**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**Washington,D.C. 20549**

 

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**FORM 10-KSB**

 

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| **ý**                                                                                                                                                                                                                  | ** ** | **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE  SECURITIES EXCHANGE ACT OF 1934**     |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                                                                        |       |                                                                                          |
| **For the  Fiscal Year Ended: December 31, 2005**                                                                                                                                                                      |
|                                                                                                                                                                                                                        |
| **o**                                                                                                                                                                                                                       | ** ** | **TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF  THE SECURITIES EXCHANGE ACT OF 1934** |
|                                                                                                                                                                                                                        |       |                                                                                          |
| **For the  transition period from               to                 ** |

 

**CommissionFile Number 000-50758**

** **

**VISTULA COMMUNICATIONSSERVICES, INC.**

(Exact name ofRegistrant as specified in its Charter)

 

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

 

**Suite 801,405 Park Avenue**

**New York,New York 10022**

(Address ofprincipal executive offices and zip code)

 

Issuer’s telephone number: **(212) 317-8900**

 

Securities registered pursuant toSection 12(b) of the Act:

 

| **Title of  Class** |   | **Name of  each exchange on which registered** |
|---------------------|--------|------------------------------------------------|
| None                |   | Not Applicable                                 |

 

Securities Registered pursuant toSection 12(g) of the Act:

 

**CommonStock, par value $0.001 per share**

(Title of class)

 

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

 

Check if there is no disclosure of delinquent filersin response to Item 405 of Regulation S-B contained in this form, and nodisclosure will be contained, to the best of registrant’s knowledge, indefinitive proxy or information statements incorporated by reference inPart III of this Form 10-KSB or any amendment to thisForm 10-KSB. ý

 

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

 

The issuer’s revenues for its most recent fiscal yearwere $840,457.

 

The aggregate market value of the voting andnon-voting common equity held by non-affiliates computed by reference to theprice at which the common equity was sold, or the average bid and asked priceof such common equity, as of a specified date within the past 60 days.(See definition of affiliate in Rule 12b-2 of the Exchange Act.) was: $28,820,867.

 

**APPLICABLEONLY TO CORPORATE REGISTRANTS**

 

As of March 22, 2006, there were 32,664,898shares of the issuer’s common stock outstanding.

 

Transitional Small Business Disclosure Format (checkone): Yes o No ý

 

 

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**VISTULACOMMUNICATIONS SERVICES, INC.**

 

**FORM10-KSB**

 

**TABLEOF CONTENTS**

 
| **PART I**    |   |                                                                                                               | **2**  |
|---------------|--------|--------------------------------------------------------------------------------------------------------------------|--------|
| Item 1.       |   | Description of Business                                                                                            | 2      |
| Item 2.       |   | Description of Property                                                                                            | 13     |
| Item  3.      |   | Legal  Proceedings                                                                                                 | 13     |
| Item 4.       |   | Submission of Matters to a Vote of Security Holders                                                                | 13     |
| **PART II**   |   |                                                                                                               | **14** |
| Item 5.       |   | Market for Common Equity and Related Stockholder Matters and Small  Business Issuer Purchases of Equity Securities | 14     |
| Item 6.       |   | Management’s Discussion and Analysis of Financial Condition and  Results of Operations                        | 14     |
| Item 7.       |   | Financial Statements                                                                                               | 31     |
| Item 8.       |   | Changes in and Disagreements with  Accountants on Accounting and Financial Disclosure                              | 53     |
| Item 8a.      |   | Controls and Procedures                                                                                            | 54     |
| Item 8b.      |   | Other Information                                                                                                  | 55     |
| **PART  III** |   |                                                                                                               | **56** |
| Item 9.       |   | Directors, Executive Officers, Promoters  and Control Persons; Compliance with Section 16(a) of the Exchange Act   | 56     |
| Item 10.      |   | Executive Compensation                                                                                             | 58     |
| Item 11.      |   | Security Ownership of Certain Beneficial  Owners and Management and Related Stockholder Matters                    | 60     |
| Item 12.      |   | Certain Relationships and Related  Transactions                                                                    | 63     |
| Item 13.      |   | Exhibits                                                                                                           | 63     |
| Item 14.      |   | Principal Accountant Fees and Services                                                                             | 67     |

 

This annual report on Form 10-KSB contains forward-lookingstatements, which involve risks and uncertainties, such as our plans,objectives, expectations and intentions. You can identify these statements byour use of words such as “may,” “expect,” “believe,” “anticipate,” “intend, ” “could,” “estimate, ” “continue, ” “plans, ” or their negatives or cognates. Some ofthese statements include discussions regarding our future business strategy andour ability to generate revenue, income and cash flow. We wish to caution thereader that all forward-looking statements contained in this Form 10-KSBare only estimates and predictions. Our actual results could differ materiallyfrom those anticipated as a result of risks facing us or actual eventsdiffering from the assumptions underlying such forward-looking statements.Readers are cautioned not to place undue reliance on any forward-lookingstatements contained in this Annual Report on Form 10-KSB. We will notupdate these forward-looking statements unless the securities laws andregulations require us to do so.

 

This Annual Report on Form 10-KSB contains trademarks and servicemarks of Vistula Communications Services, Inc. and its subsidiaries.Unless otherwise provided in this Annual Report on Form 10-KSB, trademarksidentified by Ô are trademarks ofVistula Communications Services, Inc. or its subsidiaries. All othertrademarks are the properties of their respective owners.

 

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**PART I**

 

**ITEM 1. DESCRIPTION OF BUSINESS**

 

**Business Development**

 

Vistula Communications Services, Inc. (“VCS,”the “Company,” “Vistula Companies,” “we, ” or “us”) was incorporated onSeptember 22, 2003 under the laws of the State of Delaware. OnMarch 2, 2004, VCS acquired all of the issued and outstanding ordinaryshares of Cardlink Services Limited, a company incorporated under the laws ofScotland (“Cardlink”) and all of the issued and outstanding ordinary shares ofVistula Limited, a company incorporated under the laws of England and Wales (“Vistula”).VCS issued an aggregate of 23,885,000 shares of common stock to the formershareholders of Vistula and Cardlink in exchange for all of the shares ofCardlink and Vistula. VCS was originally incorporated under the nameVCS, Inc. VCS changed its name to Vistula Communications Services, Inc.on March 4, 2004. In 2005, VCS established Vistula Communcations ServicesSA (Pty) Ltd. (“Vistula SA”), a company incorporated under the laws of SouthAfrica and which is 60% owned by VCS.

 

Cardlink was incorporated inFebruary 1996 and was acquired by Mr. Rupert Galliers-Pratt, thechairman of our board of directors and our chief executive officer andpresident, and members of his family in April, 2003 from MetromediaInternational Group Inc. (OTCBB: MMG). From the time of its acquisition byMr. Galliers-Pratt through the date of the share exchange with VCS, andfollowing completion of the share exchange with VCS through the date of filingof this Form 10-KSB, Cardlink has not generated any revenues*.*

 

Vistula was incorporated and commencedoperations in August 2002. Since its incorporation in August 2002through to the completion of the exchange of Vistula shares for shares in VCS,Vistula was owned entirely by an entity controlled by Mr. Galliers-Prattand his immediate family.

 

On February 4, 2004, VCS incorporated asubsidiary, Vistula USA, Inc. (“Vistula USA”), under the laws of the Stateof Delaware. Vistula USA provides the U.S.-based telecommunications switchingservices which were previously provided by Vistula.

 

Neither VCS nor any of its subsidiaries have beeninvolved in any bankruptcy or bankruptcy proceeding.

 

Our principal executive offices are locatedat Suite 801, 405 Park Avenue, New York, New York 10022 and our telephonenumber and fax number at that office are (212) 317-8900 and(212) 832-7563, respectively. We have offices in New York, London, Englandand Sandown, South Africa. Our principal Internet address is *www.vistula.com*.

 

**Business of the Issuer**

 

We are a provider of value-added services andsoftware to Tier 1 and Tier 2 telecommunications carriers and transit networkoperators throughout the world. We currently have four principal subsidiaries:our wholly owned subsidiaries, Vistula, Vistula USA, and Cardlink, and our60%-owned subsidiary Vistula SA.

 

Our goal is to provide state-of-the-art software andhigh-margin services to telecommunications carriers, service providers andnetwork operators. We believe that our operating subsidiaries will occupystrong positions within the telecommunications market.

 

*Voice over Internet ProtocolServices.*We expectour core product offering to be V-CubeTM, a uniquely featured InternetProtocol-P-B-X, or “IP-PBX,” that facilitates full contact communicationservices including voice, video, conferencing, call center, interactive voiceresponse systems, and multi/sub-domain and unified messaging across enterpriseand public networks. Through the V-CubeTM platform, we offer a tailored softwareset that enables carriers, service providers and transit network operators toroll out a range of managed Voice over Internet Protocol, or “VoIP,” basedproduct and service offerings to their customers.

 

VoIP enables the transmission of voice packets overthe Internet by converting voice into data, transmitting them over theInternet, and then reconverting them into voice at the call destination. VoIPtechnology enables carriers to hook into their local Internet gateway, provideeach other with their Internet address and then treat this link as if it was atraditional permanent cable/fiber or satellite circuit switched connection.This not only costs the interconnecting carriers much less on a call by callbasis, but a single link into the Internet can be used to connect to any numberof different and changing carrier partners.

 

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We face significant competition from companiesproviding similar IP-PBX and IP Centrex platforms. While we believe that theV-CubeTM platform has significant advantages over these competitivetechnologies, some of our competitors, such as Broadsoft, have significantfinancial resources including significant investment from major private equityfunds. Many of these competitors have also been in the market for considerablylonger than we have and possess significant existing customer bases.

 

However,we believe that our V-CubeTM offering has several advantages, including thefollowing:

 

•  It is a comprehensive solution supporting anextensive set of features and services including voice, video, Short MessageService (“SMS”), fax, instant messaging, presence management, email,interactive voice response, conferencing, and unified communications with realtime prepaid and post-paid billing;

 

•  It is flexible enough to provide carriers andservice providers with the ability to create new services and features to enablethem to respond to changing customer requirements (including number of users)and market demands; and

 

•  It enables faster delivery of personalizedservices, such as multi-level administrative access for the management ofinternal extensions.

 

During2005 we also entered into an agreement under which we acquired a multi-useworldwide license for a consumer VoIP portal that sits in front of the V-CubeTMengine to enable our telecommunication company and internet service provider("ISP") customers to deliver a low cost consumer VoIP service intheir markets. The product comprises a no-touch registration, sign-up andpayment system which enables our client’s customers to become VoIP telephonyusers. In contrast to our full business IP-PBX offering, this system isspecifically designed for single user consumers. This adds an important productcapability to our portfolio and one that will be sold alongside the fullV-CubeTM IP-PBX to all our customers.

 

Inaddition, we intend to provide to VoIP customers operational accommodation,technical expertise and management services for servers, routers, switches andtransmission equipment. We will provide those services to ISPs, content owners,telecommunications operators, corporate data center providers and otherbandwidth-intensive service providers. We will offer a range of co-locationservices, from basic, unmanaged rack spaces through to fully outsourced,dedicated suites, all in a secure communications environment.

 

*Wholesale Voice Services.  *With well over two hundred countries andseveral call bands within those countries (including capital city, national andmobile bands), it is impossible for any one telecommunications operator, nomatter how large, to create or even identify the lowest cost or best qualityroutes to all destinations. The result is that all operators, including theworld’s largest country carriers will buy their international telephony routeson the open market. The success of aggregators such as the Vistula Companiesoperating in this field depends upon the ability of the executives and staffwithin those companies to identify, create and run quality routes that can bemarketed to other carriers. We plan to continue to build the capability of eachof the Vistula Companies in the international wholesale voice call businessthrough the continuing development of network interconnects and commercialagreements that enable us to offer competitive call termination to ourcustomers.

 

*International Managed Bandwidth Services.  *In addition to theinternational voice services that we currently provide, we have the capabilityto offer managed bandwidth services that would provide service providers’customers with a committed and constant availability of high-speed capacitybetween locations of the customers’ choice. Our vendor-independent status couldenable them to offer fully-managed, end-to-end services across all majorsatellite and cable systems that include a range of product options to enhancethe data, voice, and IP network services on a global basis. Our serviceofferings portfolio could also include co-location services, end-user equipmentprovision and maintenance, Internet transit connectivity, and projectmanagement available 24 hours a day, seven days a week.

 

**Material Developments in 2005**

 

Thefollowing summarizes some of the important developments for our business during2005:

 

*Convertible Debenture and Warrant Financing.*   In the first quarter of 2005, weissued and sold convertible debentures and warrants to certain accreditedinstitutional and individual investors pursuant to a Securities Purchase Agreementbetween the Company and the investors. In the two closings of the privateplacement under the Securities Purchase Agreement, we sold convertibledebentures in the aggregate principal amount of $8,400,000 and warrants topurchase an aggregate of 8,400,000 shares of our common stock.

 

*MRS Partners LLC Purchase.  *We completed the purchase of certaintelecommunications equipment (including two Sonus Networks switches) from MRSPartners LLC for $500,000 in cash, 725,000 shares of our common stock and a promissorynote for an aggregate principal amount of $1,170,000, which was subsequentlyreduced to $970,000 due to certain unforeseen expenses relating to relicensingand recertifying the purchased equipment. Under the terms of the promissorynote issued to MRS Partners LLC at the closing, interest accrues daily at arate of 8.25% and is payable monthly in arrears. A principal repayment of$100,000 was made on or about September 30, 2005. An additional principalpayment of $100,000 that was due on December 31, 2005 was extended to and paidon

 

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March 31, 2006. The remaining principal amount($770,000) and any unpaid interest originally payable on the first anniversaryof the closing of the purchase, March 15, 2006, has been extended to April 28,2006.

 

*Telstra Europe Agreement.*   We entered into a distributionand marketing agreement with Telstra Europe Limited, a U.K.-basedtelecommunications carrier. Under this agreement, we have granted to TelstraEurope a license to provide hosted IP-PBX services to its customers using thehosted V-CubeTM IP-PBX platform. The agreement grants Telstra an exclusivelicense to provide the hosted solution to its customers in the United Kingdomfor a period of five years. The monthly license fee payable by Telstra to us isbased on the number of individual users at the various Telstra customers whoare using the VoIP services provided by Telstra through use of the V-CubeTMplatform. Although this agreement has not yet resulted in any revenue, webelieve the marketing advantages and customer relationships of Telstra willprovide us with significant monthly revenue in the future.

 

*Public Trading of Common Stock.*On July 21, 2005our common stock began trading on the OTC Bulletin Board under the symbol “VSTL.”  Prior to that date, there was no publicmarket for our common stock.

 

*Warrant Exercise Agreements.  *In October 2005, we entered into severalWarrant Exercise Agreements with holders of warrants issued in the privateplacement that closed in the first quarter of 2005. Pursuant to theseagreements, we issued to these holders new common stock purchase warrantsexercisable for a number of shares equal to the number of shares they purchasedupon exercise of the warrants issued to them in the private placement. Thesenew warrants have an exercise price of $1.50 per share.  We receivedaggregate gross proceeds of $3,190,499 in connection with the exercise of theprior warrants, and issued new warrants to purchase an aggregate 3,190,499 sharesof our common stock (plus an additional warrant to purchase 159,525 shares ofcommon stock to a placement agent who assisted with the transaction). Theshares of common stock underlying these warrants have been registered forresale with the Securities and Exchange Commission.

 

*Agreement with QuestTelecommunications, Inc.  *On December 13, 2005, we entered into aConsultant, Representative and Professional Services Agreement with QuestTelecommunications, Inc. (“Quest”). Under this agreement, we have appointedQuest as an independent advisor and our exclusive representative in thegeographic areas of Vietnam, Cambodia, Malaysia and Turkey (and any other areasto which we and Quest agree in writing). Within these geographic areas, Questwill (i) assist in structuring and establishing business relationships,including introducing us and the V-CubeTM IP-PBX software platform to potentialpartners, distributors, licensees and/or purchasers, and (ii) provideproject management services relating to business operations, includingdeveloping revenue targets, establishing technical support capability,facilitating technical support delivery, and monitoring license feereconciliation. Quest will also act as our agent for the V-CubeTM to consumersfrom, but residing outside, the geographic area covered by this agreement(except for consumers residing in territories for which we or any of ouraffiliates have granted or hereafter grant exclusive distribution or agencyrights).

 

Under this agreement, we are currently obligated tomake payments to Quest totaling $50,000 in consideration for Quest’s assistancerelating to the execution by us and Saigon Post and Telecommunications ServicesCorporation (“SPT”) of a memorandum of understanding and pilot licenseagreement with respect to the V-CubeTM. The memorandum of understanding, whichwe entered into on September 20, 2005, contemplates that, following legal andtechnical evaluation of the V-CubeTM platform by SPT, SPT and the company willnegotiate and enter into an agreement with respect to the deployment andcommercialization of the V-CubeTM platform in Vietnam.  The pilot licenseagreement, which we entered into on October 15, 2005, permits SPT to use theV-CubeTM platform for evaluation and testing purposes on a royalty-free basisfrom November 15, 2005 through February 15, 2006.

 

In addition, in the event we and SPT enter into adefinitive distribution or license agreement with respect to the V-CubeTM, wewill be obligated to issue to Quest 300,000 shares of our common stock and topay to Quest $150,000 in cash, plus a continuing commission of thirty percentof the license fees we receive from SPT in connection with the licensing anddistribution of the V-CubeTM in the above-mentioned geographic areas (net ofsales, use and value added taxes, if any, payable by us in connection with suchlicense fees).

 

***Vistula, VistulaUSA, and Vistula SA***

 

*Overview.*Vistula,Vistula USA, and Vistula SA are aggregators of wholesale telecommunicationsservices to Tier 1 and Tier 2 telecommunications carriers and providers ofInternet-enabled voice services to telecommunication carriers, serviceproviders and transit network operators throughout the world. Vistula, VistulaUSA, and Vistula SA are collectively referred to in this annual report as the “VistulaCompanies,” and sometimes individually as a “Vistula Company.”

 

We believe that, in the next year, theVistula Companies’ core product offering will be V-CubeÔ,a uniquely featured Internet Protocol-P-B-X, or “IP-PBX,” that facilitates fullcontact communication services including voice, video, conferencing, callcenter, interactive voice response systems, and multi/sub-domain and unifiedmessaging across enterprise and public networks. Utilizing the V-CubeÔplatform, Vistula offers a tailored software platform developed by NetYantraInc. and NetYantra India Pvt Ltd. (collectively, “NetYantra”) that enablescarriers, service providers and transit network operators to rapidly roll out aflexible range of managed Voice over Internet Protocol, or “VoIP,” basedproduct and service offerings to their customers.

 

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The Vistula Companies also have switchingfacilities in London and Los Angeles and interconnect agreements with suppliersand customers. We believe that the Vistula Companies are well positioned totake advantage of the disruption and uncertainty in the wholesaletelecommunications sector over the past few years. We further believethat the opportunity for well-managed wholesale carriers such as the VistulaCompanies is significant. Each of the Vistula Companies owns all of itsfixed equipment outright.

 

*Background—Voice over Internet Protocol or “VoIP”Services.*Whenever a telecommunications carrier wantsto pass or exchange telephone traffic with another carrier, both carriers haveto interconnect their switches or networks. This has always been achievedeither through a cable/fiber connection or through a satellite link up. Thisconnection can be very expensive with cost based on distance, size ofconnection (how many simultaneous calls it can carry) and the availableinfrastructure at each end of the link. Additionally, circuits can take a longtime (weeks) to be provisioned, often require long term commitments(12 months or more) and are specific to each carrier hook-up.

 

Voice over Internet Protocol, or “VoIP”, enables the transmission ofvoice packets over the Internet. Basically, VoIP digitizes voice into datapackets, transmits them over the Internet and reconverts them into voice at thecall destination. VoIP technology enables carriers to hook into their localInternet gateway, provide each other with their Internet address and then treatthis link as if it was a traditional permanent cable/fiber or satellite circuitswitched connection. This not only costs the interconnecting carriers much lesson a call by call basis, but a single link into the Internet can be used toconnect to any number of different and changing carrier partners. This reducesthe cost to each carrier, reduces the risk associated with a minimum commitmentto a particular circuit or fixed link, and increases the flexibility wheninterconnecting with customers and suppliers, as a single link into theInternet can be used to connect any number of customers or suppliers.

 

Although VoIP technology has been availablesince the mid 1990s, it has been only recently that this technology and theInternet have evolved to provide cost-effective and acceptable call quality andreliability, and interoperability with the signaling infrastructure of theexisting circuit switched network. Following these advances in technology andthe resulting improvement in call quality, the recent emergence of VoIP hasbeen rapid. For example, TeleGeography, a leading telecommunications advisoryand research company, estimates that the use of VoIP for the routing ofinternational calls grew from 10 million minutes of internationaltelephony traffic, or “MiTT,” in 1997 to almost 22 billion MiTT in 2003.Based on TeleGeography’s estimates, international VoIP traffic representedapproximately 11% of the estimated total international traffic of198.3 billion MiTT in 2003.

 

As a result of the cost and capacityefficiencies of VoIP and increasing user acceptance of the technology, more andmore niche route suppliers will be available only through a VoIP connection. Webelieve, supported by current experience, industry trends and recent advancesin switching technology, that VoIP will become the predominant mechanism forcarrier to carrier interconnects.

 

*The V-Cube**Ô IP-PBX Platform.*We expect the VistulaCompanies’ core product offering to be V-CubeÔ,a uniquely featured IP-PBX platform that facilitates full contact communicationservices including voice, video, conferencing, call center, interactive voiceresponse systems, and multi/sub-domain and unified messaging across enterpriseand public networks. Utilizing the V-CubeÔplatform, Vistula offers a tailored software set that enablestelecommunications carriers, service providers and transit network operators torapidly roll out a flexible range of managed VoIP-based product and serviceofferings to their customers.

 

Using the V-CubeÔIP-PBX platform, telecommunication carriers will be able to offer VoIP andother value added services to their broadband, service provider and Tier 1customers. The V-CubeÔ platformincorporates a real-time prepaid and post-paid billing engine enabling carriersto offer wholesale, retail, channel and pre-paid billing options.

 

The V-CubeÔIP-PBX also supports multi-domain capability where each customer will get aunique domain with optional web- based administrative control over theirdomain. The platform will enable individual users within an organization to getweb access (or phone short cuts) to manage network calling features such asvoice mail, call forwarding, and call conferencing. V-CubeÔalso supports voice recording and archiving of conversations and provides calldetail records which will assist financial services organizations in complyingwith regulatory record keeping and audit requirements.

 

The V-CubeÔplatform will enable service providers (including carriers offering VoIP andenhanced communication services bundled with core network technologies to theirservice provider customers) to provide the following services to theirrespective customer bases:

 

•      Wholesale andretail voice minutes, national and international VoIP, PSTN termination throughstandards-based gateways or partner service providers allowing for the exchangeof VoIP minutes;

 

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•      Optionalintegration with existing customer PBX for VoIP-enabling PBX extensions;

 

•      Prepaid andpost-paid calling;

 

•      Voice mail andvoice mail email services;

 

•      Conferencingservices including conference bridge and scheduled conference applications; and

 

•      Automatic calldistribution, interactive voice response services, and dialer services(including an extensive set of features and reporting capabilities to supportcustomer care centers).

 

*Advantages of V-Cube**Ô*

 

We believe that the V-CubeÔIP-PBX has the following advantages over similar IP-PBX offerings:

 

•      *The V-Cube**Ô**is the most comprehensive solution available in the markettoday.* The V-Cube platform supportsan extensive set of features and services including voice, video, SMS, fax,instant messaging, presence management, email, interactive voice response,conferencing, and unified communications with real time prepaid and post-paidbilling.

 

•      *The V-Cube**Ô**is the only IP-PBX offering 3 dimensional scalability.* The V-CubeÔ is the telecommunications industry’s first 5 GL(5th generation language) telecommunications platform. Its unique buildingblock structure provides carriers and service providers with the ability toinstantly create new services and features, enabling them to respond tochanging customer requirements (including number of users) and market demands.

 

•      *The V-Cube**Ô**platform enables multi-tiered network administration andcustomization.* The V-Cube platformenables faster delivery of personalized services. It allows customers to havemulti-level administrative access for managing their internal extensions, usersand services and end users to personalize and manage their individual accounts(for example, by logging in to view call data records (“CDR”), personalize callfeatures and to review call flows).

 

•      *The V-Cube**Ô**IP-PBX does not require proprietary hardware.* The V-CubeÔ platform does not rely upon any proprietaryhardware and easily integrates with and supports third party databases andstandards-based devices and legacy network equipment.

 

•      *The V-Cube**Ô**provides a multi-tiered voice failover mechanism atprocess, server and cluster levels.*In the event of a hardware or network failure, a conference automaticallyswitches over without the participants getting dropped. The V-CubeÔ platformenables high network availability and fault tolerance through hot swappablecluster configurations, media proxies and remote office sustainabilitycomponents.

 

*The Vistula Companies’ WholesaleTelecommunications Services.*The Vistula Companies areindependent suppliers of selective wholesale telecommunications services toTier 1 and Tier 2 telecommunications carriers around the world. The VistulaCompanies currently provide direct and partner direct voice routes to some ofthe world’s leading telecommunications carriers. In addition to these existingservices, the Vistula Companies intend to provide the services described below.

 

*International Voice Services (including VoIPServices):*

 

The Vistula Companies work in partnershipwith telecommunications companies worldwide to deliver voice traffic reliablyand cost-effectively on simple trade terms and via direct correspondentrelationships. The Vistula Companies currently offer constant and committedcapacity across all networks, with carrier-grade quality transport on bothswitched-circuit minutes and VoIP on selected routes. All direct correspondentroutes are backed up by target answer seizure ratios, or “ASR’s,” at carrier-gradelevel or above, and the connection flexibility of the Vistula Companies meansthe carriers have a choice of landing traffic either in the United States orthe United Kingdom.

 

The Vistula Companies’ international voiceservices are designed to meet the most challenging needs for capacity. Thisallows customers to enhance voice margins through high-quality, low pricedservice without having to commit to investment in infrastructure at the networklevel. The Vistula Companies offer a high quality of service, projectmanagement from installation through to completion, and customer supportservices available 24 hours a day, seven days a week, from Vistula’sLondon-based network operations center to its 

 

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international voice servicescustomers. The Vistula Companies also offer a range of billing and paymentoptions, and flexible contract terms to suit its customers’ business roll-outplans.

 

We own two Sonus Networks (“Sonus”) VoIPswitches, each of which is capable of running tens of thousands of simultaneousvoice calls and hundreds of millions of minutes of traffic per month. Utilizingthis equipment, Vistula USA is therefore not only able to link rapidly and atvolume to suppliers and customers, but intends to offer its own VoIP capabilityto carriers and network operators who do not have such capability themselves.

 

Each Sonus VoIP switch consists of twocascaded nodes. Each node has a fully redundant hardware structure which meansthat the nodes can be separated and appear as individual discrete switches. IfVistula USA chooses, it can relocate one of the nodes to an alternate U.S. orU.K. location. The two combined switches are each populated with 27 VoIP DS3 43megabit per second circuits. Each DS3 contains 21 E1 2 megabit per secondcircuits. Each E1 circuit can accommodate 30 simultaneous voice calls. Thetraffic capacity of a switch is easily increased by adding further nodes to theswitch.

 

Vistula USA has linked Vistula’s existingbilling engine to the Sonus VoIP switches such that it is able to maintain itspresent effective billing service. Call data records, or “CDRs”, areautomatically drawn from the switches. Vistula USA can produce and accept billson any basis and at any frequency. For example, each call may be billed on aminute, 30 second or one second minimum with incremental six or one secondunits. Vistula USA may send bills out on a daily, weekly, bi-monthly or monthlybasis. The billing system also allows for call quality statistics to be easilyproduced.

 

Features of the Vistula Companies’ wholesaleinternational telecommunications services include:

 

•      Switchedinternational minutes;

 

•      Carrier-gradequality, and quantity, VoIP service on selective routes;

 

•      Direct routesfocusing on emerging markets and high value per minute destinations;

 

•      Multiple Tier 1and Tier 2 carrier interconnects;

 

•      “24/7” customerservice and network management guarantees from the U.K.-based Vistula networkoperations center;

 

•      Competitivepricing and flexible contract options; and

 

•      In-countryintelligent network services, or “INS,” including prepaid and post-paid callingcard platforms.

 

**Strategy ofthe Vistula Companies**

 

*VoIP Strategy*

 

During 2005, we began marketing the V-CubeÔ platform to telecommunications carriers,service providers and transit networks operators. In 2004, we acquired anexclusive license from the developer of the platform to market and distributethe platform worldwide (except for India, where the licensor is based, andsubject to certain pre-existing distribution and reseller agreements which thelicensor has agreed to renew). The platform is being offered as a hostedsolution to be installed on the servers of the relevant carrier or provider andwhich in turn will enable them to provide a wide range of hosted VoIP servicesto their respective customers.

 

We have entered into a distribution andmarketing agreement with Telstra Europe Limited, a U.K.-basedtelecommunications carrier. Under this agreement, we have granted TelstraEurope a license to provide hosted IP-PBX services to its customers using thehosted V-CubeTM IP-PBX platform. The license grants Telstra the exclusive rightto provide the hosted solution to its customers in the United Kingdom for aperiod of five years. The monthly license fee payable by Telstra to us is basedon the number of individual users at the various Telstra customers who areusing the VoIP services provided by Telstra through use of the V-CubeTM platform.Although we have not generated any revenue from this license to date, weanticipate leveraging the marketing advantages and customer relationships ofTelstra to provide us with significant monthly revenue.

 

We have also entered intoa Consultant, Representative and Professional Services Agreement with QuestTelecommunications, Inc. (“Quest”), under which we have appointed Quest as anindependent advisor and our exclusive

 

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representativein the geographic areas of Vietnam, Cambodia, Malaysia and Turkey (and anyother areas to which we and Quest agree in writing). Within these geographicareas, Quest will (i) assist in structuring and establishing businessrelationships, including introducing us and the V-CubeTM IP-PBX softwareplatform to potential partners, distributors, licensees and/or purchasers, and(ii) provide project management services relating to business operations,including developing revenue targets, establishing technical supportcapability, facilitating technical support delivery, and monitoring license feereconciliation. Quest will also act as our agent for the V-CubeTM to consumersfrom, but residing outside, the geographic area covered by this agreement(except for consumers residing in territories for which we or any of ouraffiliates have granted or hereafter grant exclusive distribution or agencyrights).

 

During2005 we also entered into an agreement under which we acquired a multi-useworldwide license for a consumer VoIP portal that sits in front of the V-CubeTMengine to enable our telecommunication company and ISP customers to deliver alow cost consumer VoIP service in their markets. The product comprises ano-touch registration, sign-up and payment system which enables our client’scustomers to become VoIP telephony users. In contrast to our full businessIP-PBX offering, this system is specifically designed for single userconsumers. This adds an important product capability to our portfolio and onethat will be sold alongside the full V-CubeTM IP-PBX to all our customers.

 

*VoIP Services*

 

We intend to utilize the VoIP capabilitiesand technology of the Vistula Companies to provide competitivecarrier-to-carrier wholesale voice services. We believe this represents asignificant revenue opportunity for the Vistula Companies for the following tworeasons:

 

First, VoIP facilitates low cost and rapidaccess to traffic routes from all over the world at rates that will allow theVistula Companies to maximize margins by wholesaling the routes onwards tolarger carriers.

 

Second, as deployment of Vistula’s IPtelephony product suite increases, so does the volume of retail traffic thatthe Company will carry and the number of direct relationships Vistula has indifferent countries. These relationships, as well as the volume of retailtraffic being carried, go to establishing new routes and lower process for Vistulato market to its customers.

 

We believe that the Vistula Companies canbecome leaders in VoIP carrier-to-carrier services due to the followingfactors:

 

•      Our clearlydefined VoIP strategy;

 

•      Our numerousinterconnect agreements and relationships;

 

•      Our substantialand scalable VoIP infrastructure;

 

•      Our experiencedtechnical and management team;

 

•      Our effectivecombination of traditional time division multiplex, or “TDM”, type switching,with our VoIP technology; and

 

•      Our maturebilling platform.

 

*Summary.*We believethat the principal strengths of the Vistula Companies include:

 

•      Our exclusiverights, which expire August 11, 2006, to market and distribute the feature richand highly scalable V-CubeÔ IP-PBX platform worldwide, other than in India (seethe section titled Factors Affecting Future Performance later in thisdocument);

 

•      Our experiencedoperational management team with strong personal contacts within the Tier 1 andTier 2 carriers throughout the world;

 

•      Our ownership ofa telecommunications infrastructure which includes a Lucent XL switch locatedin TeleHouse London, SDH and TDM multiplexors and Cisco IP gateway equipment inLondon, and two Sonus VoIP switches in Los Angeles; and

 

•      Our fullydeveloped billing platform which interfaces with Tier 1 and Tier 2 carriers.

 

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We believe that the opportunities for wellfinanced and well managed wholesale carriers will continue to develop in thefuture. We intend that the Vistula Companies will continue partnering withtelecommunications companies worldwide to deliver network, voice and IPservices to their customers including Internet or multimedia service providers,established carriers, and new market entrants.

 

*Wholesale Voice Services Strategy*

 

With well over two hundred countries andseveral call bands within those countries (including capital city, national andmobile bands), it is impossible for any one telecommunications operator, nomatter how large, to create or even identify the lowest cost or best qualityroutes to all destinations. The result is that all operators, including theworld’s largest country carriers, will buy their international telephony routeson the open market. The success of aggregators such as the Vistula Companiesoperating in this field depends upon the ability of the executives and staffwithin those companies to identify, create and run quality routes that can bemarketed to other carriers.

 

We plan to continue to build the capabilityof each of the Vistula Companies in the international wholesale voice callbusiness through the continuing development of network interconnects andcommercial agreements that enable us to offer competitive call termination toour customers. We intend to:

 

•      Consolidateacross the international voice wholesale market, entering associated marketsand new geographies that offer high revenues and sustain or improve currentmargins;

 

•      Build aportfolio of software products and services to support the activities of mobileoperators in developing countries; and

 

•      Broaden themarket for our products and services to include utilities and Internet serviceproviders (“ISPs”).

 

The Vistula Companies currently haveapproximately 30 interconnect agreements in place with carriers in Europe andthe Far East, including Telstra, KDDI, Qwest, TeleGlobe, iBasis, NTT Europe andBharti under which the Vistula Companies terminate mobile and fixed lineinternational telephone traffic. The Vistula Companies source routes from jointventure partners in the United States, Europe and Asia and have long-termrelationships with a number of carriers within those routes. The operationalexperience of the Vistula Companies has enabled them to secure profitablecontracts with their carrier partners and we believe that the Vistula Companiesare well positioned to take advantage of continually expanding demand forinternational telephony minutes.

 

Our management team has considerableexperience in developing relationships with smaller niche market retail andwholesale telecommunications operators and global network operators, deliveringvalue to both parties. They also have extensive experience of working in thedeveloping country markets of Asia and the Middle East. We see the key tosuccess in delivering our strategy as having the flexibility to rapidly deployand develop wholesale solutions and in entering markets at an early stage inthe life cycle.

 

The Vistula Companies will offer public andprivate telephone operators and communications companies in emerging markets anopportunity to expand existing business and generate new revenue streams. TheVistula Companies will enter into joint venture and partnership agreements withthese operators and companies to enable them to capitalize upon the benefits ofthe liberalized international telecommunications markets while enhancing theirposition within their own country.

 

The Vistula Companies intend to offer thefollowing services to these operators and carriers:

 

•      Fully managedVoIP-PBX facility integrated into their existing infrastructure and systemssuch that the operator is able to offer a commercial telephone system to itscustomers that uses the Internet to make telephone calls;

 

•      Route managementand advisory services to rebalance international traffic flows and recoup lostrevenues, marketing and sales support programs, and tariff distributionmodeling;

 

•      Development ofnew traffic routes for licensed operators requiring international facilities;

 

•      Internet access,connectivity and IP transit, coupled with e-commerce facilitation and streamingservices; and

 

•      Skills transferinto joint venture operations, including training local employees to employ thelatest network technologies and management systems.

 

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The Vistula Companies will draw upon theexpertise of their senior management with a broad range of communicationsbackgrounds. The Vistula Companies will also work with local partners todevelop in-country skills that enable companies to add value to their serviceswith minimum investment costs.

 

*International Managed Bandwidth Services:*

 

In addition to the international voiceservices that they currently provide, the Vistula Companies have the capabilityto offer managed bandwidth services that would provide their customers with acommitted and constant availability of high-speed capacity between locations ofthe customers’ choice. The Vistula Companies’ vendor-independent status couldenable them to offer fully-managed, end-to-end services across all major satelliteand cable systems that include a range of product options to enhance the data,voice, and IP network services on a global basis. The Vistula Companies’service offerings portfolio could also include co-location services, end-userequipment provision and maintenance, Internet transit connectivity, and projectmanagement available 24 hours a day, seven days a week. Features of theVistula Companies’ managed bandwidth services could include:

 

•      Simplepoint-to-point circuits or complex network solutions;

 

•      45Mb/s, 155Mb/sand 622Mb/s bandwidths available at flexible rates on all major cable systems;

 

•      Flexiblecontracts and financing options from 6 months through to lifetime systemownership; and

 

•      End-to-endnetwork monitoring on all facilities with optional service level guarantees forcritical solutions covering installation and in-life service.

 

*CardlinkStrategy*

 

Cardlink was first acquired byMr. Galliers-Pratt and certain members of his family in April 2003.With the acquisition of Cardlink by VCS through the share exchange completed inMarch 2004, VCS intends to reactivate and refocus Cardlink’s operationsand sales and marketing efforts. Cardlink will offer an electronic top-up, or “ETU”,software product suite which will enable mobile operators to electronicallyprocess prepayments from “pay-as-you-go” customers. Cardlink’s products willallow these customers to “electronically top-up” their accounts with the mobileoperator. We believe that the market for these prepayment services is expandingboth in the developed and in the underdeveloped regions in the world and webelieve that Cardlink’s ETU product may be of significant value as new mobileoperators throughout the world seek to adopt this technology. However, we donot believe that Cardlink will represent significant activity for VCS in thenear-term.

 

We believe that the potential for providingETU services in markets where the adoption and use of mobile telephony isgrowing rapidly may create significant opportunities and long-term growth potentialfor Cardlink. We intend that Cardlink will typically receive a percentage ofthe total mobile revenues transacted through the Cardlink system. As a result,Cardlink will be a beneficiary of any increase in mobile telephony revenueswithout any investment of capital in building infrastructure.

 

*Industry Background—Prepaid Mobile Services.*Throughoutthe world, with the exception of the United States, the majority of privatesubscribers to mobile networks are “pay-as-you-go” customers. In the developedmarkets, these customers typically purchase “scratch cards” from retail outletsthat entitles them to a fixed amount of airtime. When the airtime has been usedup, the customer purchases another scratch card in order to put more airtime onhis or her mobile phone. Scratch cards are normally sold through retail shops,gas stations and other retail outlets. This system is expensive and inefficientboth from a distribution and an administration perspective. Mobile operators donot like scratch cards because they have to be distributed to thousands ofretail outlets and invariably cards get stolen or lost. As a result, over thepast two years, mobile operators have been trying to get “pay-as-you-go”customers to move from scratch cards to an ETU system.

 

In the less developed telecommunicationmarkets, ETU services are still in their infancy. In many of the largeremerging markets, “pay-as-you-go” customers are still using scratch cardsexclusively. We believe that the mobile operators in these markets would liketo convert the majority of these customers to the use of ETU services.

 

*Cardlink’s ETU Software.*Priorto its acquisition by Mr. Galliers-Pratt and his family inApril 2003, Cardlink had developed a software system which enabled prepaidtelephone cards to have additional money credited to the card each time theuser wished to “top-up” his or her account. Cardlink’s ETU software was firstused in the United Kingdom in July 2001 and had previously provided ETUfunctionality 

 

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for Vodafone, Orange, MMO2 and T-Mobile. Cardlink’s ETU software allowsthe customer to purchase one card which can then be repeatedly used.

 

The Cardlink software is electronicallyinstalled on terminals. Point of sale terminals are connected to the processingbank’s server by telephone line or cellular modem. The Cardlink software can beadapted to enable mobile handsets to access the processing server via SMSmessaging. This means that retailers can be signed up to host ETU services evenif they do not have a point of sale terminal installed on their premises.

 

We intend that Cardlink will access a newmarket by entering into agreements with mobile operators to process paymentsfor airtime using an ETU system. Each contract will provide for payment by theoperator of a monthly transactional fee to Cardlink for the use of the Cardlinksoftware. This fee will be calculated as a percentage of the monthly revenuesprocessed by Cardlink during the term of the agreement.

 

We believe that Cardlink’s business model hascapacity for growth over the next few years as increasing numbers of mobileoperators in the emerging markets install ETU systems as a method of processingpayments for airtime.

 

We expect that Cardlink will operate under aminimal cost base and, while it is intended that Cardlink will provide support24 hours a day, seven days a week, to manage and maintain the software, weexpect that the design of the system will allow us to keep Cardlink’s supportcosts low.

 

Our goal is for Cardlink to access as manyemerging markets as possible. We intend that Cardlink will focus on the marketsof Latin America, North Africa, the Middle East and the Confederation ofIndependent States, which are regions where mobile telephony is growing rapidlyand “pay-as-you-go” customers are almost entirely dependent on scratch cardsfor acquisition of additional airtime. We currently expect to use third partiesto provide necessary software updates, maintenance and support for theseactivities.

 

*Establishing the Vistula Companies BrandNames*

 

In addition to the strategies discussedabove, we believe that building awareness of the Vistula Companies brands isimportant in establishing and expanding the customer bases for the VistulaCompanies. We intend to introduce marketing efforts to build these customerbases and create brand name recognition. We will use traditional media as ourrevenues permit to attract new customers and advertise new and existingproducts and services.

 

**Competition**

 

We face significant competition fromcompanies providing similar IP-PBX and IP Centrex platforms. While we believethat the V-CubeÔ platform hassignificant advantages over these competitive technologies, some of ourcompetitors, such as Broadsoft, have significant financial resources includingsignificant investment from major private equity funds. Many of thesecompetitors have also been in the market for considerably longer than us andhave significant existing customer bases.

 

The market for wholesale voice telecommunicationservices is also extremely competitive, subject to changes in technology and isaffected by the introduction of new products and services. There are asignificant number of “aggregators” or resellers providing similar services tothe Vistula Companies operating in the international voice wholesale marketincluding, BonNet, Fewhurst, C2C, Total X, WaveCrest, TeleGlobe, ITX, iBasis,Reach and Qwest. Some of these competitors have significantly greater financialresources and more customers than we do. Some of these resellers, includingiBasis, TeleGlobe, ITX and Qwest, are also offering VoIP services to theircustomers.

 

Other than Cointel, a telecommunicationsservices company based in South Africa, we are not aware of any currentcompetition that offers pre-pay software solutions in the emerging markets thatCardlink intends to enter.

 

**Intellectual Property Rights**

 

We rely on trademark and copyright law, tradesecret protection, and confidentiality, license and other agreements with ouremployees, customers, partners and others to protect our intellectual propertyrights and the intellectual property rights of our licensors. Unauthorized useof our intellectual property or the intellectual property of our licensors bythird parties may damage our brands and reputation. Despite our precautions,third parties may obtain and use our intellectual property withoutauthorization. In addition, the laws of some foreign countries do not protectintellectual property to the same extent as do the laws of the United States.

 

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We cannot be certain that our services andproducts do not or will not infringe valid patents, copyrights, trademarks orother intellectual property rights held by third parties. We may be subject tolegal proceedings and claims by third parties from time to time relating totheir intellectual property. Successful infringement claims against us couldresult in substantial monetary liability or may materially disrupt andadversely affect our business.

 

Our rights to market anddistribute the V-CubeÔ arise under an exclusive license (except forIndia, where the licensor is based, and subject to certain pre-existingdistribution and reseller agreements which the licensor has agreed to renew)from the developer of the platform to market and distribute the platformworldwide. Under the terms of the license agreement that expires on August 11,2009, our limited exclusivity terminates on August 11, 2006. If we are unableto renew our exclusive rights to market and distribute the V-CubeÔ platform, thedeveloper may license the platform to others who may compete with us. Any suchcompetition could result in decreased margins or may require us to pursue otherstrategic alternatives for this market.

 

On March 24,2006 we received a notice from NetYantra India Pvt Ltd. claiming that we are inbreach of certain provisions of the August 11, 2004 distribution and marketingagreement that we entered into with NetYantra Inc. and NetYantra India Pvt.Ltd. (collectively “NetYantra”). The notice claimed that we have not fulfilledcertain requirements contained in the agreement as to the training ofpersonnel, recognition of NetYantra as the developer of certain technology, andthe forwarding of documentation to NetYantra regarding the licensing andsublicensing of certain technology. Further, the notice claimed that our marketing of the consumer VoIPportal product is in breach of the non-competition provisions of the agreement.Our response to this notice will describe the reasons why we believe we are notin breach of the agreement.

 

**Research and Development**

 

Our limited research and developmentactivities to date have been focused on the development of our internalsoftware and billing platforms. We expect to pursue further research anddevelopment with respect to new products and services, enhancements of existingproducts, such as the V-CubeÔIP-PBX platform, and the development of additional features and functionalityfor our existing products.

 

**Government Regulation**

 

As an international telecommunicationscompany, we are subject to varying degrees of regulation in each of thejurisdictions in which we provide services. Laws and regulations applicable tothe provision of telecommunications services, and the interpretation of suchlaws and regulations, differ significantly among the jurisdictions in which weoperate.

 

We believe that wholesalebusiness-to-business carriers such as the Vistula Companies are generally notsubject to the same level of federal and local regulation as common carriersproviding traditional telecommunications services, especially with respect toInternet-based telephony services such as VoIP. Nonetheless, some aspects ofthe Vistula Companies’ operations, including our voice-based services, may currentlybe, or may become, subject to state and federal telecommunications regulationsfor telephony services governing licensing and tariffs, in addition to federaluniversal service funding mechanisms. In particular, certain state regulatoryagencies may have jurisdiction over the Vistula Companies’ telephonyapplications when they are used to provide intrastate telecommunicationsservices. Generally, we must obtain and maintain certificates of authority andcertain approvals from regulatory bodies in most states where we offer or planto offer regulated services.

 

We believe that the Internet-related servicessuch as those currently provided or proposed to be provided by the VistulaCompanies, including dedicated IP transport and Internet telephony or VoIPservices, and software platforms that facilitate such services (such as ourV-CubeÔ IP-PBX platform)are not presently considered “telecommunications services” under theTelecommunications Act of 1996. Such services are generally not regulated inthe United States by the Federal Communications Commission (“FCC”) or stateagencies responsible for regulating the intrastate activities oftelecommunications carriers. However, the FCC has formally begun to address theregulatory characterization of Internet telephony services generally, includingVoIP. Moreover, to the extent some of the transport and switching employed bythe Vistula Companies’ Internet telephony services are not wholly Internet-related,those services may not be as lightly regulated as our wholly Internet-basedservices. Several state governments have also considered proceedings andpetitions relative to the regulation of Internet-related services.

 

Internationally, the regulatory treatment ofthe Vistula Companies’ current and proposed services varies widely and issubject to constant change, and there is no assurance that such treatment willnot be unduly burdensome. With respect to Internet telephony and VoIP, somecountries currently impose little or no regulation on such services. Other countriesregulate Internet telephony services and VoIP services like traditional voicetelephony services, requiring Internet telephony companies to obtain licenses,incorporate local subsidiaries, make universal service contributions, and payother taxes. Increased regulation of the Internet and/or Internet telephonyproviders in one or more countries could materially adversely affect ourbusiness.

 

In general, the regulation of thetelecommunications industry continues to change rapidly both domestically andglobally. In the United States, telecommunications regulations on both thefederal and state levels are from time to time subject to judicial andadministrative proceedings, as well as legislative and administrative hearings,in which proposals are made that, if adopted, could change the manner in whichour industry operates. We cannot predict the outcome of these proceedings ortheir impact on us. There can be no assurance that future regulatory, judicialand legislative changes will not have a material adverse effect on us, or thatdomestic or international regulations or third parties will not raise materialissues that may adversely affect our business.

 

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We believe that we currently have all the regulatorylicenses, approvals and consents necessary to conduct our business. However, wecan give no assurance that we will be able to maintain compliance with existingregulations or that laws or regulations enacted in the future will not hinderor prevent us from conducting our business. See “Government regulations mayadversely affect our business” under the section entitled “–Factors AffectingFuture Performance.”

 

**Employees**

 

As of March 15, 2006, we had ten full-timeemployees, three part-time employees, and sixteen consultants. Of our employeesand consultants, nine are engaged in sales and marketing, five are intechnology research and development, ten are in general and administrative andfive are in operations. None of our employees is represented by a union. Webelieve our relationship with our employees and consultants is good.

 

**ITEM 2. DESCRIPTION OF PROPERTY**

 

We maintain our principal executive officesat Suite 801, 405 Park Avenue, New York, New York 10022. Our principal officeoccupies approximately 1,300 square feet of office space pursuant to a subleasethat we entered into as of November 1, 2005. The sublease has a term of 24months and provides for annual rent of $78,174.

 

In April 2005 we relocated our office in London andare presently occupying approximately 1,600 square feet of office space with amonthly cost of approximately $6,500 per month through March 23, 2007.

 

We also rent approximately 300 square feet in theLondon facility of Telehouse, a specialty telecommunications hotel and serviceprovider. We pay approximately $8,500 per month for use of this facility andservices provided by Telehouse. The Telehouse lease expires inAugust 2006. In addition, we have also entered into a co-locationagreement pursuant to which we rent approximately 400 square feet of space at650 Grand Avenue in Los Angeles, California at a minimum monthly rental of$4,000. We anticipate that the fees for use of the Grand Avenue facility,including the minimum rent, will range between $4,000 and $6,500 per monthdepending on the level and nature of services used. The current term of theco-location agreement is through April 2007.

 

The offices at Telehouse in London and 650 GrandAvenue in Los Angeles house our telecommunication switches. The switches areinstalled in rooms that are environmentally modified, cooled and designed forswitching equipment. These facilities have full battery backup for a full24 hours in case of a power failure.

 

The offices of our 60%-owned subsidiary,Vistula SA, in South Africa are located in a managed office suite facility atNelson Mandela Square, 2nd Floor West Tower, Maude Street, Sandown,South Africa. The monthly cost to rent this space was approximately $5,400 permonth through February 2006 and then is $10,300 per month through the leaseexpiration in January 2007.

 

We believe that our present facilities are adequateto meet our current needs. If new or additional space is required, we believethat adequate facilities are available at competitive prices in the respectiveareas.

 

**ITEM 3. LEGAL PROCEEDINGS**

 

We are not a party to any legal proceedingsthe outcome of which, in the opinion of our management, would have a materialadverse effect on our business, financial condition, or results of operations.

 

**ITEM 4. SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS**

 

No matters were submitted to a vote of oursecurity holders during the fourth quarter of the fiscal year endedDecember 31, 2005.

 

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**PART II**

 

**ITEM 5. MARKET FOR COMMON EQUITY AND RELATEDSTOCKHOLDER MATTERS AND SMALL BUSINESS ISSUER PURCHASES OF EQUITY SECURITIES**

 

**Market Information**

 

Our common stock has been quoted on the OTC BulletinBoard by The National Association ofSecurities Dealers, Inc. under the symbol “VSTL” since July 21, 2005.Prior to that date there was no public market for our common stock. Thefollowing table provides, for the periods indicated, the high and low bidprices for our common stock.

 

 
| **FISCAL YEAR 2005**          | ** ** | **High** | ** ** | **Low** | ** ** |
|-----------------------------------------|------------|----------|------------|---------|------------|
| Third quarter (beginning July 21, 2005) |       | $        | 2.15       |    | $          | 1.25 |   |
| Fourth quarter                          |       | $        | 2.20       |    | $          | 1.15 |   |

 

Theseover-the-counter market quotations reflect inter-dealer prices, without retailmark-up, mark-down or commission, and may not represent actual transactions.

 

*Amendment to 2004 Stock Incentive Plan.*On December 23, 2005, our Board of Directors approvedan increase, from 8,000,000 to 15,000,000, in the number of shares of ourcommon stock authorized under our 2004 Stock Incentive Plan as described inNote 6. The increase will be submitted to our stockholders for theirratification at our next annual meeting.

 

**Number of Holders**

 

On March 22, 2006, we had approximately 60holders of record of our common stock. This number does not includestockholders for whom shares were held in a “nominee” or “street” name.

 

**Dividends**

 

We have never declared or paid cash dividendson our common stock, and we do not plan to pay any cash dividends in theforeseeable future. We currently intend to retain any future earnings tofinance our operations and future growth. Furthermore, we are currentlyprohibited from paying cash dividends to the holders of our common stock underthe terms of the convertible debentures we issued to several institutional andindividual investors on February 18, 2005 and March 4, 2005. Thisrestriction on the payment of dividends will remain in effect until thedebentures are repaid or converted in full. Under the terms of a revolving credit agreement with Indigo InvestmentsLLC dated March 30, 2006, while loans are outstanding under the creditagreement, we cannot directly or indirectly make any distribution or pay anydividends (in cash or in stock) on, or purchase, acquire, redeem or retire anyof our capital stock, of any class, or any of our other securities not held bythe lender.  

 

**ITEM 6. MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS**

 

**Forward-Looking Statements**

 

Except for historical facts, the statementsin this Annual Report are forward-looking statements. Forward-lookingstatements are merely our current predictions of future events. Thesestatements are inherently uncertain, and actual events could differ materiallyfrom our predictions. Important factors that could cause actual events to varyfrom our predictions include those discussed below under the heading “—FactorsAffecting Future Performance.” We assume no obligation to update our forward-lookingstatements to reflect new information or developments.

 

For purposes of the following discussion, allinformation is reported on a consolidated basis for VCS and its wholly ownedsubsidiaries, Vistula, Vistula USA and Cardlink, and its 60% owned subsidiary,Vistula SA.

 

**Introduction**

 

The following information should be read inconjunction with the financial statements and notes thereto in Part II,Item 7 of this Annual Report.

 

**Overview**

 

Vistula Communications Services, Inc. (“VCS”,the “Company” or “we”) currently has three wholly-owned subsidiaries: VistulaLimited (“Vistula”), Vistula USA, Inc. (“Vistula USA”) and CardlinkServices Limited (“Cardlink”), and has one subsidiary that is 60% 

 

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owned, Vistula CommunicationsServices SA (Pty) Ltd. (“Vistula SA”). Through Vistula and Vistula USA, wecurrently provide wholesale value-added telecommunications services (includingdirect and partner voice routing services) to Tier 1 and Tier 2telecommunication carriers and transit operators. In the first quarter of 2005,through Vistula, Vistula USA, and Vistula SA we began to market our V-CubeÔVoice over Internet Protocol, or “VoIP,” IP-PBX software platform totelecommunications carriers, Internet service providers, or “ISPs,” largecorporations and small and medium enterprises, or “SMEs,” throughout the world.

 

Through our Cardlink subsidiary we plan tomarket and distribute electronic top-up software, which enables prepayment forservices provided by mobile telephone operators, and associated services toTier 1 and Tier 2 telecommunications carriers and transit network operatorsthroughout the world. Cardlink has developed a software product suite thatenables mobile operators to electronically process prepayments from “pay-as-you-go”mobile phone customers.

 

***Vistula, VistulaUSA, and Vistula SA***

 

Vistula, Vistula USA, and Vistula SA areaggregators of wholesale telecommunications services to Tier 1 and Tier 2telecommunications carriers and transit network operators. Vistula, VistulaUSA, and Vistula SA are collectively referred to as the “Vistula Companies.”The Vistula Companies have switching facilities in London and Los Angeles andinterconnect agreements with suppliers and customers in these locations. Webelieve that the Vistula Companies are well positioned to take advantage of thedisruption and uncertainty in the telecommunications sector over the past fewyears. We believe the opportunity for well-managed and well-financed wholesalecarriers is significant.

 

The Vistula Companies began to activelymarket our V-CubeÔ IP-PBX platform tocarriers, transit network operators, large corporations, and SMEs in the firstquarter of 2005. We expect this multiple feature VoIP platform, which willenable customers to convert their existing PBX phone systems to provide VoIPcapability without the need for significant investment in new hardware, willprovide the Vistula Companies with a highly competitive VoIP solution.

 

On April 1, 2005, we entered into adistribution and marketing agreement with Telstra Europe Limited, a U.K.-basedtelecommunications carrier. Under this agreement, we license Telstra Europe toprovide hosted IP-PBX services to its customers using the hosted V-CubeTM IP-PBXplatform. The agreement grants Telstra Europe an exclusive license to providethe hosted solution to its customers in the United Kingdom and Ireland for aperiod of five years. The monthly license fee payable by Telstra Europe to usis based on the number of individual users at the various Telstra Europecustomers who are using the VoIP services provided by Telstra Europe throughuse of the V-CubeTM platform. We anticipate leveraging the marketing advantagesand customer relationships of Telstra Europe to provide us with regular monthlyrevenue. We expect Telstra to launch the product to their customers during thesecond quarter of 2006.

 

***Cardlink***

 

Cardlink was first acquired byMr. Rupert Galliers-Pratt and certain members of his family inApril 2003. VCS acquired Cardlink through the share exchange completed inMarch 2004. Cardlink will offer an electronic top-up, or “ETU”, softwareproduct suite which will enable mobile operators to electronically processprepayments from “pay-as-you-go” customers. Cardlink’s products will allowthese customers to “electronically top-up” their accounts with the mobileoperator. We believe that the market for these prepayment services is expandingboth in the developed and in the underdeveloped regions in the world and webelieve that Cardlink’s ETU product will be of value as new mobile operatorsthroughout the world seek to adopt this technology.

 

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

 

**Critical Accounting Policies**

 

Our consolidated financial statements areprepared in accordance with accounting principles generally accepted in theUnited States. These accounting principles require us to make certainestimates, judgments and assumptions. We believe that the estimates, judgmentsand assumptions upon which we rely are reasonable based upon informationavailable to us at the time that these estimates, judgments and assumptions aremade. These estimates, judgments and assumptions can affect the reportedamounts of assets and liabilities as of the date of the financial statements,as well as the reported amounts of revenues and expenses during the periodspresented. Those estimates and judgments are based on management’s historicalexperience, the terms of existing agreements, our observance of 

 

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trends in the industry,information that we obtain from our customers and outside sources, and onvarious other assumptions that management believes to be reasonable and appropriateunder the circumstances, the results of which form the basis for makingjudgments about the carrying values of assets and liabilities that are notreadily apparent from other sources. To the extent there are materialdifferences between these estimates, judgments or assumptions and actualresults, our financial statements will be affected.

 

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

 

**Revenue Recognition.**Our revenue is derived primarily from fees charged to terminate voice servicesover our network. We recognize such revenue, net of reserves, when persuasiveevidence of a sales arrangement exists, delivery has occurred or services have beenrendered, the sales price is fixed and determinable and collectibility isreasonably assured. We reserve for potential billing disputes at the timerevenue is recognized or the dispute is known. Such disputes can result fromdisagreements with customers regarding the duration, destination or ratescharged for each call. These revenue allowances are based on estimates derivedfrom factors that include, but are not limited to, historical results, analysisof credits issued, current economic trends and changes in demand. Amountsbilled in advance of the service month are recorded as deferred revenue andrecognized as revenue as the underlying services are rendered.

 

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

 

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

 

**Stock-BasedCompensation.**Wehave elected to follow Accounting Principles Board (APB), Opinion No. 25, *Accounting for Stock Issued to Employees*(APB 25), andrelated interpretations, in accounting for our stock-based compensation plans,rather than the alternative fair-value method provided for under Statement ofFinancial Accounting Standards (SFAS) No. 123, *Accountingfor Stock-Based Compensation*(SFAS 123). In the notes to ourfinancial statements, we provide pro forma**disclosures inaccordance with SFAS 123. We account for transactions in which servicesare received from non-employees in exchange for equity instruments based on thefair value of such services received or of the equity instruments issued,whichever is more reliably measured, in accordance with SFAS 123 and theEmerging Issues Task Force (EITF) Issue 96-18, *Accountingfor Equity Instruments That Are Issued to Other than Employees for Acquiring,or in Conjunction with Selling, Goods or Services*(EITF 96-18).

 

Accounting for equity instruments granted by us underAPB 25, SFAS 123 and EITF 96-18 requires fair-value estimates of theequity instrument granted. If our estimates of the fair value of these equityinstruments are too high or too low, our expenses may be over- or understated. Forequity instruments granted in exchange for the receipt of goods or services, weestimate the fair value of the equity instruments using the Black-Scholesoption pricing model, using assumptions that we deem to be relevant at thattime. Because shares of our common stock were not publicly traded prior to July21, 2005, market factors historically considered by our board of directors invaluing stock and stock option grants included comparative values of privateand public companies discounted for the risk and limited liquidity provided forin the shares we are issuing;  priorvaluations of stock grants and the effect of events that occurred between thetime of such grants; economic trends; the comparative rights and preferences ofthe security being granted compared to the rights and preferences of our otheroutstanding equity; our existing financial resources; our anticipatedcontinuing operating losses and increased spending levels required to penetrateour target markets; dilution to common stockholders from anticipated futurefinancings; and a general assessment of future business risks.

 

We have reviewed and determined that ourrevenue recognition and stock-based compensation policies remain our criticalaccounting policies for the year ended December 31, 2005. We did not makeany changes to these policies during this period.

 

**Results of Operations**

 

Years ended December 31, 2005 and 2004

 

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Revenues for the year ended December 31, 2005were $840,457, a decrease of 64.0% over the $2,335,408 in revenues in fiscal2004. Essentially all revenues realized in both 2005 and 2004 were from theCompany’s wholesale voice services business. Revenues for 2005 from customerslocated outside the U.S. decreased by approximately 90% from 2004. Webelieve this decrease is attributable both to the decline of the U.K. mobilemarket as a re-sellable wholesale route and to our inability to attract newwholesale business in the U.K. due to our efforts being focused in establishinga presence in the VoIP marketplace.  In addition, Vistula USA was unableto generate material revenues in the wholesale market during 2005.  Webelieve that during 2006, we will derive revenues from the equipment describedin Note 4, which will enable us to attract and serve new customers.

 

Cost of revenues for the year ended December31, 2005 were $1,008,227, a decrease of 52.9% over the $2,140,837 in fiscal2004. This decrease primarily relates to the reduction in call volumerevenues during the 2005 period. Engineering costs classified as cost ofrevenues for the year ended December 31, 2005 of $235,095 increased 48.5% ascompared to the same period in fiscal 2004. The increase is due to expenditurespertaining to support of the wholesale business and initiating routing servicesin the U.S.

 

Gross margins decreased to (20%) for the yearended December 31, 2005 from 8.3% for the year ended December 31,2004. During 2005 we were affected by price changes in the U.K. mobile marketthat effectively lowered our gross margins on this activity. The decreasedvolume of our revenue impacted our ability to cover fixed costs such as spacerental and services from the co-location facilities located in both the U.S.and in the U.K.

 

Selling, general and administrative costs for theyear ended December 31, 2005 were $10,770,524, an increase of 178.4% over the$3,869,059 in fiscal 2004. During the period ended December 31, 2005, weincurred increased compensation for employees and consultants and increasedtravel as the VoIP platform was being marketed; increased professional fees,due in part to the public reporting requirements of the Company and capitalraising activities (including the preparation and maintenance of Securities Actfilings in connection with those activities); an increase in sales andmarketing expenses in creating awareness of the Company’s VoIP productoffering; increased investment banking fees as the Company engaged infundraising activities; an increase in each of regulatory fees, printing, andinsurance costs, all related to public-company reporting requirements; anincrease in rent due to new offices in the U.K., U.S. and South Africa; anincrease in depreciation expense due to the commencement of depreciation of theequipment discussed in Note 4; an increase in non-cash compensation expense dueto the issuance of warrants and stock options; and a $1,000,000 non-cashexpense for the issuance of 500,000 shares per the NetYantra agreementdescribed in Note 9.

 

During the year ended December 31, 2005net interest expense of approximately $1,244,000 was comprised of amortizationof capitalized finance fees, amortization of the debt discount for thedebentures held, interest on the convertible debentures as per the terms statedin Note 8, and imputed interest on a capital lease obligation we entered intoduring 2004, net of interest income received on cash balances as a result ofthe financing described in Note 8. Net interest expense for the year endedDecember 31, 2004 of approximately $121,000 was comprised of imputedinterest on a capital lease obligation we entered into during 2004.

 

For the year ended December 31, 2005, weincurred a loss of $12,182,002 or $0.45 loss per common share, basic anddiluted, as compared to a loss of $3,795,276 or $0.16 loss per common share,basic and diluted, for the year ended December 31, 2004.

 

**Liquidity And Capital Resources**

 

As of December 31, 2005, we had cash and cash equivalents of$553,127, which represents an increase of $549,906 over the $3,221 atDecember 31, 2004. Also, as of December 31, 2005, we had a workingcapital deficit of approximately $342,000, which represents a decrease in theworking capital deficit of approximately 85% from that at December 31,2004. The increase in cash and cash equivalents and decrease in working capitaldeficit are principally reflective of the proceeds we received in connectionwith the private placement described below. Since our inception throughDecember 31, 2005, we have generated operating losses of approximately$16,577,000.

 

Net cash used in operating activities during 2005 of $7,782,000increased by $7,718,000 over the $64,000 used in operating activities during2004 primarily due to a net loss of $12,182,000, offset by non-cash charges of$2,660,000 for compensation, $1,200,000 pertaining to an inducement to holdersto exercise outstanding warrants, $1,000,000 for stock issued under ourcontract with NetYantra, and $672,000 for interest related to the convertibledebenture financing described further below.

 

In addition, prepaid expenses and othercurrent assets at December 31, 2005 of approximately $1,046,000 increasedapproximately 357% from the $229,000 at December 31, 2004, due to theprepayment of royalties under the NetYantra agreement described in Note 9;payment for professional services that will be rendered during 2006 that wasmade in our common stock; maintenance for the equipment described in Note 4;and prepayments for software development, value added tax, call terminationcharges, insurance and rents. Accounts receivable at December 31, 2005were approximately $131,000, an increase of approximately 134% from 

 

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December 31, 2004. Accountspayable, accrued expenses and due to stockholder at December 31, 2005 decreasedapproximately $1,357,000 from December 31, 2004 levels as a result of applyinga portion of the proceeds received from the issuance of convertible debenturesand warrants to the payment of these outstanding balances.

 

Net cash used in investing activities during2005 of $725,000 increased by $657,000 over the $68,000 used in investingactivities during 2004 due to increased expenditures for telecommunications equipmentnecessary to operate our business.

 

Net cash provided by financing activitiesduring 2005 of $9,109,000 increased by $8,984,000 over the $125,000 provided byfinancing activities during 2004. We raised capital during 2005 through theissuance of convertible debentures and through a warrant financing, bothdescribed further below. A portion of the proceeds from the issuance of ourconvertible debentures was used to pay our amount due to a stockholder, notespayable, and a capital lease obligation, also described further below.

 

During the year ended December 31, 2005 noservices were contributed to the Company by our stockholders. During the yearended December 31, 2004 one of our stockholders contributed services tothe Company totaling $82,500.

 

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

 

*Convertible Debenture and WarrantFinancing.*OnFebruary 18, 2005 and March 4, 2005, we issued and sold convertibledebentures and warrants to certain sophisticated institutional and individualinvestors pursuant to a Securities Purchase Agreement between the Company andthe investors. In the two closings of the private placement under theSecurities Purchase Agreement, we sold convertible debentures in the aggregateprincipal 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 ofour common stock, at an exercise price of $1.00 per share. These warrantsexpire five years after the issue date.

 

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

 

The debentures are convertible at the option of the holders into sharesof our common stock at any time at an initial conversion price of $0.75 pershare. Except in the case of certain designated issuances, in the event weissue shares of common stock or common stock equivalents (i.e., securitiesconvertible into, or exercisable or exchangeable for, shares of our commonstock) at a price per share (or in the case of common stock equivalents, aconversion, exercise or exchange price per share) below the then applicableconversion price of the debentures, the conversion price of the debentures willbe reduced to that lower price per share. Issuances that will not result inadjustment to the conversion price include issuances to employees, consultants,directors or officers pursuant to a stock or option plan adopted by our boardof directors, securities issued upon conversion of other securities outstandingprior to the date of issuance of the warrants, warrants issued in connectionwith obtaining bank financing, common stock issued in connection with the settlementof claims, and securities issued in connection with acquisitions, jointventures or other strategic transactions.

 

We have agreed to certain restrictions under the terms of thedebentures, including a prohibition on the payment of cash dividends to ourstockholders while any of the debentures are outstanding. Upon the occurrenceof an event of default under the debentures, an amount equal to (i) 130%of the then outstanding principal amount, plus any accrued and unpaid interestthereon, or (ii) the product of the then outstanding principal amount,plus any accrued and unpaid interest thereon, times the ratio obtained bydividing the conversion price of the debentures and the market price of ourcommon stock, whichever is greater, will, at the holder’s option, becomeimmediately due and payable in cash along with any other amounts, costs,expenses or liquidated damages then due in respect of such debentures. Theratio referred to in clause (ii) is to be calculated based on theconversion price in effect on the date of such default or the date theaccelerated amount is paid in full (whichever is less), and the market price ofour common stock on the date of such default or the date the accelerated amountis paid in full (whichever is greater, such market price to be determined inaccordance with the terms of the debenture). Upon an event of a default, theinterest rate on the debentures will also be increased to 18% per annum.

 

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

 

Through March 31, 2006, $2,100,000 in outstanding principal amount ofconvertible debentures has been converted into 2,799,993 shares of commonstock, reducing the amount of interest required to be paid in future periods.

 

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The common stock purchase warrants issued to the investors areexercisable at an initial exercise price of $1.00. The warrants have anexpiration date of five years after the date of issuance. They contain acashless exercise provision whereby the holder may pay the exercise price byhaving us withhold upon exercise shares having a fair market value equal to theapplicable aggregate exercise price if after the first anniversary of the dateof issuance of the warrant there is no effective registration statementregistering, or no current prospectus available for, the resale of the sharesissuable upon the exercise of the warrants. In the event this provision is usedwith respect to an exercise, we would receive no proceeds from the sale of ourcommon stock in connection with such exercise. The warrantswere initially exercisable for an aggregate 8,400,000 shares of our commonstock. As of December 31, 2005, we had issued 3,190,499 shares upon exercise ofwarrants, all in connection with the warrant exercise agreements describedbelow.

 

The exercise price is subject to adjustment in the event of certainissuances of new securities. Specifically, except in the case of certaindesignated issuances, if we issue shares of common stock or common stockequivalents (i.e., securities convertible into, or exercisable or exchangeablefor, shares of our common stock) at a price per share (or in the case of commonstock equivalents, a conversion, exercise or exchange price per share) belowthe then applicable exercise price of the warrants, the exercise price of thewarrants will be reduced to that lower price per share. In the event of such anadjustment, the number of shares for which the warrants are exercisable will beincreased such that the aggregate exercise price of the warrants after theadjustment will equal the aggregate exercise price immediately prior to theadjustment. Issuances that will not result in adjustment to the exercise priceinclude issuances to employees, consultants, directors or officers pursuant toa stock or option plan adopted by our board of directors, securities issued uponconversion of other securities outstanding prior to the date of issuance of thewarrants, warrants issued in connection with obtaining bank financing, commonstock issued in connection with the settlement of claims, and securities issuedin connection with acquisitions, joint ventures or other strategictransactions.

 

In connection with the two closings of the private placement, we paidplacement fees in the aggregate amount of $802,500 to the placement agent. Atthe second closing, we also issued to the placement agent a warrant to purchaseup to 802,500 shares of our common stock at an initial exercise price of $1.00per share. The warrant, which expires on March 4, 2010, is onsubstantially the same terms as the warrants issued to the investors in the privateplacement.

 

We have registered for resale under the Securities Actof 1933, as amended, the shares underlying the debentures and warrants pursuantto a registration statement on Form SB-2, as amended, (File No. 333-123815).The registration statement was declared effective on May 3, 2005.

 

*Warrant Exercise Agreements.*InOctober 2005, we entered into several Warrant Exercise Agreements with holdersof warrants issued in the private placement that closed in the first quarter of2005. Pursuant to these agreements, we issued to these holders new common stockpurchase warrants exercisable for a number of shares equal to the number ofshares they purchased upon exercise of the warrants issued to them in theprivate placement. These new warrants have an exercise price of $1.50 per share.We received aggregate proceeds of $3,190,499 in connection with the exercise ofthe prior warrants, and issued new warrants, which expire five years after theissue date, to purchase an aggregate of 3,190,499 shares of our common stock(plus an additional warrant, which expires five years after the issue date, topurchase 159,525 shares of common stock to a placement agent who assisted withthe transaction). The shares of common stock underlying these warrants havebeen registered for resale with the Securities and Exchange Commission pursuantto a registration statement on Form SB-2 (File No. 333-130808). Thisregistration statement was declared effective on January 31, 2006.

 

*Advances from Principal Stockholder.  *Wedo not believe that our available cash and cash equivalents will be sufficientto meet our working capital requirements, including the funding of operatinglosses, and capital expenditure requirements for our next fiscal year.Previously, our primary sources of capital have been the revenues generatedfrom interconnect agreements with our customers and advances made by one of ourprincipal stockholders from a credit facility established in the name of thestockholder and other of the stockholder’s personal assets. We anticipateseeking additional debt or equity financing during the first and secondquarters of 2006.

 

In the event that we do not succeed in implementing our business plan,and do not otherwise raise third-party capital, we will have to curtail certainexpenditures, seek additional financing from our principal stockholder, or bothin order to sustain operations. As noted above, the principal stockholder hashistorically provided working capital advances. While the stockholder is notobligated to provide these working capital advances to us, we expect thestockholder to continue providing funds for operations as and if needed, untilsuch time that our operations are self-sustaining or we raise additionalexternal capital, as the case may be. As described in Note 8, inOctober 2005 the Company realized approximately $3.0 million in netproceeds from the exercise of warrants associated with the convertibledebentures.

 

Also, although the acquired equipment described in Note 4 was placed inservice during the third quarter of 2005, only nominal revenues have beengenerated to date. Cash flow has therefore been negatively affected and, if weare unable to raise additional financing during the first and second quartersof 2006, we will look to one of our principal stockholders to provide workingcapital funding until additional capital can be obtained.

 

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Our plans for growth and expansion will require the need for additionalcapital in the future. As a result, we may have to rely upon the issuance ofadditional debt or equity securities in order to continue to grow our businessas well as to fund the negative cash flow we have experienced to date, and mayexperience in the future, as a result of these activities. If additional fundsare raised through the issuance of equity securities, our existing stockholdersmay experience significant dilution. In the absence of achieving profitableoperations in future periods, obtaining additional capital through asset sales,securing a revolving credit facility, debt or equity offerings, or acombination of the foregoing, we may encounter liquidity difficulties. Noassurance can be given that we will be able to raise additional capital whenneeded, or at all, or that such capital, if available, will be on acceptableterms.

 

We have made cash expenditures for capital equipmentand software from our inception until December 31, 2005 of approximately$778,000 purchasing the telecommunications equipment necessary to operate ourbusiness. This amount excludes the $1.9 million in telecommunications equipmentacquired from MRS Partners LLC (“MRS Partners”) described further below.

 

*Asset Purchase from MRS Partners.  *OnMarch 15, 2005, we completed the purchase of certain telecommunicationsequipment (including two Sonus Networks switches) from MRS Partners for$500,000 in cash, 725,000 shares of our common stock and a promissory note foran aggregate principal amount of $1,170,000. Prior to the closing, we wereleasing this equipment from MRS Partners. The principal amount of the note wassubsequently adjusted to $970,000, reflective of unanticipated recertificationcosts. Under the terms of the promissory note, interest accrues daily at a rateof 8.25% per annum and is payable monthly in arrears. An initial principalpayment of $100,000 has been made. An additional principal payment of $100,000that was due on December 31, 2005 wasextended to and paid on March 31, 2006. The remaining principal amount ($770,000)and any unpaid interest originally payable on March 15, 2006, the firstanniversary of the closing of the purchase, has been extended to April 28,2006.

 

On March 30, 2006 we entered into a revolving credit agreement withIndigo Investments LLC that provides for up to $5,000,000 in advances to beavailable to us.  Upon the closing ofthis credit facility, $1,000,000 was advanced to us and an additional $300,000advance under the credit agreement is expected to be made to us on or beforeApril 5, 2006. Additional advances under the credit facility are dependent uponour accounts receivable balances and adherence to certain covenants asdescribed in the credit agreement. Outstanding principal under this credit facility bears interest at arate of 1.5% per month, increasing to 2.5% per month in the event of a defaultby us under the credit agreement.  Inaddition, we are required to pay the lender a 2.25% commitment fee on the totalamount of the credit facility and issue the lender a five-year warrant topurchase up to 500,000 shares of our common stock at an exercise price of $1.50per share.  The exercise price of thewarrant is subject to adjustment in certain circumstances.

 

All outstanding principal and interest on the credit facility plus thecommitment fee are due and payable on the earlier of (i) September 30, 2006, or(ii) the closing of the sale of a minimum of $6,000,000 of our equitysecurities; provided, that, in the event that such a financing closes prior toSeptember 30, 2006, we will also be required to pay the lender an earlyrepayment fee equal to 2.25% of the total amount of the credit facility. Therights of the lender under the credit facility are junior to those of theoutstanding convertible debentures.

 

Advances drawn under this agreement are personally guaranteed by ourChairman and Chief Executive Officer, Rupert Galliers-Pratt.

 

We believethat we will need additional financing in order to sufficiently meet ourworking capital requirements, including the funding of operating losses, andcapital expenditure requirements for at least the next fiscal year, assumingthat our business plan is implemented successfully. Previously, our primarysources of capital had been the revenues generated from interconnect agreementswith our customers and advances made by one of our principal stockholders froma credit facility established in the name of the stockholder and other of thestockholder’s personal assets. Our plans for growth and expansion will requirethe need for additional capital in the future. As a result, we may have to relyupon the issuance of additional debt or equity securities in order to continueto grow our business as well as to fund the negative cash flow we haveexperienced to date, and may experience in the future, as a result of theseactivities. If additional funds are raised through the issuance of equitysecurities, our existing stockholders may experience significant dilution. Inthe absence of achieving profitable operations in future periods, obtainingadditional capital through asset sales, securing a revolving credit facility,debt or equity offerings, or a combination of the foregoing, we may encounterliquidity difficulties. No assurance can be given that we will be able to raiseadditional capital when needed, or at all, or that such capital, if available,will be on acceptable terms. In the event that we do not succeed inimplementing our business plan, and do not otherwise raise third-party capital,we will have to curtail certain expenditures, seek additional financing fromone of our principal stockholders, or both in order to sustain operations. Asnoted above, one of our principal stockholders has historically providedworking capital advances. While the stockholder is not obligated to providethese working capital advances to us we expect the stockholder to continueproviding funds for operations in 2006 as and if needed, until such time thatour operations are self-sustaining or we raise additional external capital, asthe case may be.

 

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

 

**Other Arrangements and Obligations**

 

*Distribution and Marketing Agreementwith NetYantra.*On August 11, 2004, we entered into adistribution and marketing agreement with NetYantra Inc. and NetYantra IndiaPvt. Ltd. (collectively, “NetYantra”) pursuant to which NetYantra grants to theCompany the exclusive worldwide rights (other than in India where NetYantra isheadquartered and subject to certain existing distribution agreements) tomarket and distribute the V-CubeTM IP-PBX software platform developed byNetYantra to Tier 1 carriers, telecommunications equipment manufacturers,internet service providers, large corporations, SMEs and other businessentities and individual retail customers. Under this agreement, we have paidNetYantra $400,000 and we are required to pay NetYantra fifty percent ofcertain net revenues that the Company derives from the distribution of theV-CubeTM platform.

 

In addition, the agreement stated that in the eventthat our common stock was quoted or traded on a stock market on or before thefirst anniversary of the agreement, we would issue to NetYantra shares of theCompany’s common stock having a market value of $1,000,000 based on the openingprice of the Company’s common stock on the first day of trading (or, at theCompany’s option, pay to NetYantra a cash payment of $1,000,000 instead ofissuing such shares). On July 21, 2005, public trading in the Company’s commonstock began jointly on the OTC Bulletin Board and the Pink Sheets ElectronicQuotation Service under the trading symbol “VSTL.”  The opening sale was at a price of $2.00 pershare. The Company issued 500,000 shares of its common stock to NetYantra incompliance with the agreement.

 

On March 24, 2006 we received a notice from NetYantra India Pvt Ltd.claiming that we are in breach of certain provisions of the August 11, 2004distribution and marketing agreement that we entered into with NetYantra Inc.and NetYantra India Pvt. Ltd. (collectively “NetYantra”). The notice claimedthat we have not fulfilled certain requirements contained in the agreement asto the training of personnel, recognition of NetYantra as the developer ofcertain technology, and the forwarding of documentation to NetYantra regardingthe licensing and sublicensing of certain technology.  Further, the notice claimed that ourmarketing of the consumer VoIP portal product is in breach of thenon-competition provisions of the agreement. Our response to this notice willdescribe the reasons why we believe we are not in breach of the agreement.

 

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We expect that we will need to raise additional debtor equity financing to pay the required interest and principal payments underthe convertible debentures issued in our private placement and the promissorynote issued to MRS Partners as part of the consideration for the purchase ofequipment from MRS Partners.

 

*Agreementwith Quest Telecommunications, Inc.*On December 13, 2005, weentered into a Consultant, Representative and Professional Services Agreementwith Quest Telecommunications, Inc. (“Quest”). Under this agreement, we haveappointed Quest as an independent advisor and our exclusive representative inthe geographic areas of Vietnam, Cambodia, Malaysia and Turkey (and any otherareas to which we and Quest agree in writing). Within these geographic areas,Quest will (i) assist in structuring and establishing business relationships,including introducing us and the V-CubeTM IP-PBX software platform to potentialpartners, distributors, licensees and/or purchasers, and (ii) provide projectmanagement services relating to business operations, including developingrevenue targets, establishing technical support capability, facilitatingtechnical support delivery, and monitoring license fee reconciliation. Questwill also act as our agent for the V-CubeTM to consumers from, but residingoutside, the geographic area covered by this agreement (except for consumersresiding in territories for which we or any of our affiliates have granted orhereafter grant exclusive distribution or agency rights).

 

Under this agreement, weare obligated to make payments to Quest totaling $50,000 in consideration forQuest’s assistance relating to the execution by us and Saigon Post andTelecommunications Services Corporation (“SPT”) of a memorandum ofunderstanding and pilot license agreement with respect to the V-CubeTM. Thememorandum of understanding, which we entered into on September 20, 2005,contemplates that, following legal and technical evaluation of the V-CubeTMplatform by SPT, SPT and the company will negotiate and enter into an agreementwith respect to the deployment and commercialization of the V-CubeTM platform inVietnam. The pilot license agreement, which we entered into on October 15,2005, permits SPT to use the V-CubeTM platform for evaluation and testingpurposes on a royalty-free basis from November 15, 2005 through February 15,2006.

 

In addition, in the eventwe and SPT enter into a definitive distribution or license agreement withrespect to the V-CubeTM, we will be obligated to issue to Quest 300,000 sharesof our common stock and to pay to Quest $150,000 in cash, plus a continuingcommission of thirty percent of the license fees we receive from SPT inconnection with the licensing and distribution of the V-CubeTM in theabove-mentioned geographic areas (net of sales, use and value added taxes, ifany, payable by us in connection with such license fees).

 

*Placement Agent Agreement*.On February 15, 2005, we entered into an agreement with a placement agent,IndiGo Securities, LLC (“IndiGo”), under which they provided services inconnection with the convertible debenture and warrant financing and willprovide ongoing consulting services to us. Under the terms of the agreement,IndiGo received a placement fee equal to 10% or, in some cases, 5% of thepurchase price paid by each investor (plus any expenses IndiGo incurs inconnection with the financing) at each of the closings described above. We alsoagreed to pay IndiGo a consulting fee of $20,000 per month for the 12-monthperiod ending February 17, 2006. We had a right to terminate the agreement uponwritten notice after August 17, 2005. IndiGo may, at its option and in lieu of50% of the cash consulting fee due for any month, accept warrants to purchase10,000 shares of our common stock at an exercise price of $1.00 per share. SeeNote 14 for a description of a new agreement entered into on January 27, 2006.

 

*Guaranty of Vistula Limited.*Oneof our subsidiaries, Vistula, had agreed to unconditionally guarantee the obligationsof one of our principal stockholders under a $3,000,000 credit facilityestablished in the name of the stockholder. This guarantee was released by thefinancial institution on March 27, 2006.

 

**Recently Issued Accounting Pronouncements**

** **

In May 2005, the Financial Accounting Standards Board issued SFASNo. 154, *Reporting Accounting Changes inInterim Financial Statements*(“SFAS154”)*,*which replaces APBOpinion No. 20, *Accounting Changes,*andSFAS No. 3, *Reporting AccountingChanges in Interim Financial Statements*, and changes therequirements for the accounting for and reporting of a change in accountingprinciple. SFAS 154 applies to all voluntary changes in accounting principle.It also applies to changes required by an accounting pronouncement in theunusual instance that the pronouncement does not include specific transitionprovisions. When a pronouncement includes specific transition provisions, thoseprovisions should be followed. SFAS 154 was effective for the Company beginningJanuary 1, 2006 and is not expected to have a material impact on theCompany’s financial position or results of operations.

 

On December 16, 2004, the Financial AccountingStandards Board issued SFAS 123(R), *Share-BasedPayment*, which is a revision of SFAS 123 (SFAS 123R). SFAS 123Rsupersedes APB 25**and amends SFAS No. 95, *Statement of Cash Flows*. Generally, theapproach in SFAS 123R is similar to the approach described in SFAS 123,detailed below. However, SFAS 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thestatement of operations based on their fair values at the date of grant. Proforma disclosure is no longer an alternative. SFAS 123R is effective for publicentities that file as small business issuers as of the beginning or the firstinterim or annual reporting period that begins after December 15, 

 

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2005. Early adoption is permitted in periods in which financialstatements have not yet been issued. We adopted SFAS 123R on January 1,2006, the commencement of our first quarter of fiscal 2006.

 

The Company will apply SFAS 123R using the “modifiedprospective” method. Under this transition method, compensation cost isrecognized on or after the required effective date for the portion ofoutstanding awards for which the requisite service has not yet been rendered,based on the grant-date fair value of those awards calculated under SFAS 123for either recognition or pro forma disclosures.

 

Aspermitted by SFAS 123, we currently account for share-based payments toemployees using APB 25’s intrinsic value method and, as such, generallyrecognize no compensation cost for employee stock options issued with anexercise price greater than or equal to the fair value of the underlying stockon the grant date. Accordingly, the adoption of SFAS 123R’s fair-value methodmay have a significant impact on our reported results of operations. Managementis still evaluating the impact of the adoption of SFAS 123R.

 

**Subsequent Events**

 

On January 5, 2006, the Company entered into anemployment agreement with Ian Cope relating to Mr. Cope’s employment as theCompany’s chief operations officer.  Under the employment agreement, theCompany will pay Mr. Cope an annual base salary of $140,000 and provide himwith certain employment related benefits.  In addition, the employmentagreement provides that the Company will grant Mr. Cope an incentive stockoption to purchase 250,000 shares of the Company’s common stock with an exerciseprice equal to $1.42 per share; 50,000 of those shares subject to the optionwill be vested immediately and the remaining 200,000 shares subject to theoption will vest in four equal annual installments of 50,000 shares beginningon January 5, 2007.  The option will be subject to the terms andconditions of the Company’s 2004 Amended and Restated Stock IncentivePlan.  The employment agreement also provides that if Mr. Cope isterminated without cause, the Company will be obligated to pay him his base salaryfor three months.

 

On January 27, 2006, we entered into aFinancial Advisory Agreement with Indigo Ventures LLC (“Indigo”) in which weagreed to appoint Indigo as our financial advisor to advise, consult with, andassist us in various matters which may include:

 

•      a review of our business, operations andfinancial condition, including advising us on capitalization structures;

 

•      advice relating to general capital raisingmatters;

 

•      recommendations relating to specific businessoperations, transactions and joint ventures;

 

•      advice regarding future financings involvingour or any of our affiliates’ debt or equity securities; and

 

•      assistance in connection with the duediligence review of any significant acquisition transactions proposed by usduring the term of the agreement.

 

In consideration for these services, we have agreedto pay Indigo a cash fee of $20,000 per month in arrears, increasing to $30,000per month beginning in the first month following the consummation by us of asignificant debt or equity financing from which we obtain gross proceeds of atleast $5 million.  Also, we have agreed to issue to Indigo 1,500,000restricted shares of our common stock, which shares will vest upon the earlierof: (i) the closing of a significant acquisition as may be described in awritten notice delivered by us to Indigo on or after the date of the agreement,(ii) subject to the approval of our compensation committee, the closing ofanother major acquisition or financing transaction on which Indigo provides adviceto us, (iii) a change of control of our company, or(iv) January 27, 2007.  The shares we are issuing to Indigo arerestricted shares and may not be sold, assigned or transferred by Indigo for aone year period beginning on January 27, 2006 and ending on January 27,2007.  If we terminate the agreement as a result of a material breach ofthis agreement, we will have the right and option to repurchase fifty percentof all of the then unvested shares at a purchase price of $0.001 per share.

 

On February 28, 2006, we finalized an agreementwith Mark Scully resolving matters relating to his cessation of employment asPresident and Chief Executive Officer of Vistula USA, our wholly ownedsubsidiary, on November 2, 2005.  In connection with a mutual releaseof claims, we agreed to pay Mr. Scully $50,000 in severance and we issuedto him 750,000 shares of our common 

 

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stock in respect of theexercise of an outstanding option issued under our stock incentive plan. These 750,000 shares are subject to our right to repurchase at a price of $1.00per share through March 31, 2006.

 

On March 30, 2006 we entered into a revolving creditagreement with Indigo Investments LLC that provides for up to $5,000,000 inadvances to be available to us.  Upon theclosing of this credit facility, $1,000,000 was advanced to us and anadditional $300,000 advance under the credit agreement is expected to be madeto us on or before April 5, 2006. Additional advances under the credit facilityare dependent upon our accounts receivable balances and adherence to certaincovenants as described in the credit agreement. Outstanding principal under this credit facility bears interest at arate of 1.5% per month, increasing to 2.5% per month in the event of a defaultby us under the credit agreement.  Inaddition, we are required to pay the lender a 2.25% commitment fee on the totalamount of the credit facility and issue the lender a five-year warrant topurchase up to 500,000 shares of our common stock at an exercise price of $1.50per share.  The exercise price of thewarrant is subject to adjustment in certain circumstances.

 

All outstanding principal and interest on the creditfacility plus the commitment fee are due and payable on the earlier of (i)September 30, 2006, or (ii) the closing of the sale of a minimum of $6,000,000of our equity securities; provided, that, in the event that such a financingcloses prior to September 30, 2006, we will also be required to pay the lenderan early repayment fee equal to 2.25% of the total amount of the creditfacility. The rights of the lender under the credit facility are junior tothose of the outstanding convertible debentures.

 

Advances made to us under the credit agreement arepersonally guaranteed by our Chairman and Chief Executive Officer, RupertGalliers-Pratt.

 

**Factors Affecting Future Performance**

 

*We have a limited operating history;therefore, we may not be able to accurately forecast future results andoperating losses in future periods could be greater than expected.*

 

We commenced operations inSeptember 2002. Thus, we have a limited operating history. As a result, itis difficult to accurately forecast our revenues and we lack meaningfulhistorical financial data upon which to base planned operating expenses. We maybe unable to adjust our spending in a timely enough manner to compensate forany unexpected revenue shortfall. Conversely, we might not be able to respondeffectively to an unexpected increase in sales activities, should one occur.This inability could cause our net losses in a given quarter to be greater thanexpected.

 

*If we do not obtain a substantial amount ofadditional financing, we may have to curtail or suspend operations.*

 

We believe we will require additional financingin order to fund our operations and to carry out our business plan. We can giveno assurance, however, that we will be able to obtain such financing or thatsuch financing will be available on satisfactory terms. To raise additionalfinancing, we intend to pursue various possible financing options, includingone or more public offerings or private placements of equity securities. If weare unable to obtain additional financing, we may have to curtail or suspendoperations.

 

*We may continue to lose money on ouroperations.*

 

We are not profitable. In the fiscal yearended December 31, 2005, we incurred a net loss of $12,182,002 and as ofDecember 31, 2005, we had an accumulated deficit of $16,576,999. Weanticipate losses to continue for the foreseeable future.

 

We can give no assurance that we will be ableto operate profitably. In general, our ability to become profitable depends onour ability to generate and sustain substantially higher revenues whilemaintaining reasonable expense levels. If we were to achieve profitability, wecannot give any assurance that we would be able to sustain or increaseprofitability on a quarterly or annual basis in the future.

 

Our efforts to operate profitably will dependon, among other things:

 

•      Developing theVistula and Cardlink brands, through marketing and other promotionalactivities;

 

•      Expanding ourproduct and services offerings;

 

•      Developingmarketing and distribution relationships with strategic business partners;

 

•      Expandinggeneral and administrative functions to support any growth that may occur; and

 

•      Establishing anddeveloping customer and carrier relationships in the telecommunicationsindustry.

 

*If we are unable to preserve ourexclusive rights to market and distribute the V-Cube**Ô, our business may suffer.*

 

We believe our coreproduct offering during the 2006 fiscal year will be the V-CubeÔ platform. Ourrights to market and distribute the V-CubeÔ arise under anexclusive license (except for India, where the licensor is based, and subjectto certain pre-existing distribution and reseller agreements which the licensorhas agreed to renew) from the developer of the platform to market anddistribute the platform worldwide. Under the terms of the license agreementthat expires on August 11, 2009, our limited exclusivity terminates on August11, 2006. If we are unable to extend our exclusive rights to market and distributethe V-CubeÔplatform, the developer may license the platform to others who may compete withus. Any such competition could result in decreased margins or may require us topursue other strategic alternatives for this market.

 

*If we fail to establish the Vistula andCardlink brands or to attract repeat customers, we may not be able to increaseour revenues sufficiently to fund our operations.*

 

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We believe that we must develop andstrengthen the Vistula and Cardlink brands, particularly because of the earlystage of our development and the highly competitive nature of our business. Ifwe fail to establish the Vistula and Cardlink brands quickly, we will remain ata competitive disadvantage and may lose the opportunity to obtain a sufficientnumber of customers. The development of the Vistula and Cardlink brands willdepend largely on the success of our marketing efforts and our ability toprovide consistent, high quality customer experiences. We cannot be certainthat we will be able to afford to conduct brand promotion activities sufficientto build awareness, or that such activities, if any, will be successful or willresult in increased revenues. If we do achieve increased revenues, we can giveno assurance that these revenues will be sufficient to offset the expendituresincurred in building our brands.

 

*We have only limited revenue of which a significantportion is derived from a limited number of contracts and customers. If we areunable to replace contracts upon completion and maintain customerrelationships, we could have a significant decrease in our revenues which wouldnegatively impact our results.*

 

We have derived, and believe that we willcontinue to derive, a significant portion of our revenues in any given yearfrom a limited number of large contracts. As these contracts wind down tocompletion, we face the task of replacing such revenues with new projects andcontracts. 89% of our revenues for the fiscal year ended December 31, 2005was derived from four customers and 78% of our revenues for the fiscal yearended December 31, 2004 was derived from four customers. Our inability toreplace such revenues would cause a significant decrease in our revenues andnegatively affect our operating results.

 

*We may experience significant fluctuations inour results as a result of uncertainties relating to our ability to generateadditional revenues, manage our expenditures and other factors, certain ofwhich are outside of our control.*

 

Our operating results have variedconsiderably in the past and are likely to vary considerably due to a number offactors, many of which are outside of our control. The factors outside ourcontrol include, among others:

 

•      The timing ofreceipt of new contracts;

 

•      The length ofour sales cycles;

 

•      Competitivepricing pressures;

 

•      Thecommencement, completion or termination of contracts during any particularreporting period;

 

•      Fluctuations indemand for our services;

 

•      The commencementof services by a customer;

 

•      Servicesfurnished by other providers;

 

•      The availabilityof new contracts sufficient to generate significant additional revenues toreplace revenues associated with contracts that are nearing or at completion;and

 

•      Telecommunicationsmarket conditions and economic conditions generally.

 

The factors within our control include, amongothers:

 

•      The amount ofsales and marketing expenses and general and administrative expenses we incur;

 

•      The timing ofour expansion into new markets, through acquisitions or otherwise;

 

•      Changes in theprices of products or services we offer; and

 

•      Attractingqualified professionals in a timely manner and retaining them.

 

Due to the above factors, quarterly revenues,expenses and results of operations could vary significantly in 2006 and beyond.

 

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*Our contracts typically contain provisionsgiving customers the ability to terminate their contracts under variouscircumstances and we may not be able to replace the revenues from suchcontracts which may have an adverse effect on our revenues and operatingresults.*

 

Our contracts typically have provisions thatpermit customers to terminate their contracts under various circumstances,including termination for convenience. Termination of such contracts by thecustomers may result in further loss of revenues and cause us to incur legaland other expenses associated with our efforts to collect some or all of theamounts we may be entitled to under such contracts. We also believe that intensecompetition and the current trend in the telecommunications industrycontracting toward shorter-term contracts that provide increased grounds forcustomer termination may result in increased frequency of customer terminationor renegotiation. If large contracts, or a number of contracts that in theaggregate account for a material amount of our revenues, are suspended for anysignificant length of time or terminated, we may encounter difficulty replacingsuch revenues and our revenues and operating results would decline.

 

*We may not be able to promptly reduceexpenses in response to any decrease in our revenues, which would result inlower net margins.*

 

We may not be able to reduce our expenses inorder to timely correspond with any decrease in our revenues, includingdecreases resulting from delays, cancellation or completion of existingcontracts. Our failure to timely reduce our costs would decrease gross profitsand increase our operating expenses. Efforts to reduce costs may include arestructuring of our business, reduction in headcount, office closings and thereduction or elimination of other administrative functions. Costs of compliancewith domestic and international regulations associated with such headcountreductions, particularly in Europe, Asia and Africa, where we anticipateconsiderable growth, could be significant. Our efforts to reduce expenses couldgive rise to significant accounting charges and the payment of certainseparation or severance benefits. Efforts to reduce expenses and the correspondingcompliance burdens would place considerable strain on our management, legal andadministrative functions.

 

*If we are unable to collect receivables fromdevelopment stage customers and other telecommunications companies, ouroperating results may be materially harmed.*

 

We may perform services for development stagecustomers that carry a higher degree of financial risk for us. Our customers,established and development stage, have been and may continue to be impacted byany tightening of available credit and general economic slowdown. As a resultof these conditions, our customers may be unable to pay, or may delay payment,for services performed by us. If we are not able to collect such amounts, wemay be required to write-off significant accounts receivable and recognize baddebt expense.

 

*The extent of our dependence on internationaloperations may give rise to increased management challenges and could harm ourresults of operations.*

 

Customers outside the United States accountedfor approximately 19% of our revenues for the year ended December 31,2005, and for approximately 72% of our revenues for the year endedDecember 31, 2004. The multi-jurisdictional nature of our revenues exposesus to additional risks. Such risks include:

 

•      The effects ofterrorism;

 

•      The generaleconomic and political conditions in each country;

 

•      The effect ofapplicable foreign tax structures, including tax rates that may be higher thantax rates in the United States;

 

•      Tariff and traderegulations;

 

•      Difficulties inobtaining local business licenses or approvals;

 

•      Management of ageographically diverse organization; and

 

•      Difficultiesand increased expenses in complying with a variety of foreign laws andregulations, including labor, employment and immigration laws where failure tocomply could expose us to substantial fines and penalties and a reduction inour available workforce.

 

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The level and timing of the demand for ourservices and products could also be affected by changes in the applicableindustry regulatory environments in foreign countries, including delays inderegulation or privatization affecting the pace at which licenses are awardedto telecommunication service providers.

 

Expansion of our international operations mayrequire significant expenditure of operating, financial and managementresources and result in increased administrative and compliance costs thatcould harm our results of operations. In addition, by expanding ourinternational operations, our revenues and earnings may be significantlyaffected by political instability and other political developments throughoutthe world, such as war and other international conflicts, civil unrest andlocal security concerns. Both the likelihood of such occurrences and theiroverall effect upon us vary greatly from country to country and are notpredictable.

 

*Providing services outside the United Statescarries the additional risk of currency fluctuations and foreign exchangecontrols imposed by certain countries since many of our non-U.S. projects areundertaken in local currency.*

 

Although we generally incur project expensesin the same currency in which payments are received under the contract, we donot currently engage in additional currency hedging activities to limit therisk of exchange rate fluctuations. Therefore, fluctuations in the currencyexchange rate could have a negative impact on the profitability of our operationsparticularly if: (i) we cannot incur project expenses in the same currencyin which payments are received under the contract; and (ii) there is anegative impact when converting back to U.S. dollars.

 

*Our inability to anticipate or adapt tochanges in technology may harm our competitive position, reputation andopportunities for revenue growth.*

 

We operate in a highly competitiveenvironment that is subject to rapid technological changes and the emergence ofnew technologies. Our future revenues depend significantly upon the adoptionand deployment by telecommunication customers of new technologies. Our successwill depend on our ability to timely enhance our current product and serviceofferings to keep pace with new technologies and the changing needs of ourcustomers. If we are not successful in responding to technological changes, orindustry or marketplace developments, our competitive position, reputation andopportunities for revenue growth may be harmed.

 

*We may not be able to hire or retain asufficient number of qualified engineers and other employees to meet ourcustomers’ needs or maintain the quality of our services.*

 

As a service business, our success dependssignificantly on our ability to attract, train and retain engineering, system deployment,managerial, marketing and sales personnel who have excellent technical skills,particularly as technology changes, as well as the interpersonal skills crucialto fostering customer satisfaction. Competition for highly skilled engineering,sales, marketing and support personnel is intense because there is a limitednumber of people available with the necessary technical skills and anunderstanding of the markets which we serve. We may have difficulty recruitingand retaining qualified technical personnel. In addition to recruitmentdifficulties, we must fully and properly train our new employees. Increasedcompetition in the telecommunication industry is increasing the level ofspecific technical experience and training required to compete in the marketplace.This process is costly and resource constraints may impede our ability toquickly and effectively hire and train all of the personnel required to staycompetitive in the marketplace.

 

*Future acquisitions of new companies ortechnologies may result in disruption to our business and expose us to risksassociated with acquisitions.*

 

We may make future acquisitions of, orinvestments in, other companies or technologies. Any future acquisitions orinvestments may require debt or equity financing, or the issuance of shares,which could be dilutive to our existing stockholders. In addition, ouroperating results may suffer as a result of any acquisition-related costs orimpairment of goodwill and other intangible assets acquired in connection withan acquisition. In addition, acquisitions could expose us to a number of otherrisks and challenges, including:

 

•      Diversion ofmanagement’s attention and resources;

 

•      Potential lossof key employees and customers of the acquired companies;

 

•      Difficult and costlyintegration of operations;

 

•      Lack ofexperience operating in the geographic market or industry sector of theacquired business;

 

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•      Adverse effectson existing business relationships;

 

•      Risks associatedwith entering markets in which we have limited or no prior experience;

 

•      An increase inour expenses and working capital requirements; and

 

•      Exposure tounanticipated contingent liabilities of acquired companies.

 

Any of these and other factors could disruptour business and harm our ability to achieve the anticipated benefits of anacquisition.

 

*The consolidation of telecommunicationservice providers could adversely impact our business.*

 

The telecommunications industry has beencharacterized by significant consolidation activity. This consolidation and thepotential continuing trend towards future consolidation within thetelecommunications industry may lead to a greater ability amongtelecommunication service providers to provide a comprehensive range of networkservices, which could lead to a reduction in demand for our services. Moreover,the consolidation of telecommunication service providers could reduce thenumber of our current or potential customers and increase the bargaining powerof our remaining customers that may adversely impact our business.

 

*Government regulations may adversely affectour business.*

 

Our products and services are subject tofederal and state regulations in the United States and foreign regulations. Webelieve that we will be able to comply in all material respects with the lawsand regulations governing the telecommunication industry and our products andservices, and that such laws will not have a material effect on our operations.However, various foreign, federal and state agencies may propose newlegislation that may adversely affect our business, financial condition andresults of operations.

 

*If we fail to retain our key personnel andattract and retain additional qualified personnel, we might not be able to meetour customers’ needs.*

 

Our future success and our ability to sustainour revenue growth depend upon the continued service of our executive officersand other key personnel. The loss of any of our key employees, in particularRupert Galliers-Pratt, the chairman of our board and our president and chiefexecutive officer, or Adam Bishop, president of Vistula Limited and Vistula USAcould adversely affect our ability to meet our customers’ needs. We haveentered into a consulting agreement for services to be rendered by RupertGalliers-Pratt with an entity affiliated with Rupert Galliers-Pratt for a termof 24 months, which term commenced as of August 17, 2005. At present, we do nothave an employment agreement with Adam Bishop.

 

*The management of our finances and thequality and timeliness of our financial reporting may be adversely affected ifwe are unable to increase the size and capabilities of our internaladministrative and finance function as our business grows.*

 

Wehave engaged an outside accounting firm (other than our independent registeredpublic accounting firm) to provide certain financial management and accountingservices on a part-time basis to supplement the services provided by our ownfinance and administrative staff. If we are unable to continue to obtainsufficient financial management and accounting services on a cost-effectivebasis, our ability to effectively manage our finances and the quality andtimeliness of our financial reporting could be adversely affected.

 

*We will not be successful if we do not growour customer base beyond our initial customers.*

 

Our future success will depend on our abilityto attract additional customers beyond our current limited number. The growthof our customer base could be adversely affected by:

 

•      Customerunwillingness to implement our products and services;

 

•      Any delays ordifficulties that we may incur in completing the development and introductionof our planned products or product enhancements;

 

•      New product orservice introductions by our competitors;

 

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•      Any failure ofour products to perform as expected; or

 

•      Any difficultywe may incur in meeting customers’ delivery requirements.

 

If we do not expand our customer base toinclude additional customers that use our services and products, our revenueswill not grow significantly, or at all.

 

*If we do not respond rapidly to technologicalchanges or to changes in industry standards, our products and services couldbecome obsolete.*

 

The market for our products and services ischaracterized by rapid technological change and frequent new product andservice introductions. We may be unable to respond quickly or effectively tothese developments. We may experience difficulties with software development, hardwaredesign, manufacturing or marketing that could delay or prevent our development,introduction or marketing of new products and services and enhancements. Theintroduction of new products and services by competitors, the market acceptanceof products and services based on new or alternative technologies or theemergence of new industry standards could render our existing or futureproducts and services obsolete. If the industry standards adopted are differentfrom those that we have chosen to support, market acceptance of our productsand services may be significantly reduced or delayed. If our products andservices become technologically obsolete, we may be unable to sell our productsand services in the marketplace and generate revenues.

 

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

 

To achieve market acceptance for our productsand services, we must effectively anticipate, and adapt in a timely manner to,customer requirements and offer products and services that meet changingcustomer demands. Prospective customers may require product features andcapabilities that our current products do not have. The introduction of new orenhanced products also requires that we carefully manage the transition fromolder products in order to minimize disruption in customer ordering patternsand ensure that adequate supplies of new products can be delivered to meetanticipated customer demand. If we fail to develop products and offer servicesthat satisfy customer requirements, or to effectively manage the transitionfrom older products, our ability to create or increase demand for our productswould be seriously harmed and we may lose current and prospective customers.

 

Many of our customers will require that ourproducts be designed to interface with their existing networks, each of whichmay have different specifications. Issues caused by an unanticipated lack ofinteroperability may result in significant warranty, support and repair costs,divert the attention of our engineering personnel from our hardware andsoftware development efforts and cause significant customer relations problems.If our products do not interoperate with those of our customers’ networks,installations could be delayed or orders for our products could be cancelled,which would seriously harm our gross margins and result in loss of revenues orcustomers.

 

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

 

Competition in the telecommunications marketis intense. This market has historically been dominated by large companies. Inaddition, a number of smaller companies, including BonNet, Fewhurst, C2C andTotal X, have products and services that address similar market opportunitiesto that which we and our subsidiaries address. Many of these competitors havealso been in the market for longer than us and have larger existing customerbases. Some of these competitors, such as Broadsoft, have greater financialresources than we do, including investment from major private equity funds.Because this market is rapidly evolving, additional competitors withsignificant financial resources may enter these markets and further intensifycompetition.

 

Many of our current and potential competitorshave significantly greater selling and marketing, technical, manufacturing,financial and other resources, including the ability to offer financingprograms. If we are unable or unwilling to offer vendor-sponsored financing,prospective customers may decide to purchase products and services from one ofour competitors who offers this type of financing. Furthermore, some of ourcompetitors are currently selling significant amounts of other products andservices to our current and prospective customers. Our competitors’ broadproduct portfolios coupled with already existing relationships may cause ourcustomers to buy our competitors’ products and services.

 

To compete effectively, we must deliverproducts and services that:

 

•      Provideextremely high reliability and quality;

 

•      Scale easily andefficiently;

 

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•      Interoperatewith existing network designs;

 

•      Provideeffective network management;

 

•      Are accompaniedby comprehensive customer support and professional services; and

 

•      Provide acost-effective solution for customers.

 

If we are unable to compete successfullyagainst our current and future competitors, we could experience pricereductions, order cancellations, loss of revenues and reduced gross margins.

 

*Our business is exposed to the generalconditions of the telecommunications market.*

 

Our business is subject to global economic conditions,and in particular, market conditions in the telecommunications industry. Ouroperations could be adversely affected if declines in capital spending fromtelecommunications service providers continue. If global economic conditionsworsen, or if the prolonged slowdown in the telecommunications industrycontinues, then we may experience adverse operating results.

 

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

 

While we believe there is a significantgrowth opportunity in providing wholesale voice termination services (includingVoIP services) and pre-pay products to carriers and operators, there can be noassurances that these technologies will be widely accepted or that a viablemarket for our services and products will fully develop or be sustainable. Ifthese markets do not develop, or develop more slowly than expected, then we maynot be able to sell our products or services in significant volume, or at all.Due to the intense competition in these markets and with respect to VoIPservices, the relatively recent introduction of this technology, there can beno assurance that we will succeed in these evolving marketplaces.

 

*Intellectual property infringement claimsagainst us or any of our subsidiaries, even without merit, could require us toenter into costly licenses or deprive us of the technology we need.*

 

Our industry is technology intensive. As thenumber of competitors in our target markets increases and the functionality ofthe products produced by such competitors further overlaps, third parties mayclaim that the technology we develop or license infringes their proprietaryrights. Any claims against us or any of our subsidiaries may affect ourbusiness, results of operations and financial conditions. Any infringementclaims, even those without merit, could require us to pay damages or settlementamounts or could require us to develop non-infringing technology or enter intocostly royalty or licensing agreements to avoid service implementation delays.Any litigation or potential litigation could result in product delays,increased costs or both. In addition, the cost of litigation and the resultingdistraction of our management resources could have a material adverse effect onour results of operations and financial condition. If successful, a claim ofproduct infringement could deprive us of the technology we need altogether.

 

*Failure to protect our intellectual propertyrights could have a material adverse effect on our business.*

 

Our success depends in part upon theprotection of our proprietary products. We have taken steps that we believe areadequate to establish, protect and enforce our intellectual property rights. Wecannot assure you that these efforts will be adequate. Despite our efforts toprotect our proprietary rights, unauthorized parties may attempt to copy orotherwise obtain rights to use our products or technology.

 

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

 

Our business strategy calls for thedevelopment of new products, services and enhancements which may from time totime contain defects or result in failures that we did not detect or anticipatewhen introducing such products, services or enhancements to the market. Inaddition, the markets in which our products and services are used arecharacterized by a wide variety of standard and non-standard configurations andby errors, failures and bugs in third-party platforms that can impede properoperation of our products and services. Despite product testing by us, defectsmay still be discovered in some new products or enhancements after the productsor enhancements are delivered to customers. The occurrence of these defectscould result in product returns, adverse publicity, loss of or delays in marketacceptance of our products, delays or cessation of service to our customers orlegal claims by customers against us.

 

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To the extent that contractual provisionsthat limit our exposure to legal claims are unenforceable or such claims arenot covered by insurance, a successful products liability claim could have amaterial adverse effect on our business, results of operations and financialcondition.

 

*We may be subject to litigation.*

 

We may be subject to claims involving how weconduct our business or the market for or issuance of our common stock or othersecurities. Any such claims against us may affect our business, results ofoperations and financial conditions. Such claims, even those without merit,could require us to pay damages or settlement amounts and would require asubstantial amount of time and attention from our senior management as well asconsiderable legal expenses. Although we do not anticipate that our activitieswould warrant such claims, there can be no assurances that such claims will notbe made.

 

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**ITEM 7. FINANCIAL STATEMENTS**

 

**INDEX TO FINANCIAL STATEMENTS**

 

 
| **CONSOLIDATED FINANCIAL STATEMENTS FOR****VISTULA COMMUNICATIONS SERVICES, INC.  AND SUBSIDIARIES**  **FOR THE YEARS  ENDED DECEMBER 31, 2005 AND 2004** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| **Reports of Independent Registered Public Accounting Firms**                                                                                                            | **32**     |
| **Consolidated Balance Sheets at December 31, 2005 and 2004**                                                                                                       | **34**     |
| **Consolidated Statements of Operations for the Years Ended  December 31, 2005 and 2004**                                                                           | **35**     |
| **Consolidated Statements of Stockholders’ Deficit for the Years Ended  December 31, 2005 and 2004**                                                           | **36**     |
| **Consolidated Statements of Cash Flows for the Years Ended  December 31, 2005 and 2004**                                                                           | **37**     |
| **Notes to Consolidated Financial Statements**                                                                                                                           | **38**     |

 

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**REPORT OF INDEPENDENT REGISTERED PUBLICACCOUNTING FIRM**

 

Tothe Board of Directors and Stockholders

VistulaCommunications Services, Inc.

NewYork, New York

 

Wehave audited the accompanying consolidated balance sheet of VistulaCommunications Services, Inc. and subsidiaries as of December 31, 2005 and the related consolidated statements of operations,stockholders’ deficit and cash flows for the year then ended. These financialstatements are the responsibility of the Company’s management. Ourresponsibility is to express an opinion on these financial statements based onour audit.

 

Weconducted our audit in accordance with the standards of the Public CompanyAccounting Oversight Board (United States). Those standards require that weplan and perform the audit to obtain reasonable assurance about whether thefinancial statements are free of material misstatement. An audit includesexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements. An audit also includes assessing the accountingprinciples used and significant estimates made by management, as well asevaluating the overall financial statement presentation. We believe that ouraudit provides a reasonable basis for our opinion.

 

Inour opinion, the consolidated financial statements referred to above presentfairly, in all material respects, the financial position of VistulaCommunications Services, Inc. and subsidiaries as of December 31, 2005 and the results of its operations and its cashflows for the year then ended in conformity with accounting principlesgenerally accepted in the United States.

 

Theaccompanying consolidated financial statements have been prepared assuming thatthe Company will continue as a going concern. As more fully described in Note1, the Company has experienced recurring operating losses and has a workingcapital deficit at December 31, 2005. The Company is working on variousalternatives to improve the Company’s financial resources which are alsodescribed in Note 1. Absent the successful completion of one or more of thesealternatives, the Company’s operating results will increasingly becomeuncertain. These conditions raise substantial doubt about the Company’s abilityto continue as a going concern; however, the financial statements do notinclude any adjustments to reflect the possible future effects on the recoverabilityand classification of assets or the amounts and classification of liabilitiesthat may result from the outcome of this uncertainty.

 
| /s/ PKF                      |   |
|------------------------------|--------|
| Certified Public Accountants |
| A Professional Corporation   |
| New York, New York           |
| March 30, 2006               |

 

32

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**REPORTOF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**

 

To the Board of Directors and Shareholders of

Vistula Communications Services, Inc.

 

We have audited the accompanying consolidatedbalance sheet of Vistula Communications Services, Inc. (a Delawarecorporation) and its wholly-owned subsidiaries, as of December 31, 2004,and the related consolidated statements of operations, stockholders’ deficitand cash flows for the year ended December 31, 2004. These financial statementsare the responsibility of the Company’s management. Our responsibility is toexpress an opinion on these financial statements based on our audits.

 

We conducted our audit in accordance with thestandards of the Public Company Accounting Oversight Board (United States.)Those standards require that we plan and perform the audit to obtain reasonableassurance about whether the financial statements are free of materialmisstatement. The company is not required to have, nor were we engaged to perform,an audit of its internal control over financial reporting. Our audit includedconsideration of internal control over financial reporting as a basis fordesigning audit procedures that are appropriate in the circumstances, but notfor the purpose of expressing an opinion on the effectiveness of the Company’sinternal control over financial reporting. Accordingly, we express no suchopinion. An audit also includes examining, on a test basis, evidence supportingthe amounts and disclosures in the financial statements, assessing theaccounting principles used and significant estimates made by management, aswell as evaluating the overall financial statement presentation. We believethat our audit provides a reasonable basis for our opinion.

 

In our opinion, the consolidated financialstatements referred to above present fairly, in all material respects, thefinancial position of Vistula Communications Services, Inc. and its wholly-ownedsubsidiaries as of December 31, 2004, and the results of their operationsand cash flows for the year ended December 31, 2004 in conformity withaccounting principles generally accepted in the United States of America.

 
| /s/ VITALE, CATURANO &  COMPANY, LTD. |   |
|-----------------------------------------------------|--------|

 

Boston, Massachusetts

March 29, 2005

 

33

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**VISTULACOMMUNICATIONS SERVICES, INC.**

**Consolidated Balance Sheets**

**December31, 2005 and 2004**

 

 
| ** **                                                                                                                                       | ** ** | **2005**    | ** ** | **2004**   | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------|------------|------------|------------|
| **ASSETS**                                                                                                                                       |       |        |       |       |       |
| Current assets:                                                                                                                                  |       |        |       |       |       |
| Cash and cash equivalents                                                                                                                        |       | $           | 553,127    |       | $          | 3,221 |   |
| Accounts receivable                                                                                                                              |       | 130,748     |       | 55,991     |       |
| Prepaid expenses and other current assets                                                                                                        |       | 1,045,795   |       | 228,870    |       |
| Total current assets                                                                                                                             |       | 1,729,670   |       | 288,082    |       |
| Property and equipment, net                                                                                                                      |       | 2,362,373   |       | 1,997,621  |       |
| Deferred financing costs                                                                                                                         |       | 613,742     |       | —     |       |
| Other assets                                                                                                                                     |       | 57,272      |       | —     |       |
| Total assets                                                                                                                                     |       | $           | 4,763,057  |       | $          | 2,285,703 |   |
| **LIABILITIES AND STOCKHOLDERS’ DEFICIT**                                                                                                   |       |        |       |       |       |
| Current liabilities:                                                                                                                             |       |        |       |       |       |
| Accounts payable                                                                                                                                 |       | $           | 398,841    |       | $          | 537,660 |   |
| Accrued expenses                                                                                                                                 |       | 628,154     |       | 1,044,343  |       |
| Due to stockholder                                                                                                                               |       | —      |       | 801,630    |       |
| Convertible promissory note to related  party                                                                                                    |       | 175,000     |       | 175,000    |       |
| Note payable                                                                                                                                     |       | 870,000     |       | —     |       |
| Total current liabilities                                                                                                                        |       | 2,071,995   |       | 2,558,633  |       |
| Capital lease obligation                                                                                                                         |       | —      |       | 1,971,167  |       |
| Convertible debentures                                                                                                                           |       | 5,424,902   |       | —     |       |
| Total liabilities                                                                                                                                |       | 7,496,897   |       | 4,529,800  |       |
| Commitments and contingencies                                                                                                                    |       |        |       |       |       |
| Stockholders’ deficit:                                                                                                                      |       |        |       |       |       |
| Preferred stock, $0.001 par value,  10,000,000 shares authorized; no share issued and outstanding                                                |       | —      |       | —     |       |
| Common stock, $0.001 par value, 100,000,000  shares authorized; 31,914,898 and 24,454,406 issued and outstanding in 2005  and 2004, respectively |       | 31,914      |       | 24,454     |       |
| Additional paid-in capital                                                                                                                       |       | 13,975,077  |       | 2,608,581  |       |
| Deferred compensation                                                                                                                            |       | (13,422     | )          | (399,000   | )          |
| Accumulated deficit                                                                                                                              |       | (16,576,999 | )          | (4,394,997 | )          |
| Cumulative translation adjustment                                                                                                                |       | (150,410    | )          | (83,135    | )          |
| Total stockholders’ deficit                                                                                                                 |       | (2,733,840  | )          | (2,244,097 | )          |
| Total liabilities and stockholders’ deficit                                                                                                 |       | $           | 4,763,057  |       | $          | 2,285,703 |   |

 

See accompanying notes toaudited consolidated financial statements.

 

34

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**VISTULACOMMUNICATIONS SERVICES, INC.**

**Consolidated Statements of Operations**

**Yearsended December 31, 2005 and 2004**

 
| ** **                                             | ** ** | **2005**    | ** **  | **2004**   | ** ** |
|--------------------------------------------------------|------------|-------------|-------------|------------|------------|
| Net revenues                                           |       | $           | 840,457     |       | $          | 2,335,408 |   |
| Cost of revenues                                       |       | 1,008,227   |        | 2,140,837  |       |
| Gross (loss) profit                                    |       | (167,770    | )           | 194,571    |       |
| Selling, general and administrative  expenses          |       | 10,770,524  |        | 3,869,059  |       |
| Loss from operations                                   |       | (10,938,294 | )           | (3,674,488 | )          |
| Interest expense, net                                  |       | (1,243,708  | )           | (120,788   | )          |
| Net loss                                               |       | $           | (12,182,002 | )          | $          | (3,795,276 | ) |
| Weighted-average basic and diluted shares  outstanding |       | 26,822,678  |        | 24,233,420 |       |
| Net loss per common share basic and diluted            |       | $           | (0.45       | )          | $          | (0.16 | ) |

 

See accompanying notes toaudited consolidated financial statements.

 

35

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**VISTULACOMMUNICATIONS SERVICES, INC.**

**Consolidated Statements of Stockholders’ Deficit**

** **
| ** **                                                                 | ** ** | ** **            | ** ** | ** **  | ** ** | **Additional** | ** ** | ** **       | ** ** | ** **      | ** ** | **Cumulative**         | ** ** | **Total**         | ** ** | ** **  | ** ** |
|----------------------------------------------------------------------------|------------|-----------------------|------------|-------------|------------|----------------|------------|------------------|------------|-----------------|------------|------------------------|------------|-------------------|------------|-------------|------------|
| ** **                                                                 | ** ** | **Common Stock** | ** ** | **Paid-In** | ** ** | **Deferred**   | ** ** | **Accumulated**  | ** ** | **Translation** | ** ** | **Stockholders’** | ** ** | **Comprehensive** | ** ** |
| ** **                                                                 | ** ** | **Shares**            | ** ** | **Amount**  | ** ** | **Capital**    | ** ** | **Compensation** | ** ** | **Deficit**     | ** ** | **Adjustment**         | ** ** | **Deficit**       | ** ** | **Loss**    | ** ** |
| Balance, January  1, 2004                                                  |       | 23,885,000            |       | $           | 23,885     |           | $          | 398,276          |       | —          |       | $                      | (599,721   | )                 | $          | (15,969     | )          | $ | (193,529 | ) |   |   |
| Contribution of  services by stockholders                                  |       | —                |       | —      |       | 262,141        |       | —           |       | —          |       | —                 |       | 262,141           |       |        |       |
| Issuance of  common stock                                                  |       | 100,000               |       | 100         |       | 44,900         |       | $                | (40,000    | )               | —     |                   | —     |              | 5,000      |        |       |   |
| Issuance of  common stock pursuant to marketing and distribution agreement |       | 50,000                |       | 50          |       | 22,450         |       | —           |       | —          |       | —                 |       | 22,500            |       |        |       |
| Issuance of  common stock for services rendered                            |       | 419,406               |       | 419         |       | 188,314        |       | —           |       | —          |       | —                 |       | 188,733           |       |        |       |
| Issuance of stock  options                                                 |       | —                |       | —      |       | 1,692,500      |       | (1,692,500       | )          | —          |       | —                 |       | —            |       |        |       |
| Amortization of  deferred compensation                                     |       | —                |       | —      |       | —         |       | 1,333,500        |       | —          |       | —                 |       | 1,333,500         |       |        |       |
| Net loss                                                                   |       | —                |       | —      |       | —         |       |             |       | (3,795,276      | )          | —                 |       | (3,795,276        | )          | $           | (3,795,276 | ) |
| Change in  cumulative translation adjustment                               |       | —                |       | —      |       | —         |       | —           |       | —          |       | (67,166                | )          | (67,166           | )          | (67,166     | )          |
| Balance, December  31, 2004                                                |       | 24,454,406            |       | 24,454      |       | 2,608,581      |       | (399,000         | )          | (4,394,997      | )          | (83,135                | )          | (2,244,097        | )          | (3,862,442  | )          |
|                                                                       |       |                  |       |        |       |           |       |             |       |            |       |                   |       |              |       |        |       |
| Issuance of common  stock                                                  |       | 910,000               |       | 910         |       | 574,464        |       | —           |       | —          |       | —                 |       | 575,374           |       |        |       |
| Issuance of stock  options                                                 |       | —                |       | —      |       | 1,814,840      |       | (1,814,840       | )          | —          |       | —                 |       | —            |       |        |       |
| Amortization of  deferred stock compensation                               |       | —                |       | —      |       | —         |       | 2,200,418        |       | —          |       | —                 |       | 2,200,418         |       |        |       |
| Issuance of  warrants with convertible debentures                          |       | —                |       | —      |       | 1,780,844      |       | —           |       | —          |       | —                 |       | 1,780,844         |       |        |       |
| Issuance of  warrant pursuant to consulting agreement                      |       | —                |       | —      |       | 29,913         |       | —           |       | —          |       | —                 |       | 29,913            |       |        |       |
| Issuance of  common stock pursuant to debenture conversions                |       | 2,799,993             |       | 2,800       |       | 1,530,292      |       | —           |       | —          |       | —                 |       | 1,533,092         |       |        |       |
| Issuance of  common stock pursuant to warrant exercises                    |       | 3,190,499             |       | 3,190       |       | 3,027,784      |       | —           |       | —          |       | —                 |       | 3,030,974         |       |        |       |
| Issuance of  warrants pursuant to inducement of warrant exercises          |       | —                |       | —      |       | 1,200,199      |       | —           |       | —          |       | —                 |       | 1,200,199         |       |        |       |
| Issuance of  common stock pursuant to marketing and distribution agreement |       | 500,000               |       | 500         |       | 999,500        |       | —           |       | —          |       | —                 |       | 1,000,000         |       |        |       |
| Exercise of stock  options                                                 |       | 60,000                |       | 60          |       | 2,940          |       | —           |       | —          |       | —                 |       | 3,000             |       |        |       |
| Compensation  expense associated with options issued to non-employees      |       | —                |       | —      |       | 405,720        |       | —           |       | —          |       | —                 |       | 405,720           |       |        |       |
| Net loss                                                                   |       | —                |       | —      |       | —         |       | —           |       | (12,182,002     | )          | —                 |       | (12,182,002       | )          | (12,182,002 | )          |
| Change in  cumulative translation adjustment                               |       | —                |       | —      |       | —         |       | —           |       | —          |       | (67,275                | )          | (67,275           | )          | (67,275     | )          |
| Balance, December  31, 2005                                                |       | 31,914,898            |       | $           | 31,914     |           | $          | 13,975,077       |       | $               | (13,422    | )                      | $          | (16,576,999       | )          | $           | (150,410   | ) | $ | (2,733,840 | ) | $ | (12,249,277 | ) |

 

See accompanying notes toaudited consolidated financial statements.

 

36

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**VISTULA COMMUNICATIONSSERVICES, INC.**

**Consolidated Statements of Cash Flows**

**Yearsended December 31, 2005 and 2004**

 
| ** **                                                                                               | ** ** | **2005**   | ** **  | **2004**  | ** ** |
|----------------------------------------------------------------------------------------------------------|------------|------------|-------------|-----------|------------|
| Cash flows from operating activities:                                                                    |       |       |        |      |       |
| Net loss                                                                                                 |       | $          | (12,182,002 | )         | $          | (3,795,276 | ) |
| Adjustments to reconcile net loss to net  cash used in operating activities:                             |       |       |        |      |       |
| Depreciation                                                                                             |       | 220,133    |        | 43,460    |       |
| Issuance of common stock pursuant to  marketing and distribution agreement                               |       | 1,000,000  |        | 22,500    |       |
| Non-cash compensation expense                                                                            |       | 2,659,944  |        | 1,333,500 |       |
| Non-cash interest expense                                                                                |       | 672,223    |        | 115,334   |       |
| Non-cash expense on warrant inducement                                                                   |       | 1,200,199  |        | —    |       |
| Issuance of warrant pursuant to consulting  agreement                                                    |       | 29,913     |        | —    |       |
| Loss on disposal of property and equipment                                                               |       | —     |        | 43,300    |       |
| Contribution of services by stockholder                                                                  |       | —     |        | 82,500    |       |
| Payment of Company expenses by stockholders  recorded as a capital contribution                          |       | —     |        | 179,642   |       |
| Company expenses paid by stockholder  recorded as due to stockholder                                     |       | —     |        | 792,413   |       |
| Issuance of common stock for services  rendered                                                          |       | —     |        | 188,733   |       |
| Changes in assets and liabilities:                                                                       |       |       |        |      |       |
| (Increase) decrease in:                                                                                  |       |       |        |      |       |
| Accounts receivable                                                                                      |       | (74,757    | )           | 188,222   |       |
| Prepaid expenses and other current assets                                                                |       | (752,503   | )           | (58,858   | )          |
| Increase (decrease) in:                                                                                  |       |       |        |      |       |
| Accounts payable                                                                                         |       | (138,819   | )           | (130,759  | )          |
| Accrued expenses                                                                                         |       | (416,189   | )           | 931,026   |       |
| Net cash used in operating activities                                                                    |       | (7,781,858 | )           | (64,263   | )          |
| Cash flows from investing activities:                                                                    |       |       |        |      |       |
| Purchases of property and equipment                                                                      |       | (725,031   | )           | (68,459   | )          |
| Net cash used in investing activities                                                                    |       | (725,031   | )           | (68,459   | )          |
| Cash flows  from financing activities:                                                                   |       |       |        |      |       |
| Proceeds from exercise of stock options                                                                  |       | 3,000      |        | 5,000     |       |
| Proceeds from notes payable                                                                              |       | —     |        | 175,000   |       |
| Payment of notes payable                                                                                 |       | (100,000   | )           |      |       |
| Payments on due to stockholder                                                                           |       | (801,630   | )           | (55,385   | )          |
| Proceeds from issuance of convertible  debentures                                                        |       | 7,452,873  |        | —    |       |
| Proceeds from warrant exercises                                                                          |       | 3,030,974  |        | —    |       |
| Payment of capital lease obligation                                                                      |       | (476,293   | )           | —    |       |
| Net cash provided by financing activities                                                                |       | 9,108,924  |        | 124,615   |       |
| Effect of exchange rates on cash                                                                         |       | (52,129    | )           | (77,316   | )          |
| Net increase (decrease) in cash and cash  equivalents                                                    |       | 549,906    |        | (85,423   | )          |
| Cash and cash equivalents, beginning of  period                                                          |       | 3,221      |        | 88,644    |       |
| Cash and cash equivalents, end of period                                                                 |       | $          | 553,127     |      | $          | 3,221 |   |
|                                                                                                     |       |       |        |      |       |
| **Supplemental disclosure of cash flow  information:**                                                   |       |       |        |      |       |
| Cash paid for interest                                                                                   |       | $          | 577,083     |      | —     |   |
| Cash paid for taxes                                                                                      |       | $          | 16,894      |      | —     |   |
| Equipment acquired pursuant to capital  lease obligation                                                 |       | —     |        | $         | 1,855,835  |   |
| Issuance of common stock pursuant to  purchase of assets under capital lease obligation                  |       | $          | 324,874     |      | —     |   |
| Issuance of common stock pursuant to  purchase of assets                                                 |       | $          | 75,000      |      | —     |   |
| Issuance of common stock pursuant to  consulting agreement                                               |       | $          | 130,000     |      | —     |   |
| Issuance of common stock pursuant to  employment agreement                                               |       | $          | 45,500      |      | —     |   |
| Issuance of note payable pursuant to  purchase of assets under capital lease obligation                  |       | $          | 970,000     |      | —     |   |
| Issuance of common stock pursuant to  debenture conversions                                              |       | $          | 1,533,092   |      | —     |   |
| Issuance of common stock warrants in  connection with convertible debenture financing                    |       | $          | 184,844     |      | —     |   |
| Reduction in fixed assets and related  indebtedness pursuant to modification of asset purchase agreement |       | $          | 200,000     |      | —     |   |

 

See accompanying notes toaudited consolidated financial statements.

 

37

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**VistulaCommunications Services, Inc.**

**Notes to Consolidated Financial Statements**

 

**1. NATURE OF ORGANIZATION**

 

VCS, Inc. was incorporated onSeptember 22, 2003 for the purpose of merging with two entities undercommon control, Vistula Limited (Vistula) and Cardlink Services Limited(Cardlink). VCS, Inc. changed its name to Vistula CommunicationsServices, Inc. on March 4, 2004; hereafter, Vistula CommunicationsServices, Inc. and its wholly-owned subsidiaries, as defined, are collectivelyreferred to as “the Company.”

 

Vistula is a provider of telephone andinternet call services throughout the world. Cardlink plans to be a provider ofprepayment processing software to mobile network operators.

 

Pursuant to the stock purchase agreementdated March 2, 2004, the Company exchanged 21,885,000 shares of commonstock for the 21,885 outstanding shares of Cardlink, and 2,000,000 shares ofcommon stock for the 1 outstanding share of Vistula. Prior to the shareexchange, Cardlink was owned by a single control group, consisting of theChairman of the Company’s Board of Directors (the Chairman), along with membersof his immediate family (who with the Chairman collectively owned a majority ofCardlink) and other shareholders bound by contract to act in concert with theChairman with regards to the share exchange. Since its inception inAugust 2002, Vistula was owned entirely by an entity controlled by theChairman and his immediate family.

 

The Chairman and his immediate familyacquired 98% of Cardlink from Metromedia InternationalTelecommunications Inc. (MITI) on April 3, 2003 for $160. At the timeof the acquisition and through the date of the share exchange with the Company,Cardlink was a dormant shell company, with only nominal assets and no operations.In June 2003, the Chairman and his immediate family distributed shares ofCardlink common stock to certain individuals and consultants. The distributionwas designed to provide the individuals and consultants a specific percentagein the Company on a post-share exchange basis. As a condition of the stockgrants, these shareholders contractually agreed to act in concert with theChairman and his immediate family with respect to the share exchange with theCompany. As a result, substantially all shares of both Cardlink and Vistulawere controlled by the Chairman and his immediate family. Accordingly, theshare exchange was accounted for as a reorganization of entities under commoncontrol. Pursuant to this accounting method, the accounts of the Company havebeen combined with those of Cardlink since April 3, 2003 and Vistula forall periods presented as if the entities were historically organized in amanner consistent with the share exchange. The assets and liabilities ofCardlink and Vistula are recorded at historical cost and the Company’s equityaccounts reflect the historical equity accounts of Cardlink and Vistula, aswell as the par value of the Company shares issued in the share exchange.

 

Since its inception, the Company hassustained its operations through funding provided by the Chairman, contributedservices by the Chairman and other stockholders, and debt and equityfinancings. The Chairman has made various advances to the Company from a$3,000,000 credit facility established in the name of the Chairman, as well asfrom other of the Chairman’s personal assets. The credit facility wasestablished by the Chairman in February 2003 and was first drawn upon bythe Chairman in May 2003. Under the credit facility, the lender may issuestandby letters of credit for the benefit of third parties at the request ofthe Chairman. The obligations of the Chairman under the credit facility aresecured by certain property in which the Chairman has a beneficial interest. Asof December 31, 2005, the Chairman has drawn approximately $2,385,000under this facility, of which approximately $262,000 was used to pay expensesincurred and accrued by the Company. Two letters of credit in the aggregateamount of $28,033 have been issued by the lender under the credit facility infavor of vendors to the Company at the request of the Chairman. As ofDecember 31, 2005, approximately $615,000 was undrawn and available underthe credit facility. The Company may obtain future advances from the Chairmanfrom both the credit facility and the Chairman’s other personal assets in orderto meet certain working capital needs. The Chairman may also cause the lenderunder the credit facility to issue standby letters of credit in favor of one ormore of the Company’s vendors to secure the Company’s obligations to suchvendor or vendors. While the Chairman is not obligated to provide theseadvances to the Company or to cause the lender to issue standby letters ofcredit in favor of the Company’s vendors, the Company expects the Chairman tocontinue providing funds for operations in 2006 as and if needed until suchtime that operations are self-sustaining or the Company raises additionalexternal capital, as the case may be. See Note 14 for a description offunding that the Company has received subsequent to December 31, 2005.

 

The Company is subject to risks common torapid growth technology-based companies, including a limited operating history,dependence on key personnel, the need to raise capital, rapid technologicalchange, competition from substitute products and larger companies, and the needfor the successful development and marketing of commercial products andservices.

 

The accompanying consolidated financialstatements have been prepared on a going concern basis which contemplates therealization of assets and the satisfaction of liabilities in the normal courseof business. As shown in the accompanying consolidated

 

38

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financial statements, theCompany incurred a net loss of $12,182,002 for the year ended December 31, 2005and had an accumulated deficit of $16,576,999 at December 31, 2005. Further,the Company had cash of $553,127 and a working capital deficit at December 31,2005 of $342,325. These factors among others may indicate that the Company willbe unable to continue as a going concern.

 

The consolidated financial statements do notinclude any adjustments relating to the recoverability of assets andsatisfaction of liabilities that might be necessary should the Company be unableto continue as a going concern. The Company has engaged financial advisors toassist in the raising of additional debt or equity capital. The Company hasalso engaged in discussions with certain debt holders to restructure paymentterms until additional debt or equity financing is obtained. The Company’scontinuation as a going concern is dependent upon its ability to generatesufficient cash flow to meet its obligations on a timely basis, to comply withthe terms of its financing arrangements, to obtain additional financing as maybe required, and ultimately to attain profitability.

 

**2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**

 

*Basis of Presentation*

 

The accompanying consolidated financialstatements include the accounts of the Company and its wholly-ownedsubsidiaries and have been prepared in accordance with accounting principlesgenerally accepted in the United States (GAAP). All significant intercompanyaccounts and transactions have been eliminated in consolidation.

 

*Use of Estimates*

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities as of the date of the financial statementsand the reported amounts of revenues and expenses during the reporting periods.Actual results could differ from those estimates.

 

*Foreign Currency*

 

The Company uses the United States dollar asits reporting currency; the British pound is the functional currency of two ofits wholly-owned subsidiaries. Assets and liabilities of the Company’sinternational operations are translated into U.S. dollars at exchange ratesthat are in effect on the balance sheet date and equity accounts are translatedat historical exchange rates. Income and expense items are translated ataverage exchange rates which are in effect during the year. Translationadjustments are accumulated in other comprehensive loss as a separate componentof stockholders’ deficit in the consolidated balance sheet. Transaction gains(losses) were immaterial for the years ended December 31, 2005 and 2004.

 

*Cash and Cash Equivalents*

 

The Company considers all highly liquidinvestments with original maturities of 90 days or less to be cash equivalents.

 

*Accounts Receivable*

 

Accounts receivable are stated at the amountmanagement expects to collect from outstanding balances. An allowance fordoubtful accounts is provided for those accounts receivable considered to beuncollectible based upon historical experience and management’s evaluation ofoutstanding accounts receivable at the end of the year. Bad debts are writtenoff against the allowance when identified. At December 31, 2005 and 2004the Company did not record an allowance for doubtful accounts, nor have therebeen any write-offs since inception.

 

*Property and Equipment*

 

Property and equipment is stated at cost.Additions and improvements are capitalized, and ordinary repairs andmaintenance are charged to expense as incurred.

 

The Company provides for depreciation expenseusing the straight-line method over the estimated useful lives of the assets asfollows:

 

39

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| **Asset Classification** | ** ** | **Estimated Useful********Life** |
|-------------------------------|------------|---------------------------------------|
| Telecommunications equipment  |       | 3-5 years                             |

 

*Deferred Financing Costs*

 

Deferred financing costs are amortized overthe term of the convertible debentures.

 

*Revenue Recognition*

 

The Company’s revenue is derived primarilyfrom fees charged to terminate voice services over the Company’s network. TheCompany recognizes such revenue, net of reserves, when persuasive evidence of asales arrangement exists, delivery has occurred or services have been rendered,the sales price is fixed and determinable and collectibility is reasonablyassured. The Company reserves for potential billing disputes at the timerevenue is recognized or the dispute is known. Such disputes can result fromdisagreements with customers regarding the duration, destination or ratescharged for each call. These revenue allowances are based on estimates derivedfrom factors that include, but are not limited to, historical results, analysisof credits issued, current economic trends and changes in demand. Amountsbilled in advance of the service month are recorded as deferred revenue andrecognized as revenue as the underlying services are rendered.

 

Reciprocal compensation is the amount paid byone carrier to complete particular calls on another local exchange carrier’snetwork. Reciprocal compensation paid to and received from other carriers isbased on contractual fixed rate per minute charges. The Company has onereciprocal compensation agreement whereby the Company and the counterparty buyand sell call termination services to each other with periodic net cashsettlements. The Company applies the receipt of reciprocal compensation againstthe cost of reciprocal compensation and reflects the net amount as eitherrevenue (receipts greater than costs) or expense (costs greater than receipts)at each settlement date.

 

The Company has entered into transactionssuch as buying, selling, swapping or exchanging capacity to complete andcomplement its network. In general, these transactions represent the exchangeof productive assets not held for sale in the ordinary course of business and, assuch, do not result in the culmination of the earnings process. Accordingly,the Company does not recognize any revenue for these types of transactions. TheCompany accounts for the exchange of a non-monetary asset based on the recordedamount of the non-monetary asset relinquished with no gain or loss recognizedin accordance with Accounting Principles Board (APB) Opinion No. 29, *Accounting for Non-Monetary Transactions*.

 

*Stock-Based Compensation*

 

The Company has elected to account for itsstock-based compensation plans under the intrinsic value method pursuant to APBNo. 25, *Accounting for Stock Issued toEmployees* (APB 25), and related Interpretations, rather than thealternative fair value accounting provided under Statement of FinancialAccounting Standards (SFAS) No. 123, *Accounting for Stock-BasedCompensation (SFAS 123)*.

 

In accordance with SFAS 123 and EmergingIssues Task Force (EITF) Issue No. 96-18, *Accountingfor Equity Instruments that are Issued to Other than Employees for Acquiring,or in Connection with Selling, Goods or Services*, the Companyrecords compensation expense equal to the fair value of the option granted tonon-employees over the vesting period, with periodic remeasurement of fairvalue when applicable, which is generally the period of service. SeeNote 6 for options accounted for in accordance with EITF No. 96-18.

 

SFAS 123, as amended by SFAS No. 148, *Accounting for Stock-Based Compensation*,requires pro forma information regarding net loss and net loss per share as ifthe Company had accounted for its stock-based awards to employees under thefair value method of SFAS 123. The fair value of the Company’s stock optionsused to compute pro forma net loss is the estimated fair value at the grantdate using the Black-Scholes option-pricing model with the following weighted-averageassumptions:

 
| ** **              | ** ** | **2005** | ** ** | **2004** | ** ** |
|-------------------------|------------|----------|------------|----------|------------|
| Risk-free interest rate |       | 4.09     | %          | 3.55     | %          |
| Expected volatility     |       | 80       | %          | 80       | %          |
| Expected lives          |       | 5 years  |       | 5 years  |       |
| Expected dividend       |       | —   |       | —   |       |

 

The per-share, weighted-average grant datefair value of options granted during the years ended December 31, 2005 and2004 was $1.31 and $0.39, respectively.

 

40

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For purposes of pro forma disclosures, theestimated fair value of the stock-based compensation is amortized over thevesting period of the award. Had compensation expense for the Company’s stock-basedcompensation plan been determined based on the fair value at the grant datesfor awards under that plan consistent with the method of SFAS 123, theCompany’s net loss and net loss per share for the years ended December 31,2005 and 2004 would have been as follows:

 
| ** **                                                                    | ** ** | **Year ended December 31,** | ** **  |
|-------------------------------------------------------------------------------|------------|--------------------------------------------|-------------|
| ** **                                                                    | ** ** | **2005**                                   | ** **  | **2004** | ** ** |
|                                                                          |       |                                       |        |   |   |
| Net loss as reported                                                          |       | $                                          | (12,182,002 | ) | $ | (3,795,276 | ) |
| Stock compensation expense included in net  loss                              |       | 2,200,418                                  |        | 1,333,500 |   |
| Stock compensation expense determined using  fair value method for all awards |       | (2,817,773                                 | )           | (1,445,736 | ) |
| Pro forma net loss                                                            |       | $                                          | (12,799,357 | ) | $ | (3,907,512 | ) |
|                                                                          |       |                                       |        |   |   |
| Loss per share (basic and diluted) as reported                                |       | $                                          | (0.45       | ) | $ | (0.16 | ) |
| Pro forma loss per share (basic and  diluted)                                 |       | $                                          | (0.48       | ) | $ | (0.16 | ) |

 

In December 2004, the Financial Accounting StandardsBoard issued SFAS No. 123(R), *Share-BasedPayment*,**(“SFAS 123R”), which is effectivefor public entities that file as small business issuers as of the beginning ofthe first interim or annual reporting period that begins after December 15,2005. SFAS 123R requires a public entity to measure the cost of employeeservices received in exchange for an award of equity instruments based on thegrant-date fair value of the award. That cost will be recognized over theperiod during which an employee is required to provide service in exchange forthe award, the requisite service period (usually the vesting period). No compensationcost is recognized for equity instruments for which employees do not render therequisite service.

 

The Company will be required to apply SFAS 123R duringthe quarter ending March 31, 2006. SFAS 123R allows two methods foraccounting for the effects of the transition: the modified prospectivetransition method and the modified retrospective method of transition. TheCompany has determined that it will implement SFAS 123R using the modifiedprospective method. Under the modified prospective transition method, theCompany will use the fair value-based accounting method for all employee awardsgranted, modified, or settled after the effective date. As of the effectivedate, compensation cost related to the nonvested portion of awards outstanding asof that date will be based on the grant-date fair value of those awards ascalculated under the original provisions of SFAS 123. The Company will notremeasure the grant-date fair value estimate of the unvested portion of awardsgranted prior to the effective date.

 

Stock or other equity-based compensation fornon-employees is accounted for under the fair-value method as required by SFAS123 and EITF No. 96-18,. Under this method, the equity-based instrument isvalued at either the fair value of the consideration received or the equityinstrument issued on the date of vesting. The resulting compensation cost isrecognized and charged to operations over the service period. The measurementdate is generally the issuance date for employees and the vesting date forconsultants. The resulting non-cash expense is being recorded in the statementsof operations over the vesting period of the stock option.

 

*Income Taxes*

 

The Company accounts for income taxes inaccordance with SFAS 109, *Accounting forIncome Taxes.* Under SFAS 109, deferred tax assets or liabilities arecomputed based on the difference between the financial statements and incometax basis of assets and liabilities, and net operating loss carryforwards,using the enacted tax rates. Deferred income tax expense or benefit is based onchanges in the asset or liability from period to period.

 

*Earnings (Loss) Per Share*

 

Basic earnings (loss) per share is computedby dividing income (loss) available to common stockholders by the weightedaverage number of common shares outstanding during the year. Diluted earningsper share is computed by dividing income available to common stockholders bythe weighted average number of common shares outstanding during the year plusthe number of additional common shares that would have been outstanding if thepotentially dilutive common shares had been issued. Dilutive securities includestock options, convertible debt and warrants. The Company’s outstanding stockoptions, convertible debentures and warrants are not included in thecalculation of loss per share because their inclusion would be antidilutive.

 

41

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*Concentration of Credit Risk and SignificantCustomers*

 

The Company maintains its cash in bankdeposit accounts, which at times, may exceed federally insured limits. TheCompany has not experienced any losses in such accounts. The Company believesit is not exposed to any significant credit risk on cash. The Company has notexperienced significant losses related to accounts receivable of individualcustomers or groups of customers in any particular industry or geographic area.At December 31, 2005 and 2004, the percentages of revenue and accountsreceivable attributable to the Company’s significant customers were as follows:

 
| **2005****Customer** | ** ** | **Revenue** | ** ** | **Accounts  Receivable** | ** ** |
|----------------------|------------|-------------|------------|--------------------------|------------|
| A                    |       | 68          | %          | 43                       | %          |
| B                    |       | 12          |       |                     | *          |
| C                    |       |        | *          | 24                       |       |
| D                    |       |        | *          |                     | *          |
| E                    |       |        | *          |                     | *          |
| F                    |       |        | *          | 15                       |       |

 
| **2004****Customer** | ** ** | **Revenue** | ** ** | **Accounts  Receivable** | ** ** |
|----------------------|------------|-------------|------------|--------------------------|------------|
| A                    |       | 26          | %          |                     | *          |
| B                    |       | 24          |       | 47                       | %          |
| C                    |       | 16          |       | 12                       |       |
| D                    |       | 12          |       |                     | *          |
| E                    |       |        | *          | 15                       |       |
| F                    |       |        | *          | 13                       |       |

 

----

*              Customer representsless than 10% of total.

 

42

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*Comprehensive Income (Loss)*

 

The Company reports its comprehensive income(loss) in accordance with SFAS 130, *ReportingComprehensive Income*, which requires presentation of the componentsof comprehensive earnings. Comprehensive income (loss) is defined as the changein equity of a business enterprise during a period from transactions and otherevents and circumstances from non-owner sources. Comprehensive income (loss) consistsof cumulative translation adjustment and net loss for the years endedDecember 31, 2005 and 2004.

 

*Fair Value of Financial Instruments*

 

The carrying value of the Company’s financialinstruments, which include cash, receivables and convertible debt, approximatefair value due to the short maturities of those instruments.

 

*Long-Lived Assets*

 

Property and equipment and other long-livedassets are reviewed for impairment whenever events or changes in circumstancesindicate that the carrying amount may not be recoverable. All impairments arerecognized in operating results when a permanent reduction in value occurs.

 

*Research and Development*

 

Research and development costs are charged toexpense as incurred.

 

*Advertising Expense*

 

Advertising costs are charged to expense asincurred.

 

*Recently Issued Accounting Standards*

 

In May 2005, the Financial Accounting Standards Board issued SFASNo. 154, *Reporting Accounting Changes inInterim Financial Statements*(“SFAS154”)*,*which replaces APBOpinion No. 20, *Accounting Changes,*andSFAS No. 3, *Reporting AccountingChanges in Interim Financial Statements*, and changes therequirements for the accounting for and reporting of a change in accountingprinciple. SFAS 154 applies to all voluntary changes in accounting principle.It also applies to changes required by an accounting pronouncement in theunusual instance that the pronouncement does not include specific transitionprovisions. When a pronouncement includes specific transition provisions, thoseprovisions should be followed. SFAS 154 was effective for the Company beginningJanuary 1, 2006 and is not expected to have a material impact on theCompany’s financial position or results of operations.

 

On December 16, 2004, the Financial AccountingStandards Board issued SFAS 123(R), *Share-BasedPayment*, which is a revision of SFAS 123 (SFAS 123R). SFAS 123Rsupersedes APB 25**and amends SFAS No. 95, *Statement of Cash Flows*. Generally, theapproach in SFAS 123R is similar to the approach described in SFAS 123,detailed below. However, SFAS 123R requires all share-based payments toemployees, including grants of employee stock options, to be recognized in thestatement of operations based on their fair values at the date of grant. Proforma disclosure is no longer an alternative. SFAS 123R is effective for publicentities that file as small business issuers as of the beginning or the firstinterim or annual reporting period that begins after December 15, 2005. Earlyadoption is permitted in periods in which financial statements have not yetbeen issued. We adopted SFAS 123R on January 1, 2006, the commencement ofour first quarter of fiscal 2006.

 

The Company will apply SFAS 123R using the “modifiedprospective” method. Under this transition method, compensation cost is recognizedon or after the required effective date for the portion of outstanding awardsfor which the requisite service has not yet been rendered, based on thegrant-date fair value of those awards calculated under SFAS 123 for eitherrecognition or pro forma disclosures.

 

Aspermitted by SFAS 123, we currently account for share-based payments toemployees using APB 25’s intrinsic value method and, as such, generallyrecognize no compensation cost for employee stock options issued with anexercise price greater than or equal to the fair value of the underlying stockon the grant date. Accordingly, the adoption of SFAS 123R’s fair-value methodmay have a significant impact on our reported results of operations. Managementis still evaluating the impact of the adoption of SFAS 123R.

 

43

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*Reclassifications*

 

Certain reclassifications have been made tothe 2004 financial statements to conform with the 2005 presentation.

 

**3. PROPERTY AND EQUIPMENT**

 

Property and equipment consists of thefollowing:

 
| ** **                         | ** ** | **December 31,** | ** ** |
|------------------------------------|------------|-----------------------|------------|
| ** **                         | ** ** | **2005**              | ** ** | **2004** | ** ** |
| Telecommunications equipment       |       | $                     | 2,646,212  |   | $ | 2,068,946 |   |
| Less—accumulated depreciation |       | 283,839               |       | 71,325 |   |
|                               |       | $                     | 2,362,373  |   | $ | 1,997,621 |   |

 

Depreciation expense was $220,133 and $43,460for the years ended December 31, 2005 and 2004, respectively.

 

**4. ASSET PURCHASE**

 

*Asset Purchase*

 

In January 2004, the Company signed anagreement to purchase certain equipment from another entity in exchange for$2,000,000, less any fees, costs and expenses incurred by the Company tore-certify or re-license such assets by June 30, 2004. The Company agreedto lease the equipment until it completed the purchase. The agreement wasamended on May 5, 2004. As a result of the amendment, the purchase pricefor the equipment was $1,670,000 and 725,000 shares of common stock and theagreement was extended through April 1, 2005. The agreement was furtheramended on March 15, 2005, at which time the Company completed thepurchase. In consideration for the equipment purchased, the Company paid$500,000 in March 2005, issued 725,000 shares of common stock, and issueda promissory note for $1,170,000. The note was subsequently adjusted on May 16,2005 to reduce the principal amount to $970,000, reflective of unanticipatedrecertification costs. Under the terms of the promissory note, interestaccrues daily at a rate of 8.25% per annum and is payable monthly in arrears. Aninitial principal payment of $100,000 was paid in 2005. An additional principalpayment of $100,000 that was due on December 31, 2005 was extended to and paidon March 31, 2006. The remaining principal amount ($770,000) and any unpaidinterest originally payable on the first anniversary of the closing of thepurchase, March 15, 2006, has been extended to April 28, 2006.

 

The Company accounted for this arrangement asa capital lease in accordance with SFAS 13 *Accountingfor Leases* up to March 15,2005, the date at which the Company completed the purchase.

 

The Company recorded the present value of theminimum lease payments as an asset of $1,855,835. The future minimum leasepayments related to the capital lease was $2,000,000, which included $144,165related to interest. The Company recorded $23,707 related to interest expenseon the capital lease for the year ended December 31, 2005. The Companydoes not have any minimum sublease rental income related to the capital lease.There were no contingent rentals during the year ended December 31, 2005.The equipment was placed in service in August 2005.

 

The Company has deemed the May 5, 2004amendment described above to be a modification of the lease pursuant toSFAS 13. As of May 5, 2004, the balance of the asset and associatedcapital lease obligation were adjusted by an amount equal to the difference betweenthe present value of the future minimum lease payments under the modifiedagreement and the present balance of the obligation, with no resulting gain orloss recognized. Under certain circumstances, the cash portion of theobligation was convertible into the Company’s common stock, at the lessor’soption. The Company accounted for the conversion feature associated with thecapital lease obligation included in the May 2004 amendment pursuant toEITF Issue No. 98-5, *Accounting forConvertible Securities with Beneficial Conversion Features or ContingentlyAdjustable Conversion Ratios,* as amended by EITF IssueNo. 00-27, *Application of IssueNo. 98-5 to Certain Convertible Instruments*, whereby theCompany measured the beneficial conversion feature on the amendment date, butdid not record any charge until the contingencies were resolved. Uponcompletion of the purchase in March 2005, the conversion feature expired,therefore no charge was recorded. The promissory note does not include aconversion feature.

 

**5. BALANCE SHEET DETAIL**

 

Prepaid expenses and other current assetsconsisted of the following at December 31, 2005 and 2004:

 

44

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| ** **                       | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------------------|------------|----------|------------|----------|------------|
| Prepaid royalties                |       | $        | 399,899    |     | $          | 150,000 |   |
| Non-trade receivables            |       | 164,472  |       | —   |       |
| Professional services            |       | 121,694  |       |     |       |
| Software                         |       | 77,436   |       | —   |       |
| Value added tax                  |       | 77,043   |       | —   |       |
| Rent                             |       | 62,736   |       | —   |       |
| Insurance                        |       | 44,610   |       | —   |       |
| Prepaid call termination charges |       | 44,446   |       | 28,756   |       |
| Maintenance agreement            |       | 40,370   |       | —   |       |
| Equipment rent                   |       | —   |       | 41,707   |       |
| Other                            |       | 13,089   |       | 8,407    |       |
|                             |       | $        | 1,045,795  |     | $          | 228,870 |   |

 

Other assets consisted of the following atDecember 31, 2005 and 2004:

 
| ** **               | ** ** | **2005** | ** ** | **2004** | ** ** |
|--------------------------|------------|----------|------------|----------|------------|
| Rent                     |       | $        | 29,522     |     | $          | — |   |
| Call termination charges |       | 21,145   |       | —   |       |
| Legal deposit            |       | 4,540    |       | —   |       |
| Other                    |       | 2,065    |       | —   |       |
|                     |       | $        | 57,272     |     | $          | — |   |

 

Accrued expenses consisted of the followingat December 31, 2005 and 2004:

 
| ** **           | ** ** | **2005** | ** ** | **2004** | ** ** |
|----------------------|------------|----------|------------|----------|------------|
| Professional fees    |       | $        | 313,897    |     | $          | 573,323 |   |
| Salary               |       | 141,983  |       | 167,500  |       |
| Termination costs    |       | 60,924   |       | —   |       |
| Travel               |       | 33,415   |       | 107,767  |       |
| Directors’ fees |       | 20,200   |       | 59,346   |       |
| Interest             |       | 17,693   |       | —   |       |
| Printing             |       | 14,655   |       | 50,764   |       |
| Rent                 |       | 8,514    |       | 25,848   |       |
| VAT payable          |       | —   |       | 47,024   |       |
| Other                |       | 16,873   |       | 12,771   |       |
|                 |       | $        | 628,154    |     | $          | 1,044,343 |   |

 

**6. EQUITY**

 

Stock Incentive Plan

 

In February 2004 the board of directorsadopted the 2004 Stock Incentive Plan (the “Plan”). Under the Plan, the Companymay grant incentive stock options, non-statutory stock options and restrictedstock which aggregate 6,000,000 shares of the Company’s common stock. The Planwas amended by the Board, on June 3, 2005 to, among other things, increasethe number of shares available for options or restricted stock grants from6,000,000 to 8,000,000. The shareholders of the Company approved the amendmentto the Plan on July 14, 2005. The Board has the authority to select theemployees, officers, directors, consultants and advisors to whom options aregranted and determine the terms of each option, including (i) the numberof shares of common stock subject to the option, (ii) when the optionbecomes exercisable, (iii) the option exercise price, which, in the caseof incentive stock options, must be at least 100% (110% in the case ofincentive stock options granted to a stockholder owning in excess of 10% of theCompany’s common stock) of the fair market value of the common stock as of thedate of grant and (iv) the duration of the option, which may be up to10 years or provided that incentive stock options issued to a stockholderowning in excess of 10% of the Company’s common stock, may not have a term ofmore than five years.

 

Options for a total of 8,583,000 have beengranted under the Plan. On June 30, 2004 two employees terminated theiremployment with the Company. As a result, 1,500,000 options previously grantedwere forfeited. Pursuant to an employment agreement, another employee had acontractual right to the grant of the terminated options. The Company thereforetreated all options as outstanding at December 31, 2004 for purposes ofcalculating stock compensation expense. On October 19, 2004, theCompany granted 2,000,000 

 

45

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options to purchase common stock to its then newly-appointed chiefexecutive officer. The options had an exercise price of $0.10 per share andwere fully vested upon grant. In February 2005 this officer resigned andagreed to relinquish 1,800,000 options in exchange for a right to exercise allor any part of the remaining 200,000 options for a period of 12 months fromtermination. Between July 7, 2005 and July 14, 2005 the Company issued1,538,000 stock options to directors and employees at an exercise price of$0.45 per share, 1,525,000 of which were fully vested at the date of grant. TheCompany has recorded charges to selling, general and administrative expense forthe year ended December 31, 2005 of $2,606,138 for the compensation valueof these options granted. At December 31, 2005, an additional $13,422 ofdeferred compensation remains on the accompanying balance sheet that will beamortized over future periods as the underlying stock options vest.

 

On May 5, 2004, the Company issued75,000 options to purchase common stock to a director. The options have anexercise price of $0.05 per share and vested in five equal quarterlyinstallments. The Company recorded the difference between the fair market valueof the Company’s common stock and the exercise price as deferred compensationand amortized this difference to compensation expense over the vesting period. OnJuly 8, 2005, the director exercised 60,000 options.

 

*Amendment to 2004 Stock Incentive Plan.*On December 23, 2005, the Company’s Board ofDirectors approved an increase, from 8,000,000 to 15,000,000, in the number ofshares of common stock authorized under the 2004 Stock Incentive Plan. Theincrease will be submitted to the Company’s stockholders for their ratificationat the next annual meeting.

 

Information with respect to activity underthe Plan is as follows:

 
| **Stock Option Activity** | ** ** | **Number of Options** | ** ** | **Weighted-Average  Exercise Price Per Share** | ** ** |
|-------------------------------------|------------|---------------------------------|------------|---------------------------------------------------------------|------------|
| Balance at January 1, 2004          |       | —                          |       | $                                                             | —     |   |
| Options granted                     |       | 6,325,000                       |       | 0.10                                                          |       |
| Options forfeited                   |       | (1,500,000                      | )          | —                                                        |       |
| Options exercised                   |       | —                          |       | —                                                        |       |
| Balance at December 31, 2004        |       | 4,825,000                       |       | $                                                             | 0.10       |   |
| Options granted                     |       | 2,258,000                       |       | 0.58                                                          |       |
| Options forfeited                   |       | (1,800,000                      | )          | 0.10                                                          |       |
| Options exercised                   |       | (60,000                         | )          | 0.05                                                          |       |
| Balance at December 31, 2005        |       | 5,223,000                       |       | $                                                             | 0.31       |   |

 

There were 5,000,000 options vested andexercisable at December 31, 2005. At December 31, 2005, the Companyhad 2,717,000 options available for future grant.

 

Thefollowing table summarizes information about stock options outstanding atDecember 31, 2005:

 
| ** **                                  | ** ** | **Outstanding**                          | ** ** | **Exercisable**                                                      | ** ** |
|---------------------------------------------|------------|------------------------------------------|------------|----------------------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Number of  Options  Outstanding** | ** ** | **Weighted-  Average  Remaining  Contractual Life  (in years)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Number of  Options** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $0.05-0.10                                  |       | 2,965,000                                |       | 3.2                                                                  |       | $ | 0.10 |   | 2,965,000 |   | $ | 0.10 |   |
| $0.45                                       |       | 1,913,000                                |       | 9.5                                                                  |       | 0.45 |   | 1,760,000 |   | 0.45 |   |
| $1.30                                       |       | 345,000                                  |       | 9.9                                                                  |       | 1.30 |   | 275,000 |   | 1.30 |   |
|                                        |       | 5,223,000                                |       | 6.0                                                                  |       | 0.31 |   | 5,000,000 |   | 0.29 |   |
|                                             |            |                                          |            |                                                                      |            |  |  |  |  |  |  |  |  |

 

*CommonStock*

 

On December 23, 2005, the Companygranted stock options to purchase 6,350,000 shares of common stock to certainconsultants, employees, and directors. All of the stock options have anexercise price of $1.50 per share and an expiration date of December 23,2015.  The stock options were granted as compensation for consulting,employment or director services, as applicable.  The options will becomevested as to 25% of the total number of option shares upon shareholderratification of the increase in the number of shares authorized under theCompany’s 2004 Stock Incentive Plan to at least 15,000,000 shares describedabove. Thereafter, the options will become vested as to an additional 6.25% ofthe total number of option shares in quarterly installments beginning onSeptember 30, 2006. 

 

46

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As the stock option grants arecontingent upon shareholder ratification as described above, they have not beenreflected as outstanding as of December 31, 2005.

 

On May 5, 2004, the Company sold 100,000shares of common stock to a director at $0.05 per share for total proceeds of$5,000. The Company has recorded the difference between the fair market valueof the Company’s common stock and the $0.05 purchase price per share of theseshares as compensation expense.

 

*Issuance of Convertible Promissory Notes toRelated Party*

 

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

 

**7. INCOME TAXES**

 

The Company did not record a provision forfederal, state or foreign income taxes for the years ended December 31,2005 and 2004 because the Company has experienced losses since inception. TheCompany has not recorded a benefit for deferred tax assets as its realizabilityis uncertain.

 

The Company’s combined effective income taxrate differed from the U.S. federal statutory income tax rate as set forthbelow:

 
| ** **                                                 | ** ** | **2005** | ** ** | **2004** | ** ** |
|------------------------------------------------------------|------------|----------|------------|----------|------------|
| Income tax benefit computed at the federal  statutory rate |       | (34      | )%         | (34      | )%         |
| Foreign rate differential                                  |       | 4        | %          | 4        | %          |
| Non-deductible contributed services                        |       | —   | %          | 2        | %          |
| Change in valuation allowances                             |       | 30       | %          | 28       | %          |
| Total                                                      |       | —   | %          | —   | %          |

 

Significant components of the Company’s netdeferred tax assets as of December 31, 2005 and 2004 were as follows:

 

Deferred tax assets:

 
| ** **                             | ** ** | **2005**   | ** ** | **2004**   | ** ** |
|----------------------------------------|------------|------------|------------|------------|------------|
| Net operating loss carryforwards       |       | $          | 2,109,000  |       | $          | — |   |
| Foreign loss carryforwards             |       |       | 1,687,000  |       |       | 1,059,941 |   |
| Deferred tax asset valuation allowance |       | (3,796,000 | )          | (1,059,941 | )          |
| Total deferred tax assets              |       | $          | —     |       | $          | — |   |
|                                        |            |            |            |            |            |  |  |  |

 

As of December 31, 2005, the Company had U.S.net operating loss carryforwards of approximately $7,100,000, which begin to expirein 2024 for federal purposes. The Company also has gross foreign tax losscarryforwards of approximately $4,100,000 that are available to offset futureliabilities for foreign income taxes. Substantially all of the foreign taxlosses are carried forward indefinitely, subject to certain limitations. Avaluation allowance has been established for certain future income tax benefitsrelated to income tax loss carryforwards and temporary tax adjustments based onan assessment that it is more likely than not that these benefits will not berealized. During the years ended December 31, 2005 and 2004, the valuationallowance increased by $2,736,059 and $1,010,303, respectively.

 

Under theprovisions of the Internal Revenue Code, certain substantial changes in theCompany’s ownership may have limited, or may limit in the future, the amount ofnet operating loss carryforwards which could be utilized annually to offsetfuture taxable income and income tax liabilities.  The amount of any limitation is determinedbased on the Company’s value and the long-term tax-exempt rate on the date ofan ownership change.

 

**8. CONVERTIBLE DEBENTURES**

 

On February 18, 2005 and March 4,2005, the Company completed a private placement of convertible debentures andwarrants to a group of sophisticated institutional and individual investors. Inthe private placement, the Company sold convertible debentures in the aggregateprincipal amount of $8,400,000, convertible into common stock of the Company at$0.75 per share, and warrants to purchase an aggregate of 8,400,000 shares ofits common stock, at an exercise price of $1.00 per share. The Company 

 

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paid placement fees to theplacement agent in the aggregate amount of $802,500. The debentures accrueinterest daily at a rate of 8% per annum, which interest is payable quarterlyon each March 31, June 30, September 30 and December 31following the issue date. The final interest payment is due on the date ofmaturity of the debentures, the third anniversary of the issue date. As ofDecember 31, 2005, $2,100,000 in outstanding principal amount of convertibledebentures has been converted into 2,799,993 shares of common stock. Thecarrying amount of these notes of $1,533,092 has been charged to additionalpaid-in-capital as of December 31, 2005.

 

In connection with the debenturefinancing transaction, the Company issued a warrant to the placement agent topurchase 802,500 shares of the Company’s common stock at an exercise priceof $1.00 per share. The Company determined the value of the warrant to be$184,844 using the Black-Scholes pricing model and the following assumptions:risk free interest rate, 3.9%; expected divided yield, 0; expected life, 5years; and expected volatility, 80%. The Company recorded the value of thiswarrant as deferred financing fees. In addition, the Company paid legalexpenses and broker fees of $947,127, which have been recorded as deferredfinancing fees. The deferred financing fees are being amortized to interestexpense using the straight-line method through the maturity date of thedebentures. When holders convert their debentures into common stock of theCompany, the pro-rata capitalized deferred financing fees are charged toadditional paid-in-capital.

 

The Company also issued 8,400,000warrants to the investors to purchase shares of the Company’s common stock atan exercise price of $1.00 per share.  The warrants expire five yearsafter the issue date. The Company determined the value of the warrants to be$1,933,108 using the Black-Scholes pricing model and the following assumptions:risk free interest rate, 3.9%; expected divided yield, 0; expected life, 5years; and expected volatility, 80%. The Company allocated value to the debtand the warrant based on their relative fair values in accordance withAccounting Principles Board Opinion No. 14, *Accountingfor Convertible Debt and Debt Issued with Stock Purchase Warrants,*resulting in an allocation of $1,596,000 to the warrants. The warrantswere recorded as a discount to the debenture and a credit toadditional paid-in capital.  This discount is amortized to interestexpense using the effective interest rate method through the maturity date ofthe debentures. When holders convert their debentures into common stock of theCompany, the pro-rata capitalized deferred financing fees are charged toadditional paid-in-capital. As of December 31, 2005,the unamortized portion of the discount was $875,098.

 

After allocation of the proceeds between thedebentures and the warrants, the Company considered whether the conversionterms of the debenture result in a beneficial conversion feature, pursuant toEmerging Issue Task Force Nos. 98-5 and 00-27. The Company determined thatthere was no beneficial conversion feature.

 

For both of the Black-Scholes computationsdescribed above, the Company used $0.45 as the fair value of its common stock,representing management’s determination of fair value based on an independentappraisal. There was no current trading market for the Company’s common stockat the time of the debenture and warrant allocation.

 

The Company is currently prohibited from paying cash dividends to theholders of common stock under the terms of these convertible debentures. Thisrestriction on the payment of dividends will remain in effect until thedebentures are repaid or converted in full.

 

In March 2005 the Company issued a warrant topurchase 100,000 shares of the Company’s common stock pursuant to a consultingagreement. The warrant is exercisable at $0.45 per share and expires in fiveyears after the date of issuance. The warrant was valued at $29,913 using theBlack-Scholes option pricing model using the following assumptions:  risk free interest rate, 4.02%; expecteddivided yield, 0; expected life, 5 years; and expected volatility, 80%. TheCompany charged the value of the warrant to selling, general and administrativeexpense.

 

*Warrant Exercise Agreements.  *In October 2005, the Company enteredinto several Warrant Exercise Agreements with holders of warrants issued in theprivate placement that closed in the first quarter of 2005. Pursuant to theseagreements, the Company issued to these holders new common stock purchasewarrants exercisable for a number of shares equal to the number of shares theypurchased upon exercise of the warrants issued to them in the privateplacement. These new warrants have an exercise price of $1.50 per share. The Company received aggregate proceeds of $3,190,499 in connection withthe exercise of the prior warrants, and issued new warrants to purchase anaggregate of 3,190,499 shares of common stock, which expire five years afterthe issue date. The Company accounted for the induced exercise transaction bycomparing the fair value of the consideration received and surrendered, andrecording a charge to selling, general and administrative expense of $1,200,199for the difference. The Company also issued a warrant to purchase 159,525shares of common stock at $1.50 per share, which expires five years after theissue date, and paid $159,525 in cash to a placement agent who assisted withthe transaction.

 

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**9. COMMITMENTS AND CONTINGENCIES**

 

*Service Agreement*

 

During 2005, the Company entered into aservices agreement with Telehouse International Corporation of Europe Limited(Telehouse) and a service agreement with U.S. Colo, LLC for the use of certainequipment and services.

 

Future minimum service commitments underthese agreements for the years ended December 31 are as follows:

 
| 2006   |   | $     | 38,258 |   |
|--------|--------|-------|--------|--------|
| 2007   |   | 8,160 |   |
|   |   | $     | 46,418 |   |

 

Services expense, classified as a cost ofrevenue in the accompanying consolidated statement of operations, under theseagreements were $46,581 and $25,617 for the years ended December 31, 2005and 2004, respectively.

 

The Telehouse service agreement is alsosecured by a letter of credit that is personally guaranteed by the Chairman.

 

*Operating Leases*

 

The Company rents approximately 300 square feet inthe London facility of Telehouse, a specialty telecommunications hotel andservice provider. In addition, the Company also entered into a co-locationagreement pursuant to which the Company rents approximately 400 square feet ofspace at 650 Grand Avenue in Los Angeles, California. During 2005,leases with these entities in Los Angeles, California and London, Englandexpired and new agreements were signed. The London lease requires a minimumpayment of approximately $8,500 per month and expires in August 2006. TheCalifornia lease required minimum rent payments of $3,000 per month for thefirst three months, $3,500 per month for the second three months, and $4,000thereafter. Future minimum rents and service commitments described above areexpected to total between $4,000 and $6,500 per month. The initial term of theagreement expires in April 2007. The Company recorded $30,500 of rent expenserelated to the California lease during the year ended December 31, 2005. Commencingin November 2005, the Company established its principal executive officesin New York under a month-to-month tenancy at the rate of approximately $6,500per month under an agreement with JBC, Inc. Commencing in April 2005, theCompany established a new London office location under a new lease forapproximately $6,500 per month. Commencing in May 2005, the Company establishedan office in South Africa under a new lease for approximately $5,400 per month.

 

Total rent expense for the years endingDecember 31, 2005 and 2004 were $277,672 and $118,500 respectively.

 

Future minimum lease commitments for theseoperating leases for the years ended December 31 are as follows:

 
| 2006   |   | $       | 398,030 |   |
|--------|--------|---------|---------|--------|
| 2007   |   | 114,969 |    |
|   |   | $       | 512,999 |   |

 

*Credit Facility*

 

Since its inception, the Company hassustained its operations through funding provided by the Chairman, as well ascontributed services by the Chairman and other stockholders, and debt andequity financings. The Chairman has made various advances to the Company from a$3,000,000 credit facility established in the name of the Chairman, as well asother of the Chairman’s personal assets. The credit facility was established bythe Chairman in February 2003 and was first drawn upon by the Chairman inMay 2003. Borrowings are payable upon demand. Interest accrues at the bank’sbase rate plus 2% for the first $300,000 of borrowings and at the bank’s baserate plus 5% on all additional borrowings. Under the credit facility, thelender may issue standby letters of credit for the benefit of third parties atthe request of the Chairman. The obligations of the Chairman under the creditfacility are secured by certain property in which the Chairman has a beneficialinterest. At December 31, 2005, the Chairman had drawn approximately$2,385,000 under this facility, of which approximately $262,000 was used to payexpenses incurred and accrued by the Company. Three letters of credit in theaggregate amount of $200,113 have been issued by the lender under the creditfacility, of which $28,033 have been issued in favor of vendors to the Companyand its affiliates at the request of the Chairman. The standby letters ofcredit were issued in order to obtain credit from the Company’s vendors. As ofDecember 31, 2005, approximately $615,000 was undrawn and available underthe credit facility and $2,385,000 was outstanding. The Company may obtainfuture advances from the Chairman from both the credit facility and theChairman’s other personal assets in order to meet certain working capitalneeds. The Chairman may also cause the lender under the credit facility toissue standby letters of credit in favor of one or more of the Company’svendors to secure the Company’s obligations

 

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to such vendor or vendors.While the Chairman is not obligated to provide these advances to the Company orto cause the lender to issue standby letters of credit in favor of the Company’svendors, the Company expects the Chairman to continue providing funds foroperations in 2006 as and if needed, until such time that the Company raisesexternal capital. In the absence of external capital, the Company will continueto be dependent on the Chairman to fund existing operations and provide growthcapital. Although the Company did raise external capital subsequent toDecember 31, 2005 (see Note 14), there can be no assurances that theCompany can continue to raise such capital on acceptable terms, if at all.

 

The credit facility is secured by certain propertyin which the Chairman has a beneficial interest. The credit facility wasguaranteed by the Company’s wholly-owned subsidiary, Vistula Limited. TheCompany evaluated the fair value of the guaranty in accordance with FinancialAccounting Standards Board Interpretation No. 45 (FIN 45) and determinedthe value to be immaterial to the financial statements and, as a result, noliability was recorded. This guaranty was released by the financialinstitution on March 27, 2006.

 

*Employment Agreements*

 

On August 17, 2005, the Company entered into aConsulting Agreement (the “Agreement”) with Executive Management ServicesLimited (“EMS”) under which EMS agrees to provide the services of RupertGalliers-Pratt, the Company’s President, Chief Executive Officer and Chairmanof the Board of Directors, to the Company.  Under the Agreement, Mr.Galliers-Pratt will continue to serve as President and Chief ExecutiveOfficer.  The Agreement provides that the Company shall pay EMS annualconsulting fees of $240,000 as consideration for these services.

 

The Agreement has an initial term of twoyears.  The term of the Agreement shall be automatically extended foradditional periods of one year unless either party to the Agreement gives theother party notice of termination of the Agreement prior to the expiration ofthe then-current term.  The Agreement may be terminated at any time by EMSor the Company.  However, in the event the Company terminates theengagement of EMS without cause, the Company will be required to make severancepayments for a period of two years after, and at the consulting fee rate ineffect at the time of, such termination and to continue to pay for certainmedical and other benefit plans for such period.  Under the Agreement, EMSand Mr. Galliers-Pratt agree to be bound by certain non-competition andnon-solicitation provisions, which are effective during the term of theAgreement and for a period of two years after termination of the Agreement.

 

Rupert Galliers-Pratt has served as the Company’sPresident, Chief Executive Officer and Chairman of the Board of Directors sincethe Company’s inception in March 2004.

 

*Distribution and Marketing Agreement*

 

On August 11, 2004, the Company enteredinto a distribution and marketing agreement with NetYantra Inc. and NetYantraIndia Pvt. Ltd. (collectively, “NetYantra”) pursuant to which NetYantragrants to the Company the exclusive worldwide rights (other than in India whereNetYantra is headquartered and subject to certain existing distributionagreements) to market and distribute the Company’s V-CubeÔIP-PBX software platform to Tier 1 carriers, telecommunications equipmentmanufacturers, internet service providers, large corporations, SMEs and otherbusiness entities and individual retail customers. Under the distribution andmarketing agreement, in consideration for the marketing and distribution rightsgranted to the Company by NetYantra, the Company has paid NetYantra $400,000and is required to pay NetYantra fifty percent of certain net revenues whichthe Company derives from the distribution of the V-CubeÔplatform. This amount paid by the Company is creditable against future royaltycommitments. Accordingly, the Company recorded this amount as prepaidroyalties, and will expense such prepaid amounts as royalties accrue.

 

In September 2004, NetYantra agreed toextend the payment due date of one of the prepaid royalty amounts. Inconsideration for this extension, the Company paid NetYantra an additionalpayment of $25,000 and issued to NetYantra 50,000 shares of the Company’scommon stock, valued at $0.45 per share, the fair value of the Company’s commonstock on that date. The additional payment of cash and stock is not creditabletowards future royalties and was charged to selling, general and administrationexpense.

 

In addition, the agreement stated that in theevent that the Company’s common stock is quoted or traded on a stock market onor before the first anniversary of the agreement, the Company must also issueto NetYantra shares of the Company’s common stock having a market value of$1,000,000 based on the opening price of the Company’s common stock on thefirst day of trading (or, at the Company’s option, pay to NetYantra a cashpayment of $1,000,000 instead of issuing such shares). On July 21, 2005,public trading in the Company’s common stock began jointly on the OTC BulletinBoard and the Pink Sheets Electronic Quotation Service under the trading symbol“VSTL.”  The opening sale was at a priceof $2.00 per share. The Company issued 500,000 shares of its common stock toNetYantra in compliance with the agreement. This payment is not creditabletoward royalty commitments and as such was charged to selling, general andadministration expense.

 

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The Agreement is for an initial term of fiveyears. NetYantra may elect to terminate the exclusivity granted to the Companyunder the Agreement after a period of two years for any reason.

 

On March 24, 2006 the Company received anotice from NetYantra India Pvt Ltd. claiming that the Company is in breach ofcertain provisions of the August 11, 2004 distribution and marketing agreemententered into with NetYantra Inc. and NetYantra India Pvt. Ltd. (collectively“NetYantra”). The notice claimed that the Company has not fulfilled certainrequirements contained in the agreement as to the training of personnel,recognition of NetYantra as the developer of certain technology, and theforwarding of documentation to NetYantra regarding the licensing andsublicensing of certain technology. Further, the notice claimed that the Company’s marketing of the consumerVoIP portal product constitutes a breach of the agreement.  We intend to respond to this noticedescribing the reasons why we believe that we have not breached the agreement.

 

*Service Agreement*

 

On February 15, 2005, the Company enteredinto a service agreement with IndiGo Securities, LLC (the “placement agent”)for the placing of the Company’s 8% Senior Convertible Debentures (“Debentures”)and warrants to acquire Company common stock described in Note 8. The placementagent received both a cash payment and warrants as described in Note 8 forthese services. In addition, the Company engaged the placement agent to performconsulting services commencing March 2005 and continuing for a twelve-monthperiod at the rate of $20,000 per month. See Note 14 regarding a FinancialAdvisory Agreement that was subsequently entered into with Indigo Ventures LLCon January 27, 2006.

 

*Private Placement Fee*

 

Shortly after the first closing of theprivate placement described in Note 8, the Company received a letter onbehalf of Kevin Dann & Partners (“KDP”), a placement agent that hadbeen retained prior to the Company’s engagement of IndiGo Securities, LLCas placement agent, demanding a placement fee of $227,000. The letter alsoincluded a claim that KDP would be entitled to additional fees in the event offuture closings. In the Company’s response to this letter, the Company deniedany such liability to KDP. On June 5, 2005 the Company entered intoa Settlement Agreement with KDP under which the Company paid $25,000 to KDPupon signing of the Settlement Agreement and paid $25,000 on December 9,2005 in exchange for a full release of all claims against the Company.

 

*Litigation*

 

The Company from time to time may become aparty to various legal proceedings arising in the ordinary course of business.Management will evaluate these claims as they arise with the assistance oflegal counsel and will make accounting entries and disclosures as appropriate. TheCompany believes, as of December 31, 2005, there were no material unrecordedliabilities related to any known legal matters.

 

**10. RELATED PARTY TRANSACTIONS**

 

*Contributed Services*

 

During the year ended December 31, 2004certain stockholders contributed services to the Company. Pursuant to StaffAccounting Bulletin Topic 5T (SAB.T.5T), the Company recorded compensation anda corresponding credit to additional paid-in capital of approximately $82,500for these services during the year ended December 31 2004. There were nocontributed services during 2005.

 

*Expenses Paid By Stockholder*

 

During the year ended December 31, 2005,no legal, accounting or operating expenses were paid on behalf of the Company. Forthe year ended December 31, 2004, pursuant to SAB.T.5T, expenses not expectedto be repaid of approximately $181,000 were recorded as expense and charged toadditional paid-in capital and expenses that were expected to be repaid of$801,630 which were included in due to stockholder at December 31, 2004were paid during the year ended 2005. The amounts due to stockholder did notbear interest.

 

*Common Stock*

 

On May 5, 2004, the Company sold 100,000shares of common stock to a director at $0.05 per share for total proceeds of$5,000. The Company recorded $40,000 as compensation expense based on thedifference between the fair market value of the Company’s common stock ($0.45)and the $0.05 purchase price per share of these shares.

 

On August 17, 2005, the Company entered into aConsulting Agreement (the “Agreement”) with Executive Management ServicesLimited (“EMS”) under which EMS agrees to provide the services of RupertGalliers-Pratt, the Company’s President, Chief Executive Officer and Chairmanof the Board of Directors, to the Company. See Note 9 for further discussion ofthis Agreement.

 

On December 7, 2005, the Company issued100,000 shares of common stock to a stockholder of Vistula CommunicationsServices SA (Pty.) Ltd. for consulting services to be rendered through December6, 2006. The shares had a fair value of $130,000 based upon the closing price($1.30) of the Company’s common stock as at December 7, 2005. Consultingservices performed during 2005

 

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have been included in selling,general and administrative expense for the year ended December 31, 2005. Thatamount attributable to 2006 is reflected as prepaid professional services atDecember 31, 2005.

 

**11. EARNINGS PER SHARE**

 

The following table is the computation ofbasic and diluted earnings per common share computed in the manner described inNote 2 for the years ended December 31, 2005 and 2004:

 
| ** **                                                    | ** ** | **2005**   | ** **  | **2004**   | ** ** |
|---------------------------------------------------------------|------------|------------|-------------|------------|------------|
| Net loss available for common shares and  assumed conversions |       | $          | (12,182,002 | )          | $          | (3,795,276 | ) |
| Weighted-average basic and diluted shares  outstanding        |       | 26,822,678 |        | 24,233,420 |       |
| Net loss per common share basic and diluted                   |       | $          | (0.45       | )          | $          | (0.16 | ) |

 

Options to purchase 5,223,000 and 4,825,000shares of common stock for the years ended December 31, 2005 and 2004,respectively, have been excluded from the computation of net loss per share astheir effect would have been antidilutive. Warrants to exercise 9,462,022shares for the year ended December 31, 2005 have been excluded from thecomputation of net loss per share as their effect would have been antidilutive.There were no warrants outstanding for the year ended December 31, 2004. Anyshares which may result from the conversion of convertible debt, but have notbeen converted as of December 31, 2005, have been excluded from the computationof net loss per share as their effect would have been antidilutive.

 

**12. GEOGRAPHIC AND SEGMENT INFORMATION**

 

Financial information by geographic area forthe years ended December 31, 2005 and 2004 was as follows:

 
| ** **                        | ** ** | **2005**   | ** **  | **2004**  | ** ** |
|-----------------------------------|------------|------------|-------------|-----------|------------|
| Net revenues:                     |       |       |        |      |       |
| United States                     |       | $          | 679,849     |      | $          | 700,946 |   |
| United Kingdom                    |       | 119,448    |        | 1,356,325 |       |
| Europe (excluding U.K.) and other |       | 41,160     |        | 278,137   |       |
|                              |       | $          | 840,457     |      | $          | 2,335,408 |   |
| Loss from operations:             |       |       |        |      |       |
| United States                     |       | $          | (8,848,036  | )         | $          | (2,706,742 | ) |
| United Kingdom                    |       | (1,554,581 | )           | (803,064  | )          |
| Europe (excluding U.K.) and other |       | (535,677   | )           | (164,682  | )          |
|                              |       | $          | (10,938,294 | )         | $          | (3,674,488 | ) |
| Tangible long-lived assets:       |       |       |        |      |       |
| United States                     |       | $          | 1,822,753   |      | $          | 1,855,835 |   |
| United Kingdom                    |       | 530,768    |        | 141,786   |       |
| Europe (excluding U.K.) and other |       | 8,852      |        | —    |       |
|                              |       | $          | 2,362,373   |      | $          | 1,997,621 |   |

 

The Company is currently managed through onebusiness segment, namely, the Vistula Companies. This includes Vistula Limited,Vistula USA, Inc. and Vistula Communcations Services SA (Pty) Ltd. whichare aggregators of wholesale telecommunications services to Tier 1 and Tier 2telecommunications carriers. The Vistula Companies have switching facilities inLondon and Los Angeles and interconnect agreements with suppliers in theselocations.  Cardlink has not generatedany revenues or incurred significant expenses since being acquired by theChairman and his immediate family and does not currently represent a businesssegment.

 

**13.INVESTMENT BANKING AGREEMENT**

 

In October 2003, the Company entered into aservice agreement with an investment bank. Pursuant to the agreement, theCompany issued 419,406 shares of common stock to the investment bank in lieu ofservice fees in May 2004. The Company recorded $188,733 as administrativeexpense upon issuance of these shares in accordance with EITF No. 96-18. 

 

**14. SUBSEQUENT EVENTS**

 

On January 5, 2006, the Company entered into anemployment agreement with Ian Cope relating to Mr. Cope’s employment as theCompany’s chief operations officer.  Under the employment agreement, theCompany will pay Mr. Cope an annual base salary of $140,000 and provide himwith certain employment related benefits.  In addition, the employmentagreement provides that the Company will grant Mr. Cope an incentive stockoption to purchase 250,000 shares of the Company’s common stock with anexercise price equal to $1.42 per share; 50,000 of those shares subject to theoption will be vested immediately and the remaining 200,000 shares subject tothe option will vest in four equal annual installments of 50,000 sharesbeginning on January 5, 2007.  The option will be subject to the terms andconditions of the Company’s 2004 Amended and Restated Stock IncentivePlan.  The employment 

 

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agreement also provides that if Mr. Cope isterminated without cause, the Company will be obligated to pay him his basesalary for three months.

 

On January 27, 2006, we entered into aFinancial Advisory Agreement (the “Agreement”) with Indigo Ventures LLC (“Indigo”)in which the Company agreed to appoint Indigo as its financial advisor toadvise, consult with, and assist in various matters. In considerationfor these services, the Company agreed to pay Indigo a cash fee of $20,000 permonth in arrears, increasing to $30,000 per month beginning in the first monthfollowing the consummation of a significant debt or equity financing from whichthe Company obtains gross proceeds of at least $5 million.  Also, theCompany agreed to issue to Indigo 1,500,000 restricted shares of common stock,which shares will vest upon the earlier of: (i) the closing of asignificant acquisition as may be described in a written notice delivered bythe Company to Indigo on or after the date of the Agreement, (ii) subjectto the approval of the Company’s compensation committee, the closing of anothermajor acquisition or financing transaction on which Indigo provides advice tothe Company, (iii) a change of control of the Company, or(iv) January 27, 2007.  The shares the Company is issuing toIndigo are restricted shares and may not be sold, assigned or transferred byIndigo for a one (1) year period beginning on January 27, 2006 andending on January 27, 2007.  If the Company terminates the Agreement as aresult of a material breach of this Agreement by Indigo, the Company will havethe right and option to repurchase fifty percent (50%) of all of the thenunvested shares at a purchase price of $0.001 per share.

 

On February 28, 2006, the Company finalized anagreement with Mark Scully resolving matters relating to his cessation ofemployment as President and Chief Executive Officer of Vistula USA, one of theCompany’s wholly owned subsidiaries, on November 2, 2005.  Inconnection with a mutual release of claims, the Company agreed to payMr. Scully $50,000 in severance and issue to him 750,000 shares of ourcommon stock in respect of the exercise of an outstanding option issued underour stock incentive plan.  These 750,000 shares are subject to the Company’sright to repurchase at a price of $1.00 per share through March 31, 2006.

 

On March 30, 2006 theCompany entered into a revolving credit agreement with Indigo Investments LLCthat provides for up to $5,000,000 in advances to be available to theCompany.  Upon the closing of this creditfacility, $1,000,000 was advanced to the Company and an additional $300,000advance under the credit agreement is expected to be made to the Company on orbefore April 5, 2006. Additional advances under the credit facility aredependent upon the Company’s accounts receivable balances and adherence tocertain covenants as described in the credit agreement.  Outstanding principal under this creditfacility bears interest at a rate of 1.5% per month, increasing to 2.5% permonth in the event of a default by the Company under the credit agreement.  In addition, the Company is required to paythe lender a 2.25% commitment fee on the total amount of the credit facilityand issue the lender a five-year warrant to purchase up to 500,000 shares ofcommon stock at an exercise price of $1.50 per share.  The exercise price of the warrant is subjectto adjustment in certain circumstances.

 

All outstanding principaland interest on the credit facility plus the commitment fee are due and payableon the earlier of (i) September 30, 2006, or (ii) the closing ofthe sale of a minimum of $6,000,000 of the Company’s equity securities;provided, that, in the event that such a financing closes prior to September 30,2006, the Company will also be required to pay the lender an early repaymentfee equal to 2.25% of the total amount of the credit facility. The rights ofthe lender under the credit facility are junior to those of the outstandingconvertible debentures.

 

Advances drawn under this agreement are personallyguaranteed by the Company’s Chairman and Chief Executive Officer, RupertGalliers-Pratt.

 

**ITEM 8. CHANGES IN AND DISAGREEMENTS WITHACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE**

 

On December 7, 2005, Vitale,Caturano & Company Ltd. resigned as our independent registered publicaccounting firm.  The reports of Vitale, Caturano & Company Ltd.on our consolidated financial statements for the fiscal years endedDecember 31, 2003 and December 31, 2004 did not contain any adverseopinion or disclaimer of opinion and were not qualified or modified as touncertainty, audit scope or accounting principles. However, as disclosed in ourAnnual Report on Form 10-KSB for the fiscal year ended December 31,2004, Vitale, Caturano & Company Ltd. advised us in connection withthe completion of their audit for the fiscal year ended December 31, 2004that they had identified certain matters involving the operation of ourinternal controls that they considered to be a material weakness. These mattersand our response to these matters are described in “Item 8A. Controls andProcedures” in our Annual Reports on Form 10-KSB for the fiscal yearsended December 31, 2005 and December 31, 2004.

 

During the fiscal years ended December 31, 2003and 2004, and during the interim period ended December 7, 2005, there wereno disagreements with Vitale, Caturano & Company Ltd. on any matter ofaccounting principles or practices, financial statement disclosure, or auditingscope or procedure, that, if not resolved to the satisfaction of Vitale,Caturano & Company Ltd., would have caused it to make referencethereto in its reports regarding our consolidated financial statements for suchyears.

 

On December 7, 2005, we engaged PKF, CertifiedPublic Accountants, A Professional Corporation, as our independent registeredpublic accounting firm. During the fiscal years ended December 31, 2003and December 31, 2004 and the subsequent interim period throughDecember 7, 2005, we did not consult with PKF, Certified PublicAccountants, A Professional Corporation, regarding the application ofaccounting principles to a specified transaction, the type of audit opinionthat might be rendered on our consolidated financial statements, or any matterthat was the subject of a disagreement with Vitale, Caturano & CompanyLtd. or a reportable event as defined in applicable SEC rules.

 

Vitale, Caturano & Company Ltd. has furnished uswith a letter addressed to the Securities and Exchange Commission stating thatit agrees with the above statements.  A copy of such letter, datedDecember 12, 2005, has been included as an exhibit to our current report onForm 8-K filed with the Securities and Exchange Commission on December 12,2005.

 

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**ITEM 8A. CONTROLS AND PROCEDURES**

 

Basedon our management’s evaluation (with the participation of our principalexecutive officer and principal financial officer), as of the end of the periodcovered by this report, our principal executive officer and principal financialofficer have concluded that our disclosure controls and procedures (as definedin Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, asamended, (the “Exchange Act”)) were effective to ensure that informationrequired to be disclosed by us in reports that we file or submit under the ExchangeAct is recorded, processed, summarized and reported within the time periodsspecified in Securities and Exchange Commission rules and forms.

 

Itshould be noted that any system of controls, however well designed andoperated, can provide only reasonable, and not absolute, assurance that theobjectives of the system are met. In addition, the design of any control systemis based in part upon certain assumptions about the likelihood of futureevents. Because of these and other inherent limitations of control systems,there can be no assurance that any design will succeed in achieving its statedgoals under all potential future conditions, regardless of how remote.

 

OnMarch 28, 2005, our independent registered public accounting firm at thetime, Vitale, Caturano & Company, Ltd., advised us in connection withthe completion of their audit for the 2004 fiscal year that they had identifiedcertain matters involving the operation of our internal controls that theyconsidered to be a material weakness.  A “material weakness” is areportable condition in which the design or operation of one or more of theinternal control components does not reduce to a relatively low level the riskthat misstatements caused by errors or fraud in amounts that would be material inrelation to the consolidated financial statements being audited may occur andnot be detected within a timely period by employees in the normal course ofperforming their assigned functions.

 

Thematerial weakness identified by Vitale, Caturano & Company, Ltd.related to our lack of full-time accounting and finance personnel and to a lackof sophistication in our accounting systems, which required significant manualeffort and lacked formal, documented procedures and controls over transactionreporting.  Both of these factors were the result of the severe capitalconstraints we faced prior to the completion of our private financing in thefirst quarter of 2005.  Although we retained during the 2004 fiscal yearthe services of a part-time Chief Financial Officer to assist in accountingconsideration and recording and the financial reporting process, Vitale,Caturano & Company, Ltd. noted delays in the communication ofinformation and documentation to the Chief Financial Officer.  While thesematters were not formally identified as a material weakness until very late inthe audit process, they were presumably present from our inception in early2003.

 

Vitale,Caturano & Company, Ltd.’s conclusion that we needed to reassess ourexisting finance organization resource requirements and re-evaluate the designand operating effectiveness of certain controls surrounding the financialstatement close process was based on several adjustments that were made in thecourse of the audit process, some of which occurred late in the audit process,and issues relating to the timely communication of information anddocumentation necessary to yield proper accounting consideration and recording.Among the issues identified or addressed late in the audit process wereaccounting for stock option arrangements, prepaid royalties, severanceaccruals, certain revenue contracts, reconciling and verifying shareholderloans, cutoff of accounts payable, and preparing complete financial statementswith footnote disclosures.

 

NotwithstandingVitale, Caturano & Company, Ltd.’s identification of a materialweakness in our internal controls, our management, including our chiefexecutive officer and chief financial officer, concluded that the presence ofthis material weakness did not necessitate a conclusion that our disclosurecontrols and procedures were not effective as of December 31, 2004.

 

Moreover,we believe that throughout the 2005 fiscal year, we have allocated significantresources to remediation of the material weakness identified by Vitale,Caturano & Company, Ltd.  In arriving at this conclusion, ourmanagement considered the following factors:

 

•      Vitale, Caturano & Company, Ltd.’sconclusions regarding the presence of a material weakness were based in part ondelays they experienced in the communication of information and documentationduring the course of their audit, not due to any observed deficiency in ourability to make timely disclosures as required by the Securities and ExchangeCommission.

 

•      Despite the presence of the materialweakness, we filed our quarterly reports and our annual report for the 2004fiscal year within the time periods specified by the Securities and ExchangeCommission.

 

•      During the quarter ended March 31, 2005,we implemented automated accounting software for our U.S. operations.

 

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•      During the quarter ended June 30, 2005,we initiated a search for a full-time manager of accounting andadministration.  We successfully identified a suitable candidate, and hecommenced full-time employment with us in July 2005.

 

Webelieve that the increased staffing and improvement in our accounting softwarehave addressed the concerns that Vitale, Caturano & Company, Ltd.raised in relation to the timeliness of our closing process.

 

*Changes in Internal Controls Over Financial Reporting*

 

Ourmanagement, in connection with its evaluation of internal controls (with theparticipation of our principal executive officer and principal financialofficer), did not identify any change in internal control over the financialreporting process that occurred during our fourth fiscal quarter of 2005 thatwould have materially affected, or would have been reasonably likely tomaterially affect, our internal control over financial reporting.

 

**ITEM 8B. OTHER INFORMATION**

 

On March 30, 2006 we entered into a revolvingcredit agreement with Indigo Investments LLC that provides for up to $5,000,000in advances to be available to us.  Uponthe closing of this credit facility, $1,000,000 was advanced to us and anadditional $300,000 advance under the credit agreement is expected to be madeto us on or before April 5, 2006. Additional advances under the credit facilityare dependent upon our accounts receivable balances and adherence to certaincovenants as described in the credit agreement. Outstanding principal under this credit facility bears interest at arate of 1.5% per month, increasing to 2.5% per month in the event of a defaultby us under the credit agreement.  Inaddition, we are required to pay the lender a 2.25% commitment fee on the totalamount of the credit facility and issue the lender a five-year warrant topurchase up to 500,000 shares of our common stock at an exercise price of $1.50per share.  The exercise price of thewarrant is subject to adjustment in certain circumstances.

 

All outstanding principal and interest on thecredit facility plus the commitment fee are due and payable on the earlier of(i) September 30, 2006, or (ii) the closing of the sale of a minimum of$6,000,000 of our equity securities; provided, that, in the event that such afinancing closes prior to September 30, 2006, we will also be required to paythe lender an early repayment fee equal to 2.25% of the total amount of thecredit facility. The rights of the lender under the credit facility arejunior to those of the outstanding convertible debentures.

 

Advances drawn under this agreement arepersonally guaranteed by our Chairman and Chief Executive Officer, RupertGalliers-Pratt.

 

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**PART III**

 

**ITEM 9. DIRECTORS, EXECUTIVE OFFICERS,PROMOTERS AND CONTROL PERSONS; COMPLIANCE WITH SECTION 16(A) OF THEEXCHANGE ACT.**

 

Our current directors and executive officers are:

 
| **Name**              | ** ** | **Age** | ** ** | **Positions Held**                                            |
|-----------------------|------------|---------|------------|---------------------------------------------------------------|
| Rupert Galliers-Pratt |       | 54      |       | Chief Executive Officer, President and  Chairman of the Board |
| George R. Vaughn      |       | 52      |       | Chief Financial Officer, Assistant  Treasurer and Secretary   |
| Ian Cope              |       | 56      |       | Chief Operations Officer                                      |
| Adam Bishop           |       | 46      |       | President, Vistula Limited and Vistula USA,  Inc.             |
| J. Marcus Payne       |       | 57      |       | Director(1)(2)(3)                                             |
| Anthony Warrender     |       | 55      |       | Director(1)(2)(3)                                             |

 

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(1)           Member of the AuditCommittee

 

(2)           Member of theCompensation Committee

 

(3)           Member of theNominating Committee

 

**Rupert Galliers-Pratt.**Mr. Galliers-Pratthas served as chairman of our board of directors since our inception*.* He served as our President and ChiefExecutive Officer from our inception until September 1, 2004 and resumedservice in those capacities on February 8, 2005. He also serves aschairman of the board of directors of our subsidiaries, Vistula Limited,Vistula USA, Inc., Vistula Communications SA (Pty) Ltd., and CardlinkServices Limited. He was one of the founding shareholders of Vistula Limited,which we acquired in March 2004. Mr. Galliers-Pratt has served aschairman of Vistula Limited since its incorporation in August 2002. From1996 through July 2002, he was a private investor. From 1992 through 1995,he served as chairman and chief executive officer of Petersburg LongDistance Inc. During that time, Mr. Galliers-Pratt was responsiblefor establishing ZAO PeterStar, which is the dominant Competitive LocalExchange Carrier in St. Petersburg and Altel, which was the first cellularoperator in Kazakhstan. In addition to Petersburg Long Distance Inc., hehas served on the board of directors of a number of listed companies in theUnited Kingdom and the United States including Optical Care (Bermuda) Limitedand Symposium Telecom Inc.

 

Mr. Galliers-Pratt was censured by theLondon Stock Exchange on July 24, 1996 for inadvertently failing todisclose in a document prepared in connection with the admission of OpticalCare (Bermuda) Limited on the U.K. Alternative Investment Market, details ofall his then current directorships and details of his then past directorshipsof companies that had gone into receivership or liquidation within12 months of his being a director. When Mr. Galliers-Pratt becameaware of the fact that these omissions had been made, he notified the LondonStock Exchange immediately and compiled a detailed list of the omissions. Inits public announcement of his censure, the London Stock Exchange accepted thatthe omissions were the result of error rather than being deliberate. Our boardof directors has considered these matters in their entirety and believes thatMr. Galliers-Pratt is a fit and proper person to serve as the chairman ofour board of directors and as our chief executive officer.

 

**George R. Vaughn.**Mr. Vaughnwas appointed interim chief financial officer, assistant treasurer and secretaryof VCS on June 30, 2004. Since April 2001, Mr. Vaughn has been Presidentof Vaughn & Associates, P.C., a professional services organization hefounded in 1995 that provides interim and part-time chief financial officer,outsourced financial management, and tax advisory services for emerging andestablished businesses. From 1990 to 1995, Mr. Vaughn was chief financialofficer of XRL, Inc., a venture capital-backed manufacturer ofsemiconductor capital equipment, which was sold in 1995. Mr. Vaughn is acertified public accountant and is a member of the American Institute ofCertified Public Accountants and the Massachusetts Society of Certified PublicAccountants. Mr. Vaughn has over thirty years of accounting, finance andoperations experience. Mr. Vaughn holds a B.S. in Business Administrationfrom Stonehill College.

 

**Ian Cope.**On January 5, 2006, our board of directorsappointed Ian Cope as our chief operations officer.  Mr. Cope was thechief technical officer at DSLi Corporation since November 2002 where he wasresponsible for the complete operations of a facilities-based competitive localexchange carrier providing a full range of voice and data services using bothtraditional circuit switched infrastructure and IP Centrex.  From January2002 through November 2002, Mr. Cope was a consultant to major internet serviceproviders and incumbent local exchange carriers on broadband access solutions,providing technical direction on the planning and implementation ofinitiatives.  From January 2001 to December 2001, Mr. Cope was the vicepresident of engineering for NX Networks, Inc. Mr. Cope has over thirtyyears experience in the global telecommunications industry.

 

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**AdamBishop.**  Mr.Bishop has served as the president and chief executive officer of VistulaLimited, a wholly-owned subsidiary of VCS, since its inception in September2002 and President and Chief Executive Officer of Vistula USA since November2005.  Mr. Bishop has significantexperience as a senior executive in the international telecommunicationsindustry.  From 1994 to 1996, Mr. Bishopwas a senior executive at British Telecom PLC. From 1997 to December 2001, Mr. Bishop served as the chief executiveofficer of Telemonde Inc., a provider of international bandwidth and fiberpipes.  Mr. Bishop also served as adirector of Symposium Telecom Inc., a U.S. listed telecommunicationscompany.  Mr. Bishop has spent over 20years in the international telecommunications field.  Mr. Bishop graduated from London Universitywith a degree in Physics.

 

**J. Marcus Payne.**Mr. Paynehas served as a member of our board of directors since our inception.Mr. Payne is a senior partner and managing director of ParringtonAssociates Limited. Parrington provides consulting and management expertise toits clients in their international telecom ventures. In 1988, Mr. Paynefounded InnerAsia Consulting Group, the predecessor to Parrington.Mr. Payne received a law degree from the Law School of The University ofWestern Ontario in London, Ontario, Canada. Mr. Payne is a member of ouraudit committee, compensation committee and nominating committee.

 

**Anthony Warrender.**Since1983, Mr. Warrender has been the president of WarrenderAssociates, Inc., a private financial consultancy and investment businessbased in Virginia. Prior to 1983, Mr. Warrender was a Vice President(investment banking) of J. Henry Schroder Corporation in New York. He has alsoserved since 1987 as an executive director and chief financial officer of Taylor,Harris Insurance Services, Ltd, a privately-owned equine insurance agency.From October 1997 through November 2002, he also served as anon-executive director and chairman of the audit committee of the board forOxus Mining PLC, a gold and base metals mining company operating in CentralAsia*.* Mr. Warrendergraduated with a M.A. from Christ Church, Oxford and is a Fellow of theInstitute of Chartered Accountants in England and Wales. Mr. Warrender isa member of our audit committee, compensation committee and nominatingcommittee.

 

Our directorshold office until the next annual meeting of stockholders or until theirsuccessor is elected and qualified or until his or her earlier resignation orremoval.

 

Each executive officer serves at thediscretion of the board of directors and holds office until his or hersuccessor is elected and qualified or until his or her earlier resignation orremoval. There are no family relationships among any of our directors andexecutive officers.

 

**Committees of the Board of Directors**

 

The board of directors currently has threestanding committees. The board of directors has an audit committee which isresponsible for overseeing all of our financial and legal and regulatorycompliance functions, including matters relating to the appointment andactivities of our independent registered public accounting firm, audit plansand procedures, various accounting and financial reporting issues and changesin accounting policies, and reviewing the results and scope of the audit andother services provided by our independent registered public accounting firm.The audit committee has adopted a written charter.

 

The board of directors also has acompensation committee responsible for determining the compensation of ourexecutive officers. The compensation committee also intends to adopt a writtencharter. The board of directors has also established a nominating committee.The purpose of the nominating committee is to identify individuals qualified tobecome members of the board, to recommend director nominees for each annualmeeting of stockholders and nominees for election to fill any vacancies on theBoard of Directors and to address related matters.

 

Currently, two of our outside directors,Mr. Warrender and Mr. Payne, serve as members of the Audit Committee,the Compensation Committee and the Nominating Committee. Although the Board ofDirectors has not determined that any member of the Audit Committee is an “auditcommittee financial expert,” as defined in the rules adopted by the Securitiesand Exchange Commission, the Board of Directors has determined that each AuditCommittee member has sufficient knowledge in financial and auditing matters todischarge the responsibilities of the Audit Committee.

 

**Code of Ethics**

 

The Board has approved and we have adopted aCode of Business Conduct and Ethics (the “Code”), applicable to all of ourdirectors, officers and employees. The Audit Committee is responsible forreviewing and approving or rejecting all requested waivers to the Code, as suchwaiver(s) may apply to the Company’s Chief Executive Officer, Chairman,principal financial officer, principal accounting officer or controller, orpersons performing similar functions. We intend to post our Code of BusinessConduct and Ethics to our website (http://www.vistula.com) as soon aspracticable, and until such time, we undertake to provide any person withoutcharge, upon request, a copy of the Code. Persons interested in obtaining acopy of the Code are directed to send a written request to the Company at thefollowing address: Suite 801, 405 Park Avenue, New York, New York 10022, Attn:Audit Committee.

 

**Section 16(a) Beneficial OwnershipReporting**

 

Section 16(a) of the Securities ExchangeAct of 1934 requires our executive officers and directors and persons whobeneficially own more than ten percent of our common stock to file reports ofownership and changes in ownership with the Securities and Exchange

 

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Commission (“SEC”). SECregulations require executive officers, directors, and greater-than-ten-percentstockholders to furnish us with copies of all Section 16(a) forms they file.

 

Based solely upon a review of Forms 3 and 4 andamendments thereto furnished to us during 2005, we believe that all Section16(a) filing requirements applicable to our officers, directors andgreater-than-ten-percent stockholders were fulfilled in a timely manner.

 

**ITEM 10. EXECUTIVE COMPENSATION**

 

**Director Compensation**

 

We pay our non-employee directors an annualfee of $40,000. The non-employee directors will also receive a fee of $1,000for any regular or special meeting attended, or $500 for each telephonicmeeting in which the director participated, for any meeting in excess of fivemeetings in any year. The meeting fees for the first five meetings of a yearwill be included within the annual fee paid to the director.

 

We also pay each non-employee director whoserves as the chair of the audit committee an additional annual fee of $10,000and each non-employee director who serves as the chairman of the compensationand nominating committees an annual fee of $5,000. The other non-employeemembers of these committees will receive an annual fee of $2,500 for serving onthe committee. The non-employee directors will also receive a fee of $600 forany regular or special meeting of a committee attended, or $300 for eachtelephonic meeting of a committee in which the director participated, for anymeeting in excess of three meetings in any year. The meeting fees for the firstthree meetings of a year will be included within the annual committee fee paidto the directors.

 

Directors who are not employees may alsoreceive stock option grants under our option plan. We will also reimbursedirectors for out-of-pocket expenses incurred in attending board and committeemeetings and undertaking certain matters on our behalf. Directors who are ouremployees will not receive separate fees for their services as directors.

 

**Executive Officer Compensation**

 

**SummaryCompensation Table**

 

The following table provides summaryinformation concerning the compensation earned by our chief executive officerand our other executive officers for services rendered for the fiscal yearsended December 31, 2005 and December 31, 2004.

 
| ** **                                                                 | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **     | ** ** | **Long-Term**                  | ** ** |
|----------------------------------------------------------------------------|------------|------------|------------|------------------------------|------------|----------------|------------|--------------------------------|------------|
| ** **                                                                 | ** ** | ** ** | ** ** | ** **                   | ** ** | ** **     | ** ** | **Compensation (6)**           | ** ** |
| ** **                                                                 | ** ** | ** ** | ** ** | **Annual Compensation** | ** ** | **Securities** | ** ** |
| **Name and Principal Position**                             | ** ** | **Year**   | ** ** | **Salary($)**                | ** ** | **Bonus($)**   | ** ** | **Underlying Options(#)** | ** ** |
| Rupert Galliers-Pratt                                                      |       | 2005       |       | $                            | 240,000    |           | $          | 98,005                         |       | 650,000 |   |
| President, Chief Executive Officer and  Chairman of the Board of Directors |       | 2004       |       | 0                            |       | 0              |       | 0                              |       |
| George R. Vaughn                                                           |       | 2005       |       | 194,619                      | (3a)       | 0              |       | 50,000                         |       |
| Chief Financial Officer, Assistant  Treasurer and Secretary                |       | 2004       |       | 54,809                       | (3b)       | 0              |       | 0                              |       |
| Adam Bishop                                                                |       | 2005       |       | 180,000                      |       | 127,859        |       | 500,000                        |       |
| President, Vistula Limited                                                 |       | 2004       |       | 27,500                       | (4)        | 0              |       | 0                              |       |
| Mark Scully                                                                |       | 2005       |       | 100,909                      |       | 0              |       | 0                              |       |
| President, Vistula USA, Inc.                                               |       | 2004       |       | 120,000                      | (5)        | 0              |       | 2,750,000                      | (5)        |
| Christopher S. Burke (1)                                                   |       | 2005       |       | 0                            |       | 0              |       | 0                              |       |
| President and Chief Executive Officer                                      |       | 2004       |       | 0                            |       | 0              |       | 2,000,000                      | (2)        |
|                                                                            |            |            |            |                              |            |                |            |                                |            |  |  |

 

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(1)           Resigned effectiveFebruary 8, 2005.

 

(2)           Represents shares ofour common stock issuable upon exercise of options as at December 31,2004. Subsequent to December 31, 2004, Mr. Burke forfeited options topurchase 1.8 million shares of our common stock in connection with hisresignation. Subsequent to December 31, 2005, Mr. Burke forfeited the remainingoptions to purchase 200,000 shares of our common stock in connection with hisresignation.

 

(3)           Represents amountsearned by Vaughn & Associates, P.C. in their capacity of providingmultiple personnel to perform outsourced accounting services for the Company.Amounts paid during (a) 2005 ($188,338) were paid to Vaughn &Associates, P.C. and not to Mr. Vaughn personally. The remaining amountearned ($6,281) represents amounts accrued, but not paid; and (b) 2004($22,621)

 

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were paid to Vaughn & Associates, P.C. and not toMr. Vaughn personally. The remaining amount earned ($32,188) representsamounts accrued, but not paid.

 

(4)           Represents cashpayments made in 2004 of $27,500. In 2004, Mr. Bishop contributed $82,500in services for which he was not paid.

 

(5)           Represents amountsaccrued, but not paid. See Note 14 regarding our subsequent agreement datedFebruary 28, 2006 with Mr. Scully.

 

(6)           Excludes stockoptions granted in December 2005 that are subject to stockholder approval of anincrease in the number of shares authorized under the Company’s 2004 StockIncentive Plan as described below.

 

**Option grants in last fiscal year**

 
| ** **               | ** ** | **Individual Grants(2)**                                                       | ** ** |
|--------------------------|------------|-------------------------------------------------------------------------------------|------------|
| **Name**                 | ** ** | **Number of securities   underlying  options granted (#)** | ** ** | **% of total options   granted to  employees in fiscal  year** | ** ** | **Exercise  or base  price  ($ /share)** | ** ** | **Expiration  date** | ** ** |
| Rupert Galliers-Pratt(1) |       | 650,000                                                                             |       | 32.4 | % | $ | 0.45 |   | July 7, 2015 |   |
| George R. Vaughn         |       | 50,000                                                                              |       | 2.5 | % | $ | 0.45 |   | July 7, 2015 |   |
| Adam Bishop              |       | 500,000                                                                             |       | 24.9 | % | $ | 0.45 |   | July 7, 2015 |   |
| Anthony Warrender        |       | 225,000                                                                             |       | 11.2 | % | $ | 0.45 |   | July 7, 2015 |   |
| J. Marcus Payne          |       | 150,000                                                                             |       | 7.5 | % | $ | 0.45 |   | July 7, 2015 |   |

 

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(1)           Shares granted toExecutive Management Services Limited, the entity which our Chairman and ChiefExecutive Officer is contracted through for consulting services.

 

(2)           Excludes stockoptions granted in December 2005 that are subject to stockholder approval of anincrease in the number of shares authorized under the Company’s 2004 StockIncentive Plan as described below.

 

*Fiscal year-end option table.*The following table sets forth certaininformation regarding stock options held as of December 31, 2005 by theexecutive officers named in the summary compensation table.

 

Thevalue of unexercised in-the-money options is based on a price of $1.42 pershare, the fair market value of our stock on December 30, 2005, minus the pershare exercise price, multiplied by the number of shares underlying the option.Actual gains, if any, will depend on the value of the common stock on the dateof the sale of the shares.

 

**Aggregated option exercises in lastfiscal year and fiscal year-end option values**

** **
| ** **               | ** ** | **Shares  acquired  on ** | ** ** | **Value ** | ** ** | **Number of securities  underlying unexercised  options at fiscal year-end(4)** | ** ** | **Value of unexercised in-the-money options at fiscal  year-end** | ** ** |
|--------------------------|------------|--------------------------------|------------|-----------------|------------|---------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------|------------|
| **Name**                 | ** ** | **Exercise**                   | ** ** | **realized**    | ** ** | **Exercisable**                                                                                               | ** ** | **Unexercisable**                                                                               | ** ** | **Exercisable** | ** ** | **Unexercisable** | ** ** |
| ** **               | ** ** | **(#)**                        | ** ** | **($)**         | ** ** | **(#)**                                                                                                       | ** ** | **(#)**                                                                                         | ** ** | **($)** | ** ** | **($)** | ** ** |
| Rupert Galliers-Pratt(1) |       | —                         |       | —          |       | 650,000                                                                                                       |       | —                                                                                          |       | $ | 630,500 |   | — |   |
| George R. Vaughn         |       | —                         |       | —          |       | 50,000                                                                                                        |       | —                                                                                          |       | $ | 48,500 |   | — |   |
| Adam Bishop              |       | —                         |       | —          |       | 500,000                                                                                                       |       | —                                                                                          |       | $ | 485,000 |   | — |   |
| Mark Scully(2)           |       | —                         |       | —          |       | 2,750,000                                                                                                     |       | —                                                                                          |       | $ | 3,630,000 |   | — |   |
| Christopher Burke(3)     |       | —                         |       | —          |       | 200,000                                                                                                       |       | —                                                                                          |       | $ | 264,000 |   | — |   |

 

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(1)       Shares granted to Executive ManagementServices Limited, the entity which our Chairman and Chief Executive Officer iscontracted through for consulting services.

 

(2)       Mr. Scully was terminated as of November 2,2005. See Note 14 regarding our subsequent agreement dated February 28,2006 with Mr. Scully.

 

(3)       Mr. Burke’s options were forfeited onFebruary 8, 2006.

 

(4)       Excludesstock options granted in December 2005 that are subject to stockholder approvalof an increase in the number of shares authorized under the Company’s 2004Stock Incentive Plan as described below.

 

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OnDecember 23, 2005, the Company granted stock options to purchase 6,350,000shares of common stock to certain consultants, employees and directors as setforth below. All of the stock options have an exercise price of $1.50 per shareand an expiration date of December 23, 2015.  The stock options weregranted as compensation for consulting, employment or director services, asapplicable.  The options will become vested as to 25% of the total numberof option shares upon shareholder ratification of the increase in the number ofshares authorized under the Company’s 2004 Stock Incentive Plan to at least 15,000,000.Thereafter, the options will become vested as to an additional 6.25% of thetotal number of option shares in quarterly installments beginning onSeptember 30, 2006.  As the stock option grants are contingent uponshareholder ratification as described above, they have not been reflected asoutstanding as of December 31, 2005.

 

Options topurchase common stock were granted to the persons and in the amounts thatfollow:

 

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

 

J. Marcus Payne, one of ourdirectors, is a director of Olympic Corporate Holdings Limited.  RupertGalliers-Pratt, our Chairman, President and Chief Executive Officer, holdsindirect voting and investment control over shares held by Executive ManagementServices Limited.

 

**Employment Agreements**

 

On August 17, 2005, the Company entered into aConsulting Agreement (the “Agreement”) with Executive Management ServicesLimited (“EMS”) under which EMS agrees to provide the services of RupertGalliers-Pratt, the Company’s President, Chief Executive Officer and Chairmanof the Board of Directors, to the Company.  Under the Agreement, Mr.Galliers-Pratt will continue to serve as the Company’s President and ChiefExecutive Officer.  The Agreement provides that the Company shall pay EMSannual consulting fees of $240,000 as consideration for these services.

 

The Agreement has an initial term of twoyears.  The term of the Agreement shall be automatically extended foradditional periods of one year unless either party to the Agreement gives theother party notice of termination of the Agreement prior to the expiration ofthe then-current term.  The Agreement may be terminated at any time by EMSor the Company.  However, in the event the Company terminates theengagement of EMS without cause, the Company will be required to make severancepayments for a period of two years after, and at the consulting fee rate ineffect at the time of, such termination and to continue to pay for certainmedical and other benefit plans for such period.  Under the Agreement, EMSand Mr. Galliers-Pratt agree to be bound by certain non-competition andnon-solicitation provisions, which are effective during the term of theAgreement and for a period of two years after termination of the Agreement.

 

Rupert Galliers-Pratt has served as the Company’sPresident, Chief Executive Officer and Chairman of the Board of Directors sincethe Company’s inception in March 2004.

 

On January 5, 2006, the Company entered into anemployment agreement with Ian Cope relating to Mr. Cope’s employment as theCompany’s chief operations officer.  Under the employment agreement, theCompany will pay Mr. Cope an annual base salary of $140,000 and provide himwith certain employment related benefits.  In addition, the employmentagreement provides that the Company will grant Mr. Cope an incentive stockoption to purchase 250,000 shares of the Company’s common stock with anexercise price equal to $1.42 per share; 50,000 of those shares subject to theoption will be vested immediately and the remaining 200,000 shares subject tothe option will vest in four equal annual installments of 50,000 sharesbeginning on January 5, 2007.  The option will be subject to the terms andconditions of the Company’s 2004 Amended and Restated Stock Incentive Plan. The employment agreement also provides that if Mr. Cope is terminated withoutcause, the Company will be obligated to pay him his base salary for threemonths.

 

On January 1, 2004, the Company enteredinto an employment agreement with Mark Scully, the president of Vistula USA andone of the Company’s named executive officers. The employment agreement wasamended and restated on May 5, 2004. The amended and restated employmentagreement had a term of 18 months. The terms of his employment agreementprovide that Mr. Scully would receive a base salary at a monthly rate of$10,000 and he would be entitled to an annual bonus based on Vistula USAmeeting certain performance milestones based on its gross profit margin.Mr. Scully was also entitled to receive a severance payment equal to sixmonths of base salary if he is terminated without cause by Vistula USA. Nobonus has been paid to Mr. Scully under the terms of this agreement. As ofNovember 2, 2005, the employment agreement with Mr. Scully had been terminated.  See Note 14 regarding our subsequentagreement dated February 28, 2006 with Mr. Scully.

 

**ITEM 11. SECURITY OWNERSHIP OF CERTAINBENEFICIAL OWNERS AND MANAGEMENT**

 

At the close of business on March 22,2006, there were issued and outstanding 32,664,898 shares of our common stock.The following table provides information regarding beneficial ownership of ourcommon stock as of March 22, 2006 by:

 

•      Each personknown by us to be the beneficial owner of more than five percent of our commonstock;

 

•      Each of ourdirectors;

 

•      Each executiveofficer named in the summary compensation table (including one former executiveofficer); and

 

60

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•      All of ourcurrent directors and executive officers as a group.

 

The persons named in this table have solevoting and investment power with respect to the shares listed, except asotherwise indicated. The inclusion of shares listed as beneficially owned doesnot constitute an admission of beneficial ownership. Shares beneficially ownedinclude shares that may be purchased through the exercise of options that vestwithin 60 days of March 22, 2006.

 
| ** **                                                                                                               | ** ** | **Shares Beneficially Owned** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------|------------|
| **Name/Address of Beneficial Owner**                                                                      | ** ** | **Number(9)**                           | ** ** | **Percent** | ** ** |
| Rupert  Galliers-Pratt(1)  Mawley Hall, Cleobury Mortimer  Worcestershire, DY14 8PN, United Kingdom;                     |       | 13,560,000                              |       | 40.8 | % |
|                                                                                                                     |       |                                    |       |   |   |
| Executive  Management Services Limited(2)  Palm Chambers No.4  Fishlock Road  Road Town  Tortola, British Virgin Islands |       | 9,150,000                               |       | 27.5 | % |
|                                                                                                                     |       |                                    |       |   |   |
| Oneta  Associates, Inc.  The Pasea Estate  Road Town  Tortola, British Virgin Islands                                    |       | 5,450,000                               |       | 16.7 | % |
|                                                                                                                     |       |                                    |       |   |   |
| Gryphon  Master Fund L.P.(10)  100 Crescent Court  Suite 490  Dallas, Texas 75201                                   |       | 3,333,650                               |       | 9.5 | % |
|                                                                                                                     |       |                                    |       |   |   |
| Mark  Scully(3)  859 Ophir Peak Road  Incline Village,  Nevada 89451                                                     |       | 750,000                                 |       | 2.3 | % |
|                                                                                                                     |       |                                    |       |   |   |
| Adam  Bishop(4)  44 Kenilworth Road  London W1H 6LT, United Kingdom                                                      |       | 1,000,000                               |       | 3.0 | % |
|                                                                                                                     |       |                                    |       |   |   |
| J. Marcus  Payne(5)  5315 N. Clark Street  Chicago, Illinois 60640                                                       |       | 325,000                                 |       | 1.0 | % |
|                                                                                                                     |       |                                    |       |   |   |
| Anthony  Warrender(6)  4392 Carrington Road  Markham, Virginia 22643                                                     |       | 400,000                                 |       | 1.2 | % |
|                                                                                                                     |       |                                    |       |   |   |
| Little Wing,  L.P./Parker L. Quillen(7)  c/o Quilcap Corp.  145 E. 57th Street, 10th Floor  New York, NY 10022           |       | 2,714,866                               |       | 7.9 | % |
|                                                                                                                     |       |                                    |       |   |   |
| George R.  Vaughn(8)  639 Granite Street  Braintree, MA 02184                                                            |       | 50,000                                  |       |   | * |
|                                                                                                                     |       |                                    |       |   |   |
| All current  directors and executive officers as a group (5 persons)                                                |       | 15,335,000                              |       | 44.8 | % |

 

61

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----

*              Indicates less than1%

 

(1)           Includes 8,500,000shares held by Executive Management Services Limited (“EMS”) and 650,000 sharesthat may be purchased upon the exercise of options held by EMS.Mr. Galliers-Pratt has indirect voting and investment power with respectto these shares. Also includes an aggregate of 3,780,000 shares held of recordby certain family members of Mr. Galliers-Pratt. Mr. Galliers-Prattis our chairman, president and chief executive officer.

 

(2)           Includes 650,000 sharesthat may be purchased upon the exercise of options.

 

(3)           Mr. Scully was thepresident of our wholly owned subsidiary, Vistula USA, Inc., throughNovember 2, 2005, at which time employment was terminated. In connection with a mutual release ofclaims, we issued to him 750,000 shares of our common stock in respect of theexercise of an outstanding option issued under our stock incentive plan. These 750,000 shares are subject to our right to repurchase at a price of $1.00per share through March 31, 2006.

 

(4)           Mr. Bishop is thepresident of our wholly owned subsidiaries Vistula Limited and Vistula USA,Inc.

 

(5)           Represents shares heldby Olympic Corporate Holdings Limited of which Mr. Payne is a director.Includes 150,000 shares that may be purchased through the exercise of optionsheld by Mr. Payne. Mr. Payne is a member of our board of directors.

 

(6)           Includes 240,000 sharesthat may be purchased through the exercise of options held by Mr. Warrender. Mr. Warrenderis a member of our board of directors.

 

(7)           Information is based onour internal records and a Schedule 13G filed by Little Wing, L.P. with theSecurities and Exchange Commission on November 7, 2005. Includes sharesbeneficially owned by Tradewinds Fund Ltd., an entity affiliated with LittleWing, L.P.

 

(8)           Mr. Vaughn is ourChief Financial Officer, Assistant Treasurer and Secretary.

 

(9)           Excludesstock options granted in December 2005 that are subject to stockholderapproval of an increase in the number of shares authorized under the Company’s2004 Stock Incentive Plan as described below.

 

(10)         Information is basedon our internal records and a Schedule 13G/A filed by Gryphon Master Fund L.P.with the Securities and Exchange Commission on December 31, 2005.

 

**Securities Authorized for Issuance UnderEquity Compensation Plans**

 

The following table sets forth certaininformation as of December 31, 2005, regarding securities authorized forissuance under our equity compensation plans, including individual compensationarrangements.

 
| **Plan Category**                                      | ** ** | **Number of Securities to be   Issued Upon Exercise of  Outstanding Options,  Warrants and Rights** | ** ** | **Weighted-Average Exercise  Price of Outstanding Options,  Warrants and Rights** | ** ** | **Number of Securities  Remaining Available for  Future Issuance Under Equity  Compensation Plans** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------|------------|
| Equity compensation plans approved by  security holders     |       | 5,223,000                                                                                                                                                  |       | $                                                                                                               | 0.31       |                                                                                                                                        | 2,717,000  |   |
| Equity compensation plans not approved by  security holders |       | —                                                                                                                                                     |       | —                                                                                                          |       | —                                                                                                                                      |       |
| **Total**                                                   |       | 5,223,000                                                                                                                                                  |       | $                                                                                                               | 0.31       |                                                                                                                                        | 2,717,000  |   |

 

Excludes stock options granted in December 2005that are subject to stockholder approval of an increase in the number of sharesauthorized under the Company’s 2004 Stock Incentive Plan as described above.

 

62

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**ITEM 12. CERTAIN RELATIONSHIPS AND RELATEDTRANSACTIONS**

 

One of our subsidiaries, Vistula Limited, hadagreed to unconditionally guarantee the obligations of one of our principalstockholders under a credit facility established in the name of thestockholder. For more information, see “PART II, Item 6. Management’sDiscussion and Analysis of Financial Condition and Results ofOperations—Off-Balance Sheet Arrangements.” This guaranty was released by the financial institution on March 27,2006.

 

On March 2, 2004, we purchased all ofthe issued and outstanding ordinary shares of Cardlink and all of the issuedand outstanding ordinary shares of Vistula. We issued an aggregate of23,885,000 shares of common stock to the former shareholders of Vistula andCardlink in exchange for all of the shares of Cardlink and Vistula.Mr. Rupert-Galliers-Pratt, the chairman of our board and our president andchief executive officer, and his affiliates, controlled Vistula and Cardlinkprior to this transaction.

 

On May 5, 2004, we sold 100,000 sharesof our common stock to Mr. Anthony Warrender, one of our directors, for atotal consideration of $5,000. On May 5, 2004, we also issued an option topurchase 75,000 shares of our common stock to Mr. Warrender.

 

On August 11, 2005, we extended theconvertible promissory note dated July 12, 2004, in the principal amount of$125,000 and the convertible promissory note dated August 11, 2004, in theprincipal amount of $50,000 issued by the Company, with the J. RothschildAssurance Self Invested Personal Pension Plan No. 2, the sole beneficiary ofwhich is our chairman, chief executive officer and president, Mr. RupertGalliers-Pratt, to December 31, 2005. On December 15, 2005, these two noteswere extended to June 30, 2006. These notes accrue interest at the rate of 7%per annum and are convertible into shares of our common stock at the price of$1.50 per share.

 

On December 7,2005, the Company issued 100,000 shares of common stock to a stockholder ofVistula Communications Services SA (Pty.) Ltd. for consulting services to berendered through December 6, 2006.  Theshares had a fair value of $130,000 based upon the closing price ($1.30) of theCompany’s common stock as at December 7, 2005. Consulting services performed during 2005 have been included in selling,general and administrative expense for the year ended December 31, 2005.  That amount attributable to 2006 is reflectedas prepaid professional services at December 31, 2005.

 

**ITEM 13. EXHIBITS**

 
| ** **       | ** ** | ** **                                                                                                                                                                                                                                     | ** ** | **Filed with**        | ** ** | **Incorporated by  Reference** |
|------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                | ** ** | **this Form  10-KSB** | ** ** | **Form**                       | ** ** | **Filing Date** | ** ** | **Exhibit  No.** |
| 2.1              |       | Asset Purchase Agreement, dated as of  January 5, 2004, by and between VCS, Inc. and MRS Partners LLC.                                                                                                                               |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 2.1 |
| 2.2              |       | Amendment and Indemnification Agreement,  dated as of May 5, 2004, by and between Vistula Communications  Services, Inc., MRS Partners LLC and Manuel Vierra, Pepper Snyder,  Steven Ziswasser, Seymour Ziswasser, and Kirk Rossman. |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 2.2 |
| 3.1              |       | Certificate of Incorporation filed with the  Delaware Secretary of State on September 22, 2003.                                                                                                                                           |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 3.1 |
| 3.2              |       | Certificate of Amendment of Certificate of  Incorporation filed with the Delaware Secretary of State on January 23,  2004.                                                                                                                |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 3.2 |
| 3.3              |       | Certificate of Amendment of Certificate of  Incorporation filed with the Delaware Secretary of State on March 4,  2004.                                                                                                                   |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 3.3 |
| 3.4              |       | Bylaws adopted on September 22, 2003.                                                                                                                                                                                                     |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 3.4 |
| 3.5              |       | Certificate of Amendment of Certificate of  Incorporation filed with the Delaware Secretary of State on July 20,  2004.                                                                                                                   |       |                  |       | Form 10-SB/A              |   | August 31,  2004 |   | 3.5 |
| 10.2*            |       | Amended and Restated Employment and  Noncompetition Agreement, dated as of May 5, 2004, by and between  Vistula Communications Services, Inc., Vistula USA, Inc. and Mark  Scully.                                              |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.2 |
| 10.3*            |       | Amended and Restated Employment and Noncompetition  Agreement, dated as of May 5, 2004, by and between Vistula  Communications Services, Inc., Vistula USA, Inc. and Eric Pomeroy.                                              |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.3 |
| 10.4 *           |       | Amended and Restated Employment and  Noncompetition Agreement, dated as of May 5, 2004, by and between  Vistula Communications Services, Inc., Vistula USA, Inc. and Edward  DeMent.                                            |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.4 |
| 10.5*            |       | Non-Statutory Stock Option, dated as of  May 5, 2004, by and between Vistula Communications Services, Inc.  and Mark Scully.                                                                                                         |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.5 |
| 10.6*            |       | Non-Statutory Stock Option, dated as of  May 5, 2004, by and between Vistula Communications Services, Inc.  and Edward DeMent.                                                                                                       |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.6 |
| 10.7*            |       | Non-Statutory Stock Option, dated as of  May 5, 2004, by and between Vistula Communications Services, Inc.  and Eric Pomeroy.                                                                                                        |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.7 |
| 10.8             |       | Telehouse FM Services Agreement, dated as  of September 3, 2003, by and between Vistula Limited and Telehouse  International Corporation of Europe Limited.                                                                               |       |                  |       | Form 10-SB/A              |   | August 31,  2004 |   | 10.8 |

 

63

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| ** **       | ** ** | ** **                                                                                                                                                                                                                           | ** ** | **Filed with**        | ** ** | **Incorporated by  Reference** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                      | ** ** | **this Form  10-KSB** | ** ** | **Form**                       | ** ** | **Filing Date** | ** ** | **Exhibit  No.** |
| 10.9             |       | Preferred Partner Agreement, dated as of  December 16, 2003, by and between Vistula Limited and Telstra Europe  Limited.                                                                                                        |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.9 |
| 10.10            |       | Resale Agreement, dated as of  September 4, 2003, by and between Vistula Limited and Telstra Europe Limited.                                                                                                                    |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.10 |
| 10.11            |       | Reciprocal International Telecommunications  Services Carrier Agreement, dated as of January 20, 2004, by and between  Vistula Limited and SwissFone Inc.                                                                       |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.11 |
| 10.12            |       | Service Agreement, dated as of  September 1, 2003, by and between Vistula Limited and iBasis  Global, Inc.                                                                                                                 |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.12 |
| 10.13            |       | Qwest Wholesale Services Agreement, dated  as of February 27, 2004, by and between Vistula Limited and Qwest  Communications Corporation.                                                                                       |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.13 |
| 10.14            |       | Reciprocal Telecommunications Services  Agreement, dated as of January 23, 2004, by and between Vistula Limited  and Teleglobe International Ltd.                                                                               |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.14 |
| 10.15            |       | Primus Telecommunications Limited Carrier  Services Agreement, dated as of February 16, 2004, by and between  Vistula Limited and Primus Telecommunications Limited.                                                            |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.15 |
| 10.16            |       | Reciprocal Telecommunications Services  Agreement, dated as of December 2, 2002, by and between Vistula Limited  and Bharti Telesonic Ltd.                                                                                      |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.16 |
| 10.17            |       | International Switched Telecommunications  Services Agreement, dated as of August 8, 2003, by and between Vistula  Limited and Elitetele SA.                                                                                    |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.17 |
| 10.18            |       | Global IP Network Service Agreement, dated  as of February 10, 2004, by and between Vistula Limited and NTT Europe  Ltd.                                                                                                        |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.18 |
| 10.19            |       | Reciprocal International Carrier Service  Agreement, dated as of April 15, 2004, by and between Vistula Limited  and KDDI America, Inc.                                                                                    |       |                  |       | Form 10-SB                |   | May 12,  2004 |   | 10.19 |
| 10.20            |       | Distribution and Marketing Agreement, dated  as of August 11, 2004, by and between NetYantra Inc., NetYantra India  Pvt. Ltd. and Vistula Communications Services, Inc.                                                    |       |                  |       | Form 10-SB/A              |   | August 31,  2004 |   | 10.20 |
| 10.21            |       | Amended and Restated Note Subscription  Agreement, dated as of August 11, 2004, by and between J. Rothschild  Assurance Self Invested PPP#2 F/B/O Rupert Anthony Galliers-Pratt and Vistula  Communications Services, Inc. |       |                  |       | Form 10-SB/A              |   | August 31,  2004 |   | 10.21 |
| 10.22            |       | Convertible Promissory Note, dated as of  July 12, 2004, issued to J. Rothschild Assurance Self Invested PPP#2  F/B/O Rupert Anthony Galliers-Pratt in the principal amount of $125,000.                                        |       |                  |       | Form 10-SB/A              |   | August 31,  2004 |   | 10.22 |

 

64

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| ** **       | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     | ** ** | **Filed with**        | ** ** | **Incorporated by  Reference** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                | ** ** | **this Form  10-KSB** | ** ** | **Form**                       | ** ** | **Filing Date** | ** ** | **Exhibit  No.** |
| 10.23            |       | Convertible Promissory Note, dated as of  August 11, 2004, issued to J. Rothschild Assurance Self Invested PPP#2  F/B/O Rupert Anthony Galliers-Pratt in the principal amount of $50,000.                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                  |       | Form 10-SB/A              |   | August 31,  2004 |   | 10.23 |
| 10.24            |       | Letter Agreement, dated September 9, 2004, by  and between NetYantra Inc., NetYantra India Pvt. Ltd. and Vistula  Communications Services, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                  |       | Form 10-QSB               |   | November 19,  2004 |   | 10.13 |
| 10.25            |       | Securities Purchase Agreement dated  February 18, 2005 by and among Vistula Communications Services, Inc.  and Bushido Capital Master Fund, L.P., Oxford Capital Management, LLC,  Stratford Partners, L.P., Gryphon Master Fund, L.P., Little Wing, L.P., Gamma  Opportunity Capital Partners L.P., GSSF Master Fund, L.P., Tradewinds Fund  Ltd., Professional Traders Fund, LLC DKR SoundShore Oasis Holding Fund Ltd.,  DKR SoundShore Strategic Holding Fund Ltd., Michael S. Urban and Sherry  Urban, Murray Chernick, Scott A. Craven, Valor Capital Management, LP, Keith  Barksdale, and Edward Neugeboren. |       |                  |       | Form 8-K                  |   | February 25,  2005 |   | 10.1 |
| 10.26            |       | Form of 8% Convertible Debenture                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          |       |                  |       | Form 8-K                  |   | February 25,  2005 |   | 4.1 |
| 10.27            |       | Form of Common Stock Purchase Warrant                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     |       |                  |       | Form 8-K                  |   | February 25,  2005 |   | 4.2 |
| 10.28            |       | Registration Rights Agreement dated  February 18, 2005 by and among Vistula Communications  Services, Inc. and Bushido Capital Master Fund, L.P., Oxford Capital  Management, LLC, Stratford Partners, L.P., Gryphon Master Fund, L.P., Little  Wing, L.P., Gamma Opportunity Capital Partners L.P., GSSF Master Fund, L.P.,  Tradewinds Fund Ltd., Professional Traders Fund, LLC DKR SoundShore Oasis  Holding Fund Ltd., DKR SoundShore Strategic Holding Fund Ltd., Michael S.  Urban and Sherry Urban, Murray Chernick, Scott A. Craven, Valor Capital  Management, LP, Keith Barksdale, and Edward Neugeboren. |       |                  |       | Form 8-K                  |   | February 25,  2005 |   | 10.2 |
| 10.29            |       | Placement Agent Agreement dated February 15,  2005 by and between Vistula Communications Services, Inc. and IndiGo  Securities, LLC.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 |       |                  |       | Form 8-K                  |   | February 25,  2005 |   | 10.3 |

 

65

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| ** **       | ** ** | ** **                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    | ** ** | **Filed with**        | ** ** | **Incorporated by  Reference** |
|------------------|------------|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               | ** ** | **this Form  10-KSB** | ** ** | **Form**                       | ** ** | **Filing Date** | ** ** | **Exhibit  No.** |
| 10.30            |       | Escrow Agreement dated February 18, 2005 by and  among Vistula Communications Services, Inc., IndiGo Securities, LLC, Feldman  Weinstein LLP, Bushido Capital Master Fund, L.P., Oxford Capital Management,  LLC, Stratford Partners, L.P., Gryphon Master Fund, L.P., Little Wing, L.P.,  Gamma Opportunity Capital Partners L.P., GSSF Master Fund, L.P., Tradewinds  Fund Ltd., Professional Traders Fund, LLC DKR SoundShore Oasis Holding Fund  Ltd., DKR SoundShore Strategic Holding Fund Ltd., Michael S. Urban and Sherry  Urban, Murray Chernick, Scott A. Craven, Valor Capital Management, LP, Keith  Barksdale, and Edward Neugeboren. |       |                  |       | Form 8-K                  |   | February 25,  2005 |   | 10.4 |
| 10.31            |       | Second Amendment to Asset Purchase Agreement dated  as of March 15, 2005, by and between Vistula Communications  Services, Inc., MRS Partners LLC, Manuel Vierra, Pepper Snyder, Steven  Ziswassser, Seymour Ziswasser and Kirk Rossman.                                                                                                                                                                                                                                                                                                                                                                                                            |       |                  |       | Form 8-K                  |   | March 21,  2005 |   | 10.1 |
| 10.32            |       | Promissory note issued on March 15,  2005 by Vistula Communications Services, Inc. to MRS Partners LLC.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                             |       |                  |       | Form 8-K                  |   | May 23,  2005 |   | 4.1 |
| 10.33            |       | Distribution and Marketing Agreement by and between  Vistula Communications Services, Inc. and Telstra Europe Limited dated  as of April 1, 2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       |                  |       | Form 8-K                  |   | April 4,  2004 |   | 10.1 |
| 10.34*           |       | Vistula Communications Services, Inc. Amended  and Restated 2004 Stock Incentive Plan.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                   |       |                  |       | Form 10-QSB               |   | August 15,  2005 |   | 10.1 |
| 10.35*           |       | Consulting Agreement dated August 17, 2005 with  Executive Management Services Limited.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  |       |                  |       | Form 8-K                  |   | August 18,  2005 |   | 10.1 |
| 10.36            |       | Form of Warrant Exercise Agreement.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                      |       |                  |       | Form 8-K                  |   | October 7,  2005 |   | 4.1 |
| 10.37            |       | Form of Warrant.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                         |       |                  |       | Form 8-K                  |   | October 7,  2005 |   | 10.1 |
| 10.38            |       | Registration Rights Agreement dated October 3,  2005.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |       |                  |       | Form 8-K                  |   | October 7,  2005 |   | 10.2 |
| 10.39            |       | Consultant, Representative and Professional Services  Agreement dated December 13, 2005 with Quest  Telecommunications, Inc.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        |       |                  |       | Form 8-K                  |   | December 19,  2005 |   | 10.1 |
| 10.40*           |       | Employment Agreement with Ian Cope dated  January 5, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                               |       |                  |       | Form 8-K                  |   | January 10,  2006 |   | 10.1 |
| 10.41            |       | Financial Advisory Agreement with Indigo Ventures  LLC dated January 27, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           |       |                  |       | Form 8-K                  |   | January 31,  2006 |   | 10.1 |
| 10.42            |       | Subscription Agreement by and between Vistula  Communications Services, Inc. and Indigo Investments I LLC dated  March 30, 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    |       | X                     |       |                           |   |   |   |   |

 

66

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| ** **       | ** ** | ** **                                                                                                                                                                                                                                             | ** ** | **Filed with**        | ** ** | **Incorporated by  Reference** |
|------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|--------------------------------|
| **Exhibit  No.** | ** ** | **Description**                                                                                                                                                                                                                                        | ** ** | **this Form  10-KSB** | ** ** | **Form**                       | ** ** | **Filing Date** | ** ** | **Exhibit  No.** |
| 10.43            |       | Loan and Security Agreement by and between Vistula  Communications Services, Inc. and Indigo Investments I LLC dated as of  March 30, 2006.                                                                                                  |       | X                     |       |                           |   |   |   |   |
| 10.44            |       | Revolving Loan Note issued by Vistula Communications  Services, Inc. to Indigo Investments I LLC on March 30, 2006.                                                                                                                          |       | X                     |       |                           |   |   |   |   |
| 10.45            |       | Common Stock Purchase Warrant issued by Vistula  Communications Services, Inc. to Indigo Investments I LLC on  March 30, 2006.                                                                                                               |       | X                     |       |                           |   |   |   |   |
| 21.1             |       | List of Subsidiaries of the Registrant.                                                                                                                                                                                                                |       |                  |       | Form SB-2                 |   | December 30,  2005 |   | 21.1 |
| 23.1             |       | Consent of PKF, Certified Public Accountants, A  Professional Corporation                                                                                                                                                                              |       | X                     |       |                           |   |   |   |   |
| 23.2             |       | Consent of Vitale, Caturano & Company, Ltd.                                                                                                                                                                                                   |       | X                     |       |                           |   |   |   |   |
| 31.1             |       | Certification by Rupert Galliers-Pratt pursuant to  Rule 13a-14(a) and 15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002, relating to Vistula  Communications Services, Inc.                        |       | X                     |       |                           |   |   |   |   |
| 31.2             |       | Certification by George R. Vaughn pursuant to  Rule 13a-14(a) and 15d-14(a), as adopted pursuant to  Section 302 of the Sarbanes-Oxley Act of 2002, relating to Vistula  Communications Services, Inc.                             |       | X                     |       |                           |   |   |   |   |
| 32.1             |       | Certification by Rupert Galliers-Pratt pursuant to  Section 1350, Chapter 63 of Title 18, United States Code, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, relating to  Vistula Communications Services, Inc. |       | X                     |       |                           |   |   |   |   |
| 32.2             |       | Certification by George R. Vaughn pursuant to  Section 1350, Chapter 63 of Title 18, United States Code, as adopted  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, relating to  Vistula Communications Services, Inc.      |       | X                     |       |                           |   |   |   |   |

 

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* Management contract orcompensatory plan or arrangement.

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

 

Aggregate fees for professional services rendered for the Company byour prior principal accountant Vitale, Caturano & Company, Ltd. (“Vitale”)and our successor accountant, PKF, Certified Public Accountants, A ProfessionalCorporation (“PKF”), for the years ended December 31, 2005 andDecember 31, 2004, were:

 
| ** **    | ** ** | **2005** | ** ** | **2004** | ** ** |
|---------------|------------|----------|------------|----------|------------|
| Audit, PKF    |       | $        | 85,000     |     | $          | — |   |
| Audit, Vitale |       | 74,964   |       | 98,000   |       |
|               |            |          |            |          |            |  |  |

 

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| Audit Related, Vitale |   | 18,802 |    | 39,000 |   |
|-----------------------|--------|--------|---------|--------|--------|
| Tax                   |   | — |    | — |   |
| All Other             |   | — |    | — |   |
| Total                 |   | $      | 178,766 |   | $      | 137,000 |   |
|                       |        |        |         |        |        |  |  |

 

The Audit fees for the years endedDecember 31, 2005 and 2004 were for professional services rendered for theaudits of the consolidated financial statements of the Company and statutoryaudits and reviews.

 

The Audit Related fees for the years endedDecember 31, 2005 and 2004 were for professional services rendered inconnection with consents and assistance with review of registration statementsfiled with the Securities and Exchange Commission (“SEC”), for consultationsconcerning financial accounting and reporting standards, and audits of businesscombinations.

 

The percentage of hours expended by PKF,Certified Public Accountants, A Professional Corporation (for 2005) and Vitale,Caturano & Company, Ltd.’s (for 2004) to audit our financialstatements that were performed by other than each respective firm’s full-timepermanent employees did not exceed 50%.

 

**Policy on Audit Committee Pre-Approval ofAudit and Permissible Non-Audit Services of Independent Registered PublicAccounting Firm**

 

At present, it is the practice of our boardof directors to approve each engagement for audit or non-audit services beforewe engage our independent registered public accounting firm to provide thoseservices. Our board of directors has established pre-approval policies andprocedures in accordance with SEC regulations, describing the specific audit,audit-related, tax and all other services that have been pre-approved by theboard of directors. The term of any general pre-approval is 12 months fromthe date of pre-approval, unless our board of directors specifically providesfor a different period. Our board will annually review the pre-approvalpolicies and procedures and the services that may be provided by ourindependent registered public accounting firm, and will revise the list of pre-approvedservices from time to time based on subsequent determinations.

 

None of the services provided by ourindependent registered public accounting firm for the year endedDecember 31, 2005 was obtained in reliance on the waiver of thepre-approval requirement afforded in SEC regulations.

 

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**SIGNATURES**

 

In accordance with Section 13 or 15(d)of the Exchange Act, the registrant caused this report to be signed on itsbehalf by the undersigned, thereunto duly authorized.

 
| ** ** | **VISTULA COMMUNICATIONS SERVICES, INC.** |
|------------|------------------------------------------------|
|       | By:                                            |
|       |                                           | /s/ Rupert Galliers-Pratt |   |
|       |                                           | Rupert Galliers-Pratt  Title: President, Chief Executive Officer and Chairman of the Board of  Directors |
|       | Date: March 31, 2006                           |

 

In accordance with the Exchange Act, thisreport has been signed below by the following persons on behalf of theregistrant and in the capacities and on the dates indicated.

 
|   | By:                  |
|--------|----------------------|
|   |                 | /s/ Rupert Galliers-Pratt |   |
|   |                 | Rupert Galliers-Pratt  Title: President, Chief Executive Officer and Chairman of the Board of  Directors (principal executive officer) |
|   | Date: March 31, 2006 |
|   | By:                  |
|   |                 | /s/ George R. Vaughn |   |
|   |                 | George R. Vaughn  Title: Chief Financial Officer (principal financial and accounting officer) |
|   | Date: March 31, 2006 |
|   | By:                  |
|   |                 | /s/ J. Marcus Payne |   |
|   |                 | J. Marcus Payne Title: Director |
|   | Date: March 31, 2006 |
|   | By:                  |
|   |                 | /s/ Anthony Warrender |   |
|   |                 | Anthony Warrender Title: Director |
|   | Date: March 31, 2006 |
|        |                      |  |  |  |  |

 

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