Company’s common stock
      at an initial exercise price of $1.00. The warrants have an expiration date
      of
      five years after the date of issuance, or April 6, 2012. They contain a cashless
      exercise provision whereby the holder may pay the exercise price by having
      the
      Company withhold upon exercise shares having a fair market value equal to the
      applicable aggregate exercise price if after the first anniversary of the date
      of issuance of the warrant there is no effective registration statement
      registering, or no current prospectus available for, the resale of the shares
      issuable upon the exercise of the warrants. In the event this provision is
      used
      with respect to an exercise, the Company would receive no proceeds from the
      sale
      of the Company’s common stock in connection with such exercise.




The
      exercise price is subject to adjustment in the event of certain issuances of
      new
      securities. Specifically, except in the case of certain designated issuances,
      if
      the Company issues shares of common stock or common stock equivalents (i.e.,
      securities convertible into, or exercisable or exchangeable for, shares of
      the
      Company’s common stock) at a price per share (or in the case of common stock
      equivalents, a conversion, exercise or exchange price per share) below the
      then
      applicable exercise price of the warrants, the exercise price of the warrants
      will be reduced to that lower price per share. In the event of such an
      adjustment, the number of shares for which the warrants are exercisable will
      be
      increased such that the aggregate exercise price of the warrants after the
      adjustment will equal the aggregate exercise price immediately prior to the
      adjustment. Issuances that will not result in adjustment to the exercise price
      include issuances to employees, consultants, directors or officers pursuant
      to a
      stock or option plan adopted by the Company’s board of directors, securities
      issued upon conversion of other securities outstanding prior to the date of
      issuance of the warrants, warrants issued in connection with obtaining bank
      financing, common stock issued in connection with the settlement of claims
      up to
      a maximum aggregate of 500,000 shares, securities issued in connection with
      acquisitions, joint ventures or other strategic transactions and securities
      issued under agreements executed by the us prior to the date of the Securities
      Purchase Agreement and disclosed in the Company’s reports filed with the SEC
      since January 1, 2006.




If,
      after
      the effectiveness of the registration statement, (i) the market price for any
      period of 20 consecutive trading days exceeds $2.50, (ii) the average daily
      trading volume for the Company’s common stock for such period exceeds 100,000
      shares and (iii) the Investor is not in possession of any information that
      constitutes, or might constitute, material non-public information which was
      provided by us, then the Company may, within 1 trading day of the end of such
      period, call for cancellation of all or any portion of the warrants for which
      a
      notice of exercise has not yet been delivered for consideration equal to $0.001
      per share.




The
      Company agreed to register for resale under the Securities Act of 1933, as
      amended, the shares underlying the notes and warrants and the bonus shares
      pursuant to a Registration Rights Agreement between the Company and the
      Investors dated April 6, 2007. On May 7, 2007, the Company filed with the SEC
      a
      registration statement covering the resale of a number of shares of common
      stock
      equal to 120% of the shares issuable upon conversion and exercise in full of
      the
      notes and warrants as of the date of filing of the registration statement plus
      the bonus shares. The registration statement covering these shares must be
      declared effective by the SEC no later than July 5, 2007 (or in the event there
      is a review, no later than August 4, 2007). In the event that it is not declared
      effective within the timeframes specified by the Registration Rights Agreement,
      the Company will be required to pay to the Investors liquidated damages equal
      to
      1.5% per month (but pro-rated on a daily basis for any period of less than
      a
      full month) of the aggregate purchase price of the notes and warrants until
      the
      registration statement is declared effective, as applicable.




If,
      at
      any time, the number of shares issuable upon conversion and exercise in full
      of
      the notes and warrants exceeds 100% of the number of shares then registered
      (e.g., due to adjustments in the conversion price of the notes or exercise
      price
      of the warrants), the Company will be required to file an additional
      registration statement covering the excess shares. The Company will have to
      file
      the additional registration statement on the earliest practicable date, and
      the
      additional registration statement must be declared effective by the SEC not
      later than the 60 th calendar
      day, following the date the 100% threshold is exceeded. If the Company does
      not
      file the registration statement or the registration statement is not declared
      effective within these time frames, the Company will be required to pay to
      the
      liquidated damages as described in the preceding paragraph.




19




In
      connection with the closing of the convertible note and warrant financing,
      the
      Company paid placement agent fees in the amount of $56,000 in cash and warrants
      to purchase 1,400,000 shares of the Company’s common stock at $1.00 per share,
      which warrants expire in five years. The Company agreed to indemnify the
      principal placement agent from claims arising in relation to the services it
      provides to us.




*Sale
      of Switching Equipment*




The
      Company entered into an Agreement on April 13, 2007, whereby it sold its
      wholesale voice switching equipment (“Switch”) located in the United Kingdom
      used in the Company’s wholesale voice services business in exchange for the
      buyer (i) assuming the co-location lease and all associated costs, including,
      without limitation the costs of the circuits, power, and running the switching
      equipment (ii) operating the Switch, (iii) allowing the Company to use the
      switch for three years at no cost to the Company and (iv) assuming any billing
      processes previously performed by one of the Company’s employees, who will
      continue to be available to the Company. The Agreement was retroactive
      to January 1, 2007.





*Extension
      of Put Option*




In
        response to a purported exercise of the First Put Option on April 25, 2007,
        since retracted, the parties reached a supplemental agreement deferring the
        time
        for exercise of the First Put Option and Second Put Option to the period
        beginning on December 1, 2007 and ending on December 31, 2007 in consideration
        of the payment to Goodwin of approximately $110,000 and the engagement of
        Goodwin for consulting services to be providedto the
        Company’s subsidiary, Goodman Blue Limited.


*Consulting
      Agreement with Jack Early*




On
      May
      16, 2007, the Company entered into a consulting agreement with Jack Early,
      a
      director, relating to Mr. Early’s serving as the Company’s chief operating
      officer. Under the consulting agreement, the Company will pay Mr. Early an
      initial fee of $15,000 for services performed during the period from May 16,
      2007 through May 31, 2007, which fee shall be payable on June 1, 2007. After
      June 1, 2007, Mr. Early will be paid fees at the rate of $10,000 per month
      which
      shall be payable in arrears in bi-monthly installments on the dates on which
      the
      Company makes its payroll payments during the term of the consulting agreement.
      In addition, the consulting agreement provides for the grant to Mr. Early of
      a
      non-statutory stock option to purchase up to 250,000 shares of the Company’s
      common stock. The board of directors approved this grant and the other terms
      of
      the consulting agreement based on a recommendation from the Company’s
      compensation committee and fixed the exercise price per share at $0.06, which
      represents the closing price of the Company’s common stock on May 15, 2007 as
      reported on the Over the Counter Bulletin Board.





The
      option is exercisable for five years from the date of grant and shall vest
      and
      become exercisable with respect to 150,000 shares of common stock on December
      31, 2007 and shall vest and become exercisable with respect to the remaining
      100,000 shares of common stock on December 31, 2008, provided, in each case,
      that Mr. Early is an officer or director of the Company on such vesting date.




In
      connection with his appointment as chief operating officer, Mr. Early has
      resigned as a member of the compensation committee and the nominating committee
      of the board of directors.




Effective
      upon the appointment of Mr. Early, Ian Cope resigned his position as the
      Company's chief operating officer and was appointed to the newly created
      position of chief technology officer.




20




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




**Introduction**




The
      following information should be read in conjunction with the financial
      statements and notes thereto in Part I, Item 1 of this Quarterly Report and
      with Management’s Discussion and Analysis of Financial Condition and Results of
      Operations contained in our Annual Report on Form 10-KSB for the year ended
      December 31, 2006 (File No. 000-50758).




**Cautionary
      Statements**




We
      do not
      provide forecasts of our future financial performance. However, from time to
      time, information provided by us or statements made by our employees may contain
      “forward-looking” information that involves risks and uncertainties. In
      particular, statements contained in this Quarterly Report that are not
      historical facts constitute forward-looking statements and are made under the
      safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
      Forward-looking statements involve substantial risks and uncertainties. You
      can
      identify these statements by forward-looking words such as “may”, “will”,
“expect”, “anticipate”, “believe”, “estimate”, “continue”, and similar words.
      You should read forward-looking statements carefully because they:
      (1) discuss our future expectations; (2) contain projections of our
      future operating results or financial condition; or (3) state other
“forward-looking” information. Various factors described below, as well as any
      other instances of cautionary language in this Quarterly Report, refer to or
      provide examples of risks, uncertainties and events that may cause our actual
      results to be materially different than the expectations described in our
      forward-looking statements. You should be aware that the occurrence of any
      of
      the events or factors described below and elsewhere in this Quarterly Report
      could materially and adversely affect our business. All forward-looking
      statements included in this Quarterly Report are based on information available
      to us on the date hereof, and we assume no obligation to update any such
      forward-looking statements.




Each
      forward-looking statement should be read in conjunction with the financial
      statements and notes thereto in Part I, Item 1 of this Quarterly Report,
      this section, and Management’s Discussion and Analysis of Financial Condition
      and Results of Operations contained in our Annual Report on Form 10-KSB for
      the year ended December 31, 2006 (File No.000-50758), including but not
      limited to the section therein entitled “Factors Affecting Future
      Performance.”




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





·
            Our
                immediate future revenues and cash flow are dependent upon one distributor
                in the United Kingdom.





·
            If
                we do not obtain a substantial amount of additional financing and/or
                concessions from creditors, we may have to curtail or suspend
                operations.





·
            We
                may not be able to accurately forecast future
                results.




·
            We
                may continue to lose money on our
                operations.





·
            If
                we fail to establish the Vistula and Goodman Blue brands or to attract
                repeat customers, we may not be able to increase our revenues sufficiently
                to fund our operations.





21


·
            We
                currently derive a significant portion of revenue from a limited
                number of
                contracts and customers, and if we are unable to replace contracts
                upon
                completion and maintain customer relationships, we could have a
                significant decrease in our revenues which would negatively impact
                our
                results.


·
            We
                may experience significant fluctuations in our results as a result
                of
                uncertainties relating to our ability to generate additional revenues,
                manage our expenditures and other factors, certain of which are outside
                of
                our control.





·
            Our
                contracts typically contain provisions giving customers the ability
                to
                terminate their contracts under various circumstances and we may
                not be
                able to replace the revenues from such contracts which may have an
                adverse
                effect on our revenues and operating
                results.





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





·
            If
                we are unable to collect receivables from development stage customers
                and
                other telecommunications companies, our operating results may be
                materially harmed.





·
            The
                extent of our dependence on international operations may give rise
                to
                increased management challenges and could harm our results of
                operations.





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





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





·
            We
                may not be able to hire or retain a sufficient number of qualified
                engineers and other employees to meet our customers’ needs or maintain the
                quality of our services.





·
            Future
                acquisitions of new companies or technologies may result in disruption
                to
                our business and expose us to risks associated with
                acquisitions.





·
            The
                consolidation of telecommunication service providers could adversely
                impact our business.





·
            Government
                regulations may adversely affect our
                business.





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





·
            The
                management of our finances and the quality and timeliness of our
                financial
                reporting may be adversely affected if we are unable to increase
                the size
                and capabilities of our internal administrative and finance function
                as
                our business grows.




·
            We
                will not be successful if we do not grow our customer base beyond
                our
                initial customers.





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





22


·
            We
                will not retain customers or attract new customers if we do not anticipate
                and meet specific customer requirements and if our products and services
                do not adequately interoperate with our customers’ existing
                networks.





·
            If
                we fail to compete successfully, our ability to increase our revenues
                or
                achieve profitability will be
                impaired.





·
            Our
                business is exposed to the general conditions of the telecommunications
                market.





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





·
            Intellectual
                property infringement claims against us or any of our subsidiaries,
                even
                without merit, could require us to enter into costly licenses or
                deprive
                us of the technology we need.





·
            Failure
                to protect our intellectual property rights could have a material
                adverse
                effect on our business.





·
            If
                our products contain defects, then our sales are likely to suffer,
                and we
                may be exposed to legal claims.





·
            Compliance
                with changing corporate governance and public disclosure regulations
                may
                result in additional expense.




·
            Our
                executive officers, directors and principal stockholders have substantial
                holdings, which could delay or prevent a change in corporate control
                favored by our other stockholders.




·
            Our
                common stock could be further diluted as the result of the issuance
                of
                additional shares of common stock, convertible securities, warrants
                or
                options.





·
            We
                may be subject to litigation.





Because
      of the foregoing and other factors, we may experience material fluctuations
      in
      our future operating results on a quarterly or annual basis which could
      materially adversely affect our business, financial condition and operating
      results.




**Overview**




Vistula
      Communications Services, Inc. (“VCS”, the “Company” or “we”) has four
      wholly-owned subsidiaries: Vistula Limited (“Vistula”), Vistula USA, Inc.
      (“Vistula USA”), Goodman Blue Limited (“Goodman Blue”) and Cardlink Services
      Limited (“Cardlink”), and has one subsidiary that is 60% owned, Vistula
      Communications Services SA (Pty) Ltd. (“Vistula SA”) (of these, principal
      operations are carried out through Vistula, Vistula USA and Goodman Blue as
      the
      other subsidiaries are dormant). Through Vistula and Goodman Blue we currently
      provide value-added telecommunications services (including direct and partner
      voice routing services) to Tier 1 and Tier 2 telecommunication carriers and
      transit operators. Beginning in the first quarter of 2005, through Vistula,
      Vistula USA, and Vistula SA we began to market our V-Cube Ô Voice
      over Internet Protocol, or “VoIP,” IP-PBX software platform to
      telecommunications carriers, ISPs, large corporations and SMEs, throughout
      the
      world. The V-CubeTM platform is a uniquely feature-rich IP-PBX, that facilitates
      full contact communication services including voice, video, conferencing, call
      center, multi/sub-domain and unified messaging across both enterprise and public
      networks.





23


We
      expect
      to dissolve Cardlink and Vistula SA by the end of 2007. Since its acquisition
      by
      VCS in March 2004, Cardlink has been inactive. Vistula SA has not generated
      any
      revenue.





**Critical
      Accounting Policies**




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





We
      believe that the following accounting policies reflect our more significant
      judgments and estimates used in the preparation of our financial statements.




**Revenue
      Recognition.** Our
      revenue is derived primarily from fees charged to terminate voice services
      over
      our network and contracted services to support software licenses. We recognize
      such revenue, net of reserves, when persuasive evidence of a sales arrangement
      exists, delivery has occurred or services have been rendered, the sales price
      is
      fixed and determinable and collectibility is reasonably assured. We reserve
      for
      potential billing disputes at the time revenue is recognized or the dispute
      is
      known. Such disputes can result from disagreements with customers regarding
      the
      duration, destination or rates charged for each call. These revenue allowances
      are based on estimates derived from factors that include, but are not limited
      to, historical results, analysis of credits issued, current economic trends
      and
      changes in demand. Amounts billed in advance of the service month are recorded
      as deferred revenue and recognized as revenue as the underlying services are
      rendered.





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





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





**Convertible
      Debt.** The
      Company applies Accounting Principles Board Opinion Number 14 (“APB 14”), *Accounting
      for Convertible Debt and Debt Issued with Stock Purchase
      Warrants* ,
      when
      recording debt with conversion features and when issuing warrants to purchase
      its common stock. When debt is issued which is convertible to equity at the
      option of the holder, no portion of the proceeds is accounted for as
      attributable to the conversion feature, and is recorded as a liability. The
      warrants to purchase the Company's stock have been determined to be detachable
      warrants as the holder of the debt and warrants may convert the debt or exercise
      the warrant without affecting the other instrument. The fair-value of the
      warrants issued is determined as of the date of the issuance by using a
      Black-Scholes pricing model. The value is then used as a discount to the
      convertible debt and is amortized to interest expense over the term of the
      convertible debt to the maturity date, or is accelerated proportionally if
      the
      debt is converted at the option of the holder prior to the maturity date.





24


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




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




Prior
      to
      July 21, 2005, the fair value of our common stock was determined by our board
      of
      directors contemporaneously with the grant. In the absence of a public trading
      market for our common stock, our board of directors considered numerous
      objective and subjective factors in determining the fair value of our common
      stock. At the time of option grants and other stock issuances, our board of
      directors considered the status of private and public financial markets;
      valuations of comparable private and public companies; the likelihood of
      achieving a liquidity event such as an initial public offering; our existing
      financial resources; our anticipated continuing operating losses and increased
      spending levels required to meet our business plan; dilution to common
      stockholders from anticipated future financings; and a general assessment of
      future business risks.




**Impairment
      of Long Lived Assets.** In
      accordance with Statement of Financial Accounting Standards No. 144, *Accounting
      for the Impairment or Disposal of Long-lived Assets* ,
      the
      Company reviews its long-lived assets whenever events or changes in
      circumstances indicate that the carrying amount of such assets may not be
      recoverable. If the carrying amount of an asset or group of assets exceeds
      its
      net realizable value, the asset will be written down to its fair value.





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





25


**Recently
      Issued Accounting Pronouncements**




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





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





In
      June
      2006, the FASB issued FASB Interpretation No. 48, *Accounting
      for Uncertainty in Income Taxes -an interpretation of FASB Statement No.
      109* (FIN
      48). The interpretation contains a two-step approach to recognizing and
      measuring uncertain tax positions accounted for in accordance with SFAS No.
      109, *Accounting
      for Income Taxes* .
      The
      first step is to evaluate the tax position for recognition by determining if
      the
      weight of available evidence indicates that it is more likely than not that
      the
      position will be sustained on audit, including resolution of related appeals
      or
      litigation processes, if any. The second step is to measure the tax benefit
      as
      the largest amount which is more than 50% likely of being realized upon ultimate
      settlement. FIN 48 is effective as of the beginning of the first fiscal
      year beginning after December 15, 2006. The Company does not believe
      adoption of FIN 48 will have a material impact on the Company’s consolidated
      financial statements.





**Results
      of Operations**





Revenues
      for the three-month period ended March 31, 2007 were $286,475, a decrease of
      10.3% compared to the $319,419 in revenues in fiscal 2006. Revenues for the
      three-month period ended March 31, 2007 for wholesale traffic decreased by
      $288,982, a decrease of 90.5% compared to the $319,419 in revenues for wholesale
      traffic in 2006. The decrease is primarily attributable to our cash position
      which limited our ability to pay vendors who in turn would not provide traffic
      routes which would allow us to generate traffic for revenue purposes. The
      decrease in wholesale traffic was mostly offset by an increase in revenue from
      contracted services for the three-month period ended March 31, 2007 of $234,539
      for services provided under a contract agreement to support our O2C software
      portal. The revenue increase recorded for software licenses is mainly
      attributable to a single sale for use of our O2C software license. Minimal
      revenue has been recognized for the V-CubeTM product offering although we
      commenced the V-CubeTM product offering in the UK, Venezuela, and Argentina.




Cost
      of
      revenues for the three-month period ended March 31, 2007 were $234,340, a
      decrease of 33.3% over the $351,513 in fiscal 2006. The decrease is primarily
      attributable to a reduction in wholesale traffic due to our cash position which
      limited our ability to pay vendors who in turn would not provide traffic routes
      which would allow us to generate traffic. The decrease in costs of wholesale
      traffic was mostly offset by an increase in costs experienced from contracted
      services for the three-month period ended March 31, 2007 of $131,192 for
      services provided under a contract agreement to support our O2C software portal.
      Engineering costs classified as cost of revenues pertaining to wholesale traffic
      for the period ended March 31, 2007 of $32,080 decreased 24.7% as compared
      to
      the same period in fiscal 2006. The decrease is mainly due to expenditures
      pertaining to staff support of the wholesale business.




Gross
      margin (loss) increased to 18.2% for the period ended March 31, 2007 from
      (10.0%) for the period ended March 31, 2006. The increase is due to contracted
      services being provided by the staff of Goodman Blue to support the software
      license contract sold to a third party. The reduction in staff levels for the
      wholesale traffic business also contributed to the increase in margin.





26


Selling,
      general and administrative costs for the period ended March 31, 2007 were
      $1,461,476, a decrease of 60.9% compared to the $3,734,401 in fiscal 2006.
      During the period ended March 31, 2007, we incurred increased compensation
      for
      employees due to non-cash options expenses and increases experienced consultants
      fees. Non-cash decreases were due to the one time issuance of 1,500,000 shares
      per the Indigo advisory agreement for $1,875,000 in the first quarter of 2006
      as
      described below under *Other
      Arrangements and Obligations* and a
      decrease in non-cash expenses due to a consulting agreement. Other decreases
      experienced were in expenses related to support fees for a consumer IP product
      no longer in use, investment fees, promotional and marketing fees, professional
      fees, repairs and maintenance fees, and travel expenses.





Depreciation
      and amortization expenses for the period ended March 31, 2007 were $1,482,166,
      an increase of 5,279% over the $27,555 in fiscal 2006. During the period ended
      March 31, 2007, we recorded decreased depreciation for equipment which was
      impaired as of December 31, 2006. During the period ended March 31, 2007, we
      recorded amortization expenses for the purchase of our V-CubeTM software as
      described in Note 9 to the financial statements included in Item 1 which did
      not
      begin to be amortized until July 1, 2006, and the acquisition of our O2C
      software as described in Note 11 to the financial statements included in Item
      2,
      which did not begin to be amortized until October 11, 2006.





Research
      and development expenses for the period ended March 31, 2007 were $65,971,
      a
      decrease of 16.1% compared to the $78,624 in fiscal 2006. During the period
      ended March 31, 2007, we incur research and development expenses for the
      MyService portal development for the V-CubeTM product and for the MyOrder portal
      development work for the O2C software which will simplify the ordering and
      billing process for our customers. The O2C portal will work along-side the
      V-CubeTM platform and allow an automated sign-up and delivery process for
      customers which we expect to enable us to sign-up a significantly greater number
      of users each month in comparison to the more manual process of customer
      installations without the portal.





During
      the period ended March 31, 2007 net interest expense of approximately $310,682
      was comprised of amortization of capitalized finance fees, amortization of
      the
      debt discount for the debentures held, interest on the convertible debentures
      as
      per the terms stated in Note 8 to the financial statements included in Item
      2,
      interest on a small business loan, and interest on a promissory note as per
      the
      terms stated in Note 14 to the financial statements included in Item 1. Net
      interest expense for the period ended March 31, 2006 of approximately $315,103
      was comprised of amortization of capitalized finance fees, amortization of
      the
      debt discount for the debentures held, interest on the convertible debentures
      as
      per the terms stated in Note 8 to the financial statements included in Item
      1,
      interest on a promissory note as per the terms stated in Note 14 to the
      financial statements included in Item 1, and interest on notes payable which
      were paid in full on May 22, 2006.




For
      the
      period ended March 31, 2007, we incurred a loss of $3,268,160 or $0.05 loss
      per
      common share, basic and diluted, as compared to a loss of $4,187,777 or $0.13
      loss per common share, basic and diluted, for the period ended March 31,
      2006.




**Liquidity
      And Capital Resources**




Since
      our
      inception, we have sustained our operations through loans, debt and equity
      financings, funding provided by our Chairman and contributed services by our
      Chairman and other stockholders.




As
      of
      March 31, 2007, we had cash and cash equivalents of approximately $2,000
      and a working capital deficit of approximately $11,893,000. This represents
      a
      decrease in cash and cash equivalents of approximately $193,000 from
      December 31, 2006 and an increase in the working capital deficit of
      approximately $7,211,000 from that at December 31, 2006. Approximately
      $5,937,000 of the increase in working capital deficit is due to the convertible
      debentures from February and March 2005 being recorded as current liabilities
      as
      they mature in February and March 2008. Since our inception through
      March 31, 2007, we have generated losses of approximately $39,375,264.
      Accounts receivable were approximately $186,000 at March 31, 2007, an
      increase of approximately $28,000 from December 31, 2006. Accounts payable
      and accrued expenses at March 31, 2007 increased approximately $1,258,000
      from December 31, 2006, which excludes a $2,500,000 liability recorded for
      shares subject to a put option as described in Note 11 to the financial
      statements in Item 1.




27


During
      the three-month periods ended March 31, 2007 and 2006 no services were
      contributed to the Company by our stockholders.





*Convertible
      Debenture and Warrant Financing.*  On
      February 18, 2005 and March 4, 2005, we sold convertible debentures maturing
      three years from issuance in the aggregate principal amount of $8,400,000,
      convertible into common stock of the Company at $0.75 per share, and warrants
      to
      purchase an aggregate of 8,400,000 shares of our common stock, at an exercise
      price of $1.00 per share to accredited investors.




The
      debentures accrue interest daily at a rate of 8% per annum, which interest
      is
      payable quarterly on each March 31, June 30, September 30 and December 31
      following the issue date. The interest payments due on December 31, 2006 and
      on
      March 31, 2007 were not paid until April 9, 2007. We received a waiver from
      each
      of the holders of the debentures for any late fee due or possible event of
      default in connection with the two late payments of interest. See Note 8 to
      the
      financial statements included in Item 1.




Through
      May 18, 2007, $2,100,000 in outstanding principal amount of convertible
      debentures has been converted into 2,799,993 shares of common stock, reducing
      the amount of interest required to be paid in future periods.




*Acquisition
      of Goodman Blue.* On
      October 11, 2006, VCS acquired 100% of the outstanding shares of Goodman Blue
      for consideration consisting of 2,500,000 shares of our common stock being
      issued to Scott Goodwin, the sole shareholder of Goodman Blue, subject to an
      option to require the Company to repurchase the shares of common stock for
      an
      aggregate purchase price of $2,500,000. We recorded the total purchase price
      of
      $2,562,643, which includes acquisition costs of $62,643, as intangible assets
      for the O2C software of $2,077,777 and as several customer contracts which
      were
      valued at $484,866. Management determined that the O2C asset will be amortized
      over a five year estimated useful life beginning on October 11, 2006. At March
      31, 2007 the net carrying value of this O2C intangible asset was $1,874,711.
      Amortization expense for the three-months ended March 31, 2007 was approximately
      $104,000. We have recorded the acquisition of Goodman Blue as a liability
      of $2,500,000 at March 31, 2007, in the expectation that Goodwin will require
      the Company to repurchase the shares. The purchase agreement, as amended,
      provides that: (i) Goodwin shall have the option to require us to purchase
      1,400,000 of the consideration shares for $1,400,000 (the “First Put Option”);
      and (ii) Goodwin shall have the option to require us to purchase 1,100,000
      of
      the consideration shares for $1,100,000 (the “Second Put Option”). In response
      to a purported exercise of the First Put Option on April 25, 2007, since
      retracted, the parties reached a supplemental agreement deferring the time
      for
      exercise of the First Put Option and Second Put Option to the period beginning
      on December 1, 2007 and ending on December 31, 2007 in consideration of the
      payment to Goodwin of approximately $110,000 and the engagement of Goodwin
      for
      consulting services to be providedto the
      Company’s subsidiary, Goodman Blue Limited.The terms of our currently
      outstanding debentures and notes prohibit the redemption of shares of our common
      stock without the debt holders consent.





As
      of
      March 31, 2007, Goodman Blue is obligated to pay approximately $ 164,000 in
      principal amount under a Small Firms Loan Guarantee Scheme from HSBC Bank plc.
      The loan accrues interest at a rate of 3.0% above the lender’s base interest
      rate of 4.5% as at March 31, 2007, and is payable in equal monthly installments
      of approximately $21,000 (which is exclusive of interest) until November 7,
      2007, the maturity date. The loan is guaranteed by the Secretary of State in
      the
      United Kingdom and the borrower pays a guarantee premium at an annual rate
      of 2%
      on the loan to the Secretary of State.




28


*Convertible
      Note and Warrant Financing.* As
      discussed in Note 15, on
      April
      6, 2007 we completed a convertible note and warrant financing for gross proceeds
      of $2,500,000. Most of these proceeds have been used in part for payments due
      to
      existing creditors and funding our working capital needs. In the event that
      the
      Company is not successful in implementing its business plan, or does not raise
      additional third-party capital, the Company will have to curtail certain
      expenditures and seek additional financing in order to sustain operations.
      See *Budget
      and Financial Forecasts for the Remainder of 2007* below
      for a more detailed explanation of the Company’s cash position.




During
      the three-month periods ended March 31, 2007 and 2006 no services were
      contributed to the Company by our stockholders. We have made cash expenditures
      for capital equipment and software from our inception until March 31, 2007
      of
      approximately $11,640,000 purchasing the telecommunications equipment necessary
      to operate our business, including the cash payment of $8,800,000 pursuant
      to
      the purchase of the V-CubeTM software and intellectual property, as described in
      Note 9 to the financial statements included in Item 1.





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





*Budget
      and Financial Forecasts for the Remainder of 2007*




The
      following disclosure includes certain statements, budgets, estimates,
      projections and other forward-looking statements with respect to the anticipated
      future performance of Vistula Communications Services, Inc. The statements,
      budgets, estimates, projections and other forward-looking statements, which
      have
      not been reviewed or examined by the Company’s independent auditors, are based
      upon various assumptions by management made on a reasonable basis and in good
      faith that may not prove to be correct. Such assumptions are inherently subject
      to significant uncertainties and contingencies, many of which are beyond the
      Company’s control. No assurance is given, that the Company can or will attain
      such results. Actual results are likely to vary, perhaps materially, from the
      Company’s projections due, at least in part, to the Company’s risks and
      uncertainties set forth above.




In
      the
      course of their due diligence, the purchasers of the Company’s convertible notes
      and warrants discussed with the Company’s management the planned use of proceeds
      and the plan for operating the Company subsequent to the closing. These
      purchasers were provided with budgetary information and financial forecasts
      which were included in the disclosure schedules incorporated into the definitive
      investment documentation and filed with the Company’s Form 8-K dated April 9,
      2007 which reported on the closing of that transaction.




Budgetary
      information contemplated that the gross proceeds of the sale of the convertible
      notes and warrants would be $3,000,000 rather than the $2,500,000 actually
      raised and that the closing would have occurred before the end of the first
      quarter of 2007 rather than at the end of the first week of the second quarter.
      As a result of these variances and the continuing negotiation by management
      with
      trade creditors and service providers to extend payment terms and/or grant
      discounts and compromise obligations, the Company is in the process of
      reformulating and adjusting the operating budget and financial forecasts for
      the
      remainder of 2007.




The
        Company believes that, irrespective of the actual adjustments made, the material
        implications of the budget are as follows:
  ·
              Following
                  the closing and the payment of expenses associated with the financing
                  and
                  the payments of past due interest on the Company’s 8% convertible
                  debentures ($254,800), past due trade payables and taxes in the
                  United
                  States and the United Kingdom as described more fully below under
                  “Non-Compliance Items,” and current amounts due, such as payroll, of
                  $1,243,000 were made. The remaining cash has been used in part
                  to pay
                  negotiated rates with other creditors for outstanding balances
                  and for
                  ongoing operational requirements, leaving approximately $270,000
                  remaining
                  as of the date of this Form 10-QSB;
  29
  ·
              The
                  Company expected to incur selling, general and administrative expenses
                  of
                  approximately $1,300,000 in each of the remaining quarters of 2007,
                  and
                  management has made reductions of and continues to work towards
                  reductions
                  in the monthly incurred expenses and continues to negotiate with
                  creditors
                  for delayed payments and possible forgiveness of amounts
                  outstanding;
  ·
              The
                  Company previously expected to generate net revenues of approximately
                  $830,000, $2,900,000 and $3,000,000 in the second, third and fourth
                  quarters of 2007, respectively and as a result of such revenue
                  generation
                  expected to have net cash positions of approximately $0, $1,000,000
                  and
                  $2,500,000 at the end of the second, third and fourth quarters
                  of 2007,
                  respectively; and
  ·
              Despite
                  the indicated cash positions, for financial reporting purposes,
                  the
                  Company would continue to show net losses in each of these three
                  quarters
                  of 2007 and for the year as a whole due to non-cash items of
                  loss.
  All
        of
        these forecasts were based on projections of revenue generated through the
        Company’s arrangement with Northamber to distribute our V-CubeTM product. The
        delay in completing the convertible note and warrant financing initially
        led the
        Company to anticipate a delay in revenue generations through the Northamber
        arrangement until late in the second quarter of 2007. The Company now believes
        that the Northamber arrangement will not result in revenue generation until
        the
        third quarter of 2007 and management is actively seeking additional capital
        to
        provide interim funding for operations until such revenues are generated.
        The
        failure to generate such revenue in the amount and in the timeframe contemplated
        in the forecast has directly and adversely effected the Company’s ability to
        continue its operations and management expects that the Company will need
        to
        raise additional capital and obtain further accommodations from trade creditors
        and service providers or it will have to curtail operations.
  As
        identified below in Other Arrangements and Obligations, *Non-Compliance
        Items* ,
        the
        Company paid the debenture holders interest outstanding as per the waivers
        received from the outstanding debenture holders as described in Note 8 to
        the
        financial statements included in Item 2, and made payments to various creditors.
        The remaining balance is expected to be used for working capital purposes
        and
        for payment towards outstanding creditor balances which management is currently
        negotiating for relief or delays in payment, in order to conserve cash, until
        the Company begins to collect cash for the sales of the V-CubeTM product from the
        Northamber distribution agreement. The majority of the revenues in the Budget
        are assumed to be from the Northamber distribution agreement and are expected
        to
        begin to be recognized late in the second quarter or early third quarter
        of
        2007. In the event the Company does not recognize revenues and collect cash
        as
        it has forecasted in the Budget during the second quarter of 2007, additional
        financing will be required or the business may have to curtail operations.




**Other
      Arrangements and Obligations**




*V-CubeTM
      Distribution Arrangements*





On
      February 2, 2007, Vistula Limited signed a distribution agreement with
      Northamber to sell its IP-PBX solutions to customers of Northamber in the United
      Kingdom. Northamber will offer a hosted IP-PBX product using our V-CubeTM
platform. The hosted IP-PBX product will be sold via Northamber's network of
      6,000 distributors and master agents in the UK. Under the agreement, we will
      host the service and provide Tier 2 and Tier 3 level support to Northamber's
      distributors and customers. Northamber is a long established and large
      trade-only distributor of IT products and equipment in the UK. We expect the
      revenues from this distribution to be a significant provider of operational
      cash
      for our business.




30


*Non-Compliance
      Items*




Delaware
      Franchise Tax. VCS and Vistula USA did not file and pay the Delaware franchise
      tax due on March 1, 2007. We have filed the required return and made aggregate
      payments of approximately $18,600 to bring each entity into good standing as
      of
      April 10, 2007.




Tax
      Returns. VCS and Vistula USA did not file and pay for the tax return extensions
      to the Internal Revenue Service or the states of New York and Massachusetts
      due
      on March 15, 2007. On April 10, 2007 the extensions and payments in aggregate
      of
      approximately $2,100 were mailed to the respective tax authorities. We will
      pay
      any late fees, expected to be minimal, related to the late filings when
      invoiced.




Debenture
      interest payments. VCS did not timely pay the quarterly interest payments that
      were due on December 31, 2006 and March 31, 2007 to the holders of VCS’
outstanding 8% convertible debentures. We paid these outstanding interest
      payments on April 9, 2007 and received a waiver from each of the debenture
      holders for any late fee due or possible event of default in connection with
      the
      two late payments of interest.




Inland
      Revenue in United Kingdom. Vistula Limited was not in good standing due to
      approximately $20,000 in amounts being due for Pay-As-You-Earn (“PAYE”) taxes,
      equivalent to the United States taxes on salaries including FICA and Medi-care,
      and Goodman Blue Limited was not in good standing due to approximately $62,000
      in amounts being due for PAYE. On April 10, 2007, payments by Vistula Limited
      for approximately $29,000 and by Goodman Blue Limited for approximately $62,000,
      brought each entity into good standing.




*Financial
      Advisory Services*




The
      Company entered into another financial advisory agreement on January 30, 2007
      with Indigo Ventures LLC ("Indigo")for a bridge financing. In connection with
      the convertible note and warrant financing, Indigo agreed to terminate the
      January 30, 2007 financial advisory agreement and waive any fees under that
      agreement in return for reimbursement of legal and travel expenses of $49,182
      and for the Company’s acknowledgement that $117,000 in connection with services
      previously rendered under the advisory agreement entered into on January 27,
      2006 remain outstanding and that this amount is payable upon the earlier of
      (i)
      the sale of the company, (ii) a capital raise of at least $5,000,000 or (iii)
      the date when the Company has sufficient cash flow available from its
      operations.





**Subsequent
      Events**





*Private
      Placement*




On
      April
      6, 2007, the Company completed a private placement of convertible
      notes and warrants pursuant to a securities purchase agreement (the “Securities
      Purchase Agreement”) with certain accredited investors (the “Investors”). The
      Investors purchased convertible notes in the aggregate principal amount of
      $2,500,000 and warrants to purchase up to an aggregate of 2,500,000 shares
      of
      the Company’s common stock. The private placement resulted in gross proceeds of
      $2,500,000. The
      investors will also receive an aggregate of 5,000,000 shares of our common
      stock, which shares will be transferred from Executive Management Services
      Limited (“EMS”), an entity of which Mr. Galliers-Pratt, is a beneficiary, to the
      investors, EMS is receiving no consideration for the transfer. It is an event
      of
      default under the terms of the convertible notes if these 5,000,000 shares
      were
      not delivered to the Investors by April 27, 2007. These shares have been
      released from a European custodian and sent to EMS' business office in the
      British Virgin Islands for processing and will be transferred to the investors
      immediately upon receipt by the Company’s counsel.




31


Each
      of
      the Investors was granted a participation right whereby they may elect to
      purchase all or a portion of securities sold in certain future financings.
      The
      participation right expires on the first anniversary of the closing
      date.




Each
      Investor was also granted the right to exchange all or some of its notes for
      securities offered in certain future financings. In the event of this exchange
      right is asserted in connection with such a future financing, we would be
      required to issue to the Investor requesting the exchange a number of new
      securities offered in such financing determined by dividing the outstanding
      principal amount of the note being exchanged (plus accrued interest or other
      fees owed to such Investor) by the price at which the new securities are being
      sold in such financing. This exchange right expires on the first anniversary
      of
      the closing date.




Under
      the
      terms of the Securities Purchase Agreement, we are prohibited from engaging
      in
      certain types of financing transactions. In particular, for a period of 45
      days
      after the date the initial registration statement covering the shares underlying
      the notes and warrants is first declared effective by the SEC (which we must
      file pursuant to a Registration Rights Agreement, as further described herein),
      we may not issue shares of common stock or common stock equivalents except
      pursuant to conversion or exercise of convertible securities or outstanding
      rights to acquire common stock that were outstanding on or prior to the closing
      date. Also, until such time as no Investor holds any of the notes, warrants
      or
      shares of common stock underlying the notes or warrants, we may not issue
      securities that are convertible into, exchangeable or exercisable for, or
      include the right to receive additional shares of our common stock at a
      conversion, exercise or exchange price, as applicable, that is (i) determined
      based on the market price of our common stock at any time after the issuance
      of
      such securities, or (ii) is subject to reset upon the occurrence of events
      directly or indirectly related to our business or the market for our common
      stock. We are also prohibited from entering into any agreement providing for
      the
      sale of securities at a price determined at a future time.




The
      notes
      issued to the Investors on April 6, 2007 accrue interest daily at an rate of
      12%
      per annum, which interest is payable quarterly on each March 31, June 30,
      September 30 and December 31 beginning on September 30, 2007. The final interest
      payment is due on the date of maturity of the note, April 6, 2009. In addition,
      on any date on which all or a portion of the principal of a note is converted,
      all unpaid interest having accrued on such principal at the time of such
      conversion will become immediately payable. We are not permitted to prepay
      any
      portion of the principal amount of any of the notes without the prior consent
      of
      the holder thereof. These notes are junior to the currently outstanding 8%
      convertible debentures due in February and March 2008.




The
      notes
      are convertible at the option of the holders into shares of the Company’s common
      stock at any time at an initial conversion price of $1.00 per share. Except
      in
      the case of certain exempted issuances, in the event we issue shares of common
      stock or common stock equivalents (i.e., securities convertible into, or
      exercisable or exchangeable for, shares of our common stock) at a price per
      share (or in the case of common stock equivalents, a conversion, exercise or
      exchange price per share) below the then applicable conversion price of the
      notes, the conversion price of the notes will be reduced to that lower price
      per
      share.




If,
      after
      the effectiveness of the registration statement, the market price for any period
      of 20 consecutive trading days exceeds $2.50 and the average daily trading
      volume for our common stock for such period exceeds 100,000 shares, we may,
      subject to certain conditions, force the holders of the notes to immediately
      convert all or any part of the then outstanding principal amount at the
      then-effective conversion price.




If,
      after
      the first year anniversary of the issuance of the notes, there is an effective
      registration statement and for a period of 20 consecutive trading days, the
      daily trading volume for the Company’s common stock exceeds 100,000 shares per
      trading day, we may, subject to certain conditions, redeem all or any part
      of
      the then outstanding principal amount of the notes for cash in an amount equal
      to the sum of (i) 150% of the then outstanding principal amount of the note,
      (ii) accrued but unpaid interest and (iii) all liquidated damages and other
      amounts due in respect of the note.




32


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




Events
      of
      default under the notes include failure to pay any amounts under the notes
      when
      due, a material default under other agreements with the Investors or default
      in
      our obligations under mortgage, credit facility or similar agreements, a
      material inaccuracy in the representations and warranties we made to the
      Investors in connection with the Financing, and the initiation of voluntary
      or
      involuntary bankruptcy proceedings against us.




The
      common stock purchase warrants issued to the Investors on April 6, 2007 are
      exercisable for an aggregate of 2,500,000 shares of our common stock at an
      initial exercise price of $1.00. The warrants have an expiration date of five
      years after the date of issuance, or April 6, 2012. They contain a cashless
      exercise provision whereby the holder may pay the exercise price by having
      us
      withhold upon exercise shares having a fair market value equal to the applicable
      aggregate exercise price if after the first anniversary of the date of issuance
      of the warrant there is no effective registration statement registering, or
      no
      current prospectus available for, the resale of the shares issuable upon the
      exercise of the warrants. In the event this provision is used with respect
      to an
      exercise, we would receive no proceeds from the sale of the our common stock
      in
      connection with such exercise.




The
      exercise price is subject to adjustment in the event of certain issuances of
      new
      securities. Specifically, except in the case of certain designated issuances,
      if
      we issue shares of common stock or common stock equivalents (i.e., securities
      convertible into, or exercisable or exchangeable for, shares of the Company’s
      common stock) at a price per share (or in the case of common stock equivalents,
      a conversion, exercise or exchange price per share) below the then applicable
      exercise price of the warrants, the exercise price of the warrants will be
      reduced to that lower price per share. In the event of such an adjustment,
      the
      number of shares for which the warrants are exercisable will be increased such
      that the aggregate exercise price of the warrants after the adjustment will
      equal the aggregate exercise price immediately prior to the adjustment.
      Issuances that will not result in adjustment to the exercise price include
      issuances to employees, consultants, directors or officers pursuant to a stock
      or option plan adopted by our board of directors, securities issued upon
      conversion of other securities outstanding prior to the date of issuance of
      the
      warrants, warrants issued in connection with obtaining bank financing, common
      stock issued in connection with the settlement of claims up to a maximum
      aggregate of 500,000 shares, securities issued in connection with acquisitions,
      joint ventures or other strategic transactions and securities issued under
      agreements executed by the us prior to the date of the Securities Purchase
      Agreement and disclosed in our reports filed with the SEC since January 1,
      2006.




If,
      after
      the effectiveness of the registration statement, (i) the market price for any
      period of 20 consecutive trading days exceeds $2.50, (ii) the average daily
      trading volume for our common stock for such period exceeds 100,000 shares
      and
      (iii) the Investor is not in possession of any information that constitutes,
      or
      might constitute, material non-public information which was provided by us,
      then
      we may, within 1 trading day of the end of such period, call for cancellation
      of
      all or any portion of the warrants for which a notice of exercise has not yet
      been delivered for consideration equal to $0.001 per share.




We
      agreed
      to register for resale under the Securities Act of 1933, as amended, the shares
      underlying the notes and warrants and the bonus shares pursuant to a
      Registration Rights Agreement between us and the Investors dated April 6, 2007.
      On May 7, 2007 we filed with the SEC a registration statement covering the
      resale of a number of shares of common stock equal to 120% of the shares
      issuable upon conversion and exercise in full of the notes and warrants as
      of
      the date of filing of the registration statement plus the bonus shares. The
      registration statement covering these shares must be declared effective by
      the
      SEC no later than July 5, 2007 (or in the event there is a review, no later
      than
      August 4, 2007). In the event that it is not declared effective within the
      timeframes specified by the Registration Rights Agreement, we will be required
      to pay to the Investors liquidated damages equal to 1.5% per month (but
      pro-rated on a daily basis for any period of less than a full month) of the
      aggregate purchase price of the notes and warrants until the registration
      statement is declared effective, as applicable.




33


If,
      at
      any time, the number of shares issuable upon conversion and exercise in full
      of
      the notes and warrants exceeds 100% of the number of shares then registered
      (e.g., due to adjustments in the conversion price of the notes or exercise
      price
      of the warrants), we will be required to file an additional registration
      statement covering the excess shares. We will have to file the additional
      registration statement on the earliest practicable date, and the additional
      registration statement must be declared effective by the SEC not later than
      the
      60 th calendar
      day, following the date the 100% threshold is exceeded. If we do not file the
      registration statement or the registration statement is not declared effective
      within these time frames, we will be required to pay to the liquidated damages
      as described in the preceding paragraph.




In
      connection with the closing of the convertible note and warrant financing,
      we
      paid placement agent fees in the amount of $56,000 in cash and warrants to
      purchase 1,400,000 shares of our common stock at $1.00 per share, which warrants
      expire in five years. We agreed to indemnify the principal placement agent
      from
      claims arising in relation to the services it provides to us.




*Sale
      of Switching Equipment*




We
      entered into an Agreement on April 13, 2007, whereby we sold our wholesale
      voice
      switching equipment (“Switch”) located in the United Kingdom used in our
      wholesale voice services business in exchange for the buyer (i) assuming the
      co-location lease and all associated costs, including, without limitation the
      costs of the circuits, power, and running the switching equipment (ii) operating
      the Switch, (iii) allowing us to use the switch for three years at no cost
      to us
      and (iv) assuming any billing processes previously performed by one our
      employees, who will continue to be available to us. The Agreement was
      retroactive to January 1, 2007.





*Extension
      of Put Option*




In
        response to a purported exercise of the First Put Option on April 25, 2007,
        since retracted, the parties reached a supplemental agreement deferring the
        time
        for exercise of the First Put Option and Second Put Option to the period
        beginning on December 1, 2007 and ending on December 31, 2007 in consideration
        of the payment to Goodwin of approximately $110,000 and the engagement of
        Goodwin for consulting services to be providedto the
        Company’s subsidiary, Goodman Blue Limited.





*Consulting
      Agreement with Jack Early*




On
      May
      16, 2007, we entered into a consulting agreement with Jack Early, a director,
      relating to Mr. Early’s serving as our chief operating officer. Under the
      consulting agreement, we will pay Mr. Early an initial fee of $15,000 for
      services performed during the period from May 16, 2007 through May 31, 2007,
      which fee shall be payable on June 1, 2007. After June 1, 2007, Mr. Early will
      be paid fees at the rate of $10,000 per month which shall be payable in arrears
      in bi-monthly installments on the dates on which we make our payroll payments
      during the term of the consulting agreement. In addition, the consulting
      agreement provides for the grant to Mr. Early of a non-statutory stock option
      to
      purchase up to 250,000 shares of our common stock. The board of directors
      approved this grant and the other terms of the consulting agreement based on
      a
      recommendation from our compensation committee and fixed the exercise price
      per
      share at $0.06, which represents the closing price of our common stock on May
      15, 2007 as reported on the Over the Counter Bulletin Board.





34


The
      option is exercisable for five years from the date of grant and shall vest
      and
      become exercisable with respect to 150,000 shares of common stock on December
      31, 2007 and shall vest and become exercisable with respect to the remaining
      100,000 shares of common stock on December 31, 2008, provided, in each case,
      that Mr. Early is an officer or director of the Company on such vesting date.




In
      connection with his appointment as chief operating officer, Mr. Early has
      resigned as a member of the compensation committee and the nominating committee
      of the board of directors.




Effective
      upon the appointment of Mr. Early, Ian Cope resigned his position as chief
      operating officer and was appointed to the newly created position of chief
      technology officer.




**Item
      3.** **** **Controls
      and Procedures.**




Evaluation
      of Disclosure Controls and Procedures




Based
      on
      Company management’s evaluation (with the participation of the Company’s
      principal executive officer and principal financial officer), as of the end
      of
      the period covered by this report, the Company’s principal executive officer and
      principal financial officer have concluded that the Company’s disclosure
      controls and procedures (as defined in Rules 13a-15(e) and
      15d-15(e) under the Securities Exchange Act of 1934, as amended, (the
“Exchange Act”)) are effective to ensure that information required to be
      disclosed by the Company in reports that it files or submits under the Exchange
      Act is recorded, processed, summarized and reported within the time periods
      specified in Securities and Exchange Commission rules and
      forms.




It
      should
      be noted that any system of controls, however well designed and operated, can
      provide only reasonable, and not absolute, assurance that the objectives of
      the
      system are met. In addition, the design of any control system is based in part
      upon certain assumptions about the likelihood of future events. Because of
      these
      and other inherent limitations of control systems, there can be no assurance
      that any design will succeed in achieving its stated goals under all potential
      future conditions, regardless of how remote.




Changes
      in Internal Control over Financial Reporting




The
      Company’s management, in connection with its evaluation of internal controls
      (with the participation of the Company’s principal executive officer and
      principal financial officer), did not identify any change in internal control
      over the financial reporting process that occurred during the Company’s first
      fiscal quarter of 2007 that would have materially affected, or would have been
      reasonably likely to materially affect, the Company’s internal control over
      financial reporting.




**PART II.               
      OTHER INFORMATION**




**Item
      1: Legal Proceedings**




None.




**Item
      2. Unregistered Sales of Equity Securities**




None.




**Item
      3. Defaults Upon Senior Securities**




None.




**Item
      4. Submission of Matters to a Vote of Security Holders**




None.




35


**Item
      5.  Other Events**




None.




**Item
      6. Exhibits**




**(a) Exhibits.**




**Incorporated
                by Reference****Exhibit**
              **Number**
            
            **Exhibit Description**
            
            **Filed
                with**
              **this
                Form**
              **10-QSB**
            
            **Form**
            
            **Filing
                Date**
            
            **Exhibit No.**10.1
            
            Form
                of Incentive Stock Option under the Company’s Amended and Restated 2004
                Stock Incentive Plan
            
            
            
            Form 8-K
            
            February
                9, 2007
            
            10.110.2
            
            Form
                of Non-Statutory Stock Option under the Company’s Amended and Restated
                2004 Stock Incentive Plan
            
            
            
            Form 8-K
            
            February
                9, 2007
            
            10.210.3
            
            Supplemental
                Agreement with Scott Goodwin dated February 12, 2007
            
            
            
            Form 8-K
            
            February
                16, 2007
            
            10.131.1
            
            Certification
                by Rupert Galliers-Pratt pursuant to Rule 13a-14(a) and
                15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
                Act of 2002, relating to Vistula Communications
                Services, Inc.
            
            X31.2
            
            Certification
                by 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.
            
            X32.1
            
            Certification
                by Rupert Galliers-Pratt pursuant to Section 1350, Chapter 63 of
                Title 18, United States Code, as adopted pursuant to Section 906 of
                the Sarbanes-Oxley Act of 2002, relating to Vistula Communications
                Services, Inc.
            
            X32.2
            
            Certification
                by 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




36





**SIGNATURES**




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


Vistula
                Communications Services, Inc.Date:
                May 22, 2007
            By:
            /s/
                RUPERT GALLIERS-PRATTRupert
                Galliers-PrattChief
                Executive Officer




37