**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K/A**


**(Amendment
      No. 1)**


(Mark
      One)





**x ANNUAL
      REPORT
      PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934**





For
      the
      fiscal year ended December 31, 2006





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





For
      the
      transition period ____________to____________


*Commission
      file number 000-28985*




**VOIP,
      INC.**


(Exact
      name of registrant as specified in its charter)





Texas
            
            75-2785941(State
                or other jurisdiction of incorporation or organization)
            
            (I.R.S.
                Employer Identification No.)151
                South Wymore Road, Suite 3000Altamonte
                Springs, Florida
            
            32714(Address
                of principal executive offices)
            
            (ZIP
                Code)





Issuer's
      telephone number, including area code: (407) 389-3232





**Securities
      registered pursuant to Section 12(g) of the Act: Common Stock, par value
      $0.001.**





Indicate
      by check mark if the registrant is a well-known seasoned issuer as defined
      in
      Rule 405 of the Securities Act.  YES o NO x





Indicate
      by check mark if the registrant is not required to file reports pursuant to
      Section 13 or Section 15(d) of the Act.  YES o NO x





Indicate
      by check mark whether the registrant (1) has filed all reports required to
      be
      filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
      the
      preceding 12 months (or for such shorter period that the registrant was required
      to file such reports), and (2) has been subject to such filing requirements
      for
      the past 90 days. YES x NO o





Indicate
      by check mark if disclosure of delinquent filers pursuant to Item 405 of
      Regulation S-K (§229.405 of this chapter) is not contained herein, and will not
      be contained, to the best of registrant's knowledge, in definitive proxy or
      information statements incorporated by reference in Part III of this Form 10-K
      or any amendment to this Form 10-K. x





Indicate
      by check mark whether the registrant is a large accelerated filer, an
      accelerated filer, or a non-accelerated filer. See definition of “accelerated
      filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check
      one):


Large
      accelerated filer o Accelerated
      filer o Non-accelerated
      filer x





Indicate
      by check mark whether the registrant is a shell company (as defined in Rule12b-2
      of the Act).  YES o NO x





Issuer's
      revenues for its most recent fiscal year were $5,933,248.





At
      June
      30, 2006, the last business day of the registrant's most recently completed
      second fiscal quarter, there were 3,525,456 shares of registrant's common stock
      outstanding (after adjustment for reverse stock split effective August 16,
      2007), and the aggregate market value of such shares held by non-affiliates
      of
      the registrant (based upon the closing sale price of such shares on the
      Over-The-Counter Bulletin Board on June 30, 2006) was approximately
      $38,722,066. Shares of the registrant's common stock held by each executive
      officer and director and by each entity or person that, to the registrant's
      knowledge, owned 5% or more of the registrant's outstanding common stock as
      of
      June 30, 2006, have been excluded in that such persons may be deemed to be
      affiliates of the registrant. This determination of affiliate status is not
      necessarily a conclusive determination for other purposes.





At
      March
      28, 2007, the registrant had outstanding 4,930,486 (after adjustment for reverse
      stock split effective August 16, 2007) and no shares of par value $0.001 common
      stock and par value $0.001 preferred stock, respectively.





Company
      Symbol: VOIC









**TABLE
      OF CONTENTS**


**PART
                  I**
              
              
              4**Item
                  1.**
              **Business**
              
              4**Item
                  1A.**
              **Risk
                  Factors**
              
              9**Item
                  2.**
              **Properties**
              
              18**Item
                  3.**
              **Legal
                  Proceedings**
              
              18**Item
                  4.**
              **Submission
                  of Matters to a Vote of Security Holders**
              
              19**PART
                  II**
              
              
              20**Item
                  5.**
              **Market
                  for Registrant's Common Equity, Related Stockholder Matters and
                  Issuer
                  Purchases of Equity Securities**
              
              20**Item
                  6.**
              **Selected
                  Financial Data**
              
              20**Item
                  7.**
              **Management's
                  Discussion and Analysis of Financial Condition and Results of
                  Operations**
              
              21**Item
                  7A.**
              **Quantitative
                  and Qualitative Disclosures About Market Risk**
              
              31**Item
                  8.**
              **Financial
                  Statements and Supplementary Data**
              
              32**Item
                  9.**
              **Changes
                  in and Disagreements With Accountants on Accounting and Financial
                  Disclosure**
              
              32**Item
                  9A.**
              **Controls
                  and Procedures**
              
              32**Item
                  9B.**
              **Other
                  Information**
              
              34**PART
                  III**
              
              
              34**Item
                  10.**
              **Directors
                  and Executive Officers of the Registrant**
              
              34**Item
                  11.**
              **Executive
                  Compensation**
              
              36**Item
                  12.**
              **Security
                  Ownership of Certain Beneficial Owners and Management and Related
                  Stockholder Matters**
              
              42**Item
                  13.**
              **Certain
                  Relationships and Related Transactions**
              
              44**Item
                  14.**
              **Principal
                  Accounting Fees and Services**
              
              44**PART
                  IV**
              
              
              45**Item
                  15.**
              **Exhibits
                  and Financial Statement Schedules**
              
              45




2




**Explanatory
      Note**





VoIP,
      Inc. (the "Company") is filing this Amendment No. 1 to its Annual Report on
      Form
      10-K for the year ended December 31, 2006 (the "2006 10-K"), which was
      originally filed on April 2, 2007.





As
      reported in the Company’s Form 8-K filed on July 3, 2007, on June 27, 2007 the
      Company sold substantially all of the tangible operating assets utilized by
      its
      Dallas, Texas, division, including assets related to its EasyTalk and Rocket
      VoIP products.  This Amendment is being filed to reclassify the Company’s
      financial position, results of operations, and cash flows related to this
      division since the date of its acquisition in October 2005 to reflect
      discontinued operations accounting treatment.





As
      reported in the Company’s Form 8-K filed on August 16, 2007, on that day the
      Company effected a reverse split of its outstanding common stock, at a ratio
      of
      1-for-20 shares Accordingly, this amendment restates all share and per-share
      information to reflect this reverse stock split. Further, the reported common
      stock in the Company's consolidated balance sheets was reduced by a factor
      of
      twenty, with corresponding increases in additional paid-in capital.





This
      Amendment No. 1 amends primarily (i) Part II, Item 7 - Management's Discussion
      and Analysis of Financial Condition and Results of Operations to reflect the
      reclassified consolidated financial statements for 2005 and 2006; and (ii)
      Part
      II, Item 8 - Financial Statements to provide the reclassified financial
      statements and notes thereto for 2005 and 2006. Other portions of the Company’s
      2006 Form 10-K are amended herein as necessary to reflect the above
      treatments.





This
      Amendment does not reflect any other events occurring after the original filing
      of the Company’s 2006 10-K, and does not update or modify the disclosures
      therein in any way other than as required to reflect the amendments described
      above.


3





**VOIP,
      INC.**




**PART
      I**




**Item
      1.**  **Business**





**Caution
      Regarding Forward-Looking Statements**





This
      annual report contains forward-looking statements relating to events anticipated
      to happen in the future. These forward-looking statements are based on the
      beliefs of our management, as well as assumptions made by and information
      currently available to our management. Forward-looking statements also may
      be
      included in other written and oral statements made or released by us. You can
      identify forward-looking statements by the fact that they do not relate strictly
      to historical or current facts. The words "believe," "anticipate," "intend,"
      "expect," "estimate," "project," “may”, “could” and similar expressions are
      intended to identify forward-looking statements. Forward-looking statements
      describe our expectations today of what we believe is most likely to occur
      or
      may be reasonably achievable in the future, but they do not predict or assure
      any future occurrence and may turn out to be wrong. Forward-looking statements
      are subject to both known and unknown risks and uncertainties and can be
      affected by inaccurate assumptions we might make. Consequently, no
      forward-looking statement can be guaranteed. Actual future results may vary
      materially. We do not undertake any obligation to publicly update any
      forward-looking statements to reflect new information or future events or
      occurrences. These statements reflect our current views with respect to future
      events and are subject to risks and uncertainties about us, including, among
      other things:




·
                Our
                    ability to market our services successfully to new
                    customers;
 
 ·
              Our
                  ability to retain a high percentage of our
                  customers;
 
 ·
              The
                  possibility of unforeseen capital expenditures and other upfront
                  investments required to deploy new technologies or to effect new
                  business
                  initiatives;
 
 ·
              Our
                  ability to raise capital;
 
 ·
              Network
                  development and operations;
 
 ·
              Our
                  expansion, including consumer acceptance of new price plans and
                  bundled
                  offerings;
 
 ·
              Additions
                  or departures of key personnel;
 
 ·
              Competition,
                  including the introduction of new products or services by our
                  competitors;
 
 ·
              Existing
                  and future laws or regulations affecting our business and our ability
                  to
                  comply with these laws or
                  regulations;
 
 ·
              Our
                  reliance on the systems and provisioning processes of regional
                  Bell
                  operating companies;
 
 ·
              Technological
                  innovations;
 
 ·
              The
                  outcome of legal and regulatory
                  proceedings;
 
 ·
              General
                  economic and business conditions, both nationally and in the regions
                  in
                  which we operate; and
 
 ·
              Other
                  factors described in this document, including those described in
                  more
                  detail in PART I, Item 1A. “Risk
                  Factors.”




**DESCRIPTION
      OF BUSINESS**





**General
      Development**





We
      were
      incorporated under the laws of the State of Texas on August 3, 1998, under
      our
      original name of Millennia Tea Masters. In February 2004 we exchanged 625,000
      shares for the assets of two start-up telecommunication businesses,
      eGlobalphone, Inc. and VoIP Solutions, Inc. We changed our name to VoIP, Inc.,
      in April 2004. We consummated the acquisitions of DTNet Technologies, a hardware
      supplier, and VoIP Americas, an interconnected Voice-over-Internet-Protocol
      (“VoIP”) related company, in June and September, respectively, of 2004. We
      decided to exit our former tea business in December 2004, and focus our efforts
      and resources in the VoIP telecommunications industry. In May 2005 we completed
      the acquisition of Caerus, Inc., a VoIP carrier and service provider, and in
      October 2005 we purchased substantially all of the VoIP-related assets of WQN,
      Inc. (“WQN”). In April 2006, we sold DTNet Technologies to a former officer of
      the Company. In October 2006 we terminated our Marketing and Distribution
      Agreement with Phone House, Inc., a wholesale prepaid telephone calling card
      business acquired in our WQN acquisition. On June 27, 2007 we sold substantially
      all of the tangible operating assets utilized by our Dallas, Texas, division
      that were acquired in our WQN acquisition.




4


We
      are an
      emerging global provider of wholesale long-distance and local telephone services
      through our VoIP network (called the VoiceOne Network). VoIP is the real time
      transmission of voice communications in the form of digitized "packets" of
      information over the public Internet or our own private network, similar to
      the
      way in which e-mail and other data is transmitted. Our services allow customers
      to communicate at significantly reduced costs compared to traditional telephony
      networks, using our softswitches that connect calls over different phone lines
      entirely by software run on a computer system. We are a certified Competitive
      Local Exchange Carrier (“CLEC”) and InterExchange Carrier (“IXC”).




Since
      2004 we have developed our business through strategic acquisitions, as noted
      in
      the second preceding paragraph. These acquisitions, and our subsequent
      VoIP-related technological enhancements, have provided us with important
      technology, intellectual capital and VoIP expertise, trade names, domain names,
      VoIP enhanced service applications, key business relationships and revenues.
      We
      own our network and technology, and provide a portfolio of advanced
      telecommunications technologies, enhanced service solutions, and broadband
      products to the VoIP industry. Our current and targeted customers include CLECs,
      IXCs, Internet Service Providers (“ISPs”), cable operators, and VoIP service
      providers in the United States and various countries around the
      world.





Our
      goal
      is to become the premier enabler for packet communication services for carriers
      (portal and ISP), service providers and cable operators seeking to offer
      value-added voice, data and enhanced services products using VoIP
      technology.





**Business
      Segments**





Our
      business was previously divided into three primary segments: (1)
      telecommunications, which consists of consumer and wholesale telecommunication
      services provided through our propriety VoIP network and technology; (2)
      wholesale sales of VoIP hardware and broadband components; and (3) the
      wholesaling of prepaid calling cards. We recently sold businesses comprising
      our
      hardware sales and prepaid calling card segments. Accordingly, separate
      financial statement information for the former segments is not
      provided.





**Our
      Technology and Network**





Our
      proprietary softswitch technology was developed in-house using protocol agnostic
      architecture, enabling virtually any network protocol, from legacy switches
      to
      the latest Multi-Protocol Label Switching (“MPLS”) standards, to communicate
      with our softswitches. Older, legacy technology uses hardware such as physical
      switches to route calls. Our technology approach enables us to integrate our
      network directly into the public switched telephone networks, with more limited
      capital expenditure costs.





Based
      on
      Microsoft .NET technology, we believe that integration to the enterprise desktop
      will drive market acceptance and use of our advanced services. Our network
      currently supports its own media gateways, softswitch controller, unified
      messaging systems, voicemail, media trans-coding and many other integral parts
      of a complete solution. Using our web interfaces, our customers also have the
      management tools needed for provisioning and maintenance of their
      services.





Our
      network operations center (“NOC”) located in Orlando, Florida, is a fully
      staffed, 24x7x365 operation. From the NOC we monitor all aspects of the
      technical environment, from our nationwide OC-12 backbone to network routers,
      SIP proxies and numerous routing gateways, soft switches and other aspects
      of
      our VoIP infrastructure. Fully redundant technologies are deployed in a scalable
      network environment that we believe will enable us to compete in the demanding
      IP telephony marketplace. Our network incorporates an advanced MPLS architecture
      which provides services to carriers and other service providers. Our network
      features direct interconnection facilities with multiple RBOCs, CLECs, IXCs,
      service providers, cable operators, wireless carriers and resellers.




**Products and
      Services**





Our
      telecommunications products and service offerings target VoIP wholesale
      customers, CLECs, IXCs, ISPs, cable operators and other providers of telephony
      services in the United States and various countries around the world.





*Call
      Termination*





We
      charge
      our wholesale customers minute-based fees to terminate calls on our network.
      We
      pay termination fees when it is necessary to route calls from our network to
      other networks for termination. Our revenues and profit margins on those
      revenues are a function of the number and duration of calls handled by our
      network and what we charge and pay to handle this traffic.




5


U.S.
      call
      termination takes place either on our network or that of one of our network
      partners to which we route traffic. Our international termination product
      features direct routes and connections established to many international voice
      carriers worldwide. Carriers use complex least-cost-routing algorithms that
      direct traffic to the lowest cost carrier. We are attempting to establish a
      competitive cost structure through the efficiencies of our network design,
      the
      completion and implementation of our own least-cost routing algorithms, and
      through current and future partnerships with key off-net and niche providers.
      Revenues generated from these services for the year ended December 31, 2006,
      substantially all of which were derived from one customer, amounted to $5.7
      million or 39% of our consolidated revenues during this period.




*VoiceOne
      Carrier Direct*





We
      are in
      the early stages of implementing our VoiceOne Carrier Direct program which
      we
      believe will enable us to develop a significant facilities-based, carrier
      customer base. We believe that carriers that want to offer VoIP services have
      essentially three options: create their own internal VoIP capabilities, acquire
      a VoIP carrier, or partner with a VoIP carrier. The first two of these options
      are typically expensive and time consuming, both initially and with respect
      to
      ongoing system maintenance. With respect to the third option, our VoiceOne
      Carrier Direct is a partner program for carriers that provides them with our
      technology to IP-enable their TDM networks. With this program the carriers
      receive our equipment and expertise, enabling them to rapidly enter the VoIP
      services market without making significant capital expenditures. Because our
      technology is protocol agnostic, by implementing the VoiceOne Carrier Direct
      program we believe our customers can avoid modifications to their TDM networks
      and the operability issues that can plague the interface of legacy systems
      with
      IP technology. We interface our customers' TDM systems to our VoIP network.
      We
      do not charge the carriers for equipment that includes softswitch technology,
      a
      media gateway, a service creation environment, a multi-protocol label switching
      network and access to our products and services. In return for our equipment
      and
      expertise, the facilities based carrier pays us fees to terminate calls on
      our
      network and for other services such as Hosted IP Centrex and local inbound.
      We
      anticipate that this strategy will be attractive to the carriers since it
      provides them with a new group of customers and revenue sources without
      requiring them to modify their legacy systems or expend capital. Once the
      carriers are part of our Carrier Direct Program, we can obtain revenues from
      calls the carriers terminate on our network, and can terminate calls on their
      network. Through December 31, 2006 we had not generated any
      significant revenues from our VoiceOne Carrier Direct program.





*Click-to-Call*





In
      November 2006 we introduced Click-to-Call, which involves initiating phone
      calls
      from computers without dialing. This technology is currently used as a sales
      lead generator in online ads. From a web site, users type in the desired service
      (flowers, pizza, etc.) along with their zip code. Once a service provider is
      located and selected, the user then enters their phone number, clicks “call” on
      the web site, and their phone will ring connecting them to the service provider.
      We receive minute-based revenue for each call carried on our network. Through
      December 31, 2006 we had not generated significant revenues from our
      Click-to-Call program.




**Prepaid
      Calling Cards Segment**





We
      previously sold prepaid calling cards that we purchased from other carriers
      to
      private distributors located in Southern California. Unlike our other
      communications products, the communication traffic arising from the use of
      these
      cards to place telephone calls was handled by carriers affiliated with vendors
      we purchased the cards from, and not by our network. In October 2006, we
      terminated our Marketing and Distribution Agreement with Phone House, Inc.,
      effectively discontinuing this business segment, and its operations are
      accounted for as discontinued.





**Hardware
      Sales Segment**





Our
      hardware sales subsidiary, doing business as DTNet Technologies, operated a
      fulfillment center in Clearwater, Florida, from which we sold a variety of
      VoIP
      hardware and broadband components to broadband service providers. These products
      included cable modems, DSL modems, AV power line and home plug adapters, and
      multimedia terminal adapters. In April 2006, we sold DTNet Technologies to
      our
      former Chief Operating Officer, and its operations have since been accounted
      for
      as discontinued.





**OUR
      STRATEGY**





Our
      objective is to provide reliable, scalable, and competitively-priced worldwide
      VoIP communication services with unmatched quality. We plan to achieve this
      objective by delivering innovative technologies and services while balancing
      the
      needs of our customers with the needs of our business. We intend to bring high
      quality voice products and services at an affordable price to other
      communication providers, businesses and residential consumers to enhance the
      ways in which these customers communicate with the rest of the world.
      Recognizing that basic voice service is a commodity item that does not drive
      significant profits, we plan to provide basic services to customers that will
      lead into margin expansion as more advanced features are offered on our network,
      including initiating phone calls from computers without dialing (click-to-call
      technology), checking voicemail, faxes, and emails from a single computer in-box
      (unified messaging), providing audio and video teleconferencing, and offering
      VoIP services with leased lines.





Specific
      strategies to accomplish this objective include:





·
            Building
                our carrier/service provider customer base through aggressive marketing
                of
                our VoiceOne Carrier Direct
                program;


6


·
            Completing
                the expansion of our network (currently in
                process);


·
            Capitalizing
                on our technological expertise to introduce new products, services
                and
                features;


·
            Customizing
                our service offerings for the purpose of pursuing strategic partnerships
                with major customers and suppliers;


·
            Offering
                the best possible service and support to our
                customers;


·
            Developing
                additional distribution channels;


·
            Increasing
                our customer base by introducing cost-effective solutions to interconnect
                with our network; and


·
            Controlling
                operating expenses and capital
                expenditures.





**Competition**





We
      compete primarily in the market for enhanced IP communications services. This
      market is highly competitive and has numerous service providers. The market
      for
      enhanced Internet and IP communications services is new and rapidly evolving.
      We
      believe that the primary competitive factors determining success in the Internet
      and IP communications market are:





·
            Quality
                of service;


·
            Breadth
                and depth of service offerings;


·
            Ability
                to custom create innovative
                solutions;


·
            Ability
                to meet and anticipate customer needs through multiple service offerings
                and feature sets;


·
            Responsive
                customer care services; and


·
            Price.





Future
      competition could come from a variety of companies both in the Internet and
      telecommunications industries. These industries include major companies that
      have greater resources and larger customer bases than we have, and have been
      in
      operation for many years. In addition, some Internet service providers have
      begun to aggressively enhance their real time interactive communications,
      including instant messaging, PC-to-PC and PC-to-Phone services, and broadband
      phone services.





Some
      competitors may be able to bundle services and products that are not offered
      by
      us together with enhanced Internet and IP communications services, which could
      place us at a significant competitive disadvantage. Many of our competitors
      enjoy economies of scale that can result in lower cost structure for
      transmission and related costs, which could cause significant pricing pressures
      within the industry. At the same time, we see these potential competitors as
      potential customers, and have organized our various reseller and service
      provider products and services to meet the emergent needs of these
      companies.





Our
      primary competitors include:





·
            Carriers
                operating in the U.S. and abroad, including Level 3, Global Crossing,
                Cogent Communications Group, Inc., XO Holdings, Inc., US LEC Corporation,
                Pac-West Telecomm, Inc.; and


·
            Subscriber-based
                service provider competitors, including Vonage, Packet8, DeltaThree,
                SunRocket, Time Warner, Comcast, and
                Net2phone.





**Human
      Resources**





VoIP,
      Inc. currently employs 53 persons in the following capacities: 3 officers,
      26
      general and administrative employees, and 24 technology personnel. We consider
      our relations with our employees to be favorable. We have never had a work
      stoppage, and none of our employees is represented by collective bargaining
      agreements. We believe that our future success will depend in part on our
      ability to attract, integrate, retain and motivate highly qualified personnel,
      and upon the continued service of our senior management and key technical
      personnel. Our Chief Executive Officer and Chief Operating Officer are bound
      by
      employment agreements through September 2009. Competition for qualified
      personnel in our industry and geographical location is intense. We cannot assure
      you that we will be successful in attracting, integrating, retaining and
      motivating a sufficient number of qualified employees to conduct our business
      in
      the future.





**Intellectual
      Property**





We
      have
      developed several important intellectual property features. VoiceOne has
      developed and the network provides an E911 solution to comply with the FCC's
      recent order imposing E911 requirements on VoIP service providers. VoiceOne's
      911 service is known as Enhanced E911. A key feature of the E911 service is
      that
      it can route emergency calls for the customer whose location is constant as
      well
      as the customer who often moves the location of his VoIP device. Customers
      can
      update their location information in real time, so that their 911 call will
      be
      delivered to the appropriate PSAP in the new location. To further support the
      FCC 911 mandate, we have applied for a patent for our 911 compliant VoIP
      Multimedia Terminal Adaptor.




7


We
      have
      developed Pathfinder as a "cascading provisioning server" feature for deployment
      of zero-touch hardware deployment and is a new development that is exclusive
      to
      our platform. The system allows each device to auto-provision without any
      customer interaction even in situations where there are multiple levels of
      resellers to distribute the product to their customers (to any number of resale
      levels). This allows for installations without any customer service or technical
      support time spent in configuration issues.





**REGULATION**





We
      are
      currently both a value added service provider and a provider of interconnected
      Voice over Internet Protocol (“VoIP”) services as that term is defined under
      federal law. The integration and softswitch portions of our business are
      expected to remain unthreatened by traditional common carrier regulation in
      major nations in which we expect to do business. Our telecommunications service
      offerings may potentially experience regulatory pressures as the United States
      makes changes in its telecommunications law to encompass interconnected VoIP
      services. The imposition of government regulation on our business could
      adversely affect our operations by requiring additional expense to meet
      compliance requirements and subject us to additional fees and surcharges that
      are currently applicable to providers of legacy telecommunications
      services.





The
      FCC
      regulates interstate and international telecommunications services. The FCC
      imposes extensive regulations on common carriers such as ILECs that have some
      degree of market power. The FCC imposes less regulation on common carriers
      without market power, such as the Company. The FCC permits these non-dominant
      carriers to provide domestic interstate services (including long-distance and
      access services) without prior authorization; but it requires carriers to
      receive an authorization to construct and operate telecommunications facilities
      and to provide or resell telecommunications services between the United States
      and international points. Under the Telecommunications Act of 1996 (the "1996
      Act"), any entity, including cable television companies and electric and gas
      utilities, may enter any telecommunications market, subject to reasonable state
      regulation of safety, quality and consumer protection. The 1996 Act opened
      the
      local services market by requiring ILECs to permit interconnection to their
      networks.





The
      FCC
      has to date treated Internet service providers (“ISPs”) as "enhanced service
      providers," exempt from federal and state regulations governing common carriers,
      including the obligation to pay access charges and contribute to the universal
      service fund. Nevertheless, regulations governing disclosure of confidential
      communications, copyright, excise tax and other requirements may apply to the
      provision of Internet access services.





**FCC
      Regulation of Interconnected VoIP Services**





There
      are
      a number of regulatory proceedings underway or being considered by federal
      and
      state authorities, including the FCC and state regulatory agencies, that could
      potentially impact providers of interconnected VoIP services like us. Currently,
      providers of interconnected VoIP services are largely unregulated in the United
      States particularly when compared to providers of traditional telecommunications
      services. On March 10, 2004, the FCC adopted a Notice of Proposed Rulemaking,
      which will address a variety of issues concerning the regulatory treatment
      of
      VoIP telephony. We cannot predict the outcome of this proceeding. Should the
      FCC
      adopt additional regulations that would be applicable to interconnected VoIP
      providers like us, our costs of doing business would likely increase and would
      make our services less competitive with traditional providers of
      telecommunications services.





In
      November 2004, the FCC ruled that the interconnected VoIP services of a
      particular company are jurisdictionally interstate and not subject to state
      certification, tariffing and most other state telecommunications regulations.
      The FCC ruling was upheld on appeal. We believe that our interconnected VoIP
      service is substantially similar to the one the FCC ruled on and that our
      service would also be considered interstate and free from state
      regulation.




In
      June
      2006, the FCC determined that providers of interconnected VoIP services must
      contribute to the federal Universal Service Fund, or USF. For a period of at
      least two quarters beginning October 1, 2006, we will be required to contribute
      to the USF for its subscribers' retail revenues as well as through its
      underlying carriers' wholesale charges. The impact of this obligation is to
      either increase prices for our services to our customers or to reduce our profit
      margin. This could have a material adverse effect on our financial position,
      results of operations and cash flows. The FCC Order applying USF contributions
      to interconnected VoIP providers is currently under appeal, and the FCC
      continues to evaluate alternative methods for assessing USF charges, including
      imposing an assessment on telephone numbers. The outcome of these proceedings
      cannot be determined at this time.





On
      August
      5, 2005, the FCC unanimously adopted an order requiring interconnected VoIP
      providers, like the Company, to comply with the Communications Assistance for
      Law Enforcement Act, or CALEA. CALEA requires covered providers to assist law
      enforcement agencies in conducting lawfully authorized electronic surveillance.
      Under the FCC Order, interconnected VoIP providers will be required to comply
      with CALEA obligations by May 14, 2007 and make certain filings prior to that
      date. Consistent with the relevant rules, we are working with a third-party
      solution provider to devise a CALEA solution. Our failure to achieve compliance
      with any future CALEA orders, rules, filings or standards, or any enforcement
      action initiated by the FCC or other agency, state or task force against us
      could have a material adverse effect on our financial position, results of
      operations or cash flows.





The
      effect of any future laws and regulations on our operations cannot be
      determined.




8


**State
      Regulation**





The
      1996
      Act is intended to increase competition in the telecommunications industry,
      especially in the local exchange market. With respect to local services, ILECs
      are required to allow interconnection to their networks and to provide unbundled
      access to network facilities, as well as a number of other pro-competitive
      measures. Because the implementation of the 1996 Act is subject to numerous
      state rulemaking proceedings on these issues, it is currently difficult to
      predict how quickly full competition for local services will
      develop.





**Local
      Regulation**





Our
      network is subject to numerous local regulations such as building codes and
      licensing. Such regulations vary on a city-by-city, county- by-county and
      state-by-state basis.




**Item
      1A.**  **Risk
      Factors**





**RISKS
      RELATED TO OUR COMPANY**




**We
      are not in compliance with the terms of our secured loan agreement, and the
      note
      holders may accelerate the amounts due at any time.**




We
      are
      not in compliance with certain covenants of the agreement for our secured loan
      from a lending institution, now held by a group of institutional investors
      (and
      formerly held by Cedar Boulevard Lease Funding LLC). The loan balance currently
      amounts to approximately $1.9 million, and we have also not made scheduled
      principal and interest payments. In addition, the loan is now accruing
      interest at 17.5%, and is repayable through May 2007. Because the investors
      have
      a security interest in all of our assets, they may choose to accelerate the
      loan
      payments at any time, which would have a significant adverse impact on our
      financial condition, and could impair our ability to continue as a going
      concern.





**We
      are not in compliance with the terms of our convertible notes issued in July
      and
      October 2005, in January and February of 2006, and in October 2006, and the
      note
      holders may accelerate the amounts due at any time.**




The
      provisions of the convertible notes issued in July and October 2005, in January
      and February 2006, and in October 2006 provide that the failure to pay principal
      and interest timely and the failure to register the securities underlying the
      notes within the required time limit are events of default under the notes.
      We
      have not made scheduled payments of $217,506 under the 2005 notes and have
      not
      made scheduled payments of $1,286,079 under the 2006 notes. Also we have not
      registered all of these note shares and related warrant shares. The convertible
      note holders have not declared a default under the loan agreements. However,
      the
      amounts due under the notes could be accelerated and immediately due and
      payable, which would adversely affect our financial condition.




**Because
      we failed to meet our obligations to file registration statements required
      under
      the various subscription agreements related to certain of our note, warrant
      and
      common stock financings timely, we are accruing liquidated damages for breach
      of
      contract until such time as the registration statements are filed and are
      declared effective.**




Pursuant
      to the subscription agreements under which certain investors purchased notes,
      common stock and warrants in 2005 and 2006, we agreed to register the securities
      purchased for resale by those investors under the Securities Act of 1933, as
      amended, within a specified time. Because we failed to comply with these
      requirements, we currently owe liquidated damages of $2,200,631 plus 76,761
      shares of common stock, and will continue to incur liquidated damages amounting
      to $278,432 per month until there are effective registration statements covering
      the notes and warrants. Because we are incurring substantial liquidated damages
      on a monthly basis, our failure to comply with the terms of the notes and
      warrants could continue to have an adverse effect on our financial position
      and
      our results of operations. We are currently contractually obligated to register
      approximately 13.5 million shares, warrants and options. There is no assurance
      that sufficient registration statements can be filed or declared effective
      by
      the SEC, in which case we would continue to be unable to satisfy our contractual
      obligations to register shares.





**Our
      substantial debt could adversely affect our financial position, operations
      and
      ability to grow.**





As
      of
      December 31, 2006, our total liabilities were approximately $32.9 million,
      most
      of which are classified as current. Our substantial indebtedness could have
      adverse consequences in the future. For example, it could:




·
              Require
                  us to dedicate a substantial portion of our cash flow from operations
                  to
                  payments on our debt, which would reduce amounts available for
                  working
                  capital, capital expenditures, research and development, and other
                  general
                  corporate purposes;
 
 ·
              Limit
                  our flexibility in planning for, or reacting to, changes in our
                  business
                  and the industries in which we
                  operate;
 
 ·
              Increase
                  our vulnerability to general adverse economic and industry
                  conditions;
  9
  ·
              Place
                  us at a disadvantage compared to our competitors that may have
                  less debt
                  than we do;
 
 ·
              Make
                  it more difficult for us to obtain additional financing that may
                  be
                  necessary in connection with our
                  business;
 
 ·
              Make
                  it more difficult for us to implement our business and growth strategies;
                  and
 
 ·
              Cause
                  us to have to pay higher interest rates on future
                  borrowings.





**We
      need immediate additional capital to continue our
      operations.**





Our
      operations currently require significant amounts of cash. We intend to continue
      to enhance and expand our network in order to maintain our competitive position
      and meet the increasing demands for service quality, capacity and competitive
      pricing. Also, our pursuit of new customers and the introduction of new products
      and/or services will require significant marketing and promotional expenses
      that
      we often incur before we begin to receive the related revenue. To date, our
      operations have consumed, rather than generated, cash. Our working capital
      and
      capital expenditure requirements have been met by sales of debt and equity
      securities. We need to raise additional capital to continue our operations.
      We
      may not be able to raise additional capital. If we are able to raise additional
      capital through the issuance of additional equity or debt, our current investors
      could experience further dilution. We need to raise additional debt or equity
      capital imminently to provide the funds necessary to repay or restructure our
      debt and continue operations. If unsuccessful, or if the note holders declare
      the Company's notes in default, we may not be able to continue
      operations.





**We
      have experienced significant changes in our top
      management.**





On
      September 12, 2006, we underwent a reorganization of our executive management.
      Accordingly, Mr. Anthony J. Cataldo was appointed Chief Executive
      Officer and Chairman, replacing Mr. Gary Post, who himself replaced a
      former Chief Executive Officer on May 19, 2006. Mr. David Ahn, Vice
      President Corporate Planning, also left the Company effective
      September 12, 2006. On May 19, 2006, Mr. Robert V. Staats was appointed
      Chief Accounting Officer, and Mr. David Sasnett resigned as Chief Financial
      Officer. On July 28, 2006, Mr. Shawn M. Lewis was appointed Chief Operating
      Officer in addition to Chief Technology Officer. Although the board of directors
      believes that these management changes are in our best interests and that the
      new management will have a positive impact, significant personnel changes may
      have the effect of disrupting our day-to-day operations until such time as
      the
      new management is integrated and fully informed with respect to our business
      and
      operations.




**We
      may incur goodwill and intangible asset impairment
      charges.**





Our
      balance sheet at December 31, 2006 includes approximately $16.8 million in
      goodwill and approximately $9.2 million in other intangible assets recorded
      in
      connection with our acquisitions. We recorded a significant additional amount
      of
      goodwill and intangible assets as a result of our acquisition in May 2005 of
      Caerus and its subsidiaries.





In
      accordance with SFAS 142, we test the carrying value of our goodwill and our
      other intangible assets for impairment at least annually by comparing the fair
      values of these assets to their carrying values. During the year ended
      December 31, 2005 we recorded an impairment charge to our operating
      results of approximately $4.2 million relating to goodwill previously recorded
      for an acquisition. During the year ended December 31, 2006, we recorded an
      impairment charge to operating results of $839,101 as a result of selling our
      interest in our subsidiary, DTNet Technologies, in April 2006. These charges
      reduced the carrying value of the subsidiary to its estimated fair value. We
      may
      be required to record additional impairment charges for these assets in the
      future, which could materially adversely affect our financial condition and
      results of operations. If the traded market price of our common stock declines,
      a material goodwill impairment charge in the future is possible.





**Our
      internal controls over financial reporting are not adequate, and our independent
      auditors may not be able to later certify as to their adequacy, which could
      have
      a significant and adverse effect on our business and
      reputation.**





Section
      404 of Sarbanes-Oxley and the rules and regulations of the Securities Exchange
      Commission (the “Commission”) associated with Sarbanes-Oxley, which we refer to
      as Section 404, require a reporting company to, among other things, annually
      review and disclose its internal controls over financial reporting, and evaluate
      and disclose changes in its internal controls over financial reporting
      quarterly. Under Section 404 a reporting company is required to document and
      evaluate such internal controls in order to allow its management to report
      on,
      and its independent auditors to attest to, these controls. We are required
      to
      comply with Section 404 not later than our fiscal year ending December 2007.
      We
      are currently evaluating our strategy to begin performing the system and process
      documentation, evaluation and testing required (and any necessary remediation)
      in an effort to comply with management certification and auditor attestation
      requirements of Section 404. As reported in Item 9A. Controls and Procedures
      beginning at page 32 ,
      we have
      concluded that our disclosure controls and procedures, and our financial
      reporting controls, are currently ineffective. Further, in the course of our
      ongoing evaluation, we may identify additional areas of our internal controls
      requiring improvement, and plan to design enhanced processes and controls to
      address issues that might be identified through this review. As a result, we
      expect to incur additional expenses and diversion of management's time. We
      cannot be certain as to the timing of completion of our documentation,
      evaluation, testing and remediation actions or the impact of the same on our
      operations, and may not be able to ensure that the process is effective or
      that
      the internal controls are or will be effective in a timely manner. If we are
      not
      able to implement the requirements of Section 404 in a timely manner or with
      adequate compliance, our independent auditors may not be able to certify as
      to
      the effectiveness of our internal control over financial reporting, and we
      may
      be subject to sanctions or investigation by regulatory authorities, such as
      the
      Commission. As a result, there could be an adverse reaction in the financial
      markets due to a loss of confidence in the reliability of our financial
      statements. In addition, we may be required to incur costs in improving our
      internal control system and the hiring of additional personnel. Any such actions
      could adversely affect our results of operations, cash flows and financial
      condition.




10


**We
      have a history of losses and negative cash flows from operations, and we
      anticipate such losses and negative cash flows will
      continue.**





We
      have
      incurred significant losses since inception, and we anticipate continuing to
      incur significant losses for the foreseeable future. Our net loss for the fiscal
      years ended December 31, 2006 and 2005 was approximately $41.2 million and
      $28.3
      million, respectively. Our net cash used for operating activities for these
      same
      periods was approximately $12.4 million and $17.6 million, respectively. As
      of
      December 31, 2006, our accumulated deficit was approximately $76.0 million.
      Our
      revenues may not grow or even continue at their current level. We will need
      to
      significantly increase our revenues and gross margins to become profitable.
      In
      order to increase our revenues, we need to attract and maintain customers to
      increase the fees we collect for our services. If our revenues do not increase
      as much as we expect, we may never be profitable. Even if our revenues increase,
      if we are unable to generate sufficiently profitable margins on these revenues,
      we may never be profitable. If we become profitable, we may not be able to
      sustain or increase profitability.





**We
      have a limited operating history upon which you can evaluate
      us.**





We
      have
      only a limited operating history upon which you can evaluate our business and
      prospects. We commenced operations of our current business in 2004, and the
      majority of our operations are comprised of businesses we acquired in 2005.
      You
      should consider our prospects in light of the risks, expenses and difficulties
      we may encounter as an early stage company in the new and rapidly evolving
      market for Internet protocol (IP) communications services. These risks include
      our ability:




·
                To
                    successfully integrate our recent
                    acquisitions;
 
 ·
              To
                  increase acceptance of our VoIP communications services, thereby
                  increasing the number of users of our IP telephony
                  services;
 
 ·
              To
                  compete effectively; and
 
 ·
              To
                  develop new products and keep pace with developing
                  technology.




In
      addition, because we expect an increasing percentage of our revenues to be
      derived from our IP communications services, our past operating results may
      not
      be indicative of our future results.





**We
      may not be able to expand our revenue base and achieve
      profitability.**





Our
      business strategy is to expand our revenue sources by providing IP
      communications services to several different customer groups. We can neither
      assure you that we will be able to accomplish this nor that this strategy will
      be profitable. Substantially all of our consolidated revenues for the year
      ended
      December 31, 2006 were derived from one customer, and our gross margins for
      these revenues were negative. Currently, our revenues are generated by providing
      termination services for other carriers and end users.. These services have
      not
      been profitable to date and may not be profitable in the future.





In
      the
      future, we intend to generate increased revenues from IP communications services
      from multiple sources, many of which are unproven. We expect that our revenues
      for the foreseeable future will be dependent on, among other
      factors:




·
              Acceptance
                  and use of IP telephony;
 
 ·
              Growth
                  in the number of our customers;
 
 ·
              Expansion
                  of service offerings;
 
 ·
              Traffic
                  levels on our network;
 
 ·
              The
                  effect of competition, regulatory environment, international long
                  distance
                  rates, and access and transmission costs on our prices;
                  and
 
 ·
              Continued
                  improvement of our global network
                  quality.




11


We
      cannot
      assure you that a market for our services will develop. Our market is new and
      rapidly evolving. Our ability to sell our services may be inhibited by, among
      other factors, the reluctance of some end-users to switch from traditional
      communications carriers to IP communications carriers and by concerns with
      the
      quality of IP telephony and the adequacy of security in the exchange of
      information over the Internet, and the reluctance of our resellers and service
      providers to utilize outsourced solutions providers.




End-users
      in markets serviced by recently deregulated telecommunications providers are
      not
      familiar with obtaining services from competitors of these providers and may
      be
      reluctant to use new providers such as us. We will need to devote substantial
      resources to educate customers and end-users about the benefits of IP
      communications solutions in general and our services in particular. If
      enterprises and their customers do not accept our enhanced IP communications
      services as a means of sending and receiving communications, we will not be
      able
      to increase our number of paid users or successfully generate revenues in the
      future.





**Potential
      fluctuations in our quarterly financial results may make it difficult for
      investors to predict our future performance.**





Our
      quarterly operating results may fluctuate significantly in the future as a
      result of a variety of factors, many of which are outside our
      control.





Such
      factors also may create other risks affecting our long-term success, as
      discussed in the other risk factors. We believe that quarter-to-quarter
      comparisons of our historical operating results may not be a good indication
      of
      our future performance, nor would our operating results for any particular
      quarter be indicative of our future operating results.





**Our
      network may not be able to accommodate our capacity needs.**





We
      expect
      the volume of traffic we carry over our network to increase significantly as
      we
      expand our operations and service offerings. Our network may not be able to
      accommodate this additional volume. In order to ensure that we are able to
      handle additional traffic, we may have to enter into long-term agreements for
      leased capacity. To the extent that we overestimate our capacity needs, we
      may
      be obligated to pay for more transmission capacity than we actually use,
      resulting in costs without corresponding revenues. Conversely, if we
      underestimate our capacity needs, we may be required to obtain additional
      transmission capacity from more expensive sources. If we are unable to maintain
      sufficient capacity to meet the needs of our users, our reputation could be
      damaged and we could lose customers and revenues.




Additionally,
      our success depends on our ability to handle a large number of simultaneous
      calls. We expect that the volume of simultaneous calls will increase
      significantly as we expand our operations. If this occurs, additional stress
      will be placed upon the network hardware and software that manages our traffic.
      We cannot assure stockholders of our ability to efficiently manage a large
      number of simultaneous calls. If we are not able to maintain an appropriate
      level of operating performance, or if our service is disrupted, then we may
      develop a negative reputation, and our business, results of operations, and
      financial condition could be materially adversely affected.





**We
      may be unsuccessful selecting the most economical call
      routing.**





We
      rely
      on vendors to terminate calls. Vendor charges for these services vary by call
      route, and costs between vendors for the same routes vary. Because of the heavy
      volume of calls handled by our network, automation of the call routing to the
      “least-cost” vendor for each route is typically required to generate a positive
      gross margin. We are currently developing such automation, but we may not be
      successful in its implementation or further maintenance, which would adversely
      affect our financial performance.




**We
      face a risk of failure of computer and communications systems used in our
      business.**





Our
      business depends on the efficient and uninterrupted operation of our computer
      and communications systems as well as those that connect to our network. We
      maintain communications systems (also referred to as network access points)
      in
      facilities in Orlando, Atlanta, New York, Dallas, and Los Angeles. Our
      systems and those that connect to our network are subject to disruption from
      natural disasters or other sources such as power loss, communications failure,
      hardware or software malfunction, network failures, and other events both within
      and beyond our control. Any system interruptions that cause our services to
      be
      unavailable, including significant or lengthy telephone network failures or
      difficulties for users in communicating through our network or portal, could
      damage our reputation and result in a loss of users.




12


**Our
      computer systems and operations may be vulnerable to security
      breaches.**





Our
      computer infrastructure is potentially vulnerable to physical or electronic
      computer viruses, break-ins and similar disruptive problems and security
      breaches that could cause interruptions, delays or loss of services to our
      users. We believe that the secure transmission of confidential information,
      such
      as credit card numbers, over the Internet is essential in maintaining user
      confidence in our services. We rely on licensed encryption and authentication
      technology to effect secure transmission of confidential information, including
      credit card numbers. It is possible that advances in computer capabilities,
      new
      technologies or other developments could result in a compromise or breach of
      the
      technology we use to protect user transaction data. A party that is able to
      circumvent our security systems could misappropriate proprietary information
      or
      cause interruptions in our operations. Security breaches also could damage
      our
      reputation and expose us to a risk of loss or litigation and possible liability.
      Although we have experienced no security breaches to date of which we are aware,
      we cannot guarantee you that our security measures will prevent security
      breaches.





**We
      depend on highly qualified technical and managerial
      personnel.**





Our
      future success also depends on our continuing ability to attract, retain and
      motivate highly qualified technical expertise and managerial personnel necessary
      to operate our businesses. We may need to give retention bonuses and stock
      incentives to certain employees to keep them, which can be costly to us. The
      loss of the services of members of our management team or other key personnel
      could harm our business. Our future success depends to a significant extent
      on
      the continued service of key management, client service, product development,
      sales and technical personnel. We do not maintain key person life insurance
      on
      any of our executive officers and do not intend to purchase any in the future.
      Although we generally enter into non-competition agreements with our key
      employees, our business could be harmed if one or more of our officers or key
      employees decided to join a competitor or otherwise compete with
      us.





We
      may be
      unable to attract, assimilate or retain highly qualified technical and
      managerial personnel in the future. Wages for managerial and technical employees
      are increasing and are expected to continue to increase in the future. We may
      have difficulty in hiring and retaining highly skilled employees with
      appropriate qualifications. If we were unable to attract and retain the
      technical and managerial personnel necessary to support and grow our businesses,
      our business would likely be materially and adversely affected.





**International
      operations may expose us to additional and unpredictable
      risks.**





We
      may
      enter international markets such as Eastern Europe, the Middle East, Latin
      America, Africa and Asia and may expand our existing operations outside the
      United States. International operations are subject to inherent risks,
      including:




·
              Potentially
                  weaker protection of intellectual property
                  rights;
 
 ·
              Political
                  and economic instability;
 
 ·
              Unexpected
                  changes in regulations and tariffs;
 
 ·
              Fluctuations
                  in exchange rates;
 
 ·
              Varying
                  tax consequences; and
 
 ·
              Uncertain
                  market acceptance and difficulties in marketing efforts due to
                  language
                  and cultural differences.


**Our
      entry into new lines of business, as well as potential future acquisitions,
      joint ventures or strategic transactions, entail numerous risks and
      uncertainties that could have an adverse effect on our
      business.**





We
      may
      enter into new or different lines of business, as determined by management
      and
      our board of directors. Our acquisitions, as well as any future acquisitions
      or
      joint ventures, could result, and in some instances have resulted, in numerous
      risks and uncertainties including:





·
            Potentially
                dilutive issuances of equity securities, which may be issued at the
                time
                of the transaction or in the future if certain performance or other
                criteria are met or not met, as the case may be. These securities
                may be
                freely tradable in the public market or subject to registration rights
                which could require us to publicly register a large amount of our
                common
                stock, which could have a material adverse effect on our stock
                price;




·
            Diversion
                of management's attention and resources from our existing
                businesses;





·
            Significant
                write-offs if we determine that the business acquisition does not
                fit or
                perform up to expectations;





·
            The
                incurrence of debt and contingent liabilities or impairment charges
                related to goodwill and other long-lived
                assets;





13


·
            Difficulties
                in the assimilation of operations, personnel, technologies, products
                and
                information systems of the acquired
                companies;





·
            Regulatory
                and tax risks relating to the new or acquired
                business;





·
            The
                risks of entering geographic and business markets in which we have
                limited
                (or no) prior experience;





·
            The
                risk that the acquired business will not perform as expected;
                and





·
            Material
                decreases in short-term or long-term
                liquidity.





**RISKS
      RELATED TO OUR INDUSTRY**





**Our
      future success depends on the growth in the use of Internet Protocol as a means
      of communications.**





If
      the
      market for IP communications in general, and our services in particular, does
      not grow or does not grow at the rate we anticipate, we will not be able to
      increase our number of customers or generate the revenues we anticipate. To
      be
      successful, IP communication requires validation as an effective, quality means
      of communication and as a viable alternative to traditional telephone service.
      Demand and market acceptance for recently introduced services are subject to
      a
      high level of uncertainty. The Internet may not prove to be a viable alternative
      to traditional telephone service for reasons including:


·
              Inconsistent
                  quality or speed of service;
 
 ·
              Traffic
                  congestion;
 
 ·
              Potentially
                  inadequate development of the necessary
                  infrastructure;
 
 ·
              Lack
                  of acceptable security
                  technologies;
 
 ·
              Lack
                  of timely development and commercialization of performance improvements;
                  and
 
 ·
              Unavailability
                  of cost-effective, high-speed
                  access.




If
      Internet usage grows, the Internet infrastructure may not be able to support
      the
      demands placed on it by such growth, or its performance or reliability may
      decline. In addition, Web sites may from time to time experience interruptions
      in their service as a result of outages and other delays occurring throughout
      the Internet network infrastructure. If these outages or delays frequently
      occur
      in the future, Internet usage, as well as usage of our communications portal
      and
      our services, could be adversely affected.





**Intense
      competition could reduce our market share and harm our financial
      performance.**





Competition
      in the market for IP communications services is becoming increasingly intense,
      and such competition is expected to increase significantly in the future. The
      market for Internet and IP communications is new and rapidly evolving. We expect
      that competition from companies both in the Internet and telecommunications
      industries will increase in the future. Our competitors include both start-up
      IP
      telephony service providers and established traditional communications
      providers. Many of our existing competitors and potential competitors have
      broader portfolios of services; greater financial, management and operational
      resources; greater brand-name recognition; larger subscriber bases; and more
      experience than we have. In addition, many of our IP telephony competitors
      use
      the public Internet instead of a private network to transmit traffic. Operating
      and capital costs of these providers may be less than ours, potentially giving
      them a competitive advantage over us in terms of pricing. In addition, some
      Internet service providers have begun to aggressively enhance their real time
      interactive communications, focusing on instant messaging, PC-to-PC and
      PC-to-phone, and/or broadband phone services.





In
      addition, traditional carriers, cable companies and satellite television
      providers are bundling services and products not offered by us with Internet
      telephony services. While this provides us with the opportunity to offer these
      companies our products and services as a way for them to offer Internet
      telephony services, it also introduces the risk that they will introduce these
      services on their own utilizing other options while at the same time making
      it
      more difficult for us to compete against them with direct-to-consumer offerings
      of our own. If we are unable to provide competitive service offerings, we may
      lose existing users and be unable to attract additional users. In addition,
      many
      of our competitors, especially traditional carriers, enjoy economies of scale
      that result in a lower cost structure for transmission and related costs, and
      which cause significant pricing pressures within the industry. In order to
      remain competitive we intend to increase our efforts to promote our services,
      and we cannot be sure that we will be successful in doing this.




14


In
      addition to these competitive factors, recent and pending deregulation in some
      of our markets may encourage new entrants. We cannot assure you that additional
      competitors will not enter markets that we plan to serve or that we will be
      able
      to compete effectively.





**Decreasing
      telecommunications rates may diminish our revenues and
      profitability.**





International
      and domestic telecommunications rates have decreased significantly over the
      last
      few years in most of the markets in which we operate, and we anticipate that
      rates will continue to be reduced in all of the markets in which we do business
      or expect to do business. Users who select our services to take advantage of
      the
      current pricing differential between traditional telecommunications rates and
      our rates may switch to traditional telecommunications carriers as such pricing
      differentials diminish or disappear, and we will be unable to use such pricing
      differentials to attract new customers in the future. In addition, our ability
      to market our carrier transmission services to telecommunications carriers
      depends upon the existence of spreads between the rates offered by us and the
      rates offered by traditional telecommunications carriers, as well as a spread
      between the retail and wholesale rates charged by the carriers from which we
      obtain wholesale service. Continued rate decreases will require us to lower
      our
      rates to remain competitive, could reduce our revenues, and reduce or possibly
      eliminate our gross profit from our carrier transmission services. If
      telecommunications rates continue to decline, we may lose users for our
      services.





**We
      may not be able to keep pace with rapid technological changes in the
      communications industry.**





Our
      industry is subject to rapid technological change. We cannot predict the effect
      of technological changes on our business. In addition, widely accepted standards
      have not yet developed for the technologies we use. We expect that new services
      and technologies will emerge in the market in which we compete. These new
      services and technologies may be superior to the services and technologies
      that
      we use, or these new services may render our services and technologies obsolete.
      To be successful, we must adapt to our rapidly changing market by continually
      improving and expanding the scope of services we offer and by developing new
      services and technologies to meet customer needs. Our success will depend,
      in
      part, on our ability to license leading technologies and respond to
      technological advances and emerging industry standards on a cost-effective
      and
      timely basis. We may need to spend significant amounts of capital to enhance
      and
      expand our services to keep pace with changing technologies.





**Third
      parties might infringe upon our proprietary technology, and we could be deemed
      to have infringed upon others' proprietary technology.**





We
      cannot
      assure you that the steps we have taken to protect our intellectual property
      rights will prevent misappropriation of our proprietary technology. To protect
      our rights to our intellectual property, we rely on a combination of trademark
      and trade secret protection, confidentiality agreements and other contractual
      arrangements with our employees, affiliates, strategic partners and others.
      We
      may be unable to detect the unauthorized use of, or take appropriate steps
      to
      enforce, our intellectual property rights. Effective copyright and trade secret
      protection may not be available in every country in which we offer or intend
      to
      offer our services. Failure to adequately protect our intellectual property
      could harm our brand, devalue our proprietary content and affect our ability
      to
      compete effectively. Further, defending our intellectual property rights could
      result in the expenditure of significant financial and managerial resources.
      In
      addition, given the growing level of VoIP-related patents and related patent
      litigation, we could be deemed to have infringed on the patent rights of others,
      which could also result in the expenditure of significant financial and
      managerial resources, and which, if we are unsuccessful in defending, could
      result in significant damage awards.




**If
      we are not able to obtain necessary licenses of third-party technology at
      acceptable prices, or at all, some of our products may become
      obsolete.**





From
      time
      to time, we may be required to license technology from third parties to develop
      new products or product enhancements. Third-party licenses may not be available
      or continue to be available to us on commercially reasonable terms. The
      inability to maintain or re-license any third-party licenses required in our
      current products, or to obtain any new third-party licenses to develop new
      products and product enhancements, could require us to obtain substitute
      technology of lower quality or performance standards or at greater cost, and
      delay or prevent us from making these products or enhancements, any of which
      could seriously harm the competitiveness of our products.





**Government
      regulation and legal uncertainties relating to IP telephony could harm our
      busines** s.





Historically,
      voice communications services have been provided by regulated telecommunications
      common carriers. We offer voice communications to the public for international
      and domestic calls using IP telephony. Based on specific regulatory
      classifications and recent regulatory decisions, we believe we qualify for
      certain exemptions from telecommunications common carrier regulation in many
      of
      our markets. However, the growth of IP telephony has led to close examination
      of
      its regulatory treatment in many jurisdictions, making the legal status of
      our
      services uncertain and subject to change as a result of future regulatory
      action, judicial decisions or legislation in any of the jurisdictions in which
      we operate. Established regulated telecommunications carriers have sought and
      may continue to seek regulatory actions to restrict the ability of companies
      such as ours to provide services or to increase the cost of providing such
      services. In addition, our services may be subject to regulation if regulators
      distinguish phone-to-phone telephony service using IP technologies over
      privately-managed networks such as our services from integrated PC-to-PC and
      PC-originated voice services over the Internet. Some regulators may decide
      to
      treat the former as regulated common carrier services and the latter as
      unregulated enhanced or information services. Application of new regulatory
      restrictions or requirements to us could increase our costs of doing business
      and prevent us from delivering our services through our current arrangements.
      In
      such event, we would consider a variety of alternative arrangements for
      providing our services, including obtaining appropriate regulatory
      authorizations for our local network partners or ourselves, changing our service
      arrangements for a particular country or limiting our service offerings. Such
      regulations could limit our service offerings, raise our costs and restrict
      our
      pricing flexibility, and potentially limit our ability to compete effectively.
      Further, regulations and laws which affect the growth of the Internet could
      hinder our ability to provide our services over the Internet.





15


Recent
      regulatory enactments by the FCC will require us to provide enhanced Emergency
      911 dialing capabilities to our subscribers as part of our standard VoIP
      services and to comply with certain notification requirements with respect
      to
      such capabilities. These requirements will result in increased costs and risks
      associated with the delivery of our VoIP services. Even assuming our full
      compliance with Emergency 911 requirements, such compliance and our efforts
      to
      achieve such compliance will increase our cost of doing business in the VoIP
      arena and may adversely affect our ability to deliver our VoIP telephony
      services to new and existing customers in all geographic regions.





**Our
      products must comply with industry standards, FCC regulations, state,
      country-specific and international regulations, and changes may require us
      to
      modify existing products.**





In
      addition to reliability and quality standards, the market acceptance of
      telephony over broadband IP networks is dependent upon the adoption of industry
      standards so that products from multiple manufacturers are able to communicate
      with each other. There is currently a lack of agreement among industry leaders
      about which standard should be used for a particular application, and about
      the
      definition of the standards themselves. These standards, as well as audio and
      video compression standards, continue to evolve. We also must comply with
      certain rules and regulations of the Federal Communications Commission (FCC)
      regarding electromagnetic radiation and safety standards established by
      Underwriters Laboratories, as well as similar regulations and standards
      applicable in other countries. Standards are continuously being modified and
      replaced. As standards evolve, we may be required to modify our existing
      products or develop and support new versions of our products. The failure of
      our
      products to comply, or delays in compliance, with various existing and evolving
      industry standards could delay or interrupt volume production of our IP
      telephony products, which would have a material adverse effect on our business,
      financial condition and operating results.





**Terrorist
      attacks, hostilities or other sustained military campaigns may adversely impact
      the industry and us.**





The
      terrorist attacks that took place in the United States on September 11, 2001,
      were unprecedented events that have created many economic and political
      uncertainties, some of which may materially adversely impact us. The long-term
      impact that terrorist attacks and the threat of terrorist attacks may have
      on
      the telecommunications industry is not known at this time. Uncertainty
      surrounding future hostilities both in the United States and abroad may
      adversely impact us in unpredictable ways.




**RISKS
      RELATED TO OUR STOCK**




**Because
      many of our current financing agreements contain “favored nations” clauses,
      future securities issuances at prices below contractual thresholds may trigger
      price ratchets that could decrease the exercise price or conversion rate of
      our
      existing convertible debt and warrants, significantly diluting existing
      shareholders.**





Many
      of
      our existing convertible debt and warrant agreements contain “favored nations”
clauses, whereby their related conversion or exercise prices automatically
      ratchet downward to match potentially more favorable terms issued to new
      security holders. This has the effect of increasing the number of our common
      shares issuable upon the assumed conversion or exercise of our existing
      convertible debt and warrants. Existing conversion or exercise prices related
      to
      financing agreements with favored nations clauses have been ratcheted to as
      low
      as $3.60 per share. If future issuances of securities are made at conversion
      or
      exercise prices with terms more favorable than this, existing shareholders
      could
      be significantly diluted.




**Our
      stock price has been and may continue to be volatile.**





The
      market for technology stocks in general and our common stock in particular,
      has
      been and will likely continue to be extremely volatile. The following factors
      could cause the market price of our common stock to fluctuate
      significantly:




·
              The
                  addition or loss of any major
                  customer;
 
 ·
              Changes
                  in the financial condition or anticipated capital expenditure purchases
                  of
                  any existing or potential major
                  customer;
 
 ·
              Quarterly
                  variations in our operating
                  results;
  16
  ·
              Changes
                  in financial estimates by securities
                  analysts;
 
 ·
              Speculation
                  in the press or investment
                  community;
 
 ·
              Announcements
                  by us or our competitors of significant contracts, new products
                  or
                  acquisitions, distribution partnerships, joint ventures, or capital
                  commitments;
 
 ·
              Sales
                  of common stock or other securities by us or by our shareholders
                  in the
                  future;
 
 ·
              Securities
                  and other litigation;
 
 ·
              Announcement
                  of a stock split, reverse stock split, stock dividend, or similar
                  event;
 
 ·
              Economic
                  conditions for the telecommunications, networking, and related
                  industries;
                  and
 
 ·
              Economic
                  instability.


**We
      do not expect to pay dividends.**





We
      do not
      anticipate paying any cash dividends on our common stock in the foreseeable
      future. We intend to retain profits, if any, to fund growth and
      expansion.





**We
      do not have sufficient authorized or registered shares, and future common stock
      dilution is likely.**





Our
      authorized shares of stock consist of 400,000,000 shares of common stock. As
      of
      March 28, 2007, 4,930,485 common shares (98,609,701 shares pre-split) were
      issued and outstanding, and approximately 12.1 million additional shares (242.1
      million shares pre-split) are currently issuable upon the conversion of all
      convertible debt, and the exercise of all options and warrants. We are also
      required to reserve an additional 3.8million common shares (76.6 million shares
      pre-split) under our various financing agreements and stock option plans. We
      will need to seek future shareholder approval of additional common shares to
      meet these obligations. If such approval is not obtained, we will be unable
      to
      satisfy all of the contractual obligations we have undertaken to issue and
      reserve future shares of common stock. Also if significant numbers of additional
      common shares are issued as allowed for above or in conjunction with new
      financing, our current shareholders would experience significant dilution of
      their ownership, and our stock price per share could decline substantially.
      The
      following table specifies, for each listed obligation, the common shares
      issuable upon the conversion of all convertible debt and the exercise of all
      options and warrants, additional reservation requirements, and planned common
      share issuances upon approval of our proposed increase in our authorized common
      shares.


17





**Additional
                Common Stock Outstanding**
            
            **Additional
                Reservation**
            
            **Current**
            
            **Minimim Total****Upon
                Conversion/Exercise 1**
            
            **Requirements
                2**
            
            **Obligations**
            
            **Additional****Convertible**
            
            
            
            
            
            
            
            **Convertible**
            
            
            
            
            
            **To Issue**
            
            **Authorized****Notes**
            
            **Warrants**
            
            **Options**
            
            **Subtotal**
            
            **Notes**
            
            **Options**
            
            **Subotal**
            
            **Shares****3**
            
            **Shares Required**May
                2005 private placement
            
            
            -
            
            
            124,349
            
            
            -
            
            
            124,349
            
            
            -
            
            
            -
            
            
            -
            
            
            76,761
            
            
            201,110July
                and October 2005 convertible notes and warrants
            
            
            135,707
            
            
            185,678
            
            
            -
            
            
            321,385
            
            
            636,539
            
            
            -
            
            
            636,539
            
            
            500,834
            
            
            1,458,758January
                and February 2006 convertible notes and warrants
            
            
            2,320,307
            
            
            453,706
            
            
            -
            
            
            2,774,013
            
            
            525,712
            
            
            -
            
            
            525,712
            
            
            308,254
            
            
            3,607,979November
                2005 financing agreement
            
            
            -
            
            
            111,250
            
            
            -
            
            
            111,250
            
            
            -
            
            
            -
            
            
            -
            
            
            236,806
            
            
            348,056WQN,
                Inc.
            
            
            1,098,906
            
            
            -
            
            
            -
            
            
            1,098,906
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            1,098,906October
                06 convertible notes and warrants
            
            
            807,188
            
            
            518,907
            
            
            -
            
            
            1,326,095
            
            
            807,188
            
            
            -
            
            
            807,188
            
            
            -
            
            
            2,133,283January
                07 convertible notes
            
            
            532,662
            
            
            -
            
            
            -
            
            
            532,662
            
            
            -
            
            
            
            
            
            -
            
            
            -
            
            
            532,662February
                07 convertible notes
            
            
            1,162,220
            
            
            1,066,034
            
            
            -
            
            
            2,228,254
            
            
            1,162,220
            
            
            
            
            
            1,162,220
            
            
            -
            
            
            3,390,474Nov/Dec
                06 & Jan 07 bridge notes
            
            
            -
            
            
            121,095
            
            
            -
            
            
            121,095
            
            
            -
            
            
            -
            
            
            -
            
            
            200,000
            
            
            321,0952004
                Stock Option Plan
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            200,000
            
            
            200,000
            
            
            -
            
            
            200,0002006
                Stock Option Plan
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            500,000
            
            
            500,000
            
            
            -
            
            
            500,000Securities
                owned by consulting and other professional firms
            
            
            -
            
            
            217,467
            
            
            15,283
            
            
            232,750
            
            
            -
            
            
            
            
            
            -
            
            
            108,500
            
            
            341,250Current
                and former officer and employee securities 4
            
            
            -
            
            
            311,250
            
            
            78,125
            
            
            389,375
            
            
            -
            
            
            -
            
            
            -
            
            
            1,171,761
            
            
            1,561,136Securities
                owned by or owed to shareholders
            
            
            -
            
            
            194,620
            
            
            -
            
            
            194,620
            
            
            -
            
            
            -
            
            
            -
            
            
            48,965
            
            
            243,585**Totals**
            
            
            **6,056,990**
            
            
            **3,304,356**
            
            
            **93,408**
            
            
            **9,454,754**
            
            
            **3,131,659**
            
            
            **700,000**
            
            
            **3,831,659**
            
            
            **2,651,881**
            
            
            **15,938,294**




1 These
        columns represent common shares issuable upon the hypothetical conversion
        of
        outstanding convertible debt, and the exercise of all outstanding warrants
        and
        options.
 2 These
        columns represent contractual requirements to reserve specified or computed
        numbers of common shares from our authorized capital, in addition to the
        conversion/exercise amounts referred to in footnote 1.
 3 These are
        common shares that are contractually owing to various individuals or firms,
        and
        are expected to be issued after our authorized shares are increased. (See
        Note R
        to our December 31, 2006 consolidated financial statements for subsequent
        authorized common stock increase.)
 4 In
        addition, our Chief Executive Officer and Chief Operating Officer may receive
        additional options sufficient to maintain their common share ownership at
        5% and
        8%, respectively.


**Item
      2.****Properties**





Our
      headquarters are in Altamonte Springs, Florida. Following is a description
      of
      these facilities, which are leased, as of December 31, 2006.




Location
              
              Purpose
              
              Approx. Sq. Ft.
              
              Annual
                  Rent151
                  S. Wymore Rd, Suite 3000
                Altamonte
                  Springs, FL 32714
              
              Network
                facilities and corporate offices
              
              
              11,500
              
              $
              208,000




**Item
      3.****Legal
      Proceedings**





**MCI**





On
      April
      8, 2005, our subsidiary, Volo Communications, filed suit against MCI WorldCom
      Network Services, Inc. d/b/a UUNET ("MCI WorldCom"). Volo alleges that MCI
      WorldCom engaged in a pattern and practice of over-billing Volo for the
      telecommunications services it provided pursuant to the parties' Services
      Agreement, and that MCI WorldCom refused to negotiate such overcharges in good
      faith. Volo also seeks damages arising out of MCI WorldCom's fraudulent practice
      of submitting false bills by, among other things, re-routing long distance
      calls
      over local trunks to avoid access charges, and then billing Volo for access
      charges that were never incurred.




On
      April
      4, 2005, MCI WorldCom declared Volo in default of its obligations under the
      Services Agreement, claiming that Volo owes a past due amount of $8,365,980,
      and
      threatening to terminate all services to Volo within five days. By this action
      Volo alleges claims for (1) breach of contract; (2) fraud in the inducement;
      (3)
      primary estoppel; and (4) deceptive and unfair trade practices. Volo also
      seeks a declaratory judgment that (1) MCI WorldCom is in breach of the Services
      Agreement; (2) $8,365,980 billed by MCI WorldCom is not "due and payable" under
      that agreement; and (3) MCI WorldCom's default letter to Volo is in violation
      of
      the Services Agreement. Volo seeks direct, indirect and punitive damages in
      an
      amount to be determined at trial.




On
      May
      26, 2005, MCI WorldCom filed an Answer, Affirmative Defenses, Counterclaim
      and
      Third-Party Complaint naming Caerus as a third-party defendant. MCI WorldCom
      asserts a breach of contract claim against Volo, a breach of guarantee claim
      against Caerus, and a claim for unjust enrichment against both parties, seeking
      an amount to be determined at trial. On July 11, 2005, Volo and Caerus answered
      the counterclaim and third-party complaint, and filed a third-party counterclaim
      against MCI WorldCom for declaratory judgment, fraud in the inducement, and
      breach of implied duty of good faith and fair dealing. Volo and Caerus seek
      direct, indirect and punitive damages in an amount to be determined at
      trial.




18


Extensive
      discovery took place throughout 2006, with multiple depositions taking place,
      written discovery requests being exchanged, and extensive document productions
      being held.





On
      December 20, 2006, the Court granted MCI WorldCom summary judgment dismissing
      Caerus' claim for slander of credit. On January 7, 2007, the Court issued a
      scheduling order setting a trial date for June 18, 2007, with several interim
      deadlines. On February 28, 2007, the Court denied MCI WorldCom's motion for
      summary judgment of dismissal of the claims of Volo and Caerus for declaratory
      relief, denied Caerus' motion for clarification or reargument of the dismissal
      of the slander of credit claim and denied Volo's and Caerus' motions in the
      alternative to amend their complaints.





On
      January 2, 2007, an Amended Case Management and Scheduling Order was entered
      which imposed a May 18, 2007 discovery cutoff; a June 5, 2007 pre-trial
      conference; and a June 18, 2007 time-certain trial. On January 11, 2007, MCI
      WorldCom and Volo/Caerus participated in a Court-ordered mediation conference.
      The parties engaged in further settlement discussions in February and March
      2007, which ultimately led to an agreement to terms to settle the litigation
      and
      the signing of a mutually acceptable settlement term sheet on March 27, 2007.
      The term sheet contains a due diligence provision that, upon completion under
      certain circumstances, permits MCI WorldCom to decide whether or not to proceed
      with the settlement. The parties' contemplate finalizing and executing mutually
      acceptable settlement documents reflecting the confidential settlement term
      sheet before the case is be dismissed.





In
      the
      event the parties withdraw from the settlement, we are currently unable to
      assess the likelihood of a favorable or unfavorable outcome. In that event,
      it
      is not clear whether or not the Court will hold the parties to the
      previously-ordered June 2007 trial.





**Cross
      Country Capital Partners, L.P.**





On
      or
      about September 25, 2006, Cross Country Capital Partners, L.P. (“Cross Country”)
      filed suit against us in the District Court, 116 th Judicial
      Circuit, Dallas County, Texas. Cross Country asserts a claim for breach of
      contract in connection with a securities purchase agreement entered into with
      us. Cross Country also seeks specific performance of the securities purchase
      agreement at issue. Cross Country seeks unspecified damages and attorneys'
      fees,
      which fees are provided for in the securities purchase agreement and under
      Texas
      law. On or about December 14, 2006, we filed our Answer denying any wrongdoing
      and asserting numerous affirmative defenses. We intend to vigorously defend
      this
      matter but are unable to assess the outcome of this litigation or its impact
      on
      our financial condition and results of operations.





**Other
      Litigation**





We
      are
      currently a defendant in other lawsuits and disputes arising in the ordinary
      course of business, and have accrued related litigation charges totaling
      $561,305 for the year ended December 31, 2006. We believe that resolution of
      all
      known contingencies is uncertain, and there can be no assurance that future
      costs related to such litigation would not exceed the amounts accrued in our
      consolidated financial statements, which may in turn materially adversely affect
      our financial position or results of operations.





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





No
      matters were submitted to a vote of security holders during the quarter ended
      December 31, 2006.


19


**PART
      II**





**Item
      5.** **Market
      for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases
      of Equity Securities**





**Dividends**





We
      have
      no current plans to pay any future cash dividends on the common stock. Instead,
      we intend to retain all earnings, other than those required to be paid to the
      holders of any preferred stock we may issue in the future, to support our
      operations and future growth. The payment of any future dividends on the common
      stock will be determined by the board of directors based upon our earnings,
      financial condition and cash requirements; possible restrictions in future
      financing agreements, if any; business conditions; and such other factors deemed
      relevant.





**Market
      Information**





The
      common stock is traded on the OTCBB under the symbol “VOIC.” The following
      quotations reflect the high and low for our common stock based on inter-dealer
      prices, without retail mark-up, mark-down or commission and may not represent
      actual transactions. The high and low bid prices of our common stock for the
      periods indicated below are as follows:




Quarter
                Ended
            
            High
            
            Low12/31/06
            
            $
            9.40
            
            $
            5.809/30/06
            
            
            13.60
            
            
            5.206/30/06
            
            
            25.80
            
            
            9.803/31/06
            
            
            52.40
            
            
            25.6012/31/05
            
            
            41.40
            
            
            25.409/30/05
            
            
            46.00
            
            
            19.006/30/05
            
            
            33.00
            
            
            20.603/31/05
            
            
            81.60
            
            
            32.20




**Holders**





As
      of March 22, 2007 there were approximately 424 shareholders of record
      and an unknown number of beneficial holders holding through
      brokers.





**Common
      Stock**





We
      are
      authorized to issue up to 400,000,000 shares of common stock, par value $.001
      per share. As of March 28, 2007, approximately 4,930,485 shares of our common
      stock were issued and outstanding.





Holders
      of the common stock are entitled to one vote per share on all matters to be
      voted upon by the stockholders. Holders of common stock are entitled to receive
      ratably such dividends, if any, as may be declared by the board of directors
      out
      of funds legally available therefore. Upon the liquidation, dissolution, or
      winding up of our company, the holders of common stock are entitled to share
      ratably in all of our assets which are legally available for distribution after
      payment of all debts and other liabilities and liquidation preference of any
      outstanding common stock. Holders of common stock have no preemptive,
      subscription, redemption or conversion rights. The outstanding shares of common
      stock are validly issued, fully paid and non-assessable.




**Item
      6.**  **Selected
      Financial Data**





The
      following table sets forth selected historical financial data as of and for
      each
      of the years ended December 31, 2002, 2003, 2004, 2005, and 2006. The
      related financial data as of December 31, 2004, 2005, and 2006 and for the
      years
      then ended are derived from our consolidated financial statements which have
      been audited by Berkovits, Lago & Company, LLP, independent auditors, and
      their report is included elsewhere in this annual report. The selected financial
      data as of December 31, 2002, and 2003 and for the years then ended are derived
      from our consolidated financial statements which have been audited by Tschopp,
      Whitcomb &
      Orr, P.A., independent auditors. The following financial information should
      be
      read in conjunction with “Management's Discussion and Analysis of Financial
      Condition and Results of Operations,” and our consolidated financial statements
      and related notes appearing elsewhere in this Form 10-K.


20





**2002****(1)**
            
            **2003****(1)**
            
            **2004****(1)**
            
            **2005****(1)**
            
            **2006****(1)**Revenues
            
            $
            -
            
            $
            -
            
            $
            1,020,285
            
            $
            6,321,115
            
            $
            5,933,248Gross
                profit (loss)
            
            
            -
            
            
            -
            
            
            265,687
            
            
            (1,513,009
            )
            
            (2,691,628
            )Operating
                expenses
            
            
            -
            
            
            -
            
            
            5,573,575
            
            
            20,361,386
            
            
            28,849,397Loss
                from continuing operations
            
            $
            -
            
            $
            -
            
            $
            (5,307,888
            )
            $
            (23,145,900
            )
            $
            (39,232,761
            )Net
                loss
            
            $
            (61,926
            )
            $
            (352,968
            )
            $
            (5,862,120
            )
            $
            (28,313,333
            )
            $
            (41,196,512
            )Net
                loss per share:Loss
                from continuing operations
            
            $
            -
            
            $
            -
            
            $
            (7.27
            )
            $
            (12.04
            )
            $
            (10.42
            )Net
                loss
            
            $
            (0.80
            )
            $
            (4.00
            )
            $
            (8.03
            )
            $
            (14.72
            )
            $
            (10.94
            )Summary
                cash flow data:Net
                cash used in operating activities
            
            $
            -
            
            $
            (78,706
            )
            $
            (3,330,574
            )
            $
            (17,601,150
            )
            $
            (12,371,474
            )Net
                cash provided by (used in) investing activities
            
            
            73,849
            
            
            82,196
            
            
            479,594
            
            
            (4,909,352
            )
            
            (6,495
            )Net
                cash provided by financing activities
            
            
            -
            
            
            -
            
            
            3,988,618
            
            
            24,598,110
            
            
            9,239,396Balance
                Sheet Data (at period end):Cash
            
            
            9
            
            
            3,499
            
            
            1,141,137
            
            
            3,228,745
            
            
            90,172Property
                and equipment
            
            
            -
            
            
            -
            
            
            389,528
            
            
            9,687,470
            
            
            6,604,285Goodwill
                and other intangible assets
            
            
            -
            
            
            -
            
            
            1,713,301
            
            
            29,125,481
            
            
            25,992,034Total
                assets
            
            
            530,230
            
            
            259,459
            
            
            8,672,548
            
            
            49,215,068
            
            
            35,928,963Long
                term obligations
            
            
            -
            
            
            -
            
            
            -
            
            
            245,248
            
            
            222,669Total
                liabilities
            
            
            68,970
            
            
            151,167
            
            
            1,027,727
            
            
            22,349,148
            
            
            32,884,147Total
                shareholders' equity
            
            
            461,260
            
            
            108,292
            
            
            7,644,821
            
            
            26,865,920
            
            
            3,044,816Book
                value per share
            
            $
            5.96
            
            $
            1.25
            
            $
            6.30
            
            $
            9.03
            
            $
            0.62Cash
                dividends per share
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -




(1)
            Operations
                relating to Millennia Tea Masters, DTNet Technologies, Phone House,
                Inc.
                and the Dallas, Texas tangible assets acquired from WQN, Inc. were
                discontinued in 2004, 2005, 2006, and 2007, respectively. Operating
                results prior to these events were reclassified as discontinued
                operations.





**Item
      7.****Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations******





**General**





The
      following discussion should be read in conjunction with the unaudited
      consolidated financial statements and the notes thereto and the other financial
      information appearing elsewhere in this Form 10-K. Certain statements contained
      in this Form 10-K and
      other
      written material and oral statements made from time to time by us do not relate
      strictly to historical or current facts. As such, they are considered
      "forward-looking statements," that provide current expectations or forecasts
      of
      future events. Such statements are typically characterized by terminology such
      as "believe," "anticipate," "should," "intend," "plan," "will," "expect,"
      "estimate," "project," "strategy," and “may,” and similar expressions. Our
      forward-looking statements generally relate to the prospects for future sales
      of
      our products, the success of our marketing activities, and the success of our
      strategic corporate relationships. These statements are based upon assumptions
      and assessments made by our management in light of its experience and its
      perception of historical trends, current conditions, expected future
      developments and other factors our management believe to be appropriate. These
      forward-looking statements are subject to a number of risks and uncertainties,
      including the following: our ability to achieve profitable operations and to
      maintain sufficient cash to operate our business and meet our liquidity
      requirements; our ability to obtain financing, if required, on terms acceptable
      to us, if at all; the success of our research and development activities;
      competitive developments affecting our current products; our ability to
      successfully attract strategic partners and to market both new and existing
      products; exposure to lawsuits and regulatory proceedings; our ability to
      protect our intellectual property; governmental laws and regulations affecting
      operations; our ability to identify and complete diversification opportunities;
      and the impact of acquisitions, divestitures, restructurings, product
      withdrawals, and other unusual items. A further list and description of these
      risks, uncertainties and other matters can be found elsewhere in this Form
      10-K.
      Except as required by applicable law, we undertake no obligation to update
      any
      forward-looking statements, whether as a result of new information, future
      events or otherwise.




21




**Consolidated
      Summary**




**Balance
              Sheet Data:**
            
            December
                31,2006
                (2)
            
            2005
                (1)(2)(Reclassified)
            
            (Reclassified)Goodwill
                and other intangible assets
            
            $
            25,992,034
            
            $
            29,125,481Total
                assets
            
            
            35,928,963
            
            
            49,215,068Notes
                and loans payable, current
            
            
            2,574,835
            
            
            4,685,236Total
                liabilities
            
            
            32,884,147
            
            
            22,349,148Shareholders'
                equity
            
            
            3,044,816
            
            
            26,865,920




**Statement
                of Operations Data:**
            
            For
                the Year Ended December 31,2006
                (2)
            
            2005
                (1)(2)
            
            2004
                (2)(Reclassified)
            
            (Reclassified)Revenues
            
            $
            5,933,248
            
            $
            6,321,115
            
            $
            1,020,285Cost
                of sales
            
            
            8,624,876
            
            
            7,834,124
            
            
            754,598Gross
                profit (loss)
            
            
            (2,691,628
            )
            
            (1,513,009
            )
            
            265,687Operating
                expenses
            
            
            28,849,396
            
            
            20,361,386
            
            
            5,573,575Loss
                from continuing operations
            
            
            (31,541,022
            )
            
            (21,874,395
            )
            
            (5,307,888
            )Other
                expenses, net
            
            
            7,691,737
            
            
            1,271,505
            
            
            -Loss
                before discontinued operations
            
            
            (39,232,760
            )
            
            (23,145,900
            )
            
            (5,307,888
            )Loss
                from discontinued operations
            
            
            (1,963,751
            )
            
            (5,167,433
            )
            
            (554,232
            )Net
                loss
            
            $
            (41,196,512
            )
            $
            (28,313,333
            )
            $
            (5,862,120
            )Per
                common share:Loss
                before discontinued operations
            
            $
            (10.42
            )
            $
            (12.03
            )
            $
            (7.27
            )Net
                loss
            
            $
            (10.94
            )
            $
            (14.72
            )
            $
            (8.03
            )





(1)
            Includes
                the results of Caerus, Inc. and subsidiaries (“Caerus”) subsequent to
                their acquisition in May 2005.





(2)
            Adjusted
                to reflect discontinued operations classification pertaining to the
                sale
                of our DTNet Technologies subsidiary in April 2006, the October 2006
                termination of our Marketing and Distribution Agreement with Phone
                House,
                Inc., a wholesale prepaid telephone calling card business acquired
                in our
                WQN acquisition, and the June 2007 sale of our tangible operating
                assets
                utilized by our Dallas, Texas, division also acquired in our WQN
                acquisition.





**Comparability
      of Results**





The
      comparability of our results of operations is significantly impacted by the
      acquisition in May 2005 of Caerus. The following table presents our pro forma
      results of operations for the year ended December 31, 2005, assuming this
      business combination had occurred at the beginning of 2005.





Revenues
            
            $
            15,585,624Net
                loss
            
            
            (36,352,750
            )Net
                loss per share
            
            
            (18.90
            )




**Reclassification
      of Financial Statements**





As
      a
      result of the June 27, 2007 sale of substantially all of the tangible operating
      assets utilized by our Dallas, Texas division, we have reclassified our
      financial position, results of operations, and cash flows related to this
      division since the date of its acquisition in October 2005 to reflect
      discontinued operations accounting treatment. The following tables set forth
      the
      impact of this reclassification on certain amounts previously reported in our
      consolidated financial statements as of and for the years ended December 31,
      2006 and 2005.


22





Year
                EndedDecember
                31, 2006
            
            December
                31, 2005Previously
            
            
            
            PreviouslyStatement
                of Operations Data
            
            Reported
            
            Reclassified
            
            Reported
            
            ReclassifiedRevenues
            
            $
            14,676,948
            
            $
            5,933,248
            
            $
            8,945,868
            
            $
            6,321,115Cost
                of sales
            
            
            14,685,010
            
            
            8,624,876
            
            
            10,245,516
            
            
            7,834,124Gross
                profit (loss)
            
            
            (8,062
            )
            
            (2,691,628
            )
            
            (1,299,648
            )
            
            (1,513,009
            )Operating
                expenses
            
            
            31,015,685
            
            
            28,849,396
            
            
            21,063,041
            
            
            20,361,386Other
                expenses
            
            
            8,192,812
            
            
            7,691,737
            
            
            1,432,305
            
            
            1,271,505Net
                loss before discontinued operations
            
            
            (39,216,559
            )
            
            (39,232,761
            )
            
            (23,794,994
            )
            
            (23,145,900
            )Loss
                from discontinued operations
            
            
            (1,979,953
            )
            
            (1,963,751
            )
            
            (4,518,339
            )
            
            (5,167,433
            )Net
                loss
            
            $
            (41,196,512
            )
            $
            (41,196,512
            )
            $
            (28,313,333
            )
            $
            (28,313,333
            )




December
                31, 2006
            
            December
                31, 2005Previously
            
            
            
            
            
            PreviouslyBalance
                Sheet Data
            
            
            Reported
            
            
            Reclassified
            
            
            Reported
            
            
            ReclassifiedCurrent
                assets
            
            $
            1,277,238
            
            $
            871,091
            
            $
            5,035,536
            
            $
            4,284,006Property
                and equipment, net
            
            
            6,860,233
            
            
            6,604,285
            
            
            10,141,872
            
            
            9,687,470Goodwill
                and other intangible assets
            
            
            32,687,822
            
            
            25,992,034
            
            
            36,044,271
            
            
            29,125,481Net
                assets of discontinued operations
            
            
            -
            
            
            2,367,007
            
            
            1,767,475
            
            
            5,875,253Other
                assets
            
            
            99,828
            
            
            94,546
            
            
            349,205
            
            
            242,858Total
                assets
            
            $
            40,925,121
            
            $
            35,928,963
            
            $
            53,338,359
            
            $
            49,215,068Current
                liabilities
            
            $
            37,657,636
            
            $
            32,661,478
            
            $
            26,227,191
            
            $
            22,103,900Other
                liabilities
            
            
            222,669
            
            
            222,669
            
            
            245,248
            
            
            245,248Total
                shareholders' equity
            
            
            3,044,816
            
            
            3,044,816
            
            
            26,865,920
            
            
            26,865,920Total
                liabilities and shareholders' equity
            
            $
            40,925,121
            
            $
            35,928,963
            
            $
            53,338,359
            
            $
            49,215,068





**Revenues**





Our
      consolidated revenues for the years ended December 31, 2006 and 2005
      (reclassified to exclude revenues from discontinued operations, and as a result
      include primarily revenues from our Caerus operations) were $5.9 million and
      $6.3 million, respectively. Revenues in 2006 reflect twelve months of
      Caerus operations, whereas 2005 revenues reflect Caerus revenues since its
      acquisition on May 31, 2005. Caerus revenues declined in 2006 due to lower
      traffic on our network. Our consolidated loss before discontinued operations
      was
      $39.2 million ($10.42 per share) for the year ended December 31, 2006, as
      compared to a loss before discontinued operations of $23.1 million ($12.04
      per
      share) for the year ended December 31, 2005. The increase in our loss
      from 2005 to 2006 reflects the inclusion of the results of Caerus from the
      date
      of its acquisition, coupled with increased financing activities. Substantially
      all of the Caerus revenues for 2006 were generated by one customer. Our results
      for 2006 and 2005 include losses before discontinued operations of $13.3 million
      and $7.9 million, respectively, generated by our Caerus business.





Our
      consolidated revenues for the years ended December 31, 2005 and 2004
      (reclassified to exclude revenues from discontinued operations) were $6.3
      million and $1.0 million, respectively. Our consolidated loss before
      discontinued operations was $23.1 million ($12.04 per share) for the year ended
      December 31, 2005, as compared to a loss before discontinued operations of
      $5.3
      million ($7.27 per share) for the year ended December 31, 2004. The increases
      in
      our revenues and net loss from 2004 to 2005 reflect the inclusion of the results
      of Caerus from the date of its acquisition. Substantially all of the Caerus
      revenues for 2005 were generated by one customer. Our results for 2005 include
      a
      loss before discontinued operations of $7.9 million generated by our Caerus
      business.





23




**Cost
      of Sales and Gross Profit (Loss)**





Consolidated
      cost of sales was $8.6 million and $7.8 million for the years ended December
      31,
      2006 and 2005 (reclassified to exclude revenues from discontinued operations),
      respectively. This increase reflects the inclusion of the results of Caerus
      from
      the date of its acquisition, coupled with an increase in Caerus’s costs paid to
      third party vendors to terminate the calls of our customers. The negative gross
      profit of $2.7 million (45% of revenues) in 2006 reflects costs paid to third
      party vendors that exceeded the revenues we charged to terminate the calls
      of
      our customers. We do not expect to generate substantial positive margins on
      our
      network traffic until such time as we are able to (1) increase the overall
      volume of traffic handled by our network by growing our customer base and (2)
      continue to lower the average cost per minute we pay for call termination
      through negotiation of more favorable pricing,
      expanding our selection of third party vendors, and continuing to improve our
      routing process to ensure we are using the lowest cost route available to us
      to
      terminate each call.





Consolidated
      cost of sales was $7.8 million and $0.8 million for the years ended December
      31,
      2005 and 2004 (reclassified to exclude revenues from discontinued operations),
      respectively. This increase reflects the inclusion of the results of Caerus
      from
      the date of its acquisition. The negative gross profit of $1.5 million (24%
      of
      revenues) in 2005 reflects costs paid to third party vendors that exceeded
      the
      revenues we charged to terminate the calls of our customers.





**Operating
      Expenses**





Consolidated
      operating expenses were $28.8 million and $20.4 million for the years ended
      December 31, 2006 and 2005 (reclassified to exclude operating expenses
      from discontinued operations), respectively. Compensation and related expenses
      accounted for $5.4 million of the increase from 2005. Included in 2006
      compensation is $7.9 million of non-cash expenses connected to employee options
      and warrants, primarily related to current and former officers, including $4.9
      million of employment termination-associated expenses related to former
      officers. Professional, legal and consulting expenses increased by $4.7 million,
      due primarily to attorneys' fees related to the litigation discussed in Note
      K
      to our consolidated financial statements, and to costs associated with
      maintaining our increasingly complex financing structure and SEC filings, as
      well as increased investor relations activities in 2006. Depreciation and
      amortization increased $1.7 million in 2006, due primarily to a full year of
      amortization of intangible assets relating to the acquisition of Caerus assets
      in 2005.





We
      incurred significantly greater corporate operating expenses in 2005 ($20.4
      million) than in 2004 ($5.6 million) (reclassified to exclude operating expenses
      from discontinued operations), due to the increased size and complexity of
      our
      operations, resulting from the acquisition of Caerus assets in 2005. Included
      in
      2005 operating expenses are $7.1 million in compensation and benefits, $4.8
      million in commissions and fees paid to third parties primarily in connection
      with our capital raising efforts, professional and legal fees of $1.9 million,
      $2.9 million of depreciation and amortization, and $3.7 million of general
      and
      administrative expenses.





**Other
      Expenses, Net**





Consolidated
      net other expenses were $7.7 million and $1.3 million for the years ended
      December 31, 2006 and 2005 (reclassified to exclude other expenses
      from discontinued operations), respectively. Amortization of debt discounts,
      the
      primary component of our reported interest expense, increased by $5.8 million
      in
      2006, reflecting our significantly higher convertible note balances in 2006
      used
      to finance our operations, all which were issued at significant discounts as
      part of our fund raising activities. Financing penalties and expenses amounted
      to $6.4 million in 2006 (none in 2005), related primarily to our lack of
      compliance with the securities registration requirements in many of our
      financing agreements, as discussed in Note H to our consolidated financial
      statements. Of this $6.4 million, $5.7 million was paid or is payable in our
      common stock or warrants. We also incurred $1.1 million in 2006 (none in 2005)
      of litigation charges related to the litigation discussed in Note K to our
      consolidated financial statements.





We
      had
      insufficient authorized common shares to satisfy the warrant obligations
      associated with the convertible notes issued in January and February 2006 on
      the
      dates the warrants were issued. Therefore, in accordance with Emerging Issues
      Task Force Issue 00-19 (“EITF 00-19”), the $3,526,077 initial value of these
      warrants at their issuance dates was recorded as a debt discount and a warrant
      liability on our consolidated balance sheet. In addition, $770,314 of the
      proceeds received from the May 2006 warrant repricing and exercise as discussed
      on page
      31 were
      allocated to these warrants, and recorded as a warrant liability on our balance
      sheet. Also, the May 2006 warrant repricing to $15.60 per share triggered
      contractual “favored nations” price ratchets on a number of our existing
      convertible debt and warrant agreements, reducing their effective conversion
      and
      exercise prices to $15.60 per share. The effect was to increase the number
      of
      fully diluted shares of common stock to approximately 6.45 million (129 million
      pre-split), relative to our authorized 100 million common shares. Our total
      warrants then outstanding were approximately 1.4 million (28 million pre-split).
      Per EITF 00-19, we then began classifying all remaining warrants as a liability,
      transferring $5,406,284 from additional paid-in capital to fair value liability
      for warrants on our consolidated balance sheet. The warrant liabilities have
      since been marked-to-market, resulting in a $5,102,731 liability at December
      31,
      2006, and a corresponding $7,226,430 noncash credit to earnings for the year
      ended December 31, 2006. Future changes in the market value of these warrants
      can have a material effect on our operating results.





24




Consolidated
      net other expenses were $1.3 million and $0 for the years ended
      December 31, 2005 and 2004 (reclassified to exclude other expenses
      from discontinued operations), respectively. The expenses for 2005 include
      $1.5
      million of interest expense reflecting the buildup of interest-bearing debt
      that
      began in 2005, partially offset by a $206,184 gain on the sale of fixed
      assets.





In
      accordance with SFAS No. 142, we are required to periodically evaluate the
      carrying value of our goodwill and other intangible assets. During the years
      ended December 31, 2006 and 2005, we recognized impairment expense of $839,101
      and $4,173,452, respectively, related to goodwill recorded for our former
      hardware sales business segment, and included in our reported loss from
      discontinued operations. If in the future the remaining carrying value of our
      goodwill exceeds its fair market value, we will be required to record an
      additional impairment charge in our statement of operations. Such an impairment
      charge could have a significant adverse impact on both our operating results
      and
      financial condition. If the traded market price of our common stock declines,
      a material goodwill impairment charge in the future is possible.





**Discontinued
      Operations**





On
      April
      19, 2006, we sold our wholly-owned subsidiary, DTNet Technologies, to our former
      Chief Operating Officer (the “Purchaser”) pursuant to a stock purchase
      agreement. The consideration for the sale consisted primarily of (1) the return
      for cancellation of warrants to purchase 10,000 shares of our common stock
      held
      by the Purchaser; and (2) the return for cancellation of 10,000 shares of our
      common stock held by the Purchaser. Because DTNet Technologies' operations
      were
      the primary component of our former hardware sales business segment, we recorded
      an impairment charge of $839,101 in our statement of operations for the year
      ended December 31, 2006. The remaining $198,000 of goodwill for this former
      segment approximated the excess of the sales proceeds received over DTNet
      Technologies' carrying value (excluding goodwill) and was written off in
      conjunction with the sale of DTNet Technologies.





Effective
      October 12, 2006, we terminated our Marketing and Distribution Agreement with
      Phone House, Inc. dated September 1, 2004 and amended February 16, 2006,
      effectively discontinuing this business segment. The Agreement called for the
      wholesale distribution, marketing and selling of prepaid telephone calling
      cards
      by Phone House, Inc., under license from us. We recognized a related impairment
      loss of $936,122 for the year ended December 31, 2006, primarily related to
      inventory and accounts receivable write-offs, and have filed suit in Los Angeles
      County against the primary Phone House, Inc. employee to recover
      same.





Effective
      June 27, 2007, we entered into an Asset Purchase Agreement (the "Purchase
      Agreement") with WQN, Inc., a Texas corporation (the “Purchaser”), pursuant to
      which we sold substantially all of the tangible operating assets utilized by
      our
      Dallas, Texas subsidiary, VoIP Solutions, Inc. (the "Assets"), to the
      Purchaser.  Our patents were not sold. Pursuant to the Purchase Agreement,
      the Purchaser acquired the Assets for a purchase price consisting of (1) a
      cash
      payment of $400,000; (2) 4% of the defined monthly revenues related to the
      Assets in excess of $200,000 during the first year following execution of the
      Purchase Agreement; (3) 3% of the defined monthly revenues related to the Assets
      in excess of $150,000 during the second year following execution of the Purchase
      Agreement; and (4) 2% of the defined monthly revenues related to the Assets
      in
      excess of $100,000 during the third year following execution of the Purchase
      Agreement.





The
      following summarizes the combined operating results of DTNet Technologies,
      the
      calling card business of Phone House, Inc., and the Dallas, Texas assets of
      VoIP
      Solutions, Inc., for the years ended December 31, 2006, 2005 and 2004 (through
      the respective dates of sale or termination), and their respective financial
      position as of December 31, 2006 and 2005, classified as discontinued operations
      for all periods presented.





Statement
                of Operations
            
            Year
                ended December 31,2006
            
            2005
            
            2004Revenues
            
            $
            23,052,166
            
            $
            9,186,030
            
            $
            807,908Cost
                of sales
            
            
            20,028,689
            
            
            8,497,539
            
            
            617,547Gross
                profit
            
            
            3,023,477
            
            
            688,491
            
            
            190,361Compensation
                and benefits
            
            
            957,236
            
            
            582,919
            
            
            -Asset
                impairment charges
            
            
            1,775,223
            
            
            4,173,452
            
            
            -Other
                operating expenses
            
            
            1,753,694
            
            
            938,753
            
            
            744,593Interest
                expense
            
            
            501,075
            
            
            160,800Net
                loss
            
            $
            (1,963,751
            )
            $
            (5,167,433
            )
            $
            (554,232
            )




25




December
                31,Balance
                Sheet
            
            2006
            
            2005Current
                assets
            
            $
            406,315
            
            $
            2,159,925Property
                and equipment, net
            
            
            255,948
            
            
            468,037Goodwill
                and other intangible assets
            
            
            6,695,788
            
            
            7,955,891Other
                assets
            
            
            5,282
            
            
            106,347Total
                assets
            
            
            7,363,332
            
            
            10,690,200Less
                current liabilities
            
            
            4,996,325
            
            
            4,814,947Net
                assets of discontinued operations
            
            $
            2,367,007
            
            $
            5,875,253





**Results
      by Segment**





Our
      operations formerly consisted of three segments: Telecommunication Services,
      Hardware Sales and Calling Card Sales. However, with our sale of DTNet
      Technologies, the termination of our Marketing and Distribution Agreement with
      Phone House, Inc., and the sale of substantially all of the tangible operating
      assets utilized by our Dallas, Texas division, all referred to above, these
      former segments are being accounted for as discontinued operations, and prior
      period financial statements have been appropriately reclassified. Also as a
      result of these discontinued operations, our operations currently consist of
      one
      segment, Telecommunication Services. Therefore, separate segmented financial
      results are not presented.





**Assets**





Total
      assets (adjusted for discontinued operations classification) at December 31,
      2006 were $35.9 million, down from $49.2 million at December 31, 2005. The
      decrease is due in part to $4.6 million of depreciation and amortization of
      property and equipment and intangible assets other than goodwill in 2006. Our
      cash balance also declined by $3.1 million in 2006, primarily related to our
      operating loss. In addition, net assets from discontinued operations decreased
      by $3.5 million in 2006 due to our sale of DTNet Technologies in 2006, coupled
      with a 2006 impairment loss for contract cancellation charges related to Phone
      House, Inc.




Goodwill
      and other intangible assets comprised 72% of our consolidated total assets
      at
      December 31, 2006, attributable primarily to the acquisition of Caerus
      assets.





**Liquidity
      and Capital Resources**





Cash
      and
      cash equivalents were approximately $90 thousand at December 31, 2006. Our
      consolidated net cash used in operating activities for the year ended December
      31, 2006, was $12.4 million, due primarily to the losses described above. We
      funded our operating activities principally through financing activities that
      generated net proceeds of $17.0 million ($9.2 million net of debt repayments)
      during the year ended December 31, 2006. At December 31, 2006 our negative
      working capital was $31.8 million.





Since
      inception of business in 2004 we have never been profitable. We have experienced
      negative cash flows from operations, and have been dependent on the issuances
      of
      debt and common stock in private transactions to fund our operations and capital
      expenditures. Our independent auditors have added an explanatory paragraph
      to
      their opinion on our consolidated financial statements for the year ended
      December 31, 2006, based on substantial doubt about our ability to continue
      as a
      going concern.





At
      December 31, 2006, our contractual obligations for debt, leases and capital
      expenditures totaled approximately $25.3 million. Included in this amount is
      approximately $2.4 million due on a loan from Cedar Boulevard Lease Funding
      LLC
      (“Cedar”). This loan bears interest at 17.5%, and is repayable through May 2007.
      The loan agreement contains customary covenants and restrictions and provides
      the lender the right to a perfected, first-priority security interest in all
      of
      our assets. On February 1, 2007 Cedar assigned its rights under a subordinated
      loan and security agreement, as amended, including the note payable with a
      current principal balance of $1,917,581 and the related security interest,
      to a
      group of institutional investors. Also on February 1, 2007 the note's terms
      were
      amended to allow conversion of any unpaid principal balance into our restricted
      common stock at $5.20 per share. In conjunction with our February 2007 financing
      discussed below, on February 16, 2006 the note's common stock conversion rate
      was reduced to $3.60 per share.  We were in violation of certain
      requirements of this debt facility at December 31, 2006, and have not made
      scheduled principal and interest payments. However, the lenders have currently
      not declared this loan in default. As a result, the full amount of the loan
      at
      December 31, 2006 has been classified as current.




26




In
      July
      and October 2005 we issued and sold $3,085,832 in principal amount of
      convertible notes to institutional investors at a discount, receiving net
      proceeds of $2,520,320. These notes are immediately convertible at the option
      of
      the note holders into shares of our common stock, at an original conversion
      rate
      of $16.00 per share. These investors also received five-year warrants to
      purchase 48,217 shares of our common stock for $27.52 per share, five-year
      warrants to purchase 48,217 shares of our common stock for $33.01 per share,
      and
      one-year warrants to purchase 96,433 shares of our common stock for $32.00
      per
      share. The investors also received “favored nations” rights such that for our
      future securities offerings at a price per share less than the above conversion
      rate or warrant exercise prices, the investors' conversion rate and warrant
      exercise price would be adjusted to the lower offering price. These notes are
      secured by a subordinated lien on our assets, and the notes bear interest at
      an
      effective rate of approximately 20%. The principal balance of these notes was
      $488,543 and $1,496,804 at December 31, 2006 and 2005, respectively.
      Half of these notes became payable beginning in October 2005 and the other
      half
      beginning in January 2006 (three months following their respective issuances)
      over two years in cash or, at our option, in registered common stock at the
      lesser of $16.00 per share or 85% of the weighted average price of the stock
      on
      the OTC Bulletin Board (the “OTCBB”). In May 2006, we repriced these warrants to
      $15.60 per share, at which time these warrants were exercised, resulting in
      net
      proceeds to us of $2,740,120. We then issued warrants to the investors to
      purchase a like number of shares for $16.00 per share. As a result of the
      favored nations provision discussed above and the Section 3(a)(10) agreement
      described below, the notes' conversion rate (retroactive to the original note
      principal balances) and the exercise price of outstanding warrants were
      effectively reduced to $5.20 per share. As a result of the February 2007
      financing agreements described below, the notes' conversion rate (retroactive
      to
      the original note principal balances) and the exercise price of outstanding
      warrants were further reduced to $3.60 per share. At December 31, 2006, we
      had
      not made scheduled principal payments of $118,930 on these notes. Beginning
      October 2005, we were in violation of the registration requirements contained
      in
      the October 2005 subscription agreements, and beginning July 2006 we were in
      violation of the registration requirements contained in the July 2005
      subscription agreements. As a result, we owed related liquidated damages of
      $343,034 at December 31, 2006, and will incur additional damages of $40,494
      per
      month until a registration statement related to the shares and warrants is
      declared effective by the SEC. While the investors have not declared the notes
      currently in default, the full amount of the notes at
      December 31, 2006 has been classified as current.





In
      January and February 2006, we issued and sold $11,959,666 in principal amount
      of
      convertible notes to institutional investors at a discount, receiving net
      proceeds of $9,816,662. These notes are immediately convertible at the option
      of
      the note holders into shares of our common stock at an original conversion
      rate
      of $26.36 per share. These investors also received five-year warrants to
      purchase 226,853 shares of our common stock for $29.18 per share, and one-year
      warrants to purchase 226,853 shares of the our common stock for $31.83 per
      share. The investors also received “favored nations” rights such that for our
      future securities offerings at a price per share less than the above conversion
      rate or warrant exercise prices, the investor's conversion rate and warrant
      exercise price would be adjusted to the lower offering price. Of the total
      initial principal, $8,318,284 of the notes are secured by a subordinated lien
      on
      our assets. The principal balance of the notes was $8,353,101 at December 31,
      2006, and all the notes bear interest at an effective rate of approximately
      20%.
      The unsecured portion of these notes became payable beginning in July 2006
      over
      two years in cash
      or,
      at our option, in registered common stock at the lesser of $26.36 per share
      or
      85% of the weighted average price of the stock on the OTCBB, but not less than
      $20.00 per share. As a result of a May 2006 warrant restructure, the secured
      portion of these notes became payable beginning in August 2006 over two
      years in cash or, at our option, in registered common stock at the lesser of
      $20.00 per share or 85% of the weighted average price of the stock on the OTCBB,
      but not less than $16.00 per share. As a result of the favored nations provision
      discussed above and the Section 3(a)(10) agreement described below, the notes'
      conversion rate (retroactive to the original note principal balances) was
      effectively reduced to $5.20 per share, and the outstanding warrants were
      re-priced to $9.50 per share. As a result of the February 2007 financing
      agreements described below, the notes' conversion rate (retroactive to the
      original note principal balances) and the exercise price of outstanding warrants
      were further reduced to $3.60 per share. At December 31, 2006, we had not made
      scheduled principal payments of $1,083,782 on these notes. Beginning April
      2006,
      we were in violation of the registration requirements of the secured notes,
      and
      beginning May 2006, we were in violation of the registration requirements of
      the
      unsecured notes. In May 2006, we issued an aggregate of 8,319 shares to the
      secured investors in satisfaction of then-existing secured non-registration
      liquidated damages. We owed additional liquidated damages of $694,514 at
      December 31, 2006, and will incur additional damages of $129,014 per
      month until a registration statement related to the shares and warrants is
      declared effective by the SEC. While the investors have not declared the notes
      currently in default, the full amount of the notes at
      December 31, 2006 has been classified as current.





On
      October 17, 2006, we issued and sold $2,905,875 in secured convertible notes
      to
      twelve institutional investors, for a net purchase price of $2,324,700 (after
      a
      20% original issue discount) in a private placement. The investors also received
      five-year warrants to purchase a total of 518,907 shares of our common stock
      at
      an exercise price of $8.14 per share. These convertible notes are secured by
      a
      subordinated lien on our assets, are not interest bearing, and are due on
      December 31, 2007. The note holders may at their election convert all or part
      of
      the convertible notes into shares of our common stock at an original conversion
      rate of $5.60 per share. The investors also received “favored nations” rights
      such that for future securities offerings by us at a price per share less than
      the above conversion rate or warrant exercise prices, the investor's conversion
      rate and warrant exercise price would be adjusted to the lower offering price.
      As a result of the favored nations provision discussed above and the February
      2007 financing agreements described below, the notes' conversion rate
      (retroactive to the original note principal balances) and the exercise price
      of
      outstanding warrants were reduced to $3.60 per share. Pursuant to the
      subscription agreement, we were to obtain shareholder approval to increase
      our
      authorized common stock to 400,000,000 shares and file an amendment to its
      articles of incorporation by December 20, 2006. Failing this, the holders of
      the
      convertible notes are entitled to liquidated damages that will accrue at the
      rate of two percent of the amount of the purchase price of the outstanding
      convertible notes per month during such default. We also agreed to file
      registration statements covering the resale of 130% of the shares of common
      stock that may be issuable upon conversion of the convertible notes, and 100%
      of
      the shares of common stock issuable upon the exercise of the warrants. The
      first
      such registration statement was to be filed on or before January 2, 2007 and
      declared effective by March 31, 2007. Because we were in violation of these
      authorized share and registration requirements, liquidated damages have been
      accruing at the rate of $58,925 per month since December 20, 2006. (See Note
      R
      to our December 31, 2006 consolidated financial statements on page
      73 for
      subsequent authorized common stock increase.) While the investors have not
      declared the notes currently in default, the full amount of the notes at
      December 31, 2006 has been classified as current.




27




On
      February 16, 2007, we issued and sold $3,462,719 in secured convertible notes
      (“Convertible Notes”) to a group of institutional investors, for a net purchase
      price of $2,770,175 (after a 20% original issue discount) in a private
      placement. $900,000 of the proceeds (before closing costs of $67,512) were
      paid
      in cash to us at closing, and $1,870,175 of the proceeds were used to repay
      fourteen outstanding promissory notes (including related accrued interest and
      a
      10% premium on the promissory notes' total principal of $1,666,667) held by
      five
      of the investors in the private placement. The investors also received five-year
      warrants to purchase a total of 961,867 shares of our common stock at an
      effective exercise price of $3.60 per share. These Convertible Notes are secured
      by a subordinated lien on our assets, are not interest bearing, and are due
      on
      February 16, 2008. The note holders may at their election convert all or part
      of
      the Convertible Notes into shares of our common stock at the conversion rate
      of
      $3.60 per share, subject to adjustment as provided in the notes. The investors
      also received “favored nations” rights such that for our future securities
      offerings at a price per share less than the above conversion rate or warrant
      exercise price, the investors' conversion rate and warrant exercise price would
      be adjusted to the lower offering price. Pursuant to the related subscription
      agreement, two of the investors are to receive due diligence fees totaling
      $346,272, in the form of convertible notes having the same terms and conversion
      features as the Convertible Notes. Also pursuant to the subscription agreement,
      we agreed to issue a total of 200,000 common shares to the former holders of
      the
      above-referenced promissory notes, in lieu of and in payment for accrued damages
      associated with these promissory notes. Said common share issuance is required
      no later than April 15, 2007. Also pursuant to the subscription agreement,
      we
      must obtain the authorization and reservation of our common stock on behalf
      of
      the investors of not less than 200% of the common shares issuable upon the
      conversion of the notes, and 100% of the common shares issuable upon the
      exercise of the warrants by April 15, 2007. Failing this authorization and
      reservation, the holders of the Convertible Notes will be entitled to liquidated
      damages that will accrue at the rate of two percent of the amount of the
      purchase price of the outstanding Convertible Notes for each thirty days or
      pro
      rata portion thereof during such default.





The
      subscription agreements for our convertible notes issued in July and October
      2005 (“2005 Notes”), January and February 2006 (“Early 2006 Notes”), October
      2006 (“Late 2006 Notes”), and February 2007 (“2007 Notes”) contain the following
      provisions that could impact our future capital raising efforts and capital
      structure:




·
              We
                  are required to file registration statements to register amounts
                  ranging
                  up to 200% of the shares issuable upon conversion of these notes,
                  and all
                  of the shares issuable upon exercise of the warrants issued in
                  connection
                  with these notes. Certain registration statements were filed, but
                  have
                  since become either ineffective or withdrawn. Until sufficient
                  registration statements are declared effective by the Securities
                  and
                  Exchange Commission (the “SEC”), we are liable for liquidated damages
                  totaling $1,058,858 through December 31, 2006, and will continue
                  to incur
                  additional liquidated damages of $228,432 per month until the required
                  shares and warrants are
                  registered.




·
              Unless
                  consent is obtained from the note holders, we may not file any
                  new
                  registration statements or amend any existing registrations until
                  the
                  sooner of (a) 60 to 365 days following the effective date of the
                  notes
                  registration statement or (b) all the notes have been converted
                  into
                  shares of our common stock, and such shares of common stock and
                  the shares
                  of common stock issuable upon exercise of the warrants have been
                  sold by
                  the note holders.




·
            Since
                October 2005, we have been in violation of certain requirements of
                the
                2005 Notes, the Early 2006 Notes, and the Late 2006 Notes. While
                the
                investors have not declared these notes currently in default, the
                full
                amount of the notes at December 31, 2006 has been classified as
                current.





In
      September 2006 certain of the July and October 2005 and the January and February
      2006 convertible note holders filed actions against us claiming a breach of
      contract related to the notes. In settlement of these actions, the parties
      entered into settlement agreements pursuant to which, among other things:
      1) interest and liquidated damages due under the notes were set at $242,149
      and $415,353, respectively; 2) the note holders exchanged the interest and
      liquidated damages due, along with $3,899,803 in principal, and a discount
      of
      $881,155, for 1,045,858 shares of the our common stock through the issuance
      of
      freely trading securities issued pursuant to Section 3(a)(10) of the Securities
      Act; 3) the conversion rate for the remaining principal balance due under
      the notes was reset to $5.20; 4) the exercise price of the outstanding
      warrants purchased by the note holders in connection with the January and
      February 2006 notes was reduced to $9.50; and 5) certain investors agreed
      to surrender their claims associated with warrants issued in May 2006 in
      exchange for 125,000 shares of our common stock through the issuance of freely
      trading securities issued pursuant to Section 3(a)(10) of the Securities
      Act.





28




In
      October 2005, we acquired substantially all of the operating assets and
      liabilities of WQN, Inc. for a total purchase price of $9.8 million. The
      acquisition was funded in part with the issuance of a convertible note in the
      principal amount of $3.7 million. A debt discount was established to reflect
      an
      effective interest rate of 20%, bringing the original net note payable value
      to
      $3,216,000. The note is secured by a subordinated lien on our consolidated
      assets. The principal balance of the note was $3,700,000 at December 31,
      2006. The note, bearing a nominal interest rate of 6%, became payable beginning
      February 2006 over 12 months in cash or, at our option, in Series A
      preferred stock (subsequently authorized - see Note R) at $10.00 per share
      or in
      common stock at an original $1.06 per share. WQN received “favored nations”
rights such that for future securities offerings by us at a price per share
      less
      than this conversion price, this common stock conversion price would be adjusted
      to the lower offering price. As a result of this favored nations provision
      and
      the February 2007 financing agreements described in Note R to our consolidated
      financial statements on page 73, the note's common stock conversion rate was
      effectively reduced to $0.18 per share. At December 31, 2006, we had not made
      scheduled principal payments of $3,391,667. WQN has agreed to subordinate its
      repayment claim to the convertible note holders described in the two preceding
      paragraphs. Also as a result of the October 2005 acquisition, WQN, Inc.
      received five-year warrants to purchase 5,000,000 shares of our common stock
      for
      $0.001 per share. WQN exercised the warrants on January 5, 2006 for
      4,996,429 shares of our common stock. All WQN convertible shares and warrant
      shares have piggyback registration rights on any registration statement we
      file
      between October 2005 and October 2007. At December 31, 2006, we were
      in violation of certain requirements of this note. While WQN has not declared
      the note in default, the full amount of the note at December 31, 2006,
      has been classified as current. On March 16, 2007, WQN notified us that it
      is
      exercising its right to convert its note and related accrued interest into
      approximately 22,008,524 shares of our common stock. Due to the sale of
      substantially all of the tangible operating assets utilized by our Dallas,
      Texas
      division, this convertible note was classified with discontinued operations
      in
      our consolidated financial statements for all periods presented.




In
      connection with a private placement memorandum dated May 20, 2005, we issued
      112,125 shares of our common stock for $16.00 per share, and warrants to
      purchase 110,388 common shares at prices from $32.00 to $44.60 per share. At
      December 31, 2006, the fair value of these outstanding warrants was $58,510,
      which was recorded as a liability on our consolidated balance sheet. As required
      by the subscription agreements, a portion of the shares was registered with
      the
      SEC in October 2005, but that registration became ineffective in July 2006.
      Non-registration liquidated damages accrued until September 2006, when all
      related shares and warrants became tradable under Rule 144, and, in accordance
      with the terms of the subscription agreements, accrual of liquidated damages
      ceased. At December 31, 2006, liquidated damages totaled 1,482,500 shares and
      11,325 warrants owing, recognized as a $1,342,299 current liability on our
      balance sheet.





In
      connection with a subscription agreement dated August 26, 2005 and amended
      on
      November 16, 2005, we issued 68,750 shares of our common stock for $16.00 per
      share, and warrants to purchase 111,250 common shares at prices ranging from
      $27.40 to $32.00 per share. The investor also received “favored nations” rights
      such that for future securities offerings by us at a price per share less than
      the per share purchase price or warrant exercise prices, the investor's
      effective per share purchase price and warrant exercise price
      would be adjusted to the lower offering price. As a result of this favored
      nations provision and the February 2007 financing agreements described in Note
      R, the subscription agreement's per share purchase price and the warrants'
      exercise prices were effectively reduced to $3.60 per share. At December 31,
      2006, the fair value of these outstanding warrants was $400,500, which was
      recorded as a liability on our consolidated balance sheet. We also agreed to
      register a total of 292,500 common shares and warrants related to this agreement
      by January 17, 2006. Until a registration statement is declared effective by
      the
      SEC, we are liable for liquidated damages totaling $600,000 through December
      31,
      2006, and will continue to incur additional liquidated damages of $50,000 per
      month until the required shares and warrants are registered.





On
      March
      29, 2007, we issued an unsecured promissory note in the principal amount of
      $300,000 (the “Note”) to Shawn M. Lewis, the Company's Chief Operating Officer.
      The Note and related accrued interest at 10% per annum is payable upon demand.
      The cash proceeds to the Company were $252,000 net of related closing costs
      and
      expense reimbursements of $48,000, $30,000 of which was paid to Mr. Lewis.
      In the event of a default, in addition to all sums due and owing under the
      Note,
      we will also be required to pay the sum of $750,000 as liquidated
      damages.





We
      anticipate that we will continue to report net losses and experience negative
      cash flows from operations. We will need to raise additional debt or equity
      capital to provide the funds necessary to repay or restructure our $2.4 million
      loan, meet our other current contractual obligations and continue our
      operations. We are actively seeking to raise this additional capital. However,
      we may not be successful in obtaining imminently-required equity or debt
      financing for our business.





Our
      authorized common stock consisted of 100,000,000 common shares at December
      31,
      2006, of which 4,930,486 common shares (98,609,701 shares pre-split) were issued
      and outstanding, and approximately 7.05 million additional shares (141
      million shares pre-split) were contingently issuable upon the exercise of stock
      options and warrants, conversion of convertible securities, and increased
      authorized common shares. An additional 1.2 million (24 million pre-split)
      common shares were required to be reserved under our various existing financing
      agreements. As of December 31, 2006 we were also contractually obligated to
      register approximately 9.6 million shares (192 million shares pre-split),
      warrants and options. (See Note R for a subsequent increase in our authorized
      common stock to 400,000,000 shares, and the authorization of a new class of
      preferred stock.) As the result of transactions since December 31, 2006,
      issuable shares and reserve requirements have increased (see Part I, Item 1A.
      Risk Factors, RISKS RELATED TO OUR STOCK, on page
      16). We
      intend to seek an additional increase in our authorized common shares. If such
      proposal is not approved, we will be unable to satisfy the contractual
      obligations we have undertaken to issue future shares of common stock. There
      is
      no assurance that sufficient registration statements can be filed or declared
      effective by the SEC, or that sufficient additional common stock authorizations
      can be approved by shareholders, in which case we would continue to be unable
      to
      satisfy our contractual obligations to register shares, and would be unable
      to
      satisfy the contractual obligations we have undertaken to reserve shares of
      common stock.





29




**Capital
      Expenditure Commitments**





We
      did
      not have any substantial outstanding commitments to purchase capital equipment
      at December 31, 2006.




**Payments
      Due by Period**





The
      following table illustrates our outstanding debt, purchase obligations, and
      related payment projections as of December 31, 2006:




Less
                thanContractual
                Obligations (1)
            
            Total
            
            1
                Year
            
            1-3
                Years
            
            3-5
                YearsConvertible
                notes (principal)
            
            $
            15,447,520
            
            $
            15,447,520
            
            $
            -
            
            $
            -Loan
                payable
            
            
            2,574,835
            
            
            2,574,835
            
            
            -
            
            
            -Unsecured
                advances
            
            
            616,667
            
            
            616,667
            
            
            -
            
            
            -Nonregistration
                penalties and other stock-based payables
            
            
            4,748,381
            
            
            4,748,381
            
            
            -
            
            
            -Other
                liabilities
            
            
            1,523,020
            
            
            1,300,851
            
            
            222,169
            
            
            -Subtotal
            
            
            24,910,423
            
            
            24,688,254
            
            
            222,169
            
            
            -Purchase
                obligations
            
            
            -
            
            
            -
            
            
            -
            
            
            -Operating
                leases
            
            
            410,678
            
            
            268,557
            
            
            142,121
            
            
            -Total
            
            $
            25,321,101
            
            $
            24,956,811
            
            $
            364,290
            
            $
            -





(1)
            Includes
                contractual obligations related to our Dallas, Texas business which
                are
                being classified as discontinued
                operations.




**Critical
      Accounting Policies and Estimates**





We
      have
      identified the policies and significant estimation processes below as critical
      to our business operations and the understanding of our results of operations.
      This listing is not intended to be a comprehensive list. In many cases, the
      accounting treatment of a particular transaction is specifically dictated by
      accounting principles generally accepted in the United States, with no need
      for
      management's judgment in their application. In other cases, management is
      required to exercise judgment in the application of accounting principles with
      respect to particular transactions. The impact and any associated risks related
      to these policies on our business operations is discussed throughout
“Management's Discussion and Analysis of Financial Condition and Results of
      Operations” where such policies affect reported and expected financial results.
      For a detailed discussion on the application of these and other accounting
      policies, see Note B in the Notes to Consolidated Financial Statements for
      the
      year ended December 31, 2006, included in this annual report. Our preparation
      of
      our consolidated financial statements requires us to make estimates and
      assumptions that affect the reported amount of assets and liabilities,
      disclosure of contingent assets and liabilities at the date of our consolidated
      financial statements, and the reported amounts of revenue and expenses during
      the reporting periods. Management bases its estimates on historical experience
      and on various other assumptions that are believed to be reasonable under the
      circumstances. There can be no assurance that actual results will not differ
      from those estimates and such differences could be significant.





*Revenue
      Recognition* .
      Our
      revenue is primarily derived from fees charged to terminate voice services
      over
      our network.




Variable
      revenue is earned based on the number of minutes during a call and is recognized
      upon completion of a call. Revenue for each customer is calculated from
      information received through our network switches. We track the information
      received from the switch and analyze the call detail records and apply the
      respective revenue rate for each call.





Fixed
      revenue is earned from monthly services provided to customers that are fixed
      and
      recurring in nature, and are connected for a specified period of time. Revenue
      recognition commences after the provisioning, testing, and acceptance of the
      service by the customer. Revenues are recognized as the services are provided
      and continue until the expiration of the contract or until cancellation of
      the
      service by the customer.





*Accounts
      Receivable* .
      Accounts receivable are stated at the amount we expect to collect from
      outstanding balances. We provide for probable uncollectible amounts based on
      our
      assessment of the current status of the individual receivables and after using
      reasonable collection efforts.





30




*Goodwill.* In
      accordance with SFAS No. 142, we are required to periodically evaluate the
      carrying value of our goodwill and other intangible assets. During the years
      ended December 31, 2006 and 2005, we recognized impairment expense of $839,101
      and $4,173,452, respectively, related to goodwill recorded for our former
      hardware sales business segment, and included in our reported loss from
      discontinued operations. If in the future the remaining carrying value of our
      goodwill exceeds its fair market value, we will be required to record an
      additional impairment charge in our statement of operations. Such an impairment
      charge could have a significant adverse impact on both our operating results
      and
      financial condition. If the traded market price of our common stock declines,
      a
      material goodwill impairment charge in the future is possible.





*Convertible
      Debt and Related Detachable Warrants.* Convertible debt with beneficial conversion features is accounted for in
      accordance with Emerging Issues Task Force (“EITF”) No. 98-5 "Accounting for
      Convertible Securities with Beneficial Conversion Features or Contingently
      Adjustable Conversion Ratios" and EITF No. 00-27 "Application of EITF 98-5
      to
      Certain Convertible Instruments." The relative fair value of the warrants and
      the beneficial conversion feature at inception have generally been recorded
      as a
      discount against the debt and is amortized over the term of the debt. However,
      because we have insufficient authorized common shares to satisfy our warrant
      obligations, the initial value of warrants issued in 2006 at their issuance
      dates was recorded as a debt discount and a warrant liability on our
      consolidated balance sheet, in accordance with Emerging Issues Task Force
      (“EITF”) No. 00-19 "Accounting for Derivative Financial Instruments Indexed to,
      and Potentially Settled in, a Company's Own Stock.” Also per EITF No. 00-19,
      since we continued to have insufficient authorized common shares to satisfy
      our
      warrant obligations, all warrant liabilities have been marked-to-market,
      resulting in a $5,102,731 liability at December 31, 2006, and a corresponding
      credit to earnings for the year ended December 31, 2006 of
      $7,226,430.





*Discontinued
      Operations.* **** Our
      operations formerly consisted of three segments: Telecommunication Services,
      Hardware Sales and Calling Card Sales. However, with our sale of DTNet
      Technologies, the termination of our Marketing and Distribution Agreement with
      Phone House, Inc., and the sale of substantially all of the tangible operating
      assets utilized by our Dallas, Texas division, all referred to above, these
      former segments are being accounted for as discontinued operations, as discussed
      more fully in Note P to our December 31, 2006 consolidated financial
      statements ,
      and
      prior period financial statements have been appropriately
      reclassified. Also as a result of these discontinued operations, our operations
      currently consist of one segment, Telecommunication Services. Therefore,
      separate segmented financial results are not presented.





**Recently
      Issued Accounting Pronouncements**





In
      September 2006, the Financial Accounting Standards Board issued Statement
      of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value
      Measurements.” SFAS No. 157, defines fair value as the price that would be
      received to sell an asset or paid to transfer a liability in an orderly
      transaction between market participants at the measurement date, and also
      establishes a framework for measuring fair value. The provisions of this
      Statement are effective for fiscal years beginning after November 15, 2007.
      At
      this time we cannot determine whether or not the adoption of this Statement
      will
      have a material impact on our financial statements.





In
      February 2007, the Financial Accounting Standards Board issued SFAS
      No. 159, “The Fair Value Option for Financial Assets and Financial
      Liabilities,” which amends SFAS No. 115, “Accounting for Certain Investments in
      Debt and Equity Securities.” SFAS No. 159 permits companies to choose to measure
      many financial instruments at fair value, and could apply to our potential
      future convertible debt and stock warrant agreements. The provisions of this
      Statement are effective for fiscal years beginning after November 15, 2007.
      We
      do not plan to elect fair value accounting under SAFS No. 159, and therefore
      do
      not expect the adoption of this Statement to have a material impact on our
      financial statements.




**Item
      7A.**  **Quantitative
      and Qualitative Disclosures About Market Risk**




In
      conjunction with our May 2006 financing, we repriced a portion of our
      outstanding warrants to $15.60 per share, triggering contractual “favored
      nations” price ratchets on a number of our existing convertible debt and warrant
      agreements, bringing their effective conversion and exercise prices down to
      $15.60 per share. The effect was to increase the number of our fully diluted
      shares to approximately 6.45 million (129 million pre-split), relative to our
      authorized 100 million shares. Our total warrants then outstanding were
      approximately 1.4 million (28 million pre-split). EITF No. 00-19 states that,
      in
      this instance, asset or liability classification of the warrants is required
      (as
      opposed to permanent equity classification). From January to May 2006, only
      a
      portion of our warrants were subject to liability classification. However,
      beginning May 2006, all of our warrants were classified as a liability on our
      consolidated balance sheet, and their value was marked-to-market at December
      31,
      2006, resulting in a fair value warrant liability of $5,102,731, and a
      $7,226,430 credit to earnings for the year ended December 31, 2006. Until we
      have sufficient authorized common shares to satisfy these warrant obligations,
      we will be subject to future non-cash mark-to-market exposure to the extent
      that
      the estimated market value of these warrants changes in the future, which value
      in turn is primarily dependent on our common stock market price per share.
      As a
      hypothetical example, a $5.00 per share increase or decrease in the market
      price
      of our common stock at December 31, 2006, would have increased or decreased
      the
      estimated average market value of these warrants by $3.60 or $2.20 per warrant,
      respectively, resulting in hypothetical mark-to-market adjustments that would
      have further increased our consolidated net loss for the year ended December
      31,
      2006, by $7,168,430, or decreased that loss by $4,543,612
      respectively.





We
      are
      not exposed to significant interest rate or foreign currency exchange rate
      risk.




31




**Item
      8.**  **Financial
      Statements and Supplementary Data**





The
      financial statements required by this item begin at page
      52 herein.





**Selected
      Quarterly Financial Data**





You
      should read the following tables presenting our quarterly results of operations
      in conjunction with our consolidated financial statements and related notes
      contained elsewhere in this Form 10-K We have prepared the unaudited information
      on the same basis as our audited consolidated financial statements. You should
      also keep in mind, as you read the following tables, that our operating results
      for any quarter are not necessarily indicative of results for any future
      quarters or for a full year.





The
      following table presents our unaudited quarterly results of operations for
      the
      three years ended December 31, 2006. This table includes all
      adjustments, consisting only of normal recurring adjustments, that we consider
      necessary for fair presentation of our financial position and operating results
      for the quarters presented.





Quarter
                Ended (1) (3)Mar
                31,
            
            Jun
                30,
            
            Sep
                30,
            
            Dec
                31,
            
            Mar
                31,
            
            Jun
                30,
            
            Sep
                30,
            
            Dec
                31,
            
            Mar
                31,
            
            Jun
                30,
            
            Sep
                30,
            
            Dec
                31,2004
            
            2004
            
            2004
            
            2004
            
            2005
            
            2005
            
            2005
            
            2005
            
            2006
            
            2006
            
            2006
            
            2006(2)(Unaudited)Revenues
            
            $
            -
            
            $
            39,945
            
            
            333,309
            
            $
            647,031
            
            $
            1,006,111
            
            
            1,589,857
            
            
            1,776,155
            
            $
            1,948,992
            
            $
            2,166,928
            
            $
            2,010,391
            
            $
            598,170
            
            $
            1,157,759Gross
                profit (loss)
            
            
            -
            
            
            11,379
            
            
            (24,615
            )
            
            278,924
            
            
            8,222
            
            
            528,602
            
            
            (922,381
            )
            
            (1,127,452
            )
            
            (1,193,462
            )
            
            (455,720
            )
            
            (345,204
            )
            
            (697,242
            )Income
                          (loss) from continuing
                          operations
            
            
            (22,324
            )
            
            (417,024
            )
            
            (5,499,670
            )
            
            631,130
            
            
            (1,559,518
            )
            
            (3,482,529
            )
            
            (8,833,168
            )
            
            (9,270,684
            )
            
            (12,567,133
            )
            
            (5,010,532
            )
            
            (11,418,927
            )
            
            (10,236,169
            )Net
                income (loss)
            
            
            (22,324
            )
            
            (408,658
            )
            
            (5,647,736
            )
            
            216,598
            
            
            (1,555,398
            )
            
            (3,536,104
            )
            
            (8,742,001
            )
            
            (14,479,830
            )
            
            (13,807,034
            )
            
            (5,191,699
            )
            
            (12,312,707
            )
            
            (9,885,072
            )Per
                share:Net
                        loss from continuing operations
            
            $
            (0.20
            )
            $
            (0.51
            )
            $
            (5.60
            )
            $
            (0.20
            )
            $
            (1.22
            )
            $
            (2.56
            )
            $
            (4.15
            )
            $
            (3.19
            )
            $
            (3.83
            )
            $
            (1.46
            )
            $
            (3.24
            )
            $
            (2.12
            )Net
                loss
            
            $
            (0.20
            )
            $
            (0.50
            )
            $
            (5.75
            )
            $
            0.40
            
            $
            (1.22
            )
            $
            (2.60
            )
            $
            (4.11
            )
            $
            (4.98
            )
            $
            (4.21
            )
            $
            (1.52
            )
            $
            (3.49
            )
            $
            (2.05
            )




(1)
            These
                quarterly results reflect the merger in May 2005 of Caerus and the
                acquisition in October 2005 of the VoIP-related assets of
                WQN.(2)
            The
                results for the quarter ended September 30, 2004 include expenses
                of $4.9
                million related to the issuance of stock warrants.(3)
            Operations
                relating to Millennia Tea Masters, DTNet Technologies, Phone House,
                Inc.,
                and our Dallas, Texas division were discontinued in 2004, 2005, 2006,
                and
                2007, respectively. Operating results prior to these events were
                reclassified as discontinued
                operations.




**Item
      9.**  **Changes
      in and Disagreements With Accountants on Accounting and Financial
      Disclosure**





None.




**Item
      9A.**  **Controls
      and Procedures**





**Evaluation
      of Controls and Procedures**





As
      required by Rule 13a-15(b) under the Securities Exchange Act, as amended
      (the “Exchange Act”), as of December 31, 2006, our management conducted an
      evaluation with the participation of our Chief Executive Officer and Chief
      Accounting Officer (collectively, the “Certifying Officers”) regarding the
      effectiveness of the design and operation of our disclosure controls and
      procedures (as defined in Rules13a-15(e) and 15d-15(e) under the Exchange Act).
      Our management, with the participation of the Certifying Officers, also
      conducted an evaluation of our internal control over financial reporting and
      identified four significant control deficiencies, which in combination resulted
      in a material weakness.





A
      significant deficiency is a control deficiency, or combination of control
      deficiencies, that adversely affects a company's ability to initiate, authorize,
      record, process or report external financial data reliably in accordance with
      generally accepted accounting principles, such that there is more than a remote
      likelihood that a misstatement of our annual or interim financial statements
      that is more than inconsequential will not be prevented or detected. A material
      weakness is a significant deficiency, or combination of significant
      deficiencies, that results in more than a remote likelihood that a material
      misstatement of a company's annual or interim financial statements will not
      be
      prevented or detected, as of December 31, 2006. The control
      deficiencies identified by our management and the Certifying Officers, which
      in
      combination resulted in a material weakness, were (a) misstatements in amounts
      reported for a consolidated subsidiary; (b) insufficient personnel
      resources with appropriate accounting expertise; and (c) a lack of independent
      verification of amounts billed to certain customers.





32




Based
      on
      this evaluation and in accordance with the requirements of Auditing Standard
      No.
      2 of the Public Company Accounting Oversight Board, our Certifying Officers
      concluded that our disclosure controls and procedures were ineffective as of
      December 31, 2006.





Our
      management, including the Certifying Officers, does not expect that our
      disclosure controls and procedures will prevent all errors and all improper
      conduct. A control system, no matter how well conceived and operated, can
      provide only reasonable, not absolute, assurance that the objectives of the
      control system are met. Further, a design of a control system must reflect
      the
      fact that there are resource constraints, and the benefits of controls must
      be
      considered relative to their costs. Because of the inherent limitations in
      all
      control systems, no evaluation of controls can provide absolute assurance that
      all control issues and instances of improper conduct, if any, have been
      detected. These inherent limitations include the realities that judgments and
      decision-making can be faulty, and that breakdowns can occur because of simple
      error or mistake. Additionally, controls can be circumvented by the individual
      acts of some persons, by collusion of two or more persons, or by management
      override of the control. Further, the design of any system of controls is also
      based in part upon assumptions about the likelihood of future events, and there
      can be no assurance that any design will succeed in achieving its stated goals
      under all potential future conditions. Over time, controls may become inadequate
      because of changes in conditions, or the degree of compliance with the policies
      or procedures may deteriorate. Because of the inherent limitations and a
      cost-effective control system, misstatements due to error or fraud may occur
      and
      may not be detected.


Our
      management is responsible for establishing and maintaining adequate internal
      control over financial reporting, as such term is defined in Rule 13a-15(f)
      under the Exchange Act. Our internal control over financial reporting is a
      process designed to provide reasonable assurance regarding the reliability
      of
      financial reporting and the preparation of financial statements for external
      purposes in accordance with generally accepted accounting principles, and
      includes those policies and procedures that:




·
            Pertain
                to the maintenance of records that, in reasonable detail accurately
                and
                fairly reflect the transactions and dispositions of our
                assets;




·
              Provide
                  reasonable assurance that transactions are recorded as necessary
                  to permit
                  preparation of financial statements in accordance with generally
                  accepted
                  accounting principles, and that our receipts and expenditures are
                  being
                  made only in accordance with authorization of our management and
                  directors; and




·
              Provide
                  reasonable assurance regarding prevention or timely detection of
                  unauthorized acquisition, use or disposition of our assets that
                  could have
                  a material effect on the financial
                  statements.





Our
      management, including the Certifying Officers, assessed the effectiveness of
      our
      internal control over financial reporting as of December 31, 2006, and concluded
      that we had the following control deficiencies as of
      December 31, 2006, that, when combined, resulted in a material
      weakness:





(a)
            In
                March 2006, during their review and analysis of 2005 results and
                financial
                condition in connection with the preparation of the 2005 financial
                statements and the 2005 Annual Report on Form 10-KSB, our senior
                financial
                management discovered certain overstatements of the revenues, expenses
                and
                receivables reported, and understatement of net loss, for our consolidated
                subsidiary DTNet Technologies. Based upon an assessment of the impact
                of
                the adjustments to our financial results arising from this matter,
                we
                restated the financial information presented in our Form 10-KSB for
                the
                year ended December 31, 2004. Adjustments to reduce the
                overstatements of revenues and receivables and the understatement
                of net
                loss aggregated $791,200, $651,832, and $462,618, respectively, for
                the
                year ended December 31, 2004.





(b)
            On
                October 31, 2006, we concluded that our consolidated financial statements
                for the three and six months ended
                June 30, 2006 understated other income and warrant
                liabilities, and overstated net loss and additional paid-in
                capital, related to the accounting for our warrants under EITF 00-19.
                We therefore restated our consolidated financial statements for these
                periods. Adjustments to (i) increase the fair value warrant liability;
                (ii) decrease additional paid-in capital; and (iii) increase other
                income
                and decrease net loss aggregated $4,323,999, $5,271,659, and $947,660,
                respectively, for the three and six months ended June 30,
                2006.





(c)
            We
                do not have sufficient accounting personnel resources at corporate
                headquarters. Our management with the participation of the Certifying
                Officers determined that the potential magnitude of a misstatement
                arising
                from this deficiency is more than inconsequential to the annual and/or
                interim financial statements.




33




(d)
            The
                amounts invoiced to our wholesale telecommunications customers are
                calculated by our engineering department. This billing process is
                overseen
                solely by the head of that department, our Chief Technology Officer.
                We do
                not presently employ a separate revenue assurance process whereby
                these
                bills would be recalculated and independently verified by a department
                other than engineering. Our management with the participation of
                the
                Certifying Officers determined that the potential magnitude of a
                misstatement arising due to this deficiency is more than inconsequential
                to the annual and/or interim financial
                statements.





Management
      has concluded that the above deficiencies when combined have resulted in a
      material weakness in its internal control of financial reporting because the
      quantitative effect of any errors resulting from these deficiencies when taken
      together could result in a material misstatement of our interim and annual
      financial reports. Based on this evaluation and in accordance with the
      requirements of Auditing Standard No. 2 of the Public Company Accounting
      Oversight Board, the Certifying Officers concluded that we did not maintain
      effective internal control over financial reporting as of
      December 31, 2006 based on the criteria in the Internal Control -
      Integrated Framework.





**Remediation
      Steps to Address Control Deficiencies**





We
      are in
      the process of addressing the identified material weakness by remediating the
      control deficiencies in our internal control over financial reporting which
      comprise this material weakness as follows:




(a)
            In
                March 2006, our board of directors (the “Board”) retained counsel to
                conduct a thorough investigation of the accounting misstatements
                of our
                DTNet Technologies subsidiary. Such counsel, in turn, retained an
                independent forensic accounting firm to assist its investigation.
                Based on
                this investigation our board of directors and management have concluded
                that these intentional overstatements of revenues, expenses and
                receivables were limited to the unauthorized actions of two individuals.
                One of these individuals was employed at corporate headquarters and
                the
                other was employed at DTNet Technologies' headquarters. The individual
                employed at corporate headquarters resigned shortly after the initiation
                of the investigation, and we terminated the employment of the other
                individual immediately following the receipt of the preliminary findings
                of the investigation in April 2006. We changed the individual responsible
                for the day-to-day management of DTNet Technologies, relocated its
                accounting to our corporate offices, and increased our analysis of
                this
                subsidiary's transactions. In April 2006, we sold this subsidiary
                to our
                former Chief Operating Officer.





(b)
            We
                have recently completed a comprehensive debt, equity, warrant, and
                option
                tracking system, which includes identification of all related covenants
                and requirements including interrelated contractual debt conversion
                and
                warrant repricing impacts.





(c)
            We
                continue to seek to improve our in-house accounting resources. In
                April
                2006 we promoted the former Finance Director of one of our recently
                acquired subsidiaries to the position of Corporate Controller. This
                individual has significant financial experience (including five years
                with
                the audit department of the accounting firm of KPMG Peat Marwick),
                and has
                served as the CFO and/or controller of various companies (including
                a
                public registrant). In May 2006, our Chief Financial Officer resigned,
                and
                the Corporate Controller was promoted to Chief Accounting
                Officer.





(d)
            We
                are in the process of designing a revenue assurance process for the
                billing of our wholesale telecommunications customers to provide
                independent recalculation and verification of amounts billed. We
                anticipate implementing this methodology in
                2007.





As
      a
      non-accelerated filer, we plan to complete our assessment of, and improvements
      to, the effectiveness of our internal control over financial reporting pursuant
      to Sarbanes-Oxley Section 404 in 2007.





**Changes
      in Control Over Financial Reporting**




There
      were no changes in our internal control over financial reporting identified
      in
      connection with the evaluation of such internal control that occurred during
      our
      last fiscal quarter that have materially affected, or are reasonably likely
      to
      materially affect, our internal control over financial reporting.




**Item
      9B.**  **Other
      Information**





None.





**PART
      III**




**Item
      10.**  **Directors
      and Executive Officers of the Registrant**





**Directors,
      Executive Officers, Promoters and Control Persons**





34




The
      following table sets forth information concerning our executive officers and
      directors as of the periods set forth below:





**Name**
            
            **Age**
            
            **Position
                with Company**
            
            **Dates**Anthony
                J. Cataldo
            
            55
            
            Chairman
                and Chief Executive Officer
            
            September
                2006 to presentShawn
                M. Lewis
            
            38
            
            Chief
                Technology Officer and
            
            May
                2005 to presentChief
                Operating OfficerRobert
                V. Staats
            
            53
            
            Chief
                Accounting Officer
            
            May
                2006 to presentStuart
                Kosh
            
            50
            
            Director
            
            January
                2006 to presentGary
                Post
            
            58
            
            Director
            
            May
                2006 to presentNicholas
                A. Iannuzzi, Jr.
            
            40
            
            Director
            
            March
                2007 to present(1)




(1)
      Effective June 15, 2007 Mr. Iannuzzi resigned from
      our Board of Directors. Effective June 21, 2007 Mr. Sade Panahi was appointed
      to
      our Board.




***Anthony
      J. Cataldo*** became
      our Chief Executive Officer and Chairman in September 2006. During the past
      five
      (5) years, Mr. Cataldo has served as non-executive chairman of the board of
      directors of BrandPartners Group, Inc. (OTC BB:BPTR), a provider of integrated
      products and services dedicated to providing financial services and traditional
      retail clients with turn-key environmental solutions from October 2003 through
      August 2006. Mr. Cataldo also served as non-executive co-chairman of the board
      of MultiCell Technologies,
      Inc. (OTC BB: MUCL), a supplier of functional, non-tumorigenic immortalized
      human hepatocytes from February 2005 through July 2006. Mr. Cataldo has also
      served as executive chairman of Calypte Biomedical Corporation (AMEX: HIV),
      a
      publicly traded biotechnology company, involved in the development and sale
      of
      urine based HIV-1 screening tests from May 2002 through November 2004. Prior
      to
      that, Mr. Cataldo served as the Chief Executive Officer and Chairman of the
      Board of Directors of Miracle Entertainment, Inc., a Canadian film production
      company, from May 1999 through May 2002 where he was the executive producer
      or
      producer of several motion pictures. From August 1995 to December 1998, Mr.
      Cataldo served as President and Chairman of the Board of Senetek, PLC (OTC
      BB:SNTKY), a publicly traded biotechnology company involved in age-related
      therapies.





***Shawn
      M. Lewis*** oversees
      all of our technological and engineering activities. Mr. Lewis founded and
      was
      the President and CEO of Caerus, Inc. and its three subsidiaries, Volo
      Communications, Inc., Caerus Networks, Inc., and Caerus Billing & Mediation,
      Inc., from 2001 to 2005. We acquired Caerus, Inc. in May 2005, at which time
      Mr.
      Lewis became our Chief Technology Officer. Mr. Lewis also became our Chief
      Operating Officer in July 2006. Prior to Caerus, Mr. Lewis co-founded XCOM
      Technologies, a competitive local exchange carrier, where he served in an
      executive capacity and led the development of patents for the first softswitch
      and SS7 Media Gateway. XCOM Technologies was sold to Level 3 in 1998. His next
      venture, set-top box vendor River Delta, was sold to Motorola. His most recent
      venture, Caerus, Inc., empowers carriers and service providers to begin selling
      advanced Voice over Internet Protocol related services. In 2004, Mr. Lewis
      pled
      guilty to a felony drug possession offense and received probation. Mr.
      Lewis was recently engaged in a Chapter 11 bankruptcy in Orlando,
      Florida.





***Robert
      V. Staats*** has been
      the Director of Finance of our Caerus, Inc. unit since June 2005 and became
      our
      Chief Accounting Officer in May 2006. Mr. Staats brings 30 years of financial
      management experience to the Company including, during the past six years,
      CFO
      or Controller responsibilities at three start-up telecommunications companies
      (including the Company). From 1996 to 2000, Mr. Staats was the Director,
      Finance, with the telecommunications company Electric Lightwave, Inc. Before
      that at PacifiCorp (then a $3.4 billion company) he was Director of Financial
      Reporting and Accounting, responsible for consolidated financial statements
      and
      SEC reporting. Mr. Staats also has five years' experience with KPMG Peat
      Marwick. He graduated with high honors from the University of Washington with
      a
      bachelor's degree in Accounting and is a member of the Washington Society of
      Certified Public Accountants and the American Society of Certified Public
      Accountants. Mr. Staats was recently engaged in a Chapter 13 bankruptcy in
      Orlando, Florida.





***Stuart
      Kosh*** moved to
      Florida in 1978 to join his father and brother at Kosh Ophthalmic, Inc., a
      wholesale optical laboratory with annual sales of $15 million, where he managed
      100 employees. In 1998, the company was sold to Essilor of America, and
      Mr. Kosh maintains his position as General Manager. His leadership roles
      have included involvement with the Big Brothers Big Sisters Program of Broward
      County as a mentor to needy youth. For the past 15 years, Mr. Kosh has been
      involved with the National Multiple Sclerosis Society. He has served on its
      board and chairs its annual golf tournament fundraiser. Presently he is serving
      on the Temple Dor Dorim Board of Directors.





***Gary
      Post*** became
      our President, Chief Executive Officer and Chairman in May 2006 and served
      in
      this capacity until September 2006. Mr. Post continues to serve on our board
      of
      directors. Since 1999, Mr. Post has been a Managing Director and investment
      Principal of Ambient Advisors, LLC (“Ambient”), a venture investment and
      management company. In his capacity as Managing Director at Ambient, Mr. Post
      has acted as an interim Chief Executive Officer and/or a director for two
      private early- to mid-stage companies in which Ambient had invested since April
      2002, and at OPMI Funding, Inc., a company that acquired in July 2002 the assets
      of Opticon Medical, Inc., a public medical device company. Since March 2006,
      he
      has also been a director of Oxis International, Inc. (OXIS:BB) and in October
      2006 became Acting Chief Operating Officer of Oxis. Prior to Ambient, he served
      as First Vice President at Drexel Burnham Lambert; Vice President at Kidder
      Peabody; Managing Director at Houlihan, Lokey, Howard and Zukin; and Director
      of
      Research and Consultant at McKinsey & Company. Mr. Post holds an MBA from
      the UCLA Graduate School of Management and an AB in Economics from Stanford
      University.





35




***Nicholas
      A. Iannuzzi*** **,** ***Jr*** **.** is a
      partner in the law firm of Rothenberg, Estner, Orsi, Arone and Grumbach, LLP
      of
      Wellesley, Massachusetts, where he has worked since 2002. From 1997 to 2002,
      Mr.
      Iannuzzi maintained his own law practice in Boston, Massachusetts. Mr. Iannuzzi
      specializes in the areas of corporate and contract law, civil litigation and
      real estate. He serves as general counsel to numerous corporations and has
      advised his clients on various business matters and transactions, including
      major acquisitions and sales of businesses. Mr. Iannuzzi is a graduate of Boston
      College and received his J.D. from the Suffolk University Law
      School.(1)




(1)
      Effective June 15, 2007 Mr. Iannuzzi resigned from
      our Boad of Directors. Effective June 21, 2007 Mr. Sade Panahi was appointed
      to
      our Board.




**Board
      of Directors and Committee Meetings; Committees of the
      Board**




During
      the fiscal year ended December 31, 2004 and through October 2005, Mr. Steven
      Ivester was our sole director; consequently, formal board and committee meetings
      were not held during that time. One formal meeting of the board of directors
      was
      held in December 2005. During the fiscal year ending December 31, 2006, there
      were six board meetings.




To
      date
      we have not had a standing compensation, nominating or audit committee. Existing
      board of directors members participate in the selection of director nominees,
      with the general objective of achieving a balance of experience, knowledge,
      integrity and
      capability on the board. A nominating committee is not considered necessary
      due
      to the small size of the company and of our board.





We
      shortly plan to establish a compensation committee consisting of two or more
      independent directors. The compensation committee will operate pursuant to
      a
      written charter. We also shortly plan to establish an audit committee consisting
      of two or more independent directors, and at least one financial expert. The
      audit committee will operate pursuant to a written charter.




We
      do not
      presently have a policy with respect to attendance by the directors at the
      annual meetings of shareholders.





**Section
      16(a) Beneficial Ownership Reporting Compliance**




Section
      16(a) of the Exchange Act requires our directors, executive officers and holders
      of more than 10% of our common stock to file with the SEC reports of their
      ownership and changes in ownership of our securities. Officers, directors and
      greater than 10% shareholders are required by SEC regulations to furnish us
      with
      copies of all Section 16(a) reports they file. To our knowledge, based solely
      on
      a review of the copies of such reports and written representations that no
      other
      reports were required, we believe that all filing requirements applicable to
      our
      officers, directors and greater than 10% shareholders were satisfied during
      the
      years ended December 31, 2006 and 2005, except as noted below:




Seventeen
      (17) Forms 4 required under Section 16(a) were filed late by Mr. Steven
      Ivester, and Mr. Ivester noted in reports filed by him that he had realized
      certain “short swing profits,” all of which have been repaid to the Company. Two
      Forms 4 were filed late by Mr. Bill Burbank; one Form 4 was filed late by Mr.
      David Sasnett; and one Form 4 was filed late by Mr. John Todd. In addition,
      Forms 3 were filed late by each of Mr. Gary Post, Mr. David Ahn, Mr.
      Robert Staats, Mr. Bill Burbank, Mr. David Sasnett, and WQN,
      Inc.  Forms 4 for 2006 transactions were not filed, and the related Form 5
      was filed late, by Mr. Shawn M. Lewis.





**Code
      of Ethics**




We
      shortly plan to adopt a Code of Business Conduct and Ethics, within the meaning
      of Item 406(b) of Regulation S-K, that applies to our directors, officers
      and employees, including our principal executive officer, principal financial
      officer and principal accounting officer. Upon adoption, a complete copy of
      the
      proposed Code of Ethics will be posted at our website at *www.voipincorporated.com* under
“Investor Info.” Any amendments to, or waivers of, the Code of Ethics will be
      promptly disclosed on our website.




**Item
      11.**  **Executive
      Compensation**





**Compensation
      Discussion and Analysis**





The
      objectives of our compensation program are as follows:




·
            Reward
                performance that drives substantial increases in shareholder value,
                as
                evidenced through both future operating profits and increased market
                price
                of our common shares; and




·
              Attract,
                  hire and retain well-qualified executives given our competitive
                  industry,
                  start-up nature, and risk
                  profile.




36






The
      compensation level of our Chief Executive Officer (“CEO”) and our Chief
      Operating Officer (“COO”) in general is higher than other Company executives,
      and reflects the CEO's and COO's unique position and incentive to positively
      affect our future operating performance and shareholder value. Our CEO's and
      COO's compensation is heavily weighted toward equity compensation, primarily
      through stock options and grants, to provide a relatively strong personal
      economic incentive for these executives to increase the market price of our
      common shares. Specific salary and bonus levels, as well as the amount and
      timing of equity incentive grants, are determined informally and judgmentally,
      on an individual-case basis, taking into consideration each executive's unique
      talents and experience as they relate to our needs. Specific Company performance
      measures as they may relate to the timing and amount of executive compensation
      have not yet been developed. Executive compensation is primarily paid or granted
      pursuant to each executive's formal compensation agreement, but relatively
      small
      discretionary cash compensation is awarded at times on an individual-case basis.
      Compensation adjustments are made occasionally based on changes in an
      executive's level of responsibility or on changed local and specific executive
      employment market conditions.





Our
      current employment agreements with our CEO, COO and Chief Accounting Officer
      (“CAO”) contain provisions for lump sum payments in the event their employment
      is involuntarily terminated without defined cause. In addition, our CEO's
      employment agreement contains a provision for a lump sum payment in the event
      his employment is voluntarily terminated for good cause, as defined. For our
      CEO
      and COO, these lump sum payments would equal any earned but unpaid salary and
      bonus, unearned and unpaid bonus to the end of the contract term, plus the
      greater of unearned and unpaid salary to the end on the contract term or six
      months of salary. For our CAO, this lump sum payment would equal
      $75,000.





While
      our
      executives are involved in negotiating their own employment agreements, such
      agreements are approved by our board of directors.





On
      September 14, 2006, we entered into employment agreements with Anthony J.
      Cataldo, our Chairman and Chief Executive Officer, and Shawn Lewis, our Chief
      Operating and Technology Officer. These agreements provided for, among
      other things, the award of 500,000 stock options each to Messrs. Cataldo and
      Lewis upon sufficient underlying shares of common stock being authorized and
      available. The options were to be exercisable to purchase 500,000 shares of
      our
      common stock each for Messrs. Cataldo and Lewis at an exercise price of $0.20
      per share for a period of five (5) years. The options were to contain a cashless
      exercise provision and cost free piggyback registration rights with respect
      to
      the common stock underlying the options. Messrs. Cataldo and Lewis were also
      to
      receive sufficient additional options under the same terms to assure that they
      have the right to exercise options to maintain a minimum of 5% and 8% beneficial
      ownership, respectively, of our issued and outstanding common
      stock.





A
      number of our current financing agreements contain “favored nations”
provisions that require convertible debt conversion prices and stock warrant
      exercise prices to be repriced (reduced) in the event that, among other things,
      options are granted at exercise prices less than our quoted common stock market
      price at grant date. However, these favored nations repricing provisions
      are not triggered upon issuing employee stock grants. Accordingly, in lieu
      of
      the stock options to be granted to Messrs. Cataldo and Lewis, the
      board of directors on January 24, 2007 resolved to issue stock grants
      for 500,000 common shares each, subject to sufficient increased shares of common
      stock being authorized and available for issuance, which will require
      shareholder approval. The stock grants are to have the same 5% and 8%
      anti-dilution provisions and piggyback registration rights as the options were
      to have. On March 16, 2007, our shareholders approved an authorized common
      share
      increase sufficient to issue these shares.





**Compensation
      Committee Report**





The
      board
      of directors has reviewed and discussed the Compensation Discussion and Analysis
      with management, and based on this discussion the following board members,
      representing all current board members, recommended that this Compensation
      Discussion and Analysis be included in this annual report on Form
      10-K:





Anthony
      Cataldo;


Gary
      Post;


Stuart
      Kosh; and


Nicholas
      A. Iannuzzi, Jr.





The
      following table sets forth information with respect to the compensation for
      the
      year ended December 31, 2006 of our principal executive officers and principal
      financial officers during 2006, and each person who served as an executive
      officer of our Company as of December 31, 2006.




37


**Summary
        Compensation Table**


Name
                and
            
            
            
            
            
            
            
            Stock
            
            Option
            
            All
                OtherPrincipal
                Position
            
            Year
            
            Salary
            
            Bonus
            
            Awards
            
            Awards (1)
            
            Compensation
            
            TotalAnthony
                Cataldo(2)
            
            
            2006
            
            $
            83,333
            
            $
            23,750
            
            $
            -
            
            $
            -
            
            $
            6,000
            
            $
            113,083*Chairman
                and Chief Executive Officer**(Principal
                Executive Officer)*Shawn
                M. Lewis(3)
            
            
            2006
            
            
            214,584
            
            
            64,808
            
            
            1,080,000
            
            
            -
            
            
            35,429
            
            
            1,394,821*Chief
                Operating Officer;**Chief
                Technology Officer*Robert
                V. Staats(4)
            
            
            2006
            
            
            132,597
            
            
            5,692
            
            
            -
            
            
            133,000
            
            
            -
            
            
            271,289*Chief
                Accounting Officer**(Principal
                Financial Officer)*Gary
                Post(5)
            
            
            2006
            
            
            72,668
            
            
            -
            
            
            300,000
            
            
            930,000
            
            
            241,672
            
            
            1,544,340*Former
                President, Chief Executive**Officer
                and Chairman**(6)*Michael
                Adler
            
            
            2006
            
            
            60,923
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            60,923*Former
                Chairman and Chief**Executive
                Officer**(7)*David
                Sasnett
            
            
            2006
            
            
            54,375
            
            
            -
            
            
            -
            
            
            -
            
            
            -
            
            
            54,375*Former
                Chief Financial Officer**(8)*




(1)
            Includes
                awards of stock warrants where applicable. Values are computed in
                accordance with Statement of Financial Accounting Standards number
                123R.





(2)
            Mr.
                Cataldo's 2006 salary and bonus represent the contractual monthly
                amounts
                ($20,833 and $5,000, respectively) earned since September 2006, plus
                a
                discretionary bonus of $3,750. All Other Compensation represents
                Mr.
                Cataldo's monthly vehicle allowance since September 2006. Mr. Cataldo's
                employment agreement is effective through September 2009, and will
                thereafter automatically renew for successive one-year periods unless
                either party provides a 90-day notice of termination. See Compensation
                Discussion and Analysis for a description of certain stock options
                and
                stock grants pertaining to Mr. Cataldo. Since those stock options
                were not
                granted, they are not reflected in the Summary Compensation
                Table.





(3)
            Mr.
                Lewis' 2006 salary and bonus represent his contractual monthly amounts
                earned (which have been $20,833 and $5,000, respectively, since September
                2006), plus a discretionary bonus of $4,808. On November 8, 2006,
                Mr.
                Lewis was granted options to purchase 150,000 common shares at $7.20
                per
                share (closing market price at the grant date). On November 9, 2006,
                we
                settled Mr. Lewis' claims against us for alleged breaches of his
                employment agreement, and for nonregistration of our common shares
                he
                holds pursuant to the Caerus merger agreement dated May 31, 2005,
                for
                $1,080,000. Also on November 9, 2006, Mr. Lewis exercised his options
                to
                purchase 150,000 common shares, and the $1,080,000 proceeds were
                credited
                toward the settlement of his claims. All Other Compensation represents
                Mr.
                Lewis' $1,500 monthly vehicle allowance since July 2006, plus
                discretionary expense reimbursement treated as compensation. Mr.
                Lewis'
                employment agreement is effective through September 2009. See Compensation
                Discussion and Analysis for a description of certain stock options
                and
                stock grants pertaining to Mr. Lewis. Since those stock options were
                not
                granted, they are not reflected in the Summary Compensation
                Table.




38





(4)
            Mr.
                Staats' 2006 salary ($11,667 per month at December 31, 2006, increasing
                to
                $12,917 in January 2007) represents his contractual monthly amounts
                earned. His bonus amount was discretionary. Mr. Staats' employment
                agreement also provides for the award of 5,000 options and 5,000
                warrants,
                subject to approval by our board of directors. The options and warrants
                will each be exercisable to purchase 5,000 shares of our common stock
                at
                $20.40 a share until May 2011, and were valued at a combined $133,000
                in
                May 2006. Mr. Staats' employment agreement is effective through May
                2009,
                and will thereafter automatically renew for successive one-year periods
                unless terminated at least 90 days prior to the expiration of each
                current
                existing twelve-month period. Mr. Staats may terminate his employment
                agreement upon 30 days' prior
                notice.





(5)
            Mr.
                Post's 2006 salary represents his contractual monthly amount earned
                from
                May to September 2006. Subject to approval by our board of directors,
                Mr.
                Post's employment agreement provides for the issuance of 15,000 common
                shares. Mr. Post's employment agreement also provided for the award
                of
                options and warrants to purchase a total of 150,000 shares of the
                Company's common stock at $20.00 a share until May 2011. On December
                12,
                2006 these options and warrants were converted to warrants to purchase
                150,000 of our common shares at $9.50 per share, exercisable until
                December 2016. These new warrants were valued at $930,000. Mr. Post's
                employment agreement also provides for certain post-employment
                compensation totaling approximately $241,672, listed under All Other
                Compensation.





(6)
            Mr.
                Post resigned his position as President, Chief Executive Officer
                and
                Chairman in September, 2006.





(7)
            Mr.
                Adler resigned his position as Chairman and Chief Executive Officer
                in
                May, 2006.





(8)
            Mr.
                Sasnett resigned his position as Chief Financial Officer in May,
                2006.





**Outstanding
      Equity Awards at Fiscal Year-End**




The
      following table sets forth information with respect to grants of options to
      purchase our common stock to the named executive officers as of December 31,
      2006.


Option
                  and Warrant AwardsNumber
                  of Securities Underlying
                Unexercised
                  Options and
                Warrants
              
              Option
                  or
                Warrant
                Exercise
              
              Option
                  or
                Warrant
                ExpirationExercisable
              
              Unexercisable
              
              Price
              
              DateName
                  andPrincipal
                  PositionAnthony
                  Cataldo(1)
              
              
              -
              
              
              -
              
              $
              -*Chairman
                  and Chief Executive Officer*
              
              
              -
              
              
              -
              
              $
              -*(Principal
                  Executive Officer)*Shawn
                  M. Lewis(2)
              
              
              -
              
              
              -
              
              $
              -*Chief
                  Operating Officer;*
              
              
              -
              
              
              -
              
              $
              -*Chief
                  Technology Officer*Robert
                  V. Staats
              
              
              9,532
              
              
              2,969
              
              $
              20.40
              
              
              5/17/11*Chief
                  Accounting Officer*
              
              
              3,125
              
              
              1,925
                  (9
              )
              $
              22.40
              
              
              6/3/10Gary
                  Post(3)
              
              
              150,000
              
              
              -
              
              $
              9.50
              
              
              12/12/16*Former
                  President, Chief Executive**Officer
                  and Chairman**(6)*Michael
                  Adler(4)
              
              
              25,000
              
              
              -
              
              $
              31.20
              
              
              10/18/10*Former
                  Chairman and Chief*
              
              
              25,000
              
              
              -
              
              $
              30.00
              
              
              10/18/10*Executive
                  Officer**(7)*David
                  Sasnett(5)
              
              
              22,500
              
              
              
              
              $
              30.60
              
              
              10/18/10*Former
                  Chief Financial Officer**(8)*




39




(1)
            See
                Compensation Discussion and Analysis for a description of certain
                stock
                options and stock grants pertaining to Mr. Cataldo. Since those stock
                options were not granted, they are not reflected in the Outstanding
                Equity
                Awards at Fiscal Year-End table.





(2)
            See
                Compensation Discussion and Analysis for a description of certain
                stock
                options and stock grants pertaining to Mr. Lewis. Since those stock
                options were not granted, they are not reflected in the Outstanding
                Equity
                Awards at Fiscal Year-End table.





(3)
            Mr.
                Post's employment agreement provided for the award of options and
                warrants
                to purchase a total of 150,000 shares of the Company's common stock
                at
                $20.00 a share until May 2011. On December 12, 2006 these options
                and
                warrants were converted to warrants to purchase 150,000 of the Company's
                common shares at $9.50 per share, exercisable until December
                2016.





(4)
            Mr.
                Adler's options and warrants were issued in 2005 in conjunction with
                his
                employment agreement.





(5)
            Mr.
                Sasnett's's warrants were issued in 2005 in conjunction with his
                employment agreement.





(6)
            Mr.
                Post resigned his position as President, Chief Executive Officer
                and
                Chairman in September, 2006.





(7)
            Mr.
                Adler resigned his position as Chairman and Chief Executive Officer
                in
                May, 2006.





(8)
            Mr.
                Sasnett resigned his position as Chief Financial Officer in May,
                2006.





(9)
            Mr.
                Staats' remaining 2,969 and 1,925 options vest ratably until May
                2009 and
                June 2008, respectively.




**Option
                Exercises and Stock Vested**Option
                Awards(1)
            
            Stock
                AwardsNumber
                of Shares Acquired on
              Exercise
            
            Value
                Realized
              on
                Exercise
            
            Number
                of Shares Acquired on
              Vesting
            
            Value
                Realized
              on
                VestingName
                andPrincipal
                PositionAnthony
                Cataldo
            
            
            -
            
            $
            -
            
            
            -
            
            $
            -*Chairman
                and Chief Executive Officer**(Principal
                Executive Officer)*Shawn
                M. Lewis(2)
            
            
            150,000
            
            $
            -
            
            
            -
            
            $
            -*Chief
                Operating Officer;**Chief
                Technology Officer*Robert
                V. Staats
            
            
            -
            
            $
            -
            
            
            -
            
            $
            -*Chief
                Accounting Officer*Gary
                Post(3)
            
            
            -
            
            $
            -
            
            
            15,000
            
            $
            300,000*Former
                President, Chief Executive**Officer
                and Chairman**(4)*Michael
                Adler
            
            
            -
            
            $
            -
            
            
            -
            
            $
            -*Former
                Chairman and Chief**Executive
                Officer**(5)*David
                Sasnett
            
            
            -
            
            $
            -
            
            
            -
            
            $
            -*Former
                Chief Financial Officer**(6)*




40





(1)
            Includes
                awards of stock warrants, where applicable. Values are computed in
                accordance with Statement of Financial Accounting Standards No.
                123R.





(2)
            On
                November 8, 2006, Mr. Lewis was granted options to purchase 150,000
                common
                shares at $7.20 per share (closing market price at the grant date).
                On
                November 9, 2006, we settled Mr. Lewis' claims against us for alleged
                breaches of his employment agreement, and for nonregistration of
                our
                common shares he holds pursuant to the Caerus merger agreement dated
                May
                31, 2005, for $1,080,000. Also on November 9, 2006, Mr. Lewis exercised
                his options to purchase 150,000 common shares, and the $1,080,000
                proceeds
                were credited toward the settlement of his
                claims.





(3)
            Subject
                to approval by our board of directors, Mr. Post's employment agreement
                provides for the issuance of 15,000 common
                shares.





(4)
            Mr.
                Post resigned his position as President, Chief Executive Officer
                and
                Chairman in September, 2006.





(5)
            Mr.
                Adler resigned his position as Chairman and Chief Executive Officer
                in
                May, 2006.





(6)
            Mr.
                Sasnett resigned his position as Chief Financial Officer in May,
                2006.




**Director
                Compensation**The following table sets forth with respect to the named director,
                compensation information inclusive of equity awards and payments
                made in
                the year ended December 31, 2006.




Stock AwardsName
                of DirectorAnthony
                Cataldo
            
            $
            -Gary
                Post(1)
            
            $
            105,000Stuart
                Kosh(1)
            
            $
            105,000Nicholas
                A. Iannuzzi, Jr.(1)
            
            $
            -




(1)
            On
                December 12, 2006 non-employee directors were each awarded 15,000
                of our
                common shares, subject to sufficient authorized shares being approved
                by
                shareholders, as annual board member compensation. The fair value
                of the
                stock awards was based on the our closing common stock price of $7.00
                per
                share on the grant date. Nicholas A. Iannuzzi was elected to our
                board of
                directors on March 16, 2007.




**Potential
      Payments upon Termination or Change in Control**





Our
      current employment agreements with our CEO, COO and CAO contain provisions
      for
      lump sum payments in the event their employment is involuntarily terminated
      without defined cause. In addition, our CEO's employment agreement contains
      a
      provision for a lump sum payment in the event his employment is voluntarily
      terminated for good cause, as defined. For our CEO and COO, these lump sum
      payments would equal any earned but unpaid salary and bonus, unearned and unpaid
      bonus to the end of their contract terms (September 2009), plus the greater
      of
      unearned and unpaid salary to the end on their contract terms or six months
      of
      salary. As of December 31, 2006, this would have equated to a lump sum payment
      of approximately $840,000 each for our CEO and COO, respectively. For our CAO,
      this lump sum payment would equal $75,000.





In
      May
      2006 we entered into an employment agreement with Gary Post who became our
      President, Chief Executive Officer and Chairman and served in this capacity
      until September 2006. During his employment with us, Mr. Post served under
      an
      employment agreement. The employment agreement was for a term of three years
      (unless terminated earlier pursuant to its terms) and provided for a salary
      of
      $16,667 per month through December 31, 2006, increasing to $18,000 per month
      on
      January 1, 2007. Mr. Post's employment agreement also provides for the future
      payment of certain post-employment compensation totaling approximately $241,672
      as of December 31, 2006.





**Compensation
      Committee Interlocks and Insider Participation**





To
      date
      we have not had a standing compensation committee. Mr. Anthony Cataldo, our
      Chief Executive Officer, Mr. Shawn Lewis, our Chief Operating Officer and Chief
      Technical Officer, and Mr. Gary Post, our former Chief Executive officer,
      participated in deliberations with our board of directors concerning executive
      officer compensation during the year ended December 31, 2006.




41





**Item
      12.**  **Security
      Ownership of Certain Beneficial Owners and Management and Related Stockholder
      Matters**





**Equity
      Compensation Plan Information**





See
      Note
      L to our consolidated financial statements for a description of our 2004
      Employee Stock Option Plan (the “2004 Plan”) and our 2006 Equity Incentive Plan
      (the “2006 Plan”). The following table provides information as of
      December 31, 2006 regarding compensation plans under which our equity
      securities are authorized for issuance.





Number of securities to be
              issued upon exercise
                of
              outstanding
                options,
              warrants
                and rights
              (a)
            
            Weighted-average exercise
              price
                of outstanding
              options, warrants and rights
              (b)
            
            Number
                of securities
              remaining
                available for
              future
                issuance under
              equity compensation plans
              (excluding
                securities
              reflected in column (a))
              (c)Equity
                compensation plans approved by shareholders
            
            
            32,218
            
            $
            22.20
            
            
            667,782Equity
                compensation plans not approved by shareholders
            
            
            407,813
            
            
            20.00
            
            
            -Total
            
            
            440,031
            
            $
            20.20
            
            
            667,782




The
      above
      table excludes the 500,000 common shares that were granted to each of Messrs.
      Cataldo and Lewis by the board of directors on January 24, 2007, as more
      fully described in the Compensation Discussion and Analysis above.





**Beneficial
      Ownership**





The
      following table sets forth information as of March 15, 2007, except as otherwise
      noted, with respect to the beneficial ownership of our common stock and is
      based
      on 4,930,486 shares of common stock issued and outstanding as of March 15,
      2007:





·
            Each
                person known by us to own beneficially more than five percent of
                our
                outstanding common stock;





·
            Each
                of our directors and prospective
                directors;





·
            Our
                Chief Executive Officer and each person who serves as an executive
                officer
                of the Company; and





·
            All
                our executive officers and directors as a
                group.





The
      number of shares beneficially owned by each shareholder is determined under
      rules promulgated by the SEC. The information is not necessarily indicative
      of
      beneficial ownership for any other purpose. Under these rules, beneficial
      ownership includes any shares as to which the individual has sole or shared
      voting power or investment power and any shares as to which the individual
      has
      the right to acquire beneficial ownership within 60 days, except as otherwise
      noted, through the exercise or conversion of any stock option, warrant,
      preferred stock or other right. The inclusion in the following table of those
      shares, however, does not constitute an admission that the named shareholder
      is
      a direct or indirect beneficial owner of those shares. Unless otherwise
      indicated, to our knowledge based upon information produced by the persons
      and
      entities named in the table, each person or entity named in the table has sole
      voting power and investment power, or shares voting and/or investment power
      with
      his or her spouse, with respect to all shares of capital stock listed as owned
      by that person or entity.





The
      address for each of our officers and directors is c/o VoIP, Inc., 151 South
      Wymore Road, Suite 3000, Altamonte Springs, Florida 32714.




42





**Name
                of Beneficial Owner**
            
            **Shares of Common Stock**
              **Beneficially
                Owned (1)**
            
            **Ownership of Common**
              **Stock
                (1,2)**WQN,
                Inc. (3)
            
            1,390,812
            
            23.1%14911
                Quorum Drive, Suite 140Dallas,
                Texas 75240Nicholas
                A. Iannuzzi, Jr.
            
            15,368
            
            *Stuart
                Kosh (4)
            
            148,438
            
            3.0%Shawn
                Lewis (5,6)
            
            351,793
            
            7.0%Gary
                Post (7)
            
            180,000
            
            3.5%Robert
                Staats (8)
            
            12,657
            
            *Anthony
                Cataldo (6)
            
            0
            
            *All
                directors and executive officers as a group
                (6 persons) (9)
            
            708,256
            
            13.3%


*
        Less
        than one percent.


(1)
            We
                have issued and outstanding 4,930,486 shares of common stock; and
                a total
                of 400,000,000 shares are authorized. Additional issuances of common
                stock
                resulting from the exercise of options and/or warrants and/or the
                conversion of debt are subject to the authorized
                limit.





(2)
            Based
                upon 4,930,486 shares of common stock issued and outstanding as of
                March
                15, 2007.





(3)
            Consists
                of 289,372 shares of common stock and 1,101,440 shares issuable upon
                conversion of a convertible promissory note. Conversion shares were
                calculated by dividing (i) the sum of the note principal of $3,700,000
                and
                interest at 6% from 1/3/06 through 3/15/07 by (ii) effective conversion
                price of $3.60 per share.





(4)
            Consists
                of (a) 98,125 shares of common stock; (b) currently exercisable options
                to
                purchase 7,813 shares of common stock; and (c) warrants to purchase
                42,500
                shares of common stock.





(5)
            Consists
                of 351,793 shares of common stock.





(6)
            As
                previously disclosed, on September 14, 2006, we entered into employment
                agreements with Anthony J. Cataldo, our Chairman and Chief Executive
                Officer, and Shawn Lewis, our Chief Operating and Technology
                Officer. These agreements provided for, among other things, the award
                of
                500,000 stock options each to Messrs. Cataldo and Lewis upon sufficient
                underlying shares of common stock being authorized and available.
                The
                options were to be exercisable to purchase 500,000 shares of our
                common
                stock each for Messrs. Cataldo and Lewis at an exercise price of
                $0.20 per
                share for a period of five (5) years. The options were to contain
                a
                cashless exercise provision and cost free piggyback registration
                rights
                with respect to the common stock underlying the options. Messrs.
                Cataldo
                and Lewis were also to receive sufficient additional options under
                the
                same terms to assure that they have the right to exercise options
                to
                maintain a minimum of 5% and 8% beneficial ownership, respectively,
                of our
                issued and outstanding common stock.
              
              A
                number of our current financing agreements contain “favored nations”
                provisions that require convertible debt conversion prices and stock
                warrant exercise prices to be repriced (reduced) in the event that,
                among
                other things, options are granted at exercise prices less than our
                quoted
                common stock market price at grant date. However, these favored
                nations repricing provisions are not triggered upon issuing employee
                stock
                grants. Accordingly, in lieu of the stock options to be granted to
                Messrs. Cataldo and Lewis, the board of directors on January 24, 2007
                resolved to issue stock grants for 500,000 common shares each,
                subject to sufficient increased shares of common stock being authorized
                and available for issuance, which will require shareholder approval.
                The
                stock grants are to have the same 5% and 8% anti-dilution provisions
                and
                piggyback registration rights as the options were to have.
              
              Accordingly,
                these shares are not included with the shares, if any, reported as
                beneficially owned herein.




43





(7)
            Consists
                of 30,000 shares of common stock and warrants to purchase 150,000
                shares
                of common stock.





(8)
            Consists
                of warrants to purchase 7,500 shares of common stock and currently
                exercisable options to purchase 5,157 shares of common
                stock.





(9)
            Represents
                the combined beneficial ownership as of March 15, 2007, of the executives
                and the Company's four directors (a total of six
                persons).





**Item
      13.****Certain
      Relationships and Related Transactions**





In
      October 2005, we purchased all of the assets of WQN, Inc., a Delaware
      corporation (“WQN”). Mr. Adler, our former chairman and chief executive officer,
      was the Chief Executive Officer of WQN, and owned approximately 37% of WQN's
      outstanding common stock. In connection with the transaction, we purchased
      the
      assets for a purchase price consisting of (1) a note in the principal amount
      of
      $3,700,000 (the “Note”), (2) 1,250,000 shares of our restricted common stock and
      (3) a warrant to purchase 5,000,000 shares of our common stock at an exercise
      price of $ $0.001 per share (the “Warrant”). The Note accrues interest at the
      rate of 6% per annum. In addition, we issued WQN, Inc. an additional 500,000
      shares of restricted common stock relating to the difference between the amount
      of accounts receivable transferred in the transaction and the accounts payable.
      The Note is convertible into common stock or preferred stock (at such time
      that
      a series of preferred stock is established). The Warrant was exercised for
      common stock. Pursuant to our asset purchase agreement with WQN, on March 16,
      2007 our shareholders approved a class of preferred stock that could have been
      used to satisfy the conversion features of the Note. On March 16, 2007, WQN
      notified us that it was exercising its right to convert its note and related
      accrued interest into approximately 22,008,524 shares of our common
      stock.




The
      Company and Mr. Ivester, a shareholder and former Chief Executive Officer of
      the
      Company, entered into a 3-year consulting agreement on October 18, 2005, which
      we terminated in October 2006. Pursuant to the consulting agreement, Mr. Ivester
      provided general business strategy, financing and product development advice.
      Mr. Ivester received $200,000 per year for his services under the consulting
      agreement, as well as a $2,500 per month vehicle allowance. Mr. Ivester was
      eligible to receive bonuses and participate in our stock option plan, as
      determined by the board of directors. We also owed Mr. Ivester $305,212 as
      of
      December 31, 2006 under a demand note payable bearing interest at 3.75%. On
      March 16, 2007 we agreed to settle all of Mr. Ivester's claims under his
      consulting agreement and his demand note payable, in return for cash payments
      totaling $75,000, and 25,000 shares of the our common stock. Effective June
      27,
      2007, we entered into an Asset Purchase Agreement (the "Purchase Agreement")
      with WQN, Inc., a Texas corporation controlled by Mr. Ivester (the “Purchaser”),
      pursuant to which we sold substantially all of the tangible operating assets
      utilized by our Dallas, Texas subsidiary, VoIP Solutions, Inc. (the "Assets"),
      to the Purchaser.





On
      November 8, 2006, Mr. Lewis, our Chief Operating Officer and Chief Technology
      Officer, was granted options to purchase 150,000 common shares at $7.20 per
      share (closing market price at the grant date). On November 9, 2006, we settled
      Mr. Lewis' claims against us for alleged breaches of his employment
      agreement, and for nonregistration of our common shares he holds pursuant to
      the
      Caerus merger agreement dated May 31, 2005, for $1,080,000. Also on November
      9,
      2006, Mr. Lewis exercised his options to purchase 150,000 common shares, and
      the
      $1,080,000 proceeds from this exercise were credited toward the settlement
      of
      his claims.





On
      March
      29, 2007, we issued an unsecured promissory note in the principal amount of
      $300,000 (the “Note”) to Shawn M. Lewis, the Company's Chief Operating Officer.
      The Note and related accrued interest at 10% per annum is payable upon demand.
      The cash proceeds to the Company were $252,000 net of related closing costs
      and
      expense reimbursements of $48,000, $30,000 of which was paid to Mr. Lewis.
      In the event of a default, in addition to all sums due and owing under the
      Note,
      we will also be required to pay the sum of $750,000 as liquidated
      damages.




**Item
      14.**  **Principal
      Accountant Fees and Services**





*Audit
      Fees* .
      Berkovits, Lago & Company, LLP provided services to us during the years
      ended December 31, 2006 and 2005 in the categories shown
      below.




Fiscal
                  Years EndingDecember
                  31,2006
              
              2005Audit
                  Fees(1)
              
              $
              291,914
              
              $
              120,234Audit-Related
                  Fees(2)
              
              
              124,398
              
              
              -Tax
                  Fees(3)
              
              
              55,000
              
              
              -All
                  Other Fees(4)
              
              
              -
              
              
              -




44




(1)
            *Audit
                fees*-
                These are fees billed for professional services performed by Berkovits,
                Lago & Company, LLP for the audit of our annual financial
                statements and review of financial statements included in our Form
                10-Q
                filings, and services that are normally provided in connection with
                statutory regulatory filings or
                engagements.





(2)
            *Audit-related
                fees*-
                These are fees billed for assurance and related services performed
                by
                Berkovits, Lago & Company, LLP that are reasonably related to the
                performance of the audit or review of our financial statements. These
                include attestations that are not required by statute, and consulting
                on
                financial accounting/reporting
                standards.





(3)
            *Tax
                fees*-
                These are fees billed for professional services performed by Berkovits,
                Lago & Company, LLP with respect to tax compliance, tax advice
                and tax planning. These include preparation of original and amended
                tax
                returns for the Company and its consolidated subsidiaries, refund
                claims,
                payment planning, tax audit assistance, and tax work stemming from
                “audit-related” items.





(4)
            *All
                other fees*-
                Services that do not meet the above three category descriptions are
                not
                permissible work performed for us by Berkovits, Lago & Company,
                LLP.




**PART
      IV**




**Item
      15. Exhibits and Financial Statement Schedules**





(b)
      Exhibits





(3)
            
            2.1
            
            Stock
                Contribution Agreement dated May 25, 2004, between Registrant and
                Steven
                Ivester(12)
            
            2.2
            
            Agreement
                and Plan of Merger with Caerus, Inc. dated as of May 31,
                2005(14)
            
            2.3
            
            Asset
                Purchase Agreement dated as of August 3, 2005, by and between VoIP,
                Inc.
                Acquisition Company and WQN, Inc.(1)
            
            3.1.1
            
            Articles
                of Incorporation(1)
            
            3.1.2
            
            Bylaws(3)
            
            3.2
            
            Amendment
                to Articles of Incorporation dated April 13, 2004(32)
            
            3.3
            
            Amended
                and Restated Bylaws of VoIP, Inc.(3)
            
            4.1
            
            Specimen
                Stock Certificate(28)
            
            4.2.1
            
            Form
                of Consulting Agreement with Irawan Onggara effective November 20,
                2006(28)
            
            4.2.2
            
            Form
                of Consulting Agreement with Piter Korompis effective November 20,
                2006(2)
            
            10.1
            
            Stock
                Purchase Agreement dated February 27, 2004, between Registrant and
                Steven
                Ivester(3)
            
            10.2
            
            2004
                Stock Option Plan(4)
            
            10.3
            
            Stock
                Purchase Agreement dated June 25, 2004, among Registrant, DTNet
                Technologies and Marc Moore(5)
            
            10.4
            
            Stock
                Purchase Agreement dated September 10, 2004, among Carlos Rivas,
                Albert
                Rodriguz, Registrant and Vox Consulting Group Inc.(6)
            
            10.5.1
            
            Subscription
                Agreement dated November 11, 2004(6)
            
            10.5.2
            
            Form
                of Class A Warrant




45





(6)
            
            10.5.3
            
            Form
                of Class B Warrant(8)
            
            10.6.1
            
            Stock
                Purchase Warrant dated December 10, 2004, issued to Ivano
                Angelastri(8)
            
            10.6.2
            
            Stock
                Purchase Warrant dated December 10, 2004, issued to Ebony
                Finance(9)
            
            10.7.1
            
            Form
                of Incentive Stock Option Agreement(9)
            
            10.7.2
            
            Form
                of Non-Qualified Stock Option Agreement(10)
            
            10.8
            
            Net
                Exercise Agreement dated February 14, 2005, with John
                Todd(11)
            
            10.9
            
            Asset
                Purchase Agreement dated February 23, 2005, among Creative Marketing
                Associates, Registrant, and
                eGlobalPhone





(12)
            
            10.10
            
            Caerus,
                Inc. Merger Documents dated May 31, 2005:(12)
            
            10.10.1
            
            Option
                Exchange Agreement(12)
            
            10.10.2
            
            Registration
                Rights Agreement(12)
            
            10.10.3
            
            Exchange
                Agreement(12)
            
            10.10.4
            
            Registration
                Rights Agreement(12)
            
            10.10.5
            
            Consent
                and Waiver Agreement(12)
            
            10.10.6
            
            Guaranty(12)
            
            10.10.7
            
            Security
                Agreement(12)
            
            10.10.8
            
            Employment
                Agreement dated May 27, 2005, between Registrant and Shawn
                Lewis(13)
            
            10.11.1
            
            Subscription
                Agreement dated July 5, 2005(13)
            
            10.11.2
            
            Form
                of Class C Warrant(13)
            
            10.11.3
            
            Form
                of Class D Warrant(13)
            
            10.11.4
            
            Form
                of Convertible Note(13)
            
            10.11.5
            
            Security
                Agreement(13)
            
            10.11.6
            
            Security
                and Pledge Agreement(13)
            
            10.11.7
            
            Guaranty(14)
            
            10.12
            
            WQN,
                Inc. Documents dated August 3, 2005:(14)
            
            10.12.1
            
            Warrant(14)
            
            10.12.2
            
            Security
                Agreement between Registrant and WQN, Inc.


(14)
            
            10.12.3
            
            Consent,
                Waiver and Acknowledgement by and among Cedar Boulevard Lease Funding,
                Inc., Registrant, and certain Subsidiaries of
                Registrant(14)
            
            10.12.4
            
            Third
                Amendment to Subordinated Loan and Security Agreement by and among
                Cedar
                Boulevard Lease Funding, Inc., Registrant, and certain Subsidiaries
                of
                Registrant




46




(14)
            
            10.12.5
            
            Security
                Agreement between Cedar Boulevard Lease Funding, Inc. and VoIP Acquisition
                Company(14)
            
            10.12.6
            
            Guaranty
                between Cedar Boulevard Lease Funding, Inc. And VoIP Acquisition
                Company(15)
            
            10.13
            
            Consulting
                Services Agreement dated October 18, 2005, between Registrant and
                Steven
                Ivester(16)
            
            10.14.1
            
            Cross
                Country Capital Partners Amendment Subscription Agreement dated November
                16, 2005(16)
            
            10.14.2
            
            Cross
                Country Capital Partners Class C Warrant(16)
            
            10.14.3
            
            Stock
                Purchase Agreement with Steven Ivester(16)
            
            10.14.4
            
            Promissory
                Note to Steven Ivester





(17)
            
            10.15.1
            
            Subscription
                Agreement for Secured Notes dated January 6, 2006(17)
            
            10.15.2
            
            Subscription
                Agreement for Unsecured Notes dated January 6, 2006(17)
            
            10.15.3
            
            Form
                of Class A Warrant(17)
            
            10.15.4
            
            Form
                of Class B Warrant(17)
            
            10.15.5
            
            Form
                of Secured Convertible Note(17)
            
            10.15.6
            
            Form
                of Unsecured Convertible Note(17)
            
            10.15.7
            
            Security
                Agreement(17)
            
            10.15.8
            
            Security
                and Pledge Agreement(17)
            
            10.15.9
            
            Guaranty
                Agreement(18)
            
            10.16.1
            
            Subscription
                Agreement dated February 2, 2006(18)
            
            10.16.2
            
            Form
                of Class A Warrant(18)
            
            10.16.3
            
            Form
                of Class B Warrant(18)
            
            10.16.4
            
            Form
                of Secured Convertible Note(18)
            
            10.16.5
            
            Security
                Agreement(18)
            
            10.16.6
            
            Security
                and Pledge Agreement(18)
            
            10.16.7
            
            Guaranty
                Agreement(19)
            
            10.17
            
            2006
                Equity Incentive Plan(20)
            
            10.18
            
            Stock
                Purchase Agreement dated as of April 19, 2006, by and between Registrant,
                VCG Technologies, Inc. d/b/a DTNet Technologies and William F.
                Burbank(21)
            
            10.19.1
            
            Employment
                Agreement effective May 15, 2006, between Registrant and Mr. Gary
                Post(21)
            
            10.19.2
            
            Employment
                Agreement effective May 17, 2006, between Registrant and Mr. Robert
                Staats(21)
            
            10.19.3
            
            Employment
                Agreement effective May 15, 2006, between Registrant and Mr. David
                Ahn




47





(21)
            
            10.19.4
            
            Modification
                and Amendment Agreement dated May 22, 2006(36)
            
            10.20.1
            
            Promissory
                Note dated September 13, 2006, issued to Bristol Investment Fund,
                Ltd., in
                the Principal Amount of $166,666(36)
            
            10.20.2
            
            Promissory
                Note dated September 13, 2006, issued to Alpha Capital Anstalt in
                the
                Principal Amount of $333,334(22)
            
            10.21
            
            Promissory
                Note dated September 29, 2006, issued to Whalehaven Capital Fund
                Limited
                in the Principal Amount of $387,800(23)
            
            10.22.1
            
            Subscription
                Agreement dated October 17, 2006(23)
            
            10.22.2
            
            Form
                of Class C Warrant


(23)
            
            10.22.3
            
            Form
                of Secured Convertible Note(24)
            
            10.23
            
            Compensation
                Agreement dated October 12, 2006, among Registrant and Marc
                Ross(26)
            
            10.24.1
            
            Alpha
                et al 3(a)(10) Settlement dated September 15, 2006(26)
            
            10.24.2
            
            Stonestreet
                et al 3(a)(10) Settlement dated September 18, 2006(26)
            
            10.24.3
            
            Employment
                Agreement effective September 14, 2006, between Registrant and Mr.
                Anthony
                Cataldo(26)
            
            10.24.4
            
            Second
                Amendment effective September 14, 2006 to Employment Agreement between
                Registrant and Mr. Shawn Lewis(26)
            
            10.24.5
            
            Non-Qualified
                Stock Option Agreement dated November 8, 2006(26)
            
            10.24.6
            
            Settlement
                Agreement and Release of Claims among Shawn Lewis and
                Registrant(27)
            
            10.25.1
            
            Promissory
                Note dated November 27, 2006, issued to Whalehaven Capital Fund,
                Limited,
                in the Principal Amount of $133,333(27)
            
            10.25.2
            
            Promissory
                Note dated November 27, 2006, issued to Alpha Capital Anstalt in
                the
                Principal Amount of $133,334(27)
            
            10.25.3
            
            Promissory
                Note dated November 27, 2006, issued to Ellis International Ltd.
                in the
                Principal Amount of $100,000(29)
            
            10.26.1
            
            Form
                of Stock Purchase Warrant dated December 7, 2006, with Cashless Exercise
                Provision(29)
            
            10.26.2
            
            Form
                of Stock Purchase Warrant dated December 7, 2006, without Cashless
                Exercise Provision(30)
            
            10.27.1
            
            Promissory
                Note dated December 15, 2006, issued to Whalehaven Capital Fund,
                Limited,
                in the Principal Amount of $83,333(30)
            
            10.27.2
            
            Promissory
                Note dated December 15, 2006, issued to Alpha Capital Anstalt in
                the
                Principal Amount of $83,334(30)
            
            10.27.3
            
            Promissory
                Note dated December 15, 2006, issued to Ellis International Ltd.
                in the
                Principal Amount of $83,333(31)
            
            10.28.1
            
            Promissory
                Note dated January 4, 2007, issued to Whalehaven Capital Fund, Limited,
                in
                the Principal Amount of $83,333




48




(31)
            
            10.28.2
            
            Promissory
                Note dated January 4, 2007, issued to Alpha Capital Anstalt in the
                Principal Amount of $83,332(31)
            
            10.28.3
            
            Promissory
                Note dated January 4, 2007, issued to Alpha Capital Anstalt in the
                Principal Amount of $83,335(33)
            
            10.29.1
            
            Promissory
                Note dated January 18, 2007, issued to Alpha Capital Anstalt in the
                principal amount of $100,000(33)
            
            10.29.2
            
            Promissory
                Note dated January 18, 2007, issued to Centurion Microcap L.P. in
                the
                principal amount of $100,000(33)
            
            10.29.3
            
            Promissory
                Note dated January 18, 2007, issued to Ellis International Ltd. in
                the
                principal amount of $100,000





(33)
            
            10.29.4
            
            Form
                of Promissory Notes issued to Bristol Investment Fund, Ltd., in the
                principal amount of $250,000 each(33)
            
            10.29.5
            
            Form
                of Bridge Financing Letter Agreement with Bristol Investment Fund,
                Ltd.(34)
            
            10.30.1
            
            Form
                of Assignment of Secured Subordinated Promissory Note dated June
                1, 2004
                (Assignment dated February 1, 2007)(34)
            
            10.30.2
            
            Form
                of Addendum to Assignment of Secured Subordinated Promissory Note
                (Addendum dated February 1, 2007)(35)
            
            10.31.1
            
            Form
                of Subscription Agreement dated February 16, 2007(35)
            
            10.31.2
            
            Form
                of Convertible Note dated February 16, 2007(35)
            
            10.31.3
            
            Form
                of Class D Common Stock Purchase Warrant dated February 16,
                2007(35)
            
            10.31.4
            
            Form
                of Cedar Reallocation and Assignment Agreement dated February 16,
                2007(35)
            
            10.31.5
            
            Form
                of Reallocation and Assignment Agreement dated February 16,
                2007(36)
            
            10.32.1
            
            $300,000
                Subordinated Demand Promissory Note dated March 29,
                2007(7)
            
            16.1
            
            Resignation
                Letter from Tschopp, Whitcomb & Orr(25)
            
            21.1
            
            Subsidiaries
                of the Registrant(37)
            
            31.1
            
            Certification
                of Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a)
                and
                15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
                Act of
                2002(37)
            
            31.2
            
            Certification
                of Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a)
                and
                15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley
                Act of
                2002(37)
            
            32.1
            
            Certification
                of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
                Adopted
                Pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002(37)
            
            32.2
            
            Certification
                of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
                Adopted
                Pursuant to Section 906 of the Sarbanes-Oxley Act of
                2002(1)
            
            
            
            Filed
                as exhibit to Registrant's Form 10-SB filed January 19,
                2000(2)
            
            
            
            Filed
                as exhibit to Form 8-K filed March 3, 2004




49





(3)
            
            
            
            Filed
                as exhibit to Form 8-K filed June 9, 2004(4)
            
            
            
            Filed
                as exhibit to Form 8-K filed July 7, 2004(5)
            
            
            
            Filed
                as exhibit to Form 8-K filed September 16, 2004****(6)
            
            
            
            Filed
                as exhibit to form 8-K filed November 17, 2004(7)
            
            
            
            Filed
                as exhibit to form 8-K filed November 18, 2004(8)
            
            
            
            Filed
                as exhibit to form 8-K filed December 15, 2004(9)
            
            
            
            Filed
                as exhibit to form S-8 filed January 26, 2005(10)
            
            
            
            Filed
                as exhibit to form 8-K filed February 16, 2005(11)
            
            
            
            Filed
                as exhibit to form 8-K filed March 1,
                2005





(12)
            
            
            
            Filed
                as exhibit to form 8-K filed June 6, 2005(13)
            
            
            
            Filed
                as exhibit to Form 8-K filed July 11, 2005(14)
            
            
            
            Filed
                as exhibit to Form 8-K filed August 9, 2005(15)
            
            
            
            Filed
                as exhibit to Form 8-K filed October 24, 2005****(16)
            
            
            
            Filed
                as exhibit to Form 8-K filed November 22, 2005(17)
            
            
            
            Filed
                as exhibit to Form 8-K filed January 12, 2006(18)
            
            
            
            Filed
                as exhibit to Form 8-K filed February 8, 2006(19)
            
            
            
            Filed
                as exhibit to Form 10-KSB filed April 17, 2006(20)
            
            
            
            Filed
                as exhibit to Form 8-K filed April 25, 2006(21)
            
            
            
            Filed
                as exhibit to Form 8-K filed May 25, 2006(22)
            
            
            
            Filed
                as exhibit to Form 8-K filed October 5, 2006(23)
            
            
            
            Filed
                as exhibit to Form 8-K filed October 20, 2006(24)
            
            
            
            Filed
                as exhibit to Form S-8 filed October 27, 2006(25)
            
            
            
            Filed
                as exhibit to Form 10-KSB/A filed October 27, 2006(26)
            
            
            
            Filed
                as exhibit to Form 10-Q filed November 17, 2006(27)
            
            
            
            Filed
                as exhibit to Form 8-K filed December 1, 2006(28)
            
            
            
            Filed
                as exhibit to Form S-8 filed December 1, 2006(29)
            
            
            
            Filed
                as exhibit to Form 8-K filed December 13, 2006(30)
            
            
            
            Filed
                as exhibit to Form 8-K filed December 21, 2006(31)
            
            
            
            Filed
                as exhibit to Form 8-K filed January 10, 2007




50




(32)
            
            
            
            Filed
                as exhibit to Form 8-K filed January 29, 2007(33)
            
            
            
            Filed
                as exhibit to Form 8-K filed February 1, 2007(34)
            
            
            
            Filed
                as exhibit to Form 8-K filed February 2, 2007(35)
            
            
            
            Filed
                as exhibit to Form 8-K filed February 23, 2007(36)
            
            
            
            Filed
                as exhibit to Form 10-K filed April 2, 2007(37)
            
            
            
            Filed
              herewith




51




REPORT
      OF
      INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM





To
      the
      Board of Directors


VoIP,
      Inc. and Subsidiaries


Ft.
      Lauderdale, Florida





We
      have
      audited the accompanying consolidated balance sheets of VoIP, Inc. and
      Subsidiaries (“the Company”) as of December 31, 2006 and 2005, and the related
      consolidated statements of operations, shareholders' equity, and cash flows
      for
      the years ended December 31, 2006, 2005 and 2004. These financial statements
      are
      the responsibility of the Company's management. Our responsibility is to express
      an opinion on these financial statements based on our audits.





We
      conducted our audits in accordance with the standards of the Public Company
      Accounting Oversight Board (United States). Those standards require that we
      plan
      and perform the audits to obtain reasonable assurance about whether the
      financial statements are free of material misstatement. The Company is not
      required to have, nor were we engaged to perform, an audit of its internal
      control over financial reporting. Our audits included consideration of internal
      control over financial reporting as a basis for designing audit procedures
      that
      are appropriate in the circumstances, but not for the purpose of expressing
      an
      opinion on the effectiveness of the Company's internal control over financial
      reporting. Accordingly, we express no such opinion. An audit also includes
      examining, on a test basis, evidence supporting the amounts and disclosures
      in
      the financial statements, assessing the accounting principles used and
      significant estimates made by management, as well as evaluating the overall
      financial statement presentation. We believe that our audits provide a
      reasonable basis for our opinion.





In
      our
      opinion, the financial statements referred to above present fairly, in all
      material respects, the financial position of the Company as of December 31,
      2006
      and 2005, and the results of its operations and its cash flows
      for the years ended December 31, 2006, 2005 and 2004 in
      conformity with accounting principles generally accepted in the United States
      of
      America.





The
      accompanying financial statements have been prepared assuming that the Company
      will continue as a going concern. As discussed in Note C to the financial
      statements, the Company's dependence on outside financing, lack of sufficient
      working capital, and recurring losses raise substantial doubt about the
      Company's ability to continue as a going concern. Management's plans are
      described in Note C to the financial statements. The financial statements do
      not
      include any adjustments that might result from the outcome of this
      uncertainty.




As
      described in Note E to the consolidated financial statements, the accompanying
      consolidated balance sheet and statement of changes in shareholders' equity
      of
      VoIP, Inc. and Subsidiaries as of December 31, 2005 and for the year then ended
      have been restated to correct for misstatements in the December 31, 2005
      financial statements previously filed.





As
      discussed in Note P, the accompanying consolidated financial statements for
      2006
      and 2005 have been reclassified to reflect the accounting for the June 27,
      2007
      sale of substantially all of the tangible operating assets utilized by the
      Company’s Dallas, Texas division. Accordingly, the Company has reclassified its
      consolidated financial position, results of operations, and cash flows for
      these
      years to reflect discontinued operations accounting treatment for this division
      since the date of its acquisition in October 2005.





As
      discussed in Note R, the accompanying consolidated financial statements for
      2006, 2005 and 2004 have been retroactively adjusted to reflect the August
      16,
      2007 reverse stock split of the Company's outstanding common stock, at a ratio
      of 1-for-20 shares. Accordingly, all share and per-share information in these
      consolidated financial statements have been adjusted to retroactively reflect
      this reverse stock split. Further, the previously reported common stock in
      the
      Company's consolidated balance sheets was reduced by a factor of twenty, with
      corresponding increases in additional paid-in capital.








*/s/
      Berkovits & Company, LLP* (Formerly


known
      as
      Berkovits, Lago & Company, LLP)




Fort
      Lauderdale, Florida


March 23,
      2007, except for Notes P and R


as
      to
      which the date is October 11, 2007





52





**VoIP,
      Inc.**


**Consolidated
      Balance Sheets**





December
                312006
            
            2005ASSETS
            
            
            
            (Reclassified)
            
            (Reclassified)Current
                assets:Cash
                and cash equivalents
            
            
            
            
            $
            90,172
            
            $
            3,228,745Accounts
                receivable
            
            
            
            
            
            375,946
            
            
            332,270Due
                from related parties
            
            
            
            
            
            31,227
            
            
            161,530Inventory
            
            
            
            
            
            -
            
            
            143,282Prepaid
                expenses and deposits
            
            
            
            
            
            373,746
            
            
            418,179Total
                current assets
            
            871,091
            
            
            4,284,006Property
                and equipment, net
            
            6,604,285
            
            
            9,687,470Goodwill
                and other intangible assets
            
            25,992,034
            
            
            29,125,481Net
                assets of discontinued operations
            
            2,367,007
            
            
            5,875,253Other
                assets
            
            94,546
            
            
            242,858TOTAL
                ASSETS
            $
            35,928,963
            
            $
            49,215,068LIABILITIES
                AND SHAREHOLDERS' EQUITYCurrent
                liabilities:Accounts
                payable
            
            
            
            
            $
            7,987,316
            
            $
            10,038,696Accrued
                expenses
            
            
            
            
            
            4,534,777
            
            
            2,149,514Loans
                payable
            
            
            
            
            
            2,574,835
            
            
            4,685,236Convertible
                notes payable
            
            
            
            
            
            5,902,217
            
            
            183,798Fair
                value liability for warrants
            
            
            
            
            
            5,102,731
            
            
            -Nonregistration
                penalties and other stock-based payables
            
            
            
            
            
            4,748,380
            
            
            -Accrued
                litigation charges
            
            
            
            
            
            1,054,130
            
            
            -Notes
                and advances from investors
            
            
            
            
            
            616,667
            
            
            3,000,000Due
                to related parties
            
            
            
            
            
            -
            
            
            1,572,894Other
                current liabilities
            
            
            
            
            
            140,425
            
            
            473,762Total
                current liabilities
            
            32,661,478
            
            
            22,103,900Other
                liabilities
            
            222,669
            
            
            245,248TOTAL
                LIABILITIES
            
            32,884,147
            
            
            22,349,148Shareholders'
                equity:Common
                    stock - $0.001 par value; 100,000,000 shares authorized; 4,930,485
                    and
                    2,976,170 shares issued and outstanding, respectively
            
            
            
            
            
            4,930
            
            
            2,976Additional
                paid-in capital
            
            
            
            
            
            79,036,498
            
            
            61,663,044Accumulated
                deficit
            
            
            
            
            
            (75,996,612
            )
            
            (34,800,100
            )Total
                shareholders' equity
            
            3,044,816
            
            
            26,865,920TOTAL
                LIABILITIES AND SHAREHOLDERS' EQUITY
            $
            35,928,963
            
            $
            49,215,068




The
      accompanying notes are an integral part of these consolidated financial
      statements.




53





**VoIP
      Inc.**


**Consolidated
      Statements of Operations**





Year
                Ended December 312006
            
            2005
            
            2004(Reclassified)
            
            (Reclassified)Revenues
            
            $
            5,933,248
            
            $
            6,321,115
            
            $
            1,020,285Cost
                of sales
            
            
            8,624,876
            
            
            7,834,124
            
            
            754,598Gross
                profit (loss)
            
            
            (2,691,628
            )
            
            (1,513,009
            )
            
            265,687Operating
                expensesCompensation
                and related expenses
            
            
            12,585,330
            
            
            7,147,876
            
            
            3,800,336Commissions
                and fees to third parties
            
            
            2,573,386
            
            
            4,780,395
            
            
            400,787Professional,
                legal and consulting expenses
            
            
            6,516,502
            
            
            1,854,072
            
            
            430,432Depreciation
                and amortization
            
            
            4,608,318
            
            
            2,905,986
            
            
            70,988General
                and administrative expenses
            
            
            2,565,860
            
            
            3,673,057
            
            
            871,032Total
                operating expenses
            
            
            28,849,396
            
            
            20,361,386
            
            
            5,573,575Loss
                from continuing operations before income taxes
            
            
            (31,541,024
            )
            
            (21,874,395
            )
            
            (5,307,888
            )Other
                (income) expenses:Interest
                expense
            
            
            7,214,325
            
            
            1,477,689
            
            
            -Financing
                penalties and expenses
            
            
            6,375,342
            
            
            -
            
            
            -Gain
                on sale of fixed assets
            
            
            -
            
            
            (206,184
            )
            
            -Decrease
                in fair value liability for warrants
            
            
            (7,226,430
            )
            
            -
            
            
            -Litigation
                charges
            
            
            1,068,500
            
            
            -
            
            
            -Other
            
            
            260,000
            
            
            -
            
            
            -Total
                other (income) expenses
            
            
            7,691,737
            
            
            1,271,505
            
            
            -Loss
                before income taxes and results of  discontinued
                operations
            
            
            (39,232,761
            )
            
            (23,145,900
            )
            
            (5,307,888
            )Provision
                for income taxes
            
            
            -
            
            
            -
            
            
            -Net
                loss before discontinued operations
            
            
            (39,232,761
            )
            
            (23,145,900
            )
            
            (5,307,888
            )Loss
                    from discontinued operations,  net of income taxes
            
            
            (1,963,751
            )
            
            (5,167,433
            )
            
            (554,232
            )Net
                loss
            
            $
            (41,196,512
            )
            $
            (28,313,333
            )
            $
            (5,862,120
            )Basic
                and diluted loss per share:Loss
                before discontinued operations
            
            $
            (10.42
            )
            $
            (12.03
            )
            $
            (7.27
            )Loss
                from discontinued operations, net of income taxes
            
            
            (0.52
            )
            
            (2.69
            )
            
            (0.76
            )Net
                loss per share
            
            $
            (10.94
            )
            $
            (14.72
            )
            $
            (8.03
            )Weighted
                average number of shares outstanding
            
            
            3,766,450
            
            
            1,922,944
            
            
            729,866




The
                accompanying notes are an integral part of these consolidated financial
                statements.





54




**VoIP,
        Inc.**
 **Consolidated
        Statements of Cash Flows**


Year
                    Ended December 312006
                
                2005
                
                2004(Reclassified)
                
                (Reclassified)CASH
                    FLOWS FROM OPERATING ACTIVITIESContinuing
                    operations:Net
                    loss
                
                $
                (39,232,761
                )
                $
                (23,145,900
                )
                $
                (5,307,888
                )Adjustments
                    to reconcile net loss to net cash used in operating
                    activities:Depreciation
                    and amortization
                
                
                4,608,318
                
                
                2,935,345
                
                
                82,832Common
                    shares issued for services
                
                
                2,713,405
                
                
                3,380,474
                
                
                599,166Common
                    shares issued for nonregistration penalty settlements
                
                
                1,125,000
                
                
                -
                
                
                -Options
                    and warrants issued for services and compensation
                
                
                10,014,613
                
                
                2,181,350
                
                
                3,320,763Amortization
                    of debt discounts
                
                
                5,807,815
                
                
                416,175
                
                
                -Decrease
                    in fair value liability for warrants
                
                
                (7,226,431
                )
                
                -
                
                
                -Noncash
                    nonregistration penalties
                
                
                5,130,219
                
                
                -
                
                
                -Noncash
                    litigation charges
                
                
                663,713
                
                
                -
                
                
                -Changes
                    in operating assets and liabilities:Accounts
                    receivable
                
                
                (43,676
                )
                
                1,001,313
                
                
                202,731Due
                    from related parties
                
                
                130,303
                
                
                (161,530
                )
                
                -Inventory
                
                
                143,282
                
                
                590,251
                
                
                171,800Prepaid
                    expenses and deposits
                
                
                44,432
                
                
                (66,642
                )
                
                54,531Accounts
                    payable and accrued expenses
                
                
                2,668,158
                
                
                (4,924,948
                )
                
                (1,113,607
                )Other
                    current liabilities
                
                
                (353,336
                )
                
                413,706
                
                
                (378,670
                )Net
                    cash used in continuing operating activities
                
                
                (13,806,946
                )
                
                (17,380,406
                )
                
                (2,368,342
                )Discontinued
                    operations:Loss
                    from discontinued operations
                
                
                (1,963,751
                )
                
                (5,167,433
                )
                
                (554,232
                )Goodwill
                    impairment charge
                
                
                839,101
                
                
                4,173,452
                
                
                -Provision
                    for assets and liabilties of discontinued operations
                
                
                2,560,122
                
                
                773,237
                
                
                (408,000
                )Net
                    cash provided by (used in) discontinued operating activities
                
                
                1,435,472
                
                
                (220,744
                )
                
                (962,232
                )Net
                    cash used in operating activities
                
                
                (12,371,474
                )
                
                (17,601,150
                )
                
                (3,330,574
                )CASH
                    FLOWS FROM INVESTING ACTIVITIESContinuing
                    operations:Purchase
                    of property and equipment
                
                
                (18,522
                )
                
                (2,582,827
                )
                
                (127,541
                )Acquisition
                    of Caerus and WQN
                
                
                -
                
                
                (1,134,966
                )
                
                -Cash
                    from acquisitions
                
                
                -
                
                
                -
                
                
                104,872(Purchase)
                    or disposition of other assets
                
                
                148,312
                
                
                267,940
                
                
                (71,100
                )Net
                    cash provided by (used in) continuing investing activities
                
                
                129,790
                
                
                (3,449,853
                )
                
                (93,769
                )Discontinued
                    operations:Net
                    assets (Note P)
                
                
                (136,285
                )
                
                (1,459,499
                )
                
                573,363Net
                    cash provided by (used in) discontinued investing activities
                
                
                (136,285
                )
                
                (1,459,499
                )
                
                573,363Net
                    cash provided by (used in) investing activities
                
                
                (6,495
                )
                
                (4,909,352
                )
                
                479,594CASH
                    FLOWS FROM FINANCING ACTIVITIESProceeds
                    from issuance of notes payable and advances
                
                
                13,337,094
                
                
                13,121,390
                
                
                360,000Proceeds
                    from common stock issuances
                
                
                3,689,726
                
                
                11,719,614
                
                
                3,628,618Repayment
                    of notes payable and advances
                
                
                (7,787,424
                )
                
                (242,894
                )
                
                -Net
                    cash provided by financing activities
                
                
                9,239,396
                
                
                24,598,110
                
                
                3,988,618Net
                    increase (decrease) in cash
                
                
                (3,138,573
                )
                
                2,087,608
                
                
                1,137,638Cash
                    and cash equivalents at beginning of year
                
                
                3,228,745
                
                
                1,141,137
                
                
                3,499Cash
                    and cash equivalents at end of year
                
                $
                90,173
                
                $
                3,228,745
                
                $
                1,141,137




The
      accompanying notes are an integral part of these
      consolidated financial statements.


55


**VoIP,
        Inc.**
 **Consolidated
        Statements of Changes in Shareholders' Equity**
 **Years
        Ended December 31, 2006, 2005 and 2004**


Common Stock
              
              Common Stock
              
              Additional Paid-
              
              AccumulatedShares
              
              Amount
              
              in
                  Capital
              
              Deficit
              
              TotalBalance
                  as of December 31, 2003
              
              
              86,547
              
              $
              87
              
              $
              732,852
              
              $
              (624,647
              )
              $
              108,292Common
                  stock issued
              
              
              625,000
              
              
              625
              
              
              11,875
              
              
              -
              
              
              12,500Common
                  stock issued to investors for cash received
              
              
              276,028
              
              
              276
              
              
              3,615,843
              
              
              -
              
              
              3,616,119Common
                  stock issued for services
              
              
              45,374
              
              
              45
              
              
              494,121
              
              
              -
              
              
              494,166Common
                  Stock issued for acquisition of DTNet Tech.
              
              
              125,000
              
              
              125
              
              
              4,749,875
              
              
              -
              
              
              4,750,000Common
                  Stock issued for acquisition of VoipAmericas
              
              
              50,000
              
              
              50
              
              
              1,099,950
              
              
              -
              
              
              1,100,000Warrants
                  issued to two company officers
              
              
              -
              
              
              -
              
              
              3,320,763
              
              
              -
              
              
              3,320,763Warrants
                  issued for intellectual property
              
              
              5,000
              
              
              5
              
              
              105,095
              
              
              -
              
              
              105,100Loss
                  for the year
              
              
              -
              
              
              -
              
              
              -
              
              
              (5,862,120
              )
              
              (5,862,120
              )Balance
                  December 31, 2004
              
              
              1,212,949
              
              
              1,213
              
              
              14,130,374
              
              
              (6,486,767
              )
              
              7,644,820Common
                  Stock issued for services
              
              
              149,730
              
              
              150
              
              
              3,380,324
              
              
              -
              
              
              3,380,474Common
                  stock issued to investors for cash received
              
              
              337,002
              
              
              337
              
              
              8,029,001
              
              
              -
              
              
              8,029,338Common
                  stock issued for cash received, pursuant to exercise of
                  warrants
              
              
              164,639
              
              
              165
              
              
              3,922,488
              
              
              -
              
              
              3,922,653Common
                  stock issued for debt conversions
              
              
              202,727
              
              
              203
              
              
              2,465,084
              
              
              -
              
              
              2,465,287Common
                  Stock issued for acquisition of Caerus, Inc.
              
              
              846,624
              
              
              846
              
              
              17,614,154
              
              
              -
              
              
              17,615,000Options
                  issued for acquisition of Caerus, Inc.
              
              
              -
              
              
              -
              
              
              355,000
              
              
              -
              
              
              355,000Common
                  Stock issued for acquisition of WQN
              
              
              62,500
              
              
              62
              
              
              1,299,438
              
              
              -
              
              
              1,299,500Value
                  of warrants issued for acquisition of WQN
              
              
              -
              
              
              -
              
              
              5,200,000
              
              
              -
              
              
              5,200,000Value
                  of warrants and conversion features of debt issued
              
              
              -
              
              
              -
              
              
              3,085,832
              
              
              -
              
              
              3,085,832Stock
                  compensation - amortization
              
              
              -
              
              
              -
              
              
              242,100
              
              
              
              
              
              242,100Option
                  and warrant compensation - amortization
              
              
              -
              
              
              -
              
              
              1,939,249
              
              
              -
              
              
              1,939,249Loss
                  for the year
              
              
              -
              
              
              -
              
              
              -
              
              
              (28,313,333
              )
              
              (28,313,333
              )Balance
                  December 31, 2005
              
              
              2,976,170
              
              
              2,976
              
              
              61,663,044
              
              
              (34,800,100
              )
              
              26,865,920Common
                  Stock issued for services
              
              
              232,930
              
              
              233
              
              
              3,276,763
              
              
              
              
              
              3,276,996Common
                  stock issued for cash received, pursuant to exercise of
                  warrants
              
              
              441,330
              
              
              441
              
              
              2,348,110
              
              
              
              
              
              2,348,551Common
                  stock issued for debt conversions
              
              
              811,525
              
              
              812
              
              
              1,827,147
              
              
              
              
              
              1,827,959Common
                  stock issued for nonregistration and other penalties, and
                  interest
              
              
              429,214
              
              
              429
              
              
              3,328,812
              
              
              
              
              
              3,329,241Common
                  stock issued for acquisition of Caerus, Inc.
              
              
              33,333
              
              
              33
              
              
              259,967
              
              
              
              
              
              260,000Common
                  stock issued for cash received, pursuant to exercise of
                  options
              
              
              15,983
              
              
              16
              
              
              331,057
              
              
              
              
              
              331,073Common
                  stock acquired, DTNet sale
              
              
              (10,000
              )
              
              (10
              )
              
              (383,990
              )
              
              
              
              
              (384,000
              )Value
                  of warrants and conversion features of debt issued
              
              
              
              
              
              
              
              
              5,168,168
              
              
              
              
              
              5,168,168Stock
                  compensation - amortization
              
              
              
              
              
              
              
              
              296,875
              
              
              
              
              
              296,875Option
                  and warrant compensation - amortization
              
              
              
              
              
              
              
              
              6,326,829
              
              
              
              
              
              6,326,829Value
                  of warrants reclassified to liabilities
              
              
              
              
              
              
              
              
              (5,406,284
              )
              
              
              
              
              (5,406,284
              )Loss
                  for the year
              
              
              
              
              
              
              
              
              
              
              
              (41,196,512
              )
              
              (41,196,512
              )Balance
                  December 31, 2006
              
              
              4,930,485
              
              $
              4,930
              
              $
              79,036,498
              
              $
              (75,996,612
              )
              $
              3,044,816


The
        accompanying notes are an integral part of these consolidated financial
        statements.




56




**VoIP,
      Inc.**


**Notes
      to Consolidated Financial Statements**





**NOTE
      A - ORGANIZATION AND DESCRIPTION OF BUSINESS**





VoIP,
      Inc. (the "Company") was incorporated on August 3, 1998 under its original
      name
      of Millennia Tea Masters under the laws of the State of Texas. In February
      2004,
      the Company exchanged 625,000 shares for the common stock of two start-up
      telecommunication businesses, eGlobalphone, Inc. and VoIP Solutions, Inc. The
      Company changed its name to VoIP, Inc. in April 2004 and acquired VCG
      Technologies, Inc. d/b/a DTNet Technologies (“DTNet Technologies”), a hardware
      supplier, and VoIP Americas, Inc. (“VoIP Americas”), in June and September,
      respectively, of 2004. The Company decided to exit its former tea business
      in
      December 2004 and focus its efforts and resources in the Voice over Internet
      Protocol (“VoIP”) telecommunications industry. In May 2005 the Company acquired
      Caerus, Inc. (“Caerus”), a VoIP carrier and service provider. In October 2005
      the Company purchased substantially all of the VoIP assets of WQN Inc.'s (a
      Delaware corporation) (“WQN”) business. In April 2006 the Company sold DTNet
      Technologies to a former officer of the Company. In October 2006 the Company
      terminated its Marketing and Distribution Agreement with Phone House, Inc.,
      a
      wholesale prepaid telephone calling card business acquired in its WQN
      acquisition. In June 2007 the Company sold substantially all of the tangible
      operating assets utilized by its Dallas, Texas division.





The
      Company is an emerging global provider of advanced communications services
      utilizing VoIP technology. VoIP telephony is the real time transmission of
      voice
      communications in the form of digitized "packets" of information over the
      Internet or a private network, similar to the way in which e-mail and other
      data
      is transmitted. VoIP services are expected to allow consumers and businesses
      to
      communicate in the future at dramatically reduced costs compared to traditional
      telephony networks.





The
      Company owns its network and its technology and offers the ability to provide
      complete product and service solutions, including wholesale carrier services
      for
      call routing and termination, outsourced customer service and hardware
      fulfillment. The Company is a certified Competitive Local Exchange Carrier
      (“CLEC”) and Interexchange Carrier (“IXC”). The Company offers a portfolio of
      advanced telecommunications technologies, enhanced service solutions, and
      broadband products. Current and targeted customers include regional bell
      operating companies (“RBOCs”), CLECs, IXCs, wireless carriers, resellers,
      Internet service providers, cable multiple system operators and other providers
      of telephony services.





**NOTE B
      - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





**Principles
      of Consolidation**




The
      consolidated financial statements include the accounts of the Company and its
      wholly owned subsidiaries, Caerus, Inc., eGlobalphone, Inc., VoIP Solutions,
      Inc., and VoIP Americas, Inc. from their respective dates of acquisition. All
      significant intercompany balances and transactions have been eliminated in
      consolidation.





**Discontinued
      Operations**





The
      Company's operations formerly consisted of three segments: Telecommunication
      Services, Hardware Sales and Calling Card Sales. However, with the Company's
      sale of DTNet Technologies, the termination of its Marketing and Distribution
      Agreement with Phone House, Inc., and the sale of substantially all of the
      tangible operating assets utilized by its Dallas, Texas division, all referred
      to above, these former segments are being accounted for as discontinued
      operations, as discussed more fully in Note P, and prior period financial
      statements have been appropriately reclassified. Also as a result of these
      discontinued operations, the Company's operations currently consist of one
      segment, Telecommunication Services. Therefore, separate segmented financial
      results are not presented.





**Use
      of Estimates**





The
      preparation of financial statements in conformity with generally accepted
      accounting principles requires management to make estimates and assumptions
      that
      affect the reported amounts of assets and liabilities; disclosure of contingent
      assets and liabilities at the date of the financial statements; and the reported
      amounts of revenues and expenses. Actual results could differ from those
      estimates.




**Cash
      and Cash Equivalents**




For
      purposes of reporting cash flows, the Company considers all cash on hand, in
      banks, including amounts in book overdraft positions, certificates of deposit
      and other highly liquid debt instruments with a maturity of three months or
      less
      at the date of purchase, to be cash and cash equivalents. Cash overdraft
      positions may occur from time to time due to the timing of making bank deposits
      and releasing checks, in accordance with the Company's cash management
      policies.




57




**Accounts
      Receivable**




Accounts
      receivable are stated at the amount management expects to collect from
      outstanding balances. Management provides for probable uncollectible amounts
      based on its assessment of the current status of the individual receivables
      and
      after using reasonable collection efforts.





**Inventory**




Inventory
      consists of finished goods and is valued at the lower of cost or market using
      the first-in, first-out method.




**Convertible
      Debt**




Convertible
      debt with beneficial conversion features, whereby the conversion feature is
“in
      the money,” are accounted for in accordance with guidance supplied by Emerging
      Issues Task Force (“EITF”) No. 98-5 "Accounting for Convertible Securities with
      Beneficial Conversion Features or Contingently Adjustable Conversion Ratios"
      and
      EITF No. 00-27 "Application of Issue 98-5 to Certain Convertible Instruments."
      The relative fair value of the warrants and the beneficial conversion feature
      has been recorded as a discount against the debt and is amortized over the
      term
      of the debt.




**Fair
      Value Liability for Warrants**





As
      a
      result of the Company's 2006 financing agreements, the number of common shares
      issuable upon the exercise of outstanding warrant agreements, when combined
      with
      existing outstanding common shares and shares issuable upon the conversion
      of
      applicable notes payable, exceeded the Company's authorized common shares.
      Therefore, as required by Emerging Issues Task Force Issue No. 00-19 (“EITF
      00-19”), asset or liability classification of the warrants is required (as
      opposed to permanent equity classification) for the excess warrant shares. 
From January to May 2006, only a portion of the Company's warrants were subject
      to liability classification. However, beginning May 2006, all of the Company's
      warrants were classified as a liability on its consolidated balance sheet,
      and
      their values were marked-to-market at December 31, 2006. Until the Company
      has
      sufficient authorized common shares to satisfy these warrant obligations, it
      will be subject to future noncash mark-to-market income or expense to the extent
      that the estimated market value of these warrants changes in the future, which
      is in turn primarily dependent upon the Company's common stock market price
      per
      share. See Note R for subsequent authorization of common shares, sufficient
      to
      satisfy these warrant obligations.





**Income
      Taxes**




The
      Company follows Statement of Financial Accounting Standards No. 109 “Accounting
      for Income Taxes” (“SFAS No. 109”). Under the asset and liability method of SFAS
      No. 109, deferred tax assets and liabilities are recognized for the future
      tax
      consequences attributed to differences between the financial statement carrying
      amounts of existing assets and liabilities and their respective tax base.
      Deferred tax assets and liabilities are measured using enacted tax rates
      expected to apply to taxable income in the years in which those temporary
      differences are expected to be recovered or settled. Under SFAS No. 109, the
      effect on deferred tax assets and liabilities of a change in tax rates is
      recognized in the results of operations in the period that includes the
      enactment date. If it is more likely than not that some portion of a deferred
      tax asset will not be realized, a valuation allowance is recognized




**Earnings
      (Loss) Per Share**





Basic
      earnings (loss) per share is computed by dividing the net income (loss) for
      the
      year by the weighted-average number of shares of common stock outstanding.
      The
      calculation of fully diluted earnings per share assumes the dilutive effect
      of
      all potential outstanding common shares attributable to outstanding options,
      warrants, and convertible notes. Potential outstanding shares are not included
      in the computation of fully diluted loss per share as their effect is
      anti-dilutive.




**Fair
      Value of Financial Instruments**




The
      carrying amount of cash, accounts receivable, accounts payable and notes
      payable, as applicable, approximates fair value due to the short term nature
      of
      these items and/or the current interest rates payable in relation to current
      market conditions.




**Revenue
      Recognition**




Revenues
      are primarily derived from fees charged to terminate voice services over the
      Company's network and from monthly recurring charges associated with Internet
      and telecommunication services.




Variable
      revenue is earned based on the number of minutes during a call and is recognized
      upon completion of a call. Revenue for each customer is calculated from
      information received through the Company's network switches. The Company tracks
      the information received from the switch and analyzes the call detail records
      and applies the respective revenue rate for each call. Fixed revenue is earned
      from monthly recurring services provided to customers that are fixed and
      recurring in nature, and are connected for a specified period of time. Revenue
      recognition commences after the provisioning, testing, and acceptance of the
      service by the customer. Revenues are recognized as the services are provided
      and continue until the expiration of the contract or until cancellation of
      the
      service by the customer.




58




**Property
      and Equipment**




Property
      and equipment are stated at cost. Depreciation is provided over the estimated
      useful lives of the related assets using the straight line method. The useful
      life of assets ranges from three to five years. The leasehold improvements
      are
      amortized over the life of the related leases. The Company reviews the
      recoverability of its property and equipment when events or changes in
      circumstances occur that indicate that the carrying value of the asset group
      may
      not be recoverable.




**Business
      Combinations**





The
      Company accounts for business combinations in accordance with Statement of
      Financial Accounting Standard No. 141, “Business Combinations” (SFAS No. 141).
      SFAS No. 141 requires that the purchase method of accounting be used for all
      business combinations. SFAS No. 141 requires that goodwill and intangible assets
      with indefinite useful lives no longer be amortized, but instead be tested
      for
      impairment at least annually by comparing carrying value to the respective
      fair
      value in accordance with the provisions of Statement of Financial Accounting
      Standards No. 142, “Goodwill and Other Intangible Assets” (SFAS No. 142). This
      pronouncement also requires that the intangible assets with estimated useful
      lives be amortized over their respective estimated useful lives.





**Goodwill
      and Other Intangible Assets**




In
      accordance with Statement of Financial Accounting Standards No. 142, "Goodwill
      and Other Intangible Assets," the Company tests its goodwill and
      intangible assets for impairment at least annually by comparing the fair values
      of these assets to their carrying values, and the Company may be
      required to record impairment charges for these assets if in the future their
      carrying values exceed their fair values. During the years ended December 31,
      2006 and 2005, the Company recognized impairment expense of $839,101 and
      $4,173,452, respectively, related to goodwill recorded for its former hardware
      sales business segment, and included in its reported loss from discontinued
      operations. If in the future the remaining carrying value of our goodwill
      exceeds its fair market value, the Company will be required to record an
      additional impairment charge in its statement of operations. Such an impairment
      charge could have a significant adverse impact on both our operating results
      and
      financial condition. If the traded market price of our common stock declines,
      a
      material goodwill impairment charge in the future is possible.




**Stock
      Based Compensation**




The
      Company applies the fair value method of Statement of Financial Accounting
      Standards No. 123R, "Accounting for Stock Based Compensation" (SFAS No. 123R)
      in
      accounting for its stock options. This standard states that compensation cost
      is
      measured at the grant date based on the value of the award and is recognized
      over the service period, which is usually the vesting period. The fair value
      for
      each option granted is estimated on the date of the grant using the
      Black-Scholes option pricing model. The fair value of all vested options granted
      has been charged to salaries, wages, and benefits in accordance with SFAS No.
      123. Common stock granted to employees, directors and consultants is charged
      to
      operating expense based on the fair value of the stock at the date the stock
      rights are granted.





**Reclassifications**




Certain
      reclassifications have been made to the 2005 and 2004 financial statements
      to
      conform to the 2006 presentation, including reclassifications pertaining to
      discontinued operations as described in Note P.




**Recent
      Accounting Pronouncements**




In
      September 2006, the Financial Accounting Standards Board issued Statement
      of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value
      Measurements.” SFAS No. 157 defines fair value as the price that would be
      received to sell an asset or paid to transfer a liability in an orderly
      transaction between market participants at the measurement date, and also
      establishes a framework for measuring fair value. The provisions of this
      Statement are effective for fiscal years beginning after November 15, 2007.
      The
      Company does not expect the adoption of this Statement to have a material impact
      on its financial statements.




In
      February 2007, the Financial Accounting Standards Board issued SFAS
      No. 159, “The Fair Value Option for Financial Assets and Financial
      Liabilities,” which amends SFAS No. 115, “Accounting for Certain Investments in
      Debt and Equity Securities.” SFAS No. 159 permits companies to choose to measure
      many financial instruments at fair value, and could apply to the Company's
      potential future convertible debt and stock warrant agreements. The provisions
      of this Statement are effective for fiscal years beginning after November 15,
      2007. The Company does not plan to elect fair value accounting under SAFS No.
      159; therefore the Company does not expect the adoption of this Statement to
      have a material impact on its financial statements.




59




**NOTE
      C - LIQUIDITY, CAPITAL RESOURCES, AND GOING CONCERN**





This
      Note
      C should be reviewed in conjunction with Notes F, G, H, I and R to the Company's
      consolidated financial statements.





The
      accompanying consolidated financial statements have been prepared in conformity
      with accounting principles generally accepted in the United States of America,
      which contemplates continuation of the Company as a going concern. The Company
      has incurred operating losses and negative cash flows from operations since
      inception of its current business in 2004, has been dependent on issuances
      of
      debt and equity instruments to fund its operations and capital expenditures,
      and
      is in violation of most of its financing covenants. The Company's independent
      auditors have added an explanatory paragraph to their opinion on the Company's
      consolidated financial statements for the year ended December 31, 2006, based
      on
      substantial doubt about the Company's ability to continue as a going
      concern.





At
      December 31, 2006, the Company's contractual obligations for debt, leases and
      capital expenditures totaled approximately $25.3 million. Included in this
      amount is approximately $2.4 million due on a loan from a lending institution.
      The Company was not in compliance with certain covenants under the loan
      agreement for this debt. However, the lender has not declared this loan in
      default. (See Note R, for a description of the subsequent assignment and
      restructure of this debt.)





See
      Notes
      G and R for a description of the Company's convertible notes issued in July
      and
      October 2005 (“2005 Notes”), January and February 2006 (“Early 2006 Notes”),
      October 2006 (“Late 2006 Notes”), and February 2007 (“2007 Notes”). As explained
      below and in Notes G and R, the subscription agreements for these notes contain
      provisions that could impact the Company's future capital raising efforts and
      its capital structure:





·
            The
                Company is required to file registration statements to register amounts
                ranging up to 200% of the shares issuable upon conversion of these
                notes,
                and all of the shares issuable upon exercise of the warrants issued
                in
                connection with these notes. Certain registration statements were
                filed,
                but have since become either ineffective or withdrawn. Until sufficient
                registration statements are declared effective by the Securities
                and
                Exchange Commission (the “SEC”), the Company is liable for liquidated
                damages totaling $1,058,858 through December 31, 2006, and will continue
                to incur additional liquidated damages of $228,432 per month until
                the
                required shares and warrants are
                registered.





·
            Unless
                consent is obtained from the note holders, the Company may not file
                any
                new registration statements or amend any existing registrations until
                the
                sooner of (a) 60 to 365 days following the effective date of the
                notes
                registration statement or (b) all the notes have been converted into
                shares of the Company's common stock and such shares of common stock
                and
                the shares of common stock issuable upon exercise of the warrants
                have
                been sold by the note holders.





·
            Since
                October 2005, the Company has been in violation of certain requirements
                of
                the 2005 Notes, the Early 2006 Notes, and the Late 2006 Notes. While
                the
                investors have not declared these notes currently in default, the
                full
                amount of the notes at December 31, 2006 has been classified as
                current.





In
      connection with a private placement memorandum dated May 20, 2005, the Company
      issued 112,125 shares of its common stock for $16.00 per share, and warrants
      to
      purchase 110,388 common shares at prices from $32.00 to $44.60 per share. At
      December 31, 2006, the fair value of these outstanding warrants was $58,510,
      which was recorded as a liability on the Company's consolidated balance sheet.
      As required by the subscription agreements, a portion of the shares was
      registered with the SEC in October 2005, but that registration became
      ineffective in July 2006. Non-registration liquidated damages accrued until
      September 2006, when all related shares and warrants became tradable under
      Rule
      144, and, in accordance with the terms of the subscription agreements, accrual
      of liquidated damages ceased. At December 31, 2006, liquidated damages totaled
      74,125 shares and 11,325 warrants owing, recognized as a $1,342,299 current
      liability on the Company's balance sheet.





In
      connection with a subscription agreement dated August 26, 2005 and amended
      on
      November 16, 2005, the Company issued 68,750 shares of its common stock for
      $16.00 per share, and warrants to purchase 111,250 common shares at prices
      ranging from $27.40 to $32.00 per share. The investor also received “favored
      nations” rights such that for future securities offerings by the Company at a
      price per share less than the per share purchase price or warrant exercise
      prices, the investor's effective per share purchase price and warrant exercise
      price would be adjusted to the lower offering price. As a result of this favored
      nations provision and the February 2007 financing agreements described in Note
      R, the subscription agreement's per share purchase price and the warrants'
      exercise prices were effectively reduced to $3.60 per share. At December 31,
      2006, the fair value of these outstanding warrants was $400,500, which was
      recorded as a liability on the Company's consolidated balance sheet. The Company
      also agreed to register a total of 292,500 common shares and warrants related
      to
      this agreement by January 17, 2006. Until a registration statement is declared
      effective by the SEC, the Company is liable for liquidated damages totaling
      $600,000 through December 31, 2006, and will continue to incur additional
      liquidated damages of $50,000 per month until the required shares and warrants
      are registered.





The
      Company will need to continue to raise additional debt or equity capital to
      provide the funds necessary to restructure or repay its $2.4 million loan,
      meet
      its other contractual commitments, and continue its operations. The Company
      is
      actively seeking to raise this additional capital but may not be successful
      in
      obtaining the imminently-required debt or equity financing. The accompanying
      financial statements do not include any adjustments relating to the
      recoverability and classification of asset amounts or the amounts and
      classification of liabilities that might be necessary should the Company be
      unable to continue as a going concern.




60




The
      Company's authorized common stock consisted of 100,000,000 common shares at
      December 31, 2006, of which 4,930,486 common shares (98,609,701 common shares
      pre-split) were issued and outstanding, and approximately 7.05 million (141
      million pre-split) additional shares were contingently issuable upon the
      exercise of stock options and warrants, or conversion of convertible securities.
      An additional 1.2 million (24 million pre-split) common shares were required
      to
      be reserved under the Company's various existing financing agreements. As of
      December 31, 2006 the Company was also contractually obligated to register
      approximately 9.6 million (192 million pre-split) shares, warrants and options.
      (See Note R for a subsequent increase in the Company's authorized common stock
      to 400,000,000 shares, and the authorization of a new class of preferred stock.)
      There is no assurance that sufficient registration statements can be filed
      or
      declared effective by the SEC, or that sufficient additional common stock
      authorizations can be approved by shareholders, in which case the Company would
      continue to be unable to satisfy its contractual obligations to register shares,
      and would be unable to satisfy the contractual obligations it has undertaken
      to
      reserve shares of common stock.





**NOTE
      D - PROPERTY AND EQUIPMENT, NET**


At
        December 31, 2006 and 2005, property and equipment consisted of the
        following:




2006
            
            2005Equipment
            
            $
            8,370,278
            
            $
            8,869,410Furniture
                & Fixtures
            
            
            85,397
            
            
            160,553Software
            
            
            666,842
            
            
            1,667,864Vehicles
            
            
            15,269
            
            
            15,269Leasehold
                improvements
            
            
            95,415
            
            
            238,857Total
            
            
            9,233,201
            
            
            10,951,953Less
                accumulated depreciation
            
            
            (2,628,916
            )
            
            (1,264,483
            )Total
            
            $
            6,604,285
            
            $
            9,687,470




Depreciation
        expense for the years ended December 31, 2006, 2005 and 2004 amounted to
        $1,788,871, $1,129,525, and $82,832, respectively.





The
      amount of equipment held under capital leases, included above and net of
      accumulated amortization, was $244,656 and $259,946 at December 31, 2006 and
      2005, respectively.





**NOTE
      E - GOODWILL AND OTHER INTANGIBLE ASSETS**





In
      accordance with Statement of Financial Accounting Standards No. 142 (“SFAS No.
      142”), the Company performs an evaluation of the fair values of its operating
      segments annually, and more frequently if an event occurs or circumstances
      change that may indicate that the fair value of a reporting unit is less than
      its carrying amount. As described in Note P, on April 19, 2006, the Company
      completed the sale of its interest in its subsidiary DTNet Technologies. DTNet
      Technologies' operations were the primary component of the Company's hardware
      sales business segment, and the Company recorded a goodwill impairment charge
      of
      $839,101 in its March 31, 2006 statement of operations to reduce the carrying
      value of this subsidiary to its estimated fair value. The remaining $198,000
      balance of goodwill for this segment was a component of net assets
      sold.





The
      Company's balance sheet at December 31, 2006 includes approximately $16.8
      million in goodwill and approximately $9.2 million in other intangible assets
      recorded in connection with its acquisition in May 2005 of Caerus and its
      subsidiaries.





In
      accordance with SFAS 142, management tests the carrying value of its goodwill
      and other intangible assets for impairment at least annually by comparing the
      fair values of these assets to their carrying values. During the year ended
      December 31, 2005 the Company recorded an impairment charge to its operating
      results of approximately $4.2 million relating to goodwill previously recorded
      for an acquisition. During the year ended December 31, 2006, the Company
      recorded an impairment charge to operating results of $839,101 as a result
      of
      selling the Company's interest in its subsidiary, DTNet Technologies in April
      2006. These charges reduced the carrying value of the subsidiary to its
      estimated fair value. The Company may be required to record additional
      impairment charges for these assets in the future, which could materially
      adversely affect its financial condition and results of operations. If the
      traded market price of the Company's common stock declines, or its future
      revenue does not increase coincident with amounts previously projected and
      utilized to determine the fair value of the Company's goodwill and other
      intangible assets, a material goodwill impairment charge in the future is
      possible.




61




As
        of
        December 31, 2006 and 2005 goodwill and other intangible assets consisted
        of the
        following:




2006
            
            2005(Restated)Goodwill
            
            
            
            
            $
            16,826,301
            
            $
            16,826,301Other
                intangible assets:Useful Life (Years)Technology
            
            
            4.0
            
            $
            6,000,000
            
            $
            6,000,000Customer
                relationships
            
            
            6.0
            
            
            5,800,000
            
            
            5,800,000Trade
                names
            
            
            9.0
            
            
            1,300,000
            
            
            1,300,000Non-compete
                agreement
            
            
            1.0
            
            
            500,000
            
            
            500,000Other
                intangible assets
            
            
            Indefinite
            
            
            200,000
            
            
            200,000Subtotal
            
            
            
            
            
            13,800,000
            
            
            13,800,000Accumulated
                amortization
            
            
            
            
            
            (4,634,267
            )
            
            (1,500,820
            )Other
                intangible assets, net
            
            
            
            
            
            9,165,733
            
            
            12,299,180Total
                goodwill and other intangible assets
            
            
            
            
            $
            25,992,034
            
            $
            29,125,481





The
      December 31, 2005 goodwill amount excludes $1,037,101 related to the Company's
      former hardware sales segment, which was reclassified to net assets of
      discontinued operations. Amortization expense for the years ended December
      31,
      2006, 2005 and 2004 amounted to $2,819,447, $1,500,820 and $0,
      respectively.




The
      December 31, 2005 goodwill amount was also restated to reflect a reduction
      of
      $2,360,000 which represented contingent consideration (escrowed common shares
      -
      see Note J) related to the Caerus acquisition. According to SFAS No. 141, such
      contingent consideration should not have been included in the Caerus purchase
      price determination. The Company's consolidated statements of operations and
      cash flows for the year ended December 31, 2005 were not affected.





**NOTE
      F - LOANS PAYABLE**





At
      December 31, 2006 and 2005, loans payable consisted of the
      following:





2006
            
            2005Note
                payable to a lending institution
            
            $
            2,381,085
            
            $
            4,685,236Other
                notes payable
            
            
            193,750
            
            
            -Total
                loans payable
            
            $
            2,574,835
            
            $
            4,685,236





The
      note
      payable to a lending institution bears interest at 17.5%, and is repayable
      through May 2007. Interest expensed and paid under this debt facility during
      the
      years ended December 31, 2006, 2005 and 2004 was $443,805, $399,551, and $0,
      respectively. The loan agreement contains customary covenants and restrictions
      and provides the lender the right to a perfected, first-priority security
      interest in all of the Company's assets. The Company was in violation of certain
      requirements of this debt facility at December 31, 2006, and has not made
      scheduled principal and interest payments. However, the lender has currently
      not
      declared this loan in default. As a result, the full amount of the loan at
      December 31, 2006 has been classified as current. (See Note R for subsequent
      reassignment and restructure of this loan.)





The
      other
      notes payable at December 31, 2006 was classified as common stock and additional
      paid-in capital at December 31, 2005, because related notes payable were
      converted to common stock in 2005. According to the terms of a November 2006
      settlement agreement between the Company and the convertible note holders,
      the
      note holders returned the common stock to the Company, and the convertible
      debt
      was reclassified to loans payable.





**NOTE
      G - CONVERTIBLE NOTES AND WARRANTS PAYABLE**





At
      December 31, 2006 and 2005, convertible notes payable, and the fair value
      liability for related warrants consisted of the following:




62




Convertible
                Notes Payable
            
            Fair
                Value Liability for Warrants2006
            
            2005
            
            2006
            
            2005Payable
                to WQN, Inc. (1)
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -Payable
                to accredited investors:July
                & October 2005 (2)
            
            
            488,543
            
            
            1,496,804
            
            
            441,313
            
            
            -January
                & February 2006 (3)
            
            
            8,353,102
            
            
            -
            
            
            980,409
            
            
            -October
                2006 (4)
            
            
            2,905,875
            
            
            -
            
            
            1,971,844
            
            
            -May
                2005 private placement (5)
            
            
            -
            
            
            -
            
            
            58,510
            
            
            -August
                2005 subscription agreement (5)
            
            
            -
            
            
            -
            
            
            400,500
            
            
            -Other
                - see Note M
            
            
            -
            
            
            -
            
            
            1,250,155
            
            
            -Subtotal
            
            
            11,747,520
            
            
            1,496,804
            
            
            5,102,731
            
            
            -Less
                discounts
            
            
            (5,845,303
            )
            
            (1,313,006
            )
            
            -
            
            
            -Total
            
            $
            5,902,217
            
            $
            183,798
            
            $
            5,102,731
            
            $
            -








(1)
            
            In
                October 2005, the Company acquired substantially all of the operating
                assets and liabilities of WQN, Inc. for a total purchase price of
                $9.8 million. The acquisition was funded in part with the issuance
                of a
                convertible note in the principal amount of $3.7 million. A debt
                discount
                was established to reflect an effective interest rate of 20%, bringing
                the
                original net note payable value to $3,216,000. The note is secured
                by a
                subordinated lien on the Company's assets. The principal balance
                of the
                note was $3,700,000 at December 31, 2006. The note, bearing a nominal
                interest rate of 6%, became payable beginning February 2006 over 12
                months in cash or, at the option of the Company, in Series A preferred
                stock (subsequently authorized - see Note R) at $10.00 per share
                or in
                common stock at an original $1.06 per share. WQN received “favored
                nations” rights such that for future securities offerings by the Company
                at a price per share less than this conversion price, this common
                stock
                conversion price would be adjusted to the lower offering price. As
                a
                result of this favored nations provision and the February 2007 financing
                agreements described in Note R, the note's common stock conversion
                rate
                was effectively reduced to $0.18 per share. At December 31, 2006,
                the
                Company had not made scheduled principal payments of $3,391,667.
                WQN has
                agreed to subordinate its repayment claim to the convertible note
                holders
                described in paragraphs (2) through (4) below. Also as a result of
                the
                October 2005 acquisition, WQN, Inc. received five-year warrants to
                purchase 5,000,000 shares of the Company's common stock for $0.001
                per
                share. WQN exercised the warrants on January 5, 2006 for
                4,996,429 shares of the Company's common stock. All WQN convertible
                shares
                and warrant shares have piggyback registration rights on any registration
                statement filed by the Company between October 2005 and October 2007.
                At
                December 31, 2006, the Company was in violation of certain
                requirements of this note. Due to the sale of substantially all of
                the
                tangible operating assets utilized by our Dallas, Texas division,
                this
                convertible note was classified with discontinued operations in our
                consolidated financial statements for all periods
                presented.





2)
            
            In
                July and October 2005 the Company issued and sold $3,085,832 in principal
                amount of convertible notes to institutional investors at a discount,
                receiving net proceeds of $2,520,320. These notes are immediately
                convertible at the option of the note holders into shares of the
                Company's
                common stock, at an original conversion rate of $16.00 per share.
                These
                investors also received five-year warrants to purchase 48,217 shares
                of
                the Company's common stock for $27.52 per share, five-year warrants
                to
                purchase 48,217 shares of the Company's common stock for $33.01 per
                share,
                and one-year warrants to purchase 96,433 shares of the Company's
                common
                stock for $32.00 per share. The investors also received “favored nations”
                rights such that for future securities offerings by the Company at
                a price
                per share less than the above conversion rate or warrant exercise
                prices,
                the investors' conversion rate and warrant exercise price would be
                adjusted to the lower offering price. These notes are secured by
                a
                subordinated lien on the Company's assets, and the notes bear interest
                at
                an effective rate of approximately 20%. The principal balance of
                these
                notes was $488,543 and $1,496,804 at December 31, 2006 and 2005,
                respectively. Half of these notes became payable beginning in October
                2005
                and the other half beginning in January 2006 (three months following
                their
                respective issuances) over two years in cash or, at the option of
                the
                Company, in registered common stock at the lesser of $16.00 per share
                or
                85% of the weighted average price of the stock on the OTC Bulletin
                Board
                (the “OTCBB”). In May 2006, the Company repriced these warrants to $15.60
                per share, at which time these warrants were exercised, resulting
                in net
                proceeds to the Company of $2,740,120. The Company then issued warrants
                to
                the investors to purchase a like number of shares for $16.00. As
                a result
                of the favored nations provision discussed above and the Section
                3(a)(10)
                agreement described below, the notes' conversion rate (retroactive
                to the
                original note principal balances) and the exercise price of outstanding
                warrants were effectively reduced to $5.20 per share. As a result
                of the
                February 2007 financing agreements described in Note R, the notes'
                conversion rate (retroactive to the original note principal balances)
                and
                the exercise price of outstanding warrants were further reduced to
                $3.60
                per share. At December 31, 2006, the fair value of these outstanding
                warrants was $441,313, which was recorded as a liability on the Company's
                consolidated balance sheet. (See the last paragraph of this Note
                G below
                for additional background.) At December 31, 2006, the Company had
                not made
                scheduled principal payments of $118,930 on these notes. Beginning
                October
                2005, the Company was in violation of the registration requirements
                contained in the October 2005 subscription agreements, and beginning
                July
                2006 the Company was in violation of the registration requirements
                contained in the July 2005 subscription agreements. As a result,
                the
                Company owed related liquidated damages of $343,034 at December 31,
                2006,
                and will incur additional damages of $40,494 per month until a
                registration statement related to the shares and warrants is declared
                effective by the SEC. While the investors have not declared the notes
                currently in default, the full amount of the notes at
                December 31, 2006 has been classified as
                current.




63




(3)
            
            In
                January and February 2006, the Company issued and sold $11,959,666
                in
                principal amount of convertible notes to institutional investors
                at a
                discount, receiving net proceeds of $9,816,662. These notes are
                immediately convertible at the option of the note holders into shares
                of
                the Company's common stock at an original conversion rate of $26.36
                per
                share. These investors also received five-year warrants to purchase
                226,853 shares of the Company's common stock for $29.18 per share,
                and
                one-year warrants to purchase 226,853 shares of the Company's common
                stock
                for $31.83 per share. The investors also received “favored nations” rights
                such that for future securities offerings by the Company at a price
                per
                share less than the above conversion rate or warrant exercise prices,
                the
                investor's conversion rate and warrant exercise price would be adjusted
                to
                the lower offering price. Of the total initial principal, $8,318,284
                of
                the notes are secured by a subordinated lien on the Company's assets.
                The
                principal balance of the notes was $8,353,101 at December 31, 2006,
                and
                all the notes bear interest at an effective rate of approximately
                20%. The
                unsecured portion of these notes became payable beginning in July
                2006
                over two years in cash or, at the option of the Company, in registered
                common stock at the lesser of $26.36 per share or 85% of the weighted
                average price of the stock on the OTCBB, but not less than $20.00
                per
                share. As a result of a May 2006 warrant restructure, the secured
                portion
                of these notes became payable beginning in August 2006 over two years
                in cash or, at the option of the Company, in registered common stock
                at
                the lesser of $20.00 per share or 85% of the weighted average price
                of the
                stock on the OTCBB, but not less than $16.00 per share. As a result
                of the
                favored nations provision discussed above and the Section 3(a)(10)
                agreement described below, the notes' conversion rate (retroactive
                to the
                original note principal balances) was effectively reduced to $5.20
                per
                share, and the outstanding warrants were re-priced to $9.50 per share.
                As
                a result of the February 2007 financing agreements described in Note
                R,
                the notes' conversion rate (retroactive to the original note principal
                balances) and the exercise price of outstanding warrants were further
                reduced to $3.60 per share. At December 31, 2006, the fair value
                of these
                outstanding warrants was $980,409, which was recorded as a liability
                on
                the Company's consolidated balance sheet. (See the last paragraph
                of this
                Note G below for additional background.) At December 31, 2006, the
                Company
                had not made scheduled principal payments of $1,083,782 on these
                notes.
                Beginning April 2006, the Company was in violation of the registration
                requirements of the secured notes, and beginning May 2006, the Company
                was
                in violation of the registration requirements of the unsecured notes.
                In
                May 2006, the Company issued an aggregate of 8,319 shares to the
                secured
                investors in satisfaction of then-existing secured non-registration
                liquidated damages. The Company owed additional liquidated damages
                of
                $694,514 at December 31, 2006, and will incur additional damages
                of $129,014 per month until a registration statement related to the
                shares
                and warrants is declared effective by the SEC. While the investors
                have
                not declared the notes currently in default, the full amount of the
                notes
                at December 31, 2006 has been classified as
                current.





In
                September 2006 certain of the July and October 2005 and the January
                and
                February 2006 convertible note holders filed actions against the
                Company
                claiming a breach of contract related to the notes. In settlement
                of these
                actions, the parties entered into settlement agreements pursuant
                to which,
                among other things: 1) interest and liquidated damages due under the
                notes were set at $242,149 and $415,353, respectively; 2) the note
                holders exchanged the interest and liquidated damages due, along
                with
                $3,899,803 in principal, and a discount of $881,155, for 1,045,858
                shares
                of the Company's common stock through the issuance of freely trading
                securities issued pursuant to Section 3(a)(10) of the Securities
                Act;
                3) the conversion rate for the remaining principal balance due under
                the notes was reset to $5.20; 4) the exercise price of the
                outstanding warrants purchased by the note holders in connection
                with the
                January and February 2006 notes was reduced to $9.50; and 5)  certain
                investors agreed to surrender their claims associated with warrants
                issued
                in May 2006 in exchange for 125,000 shares of the Company's common
                stock
                through the issuance of freely trading securities issued pursuant
                to
                Section 3(a)(10) of the Securities
                Act.




64





(4)
            
            On
                October 17, 2006, the Company issued and sold $2,905,875 in secured
                convertible notes to twelve institutional investors, for a net purchase
                price of $2,324,700 (after a 20% original issue discount) in a private
                placement. Proceeds of approximately $1,436,900 (before closing costs
                of
                $308,748) were paid in cash to the Company at closing, and $887,800
                of the
                proceeds were used to repay three outstanding promissory notes held
                by
                three of the investors in the private placement. The investors also
                received five-year warrants to purchase a total of 518,907 shares
                of the
                Company's common stock at an exercise price of $8.14 per share. The
                principal balance of the notes was $2,905,875 at December 31, 2006.
                These
                convertible notes are secured by a subordinated lien on the Company's
                assets, are not interest bearing, and are due on December 31, 2007.
                The
                note holders may at their election convert all or part of the Convertible
                Notes into shares of the Company's common stock at an original conversion
                rate of $5.60 per share. The investors also received “favored nations”
                rights such that for future securities offerings by the Company at
                a price
                per share less than the above conversion rate or warrant exercise
                prices,
                the investor's conversion rate and warrant exercise price would be
                adjusted to the lower offering price. As a result of the favored
                nations
                provision discussed above and the February 2007 financing agreements
                described in Note R, the notes' conversion rate (retroactive to the
                original note principal balances) and the exercise price of outstanding
                warrants were reduced to $3.60 per share. At December 31, 2006, the
                fair
                value of these outstanding warrants was $1,971,844, which was recorded
                as
                a liability on the Company's consolidated balance sheet. (See the
                last
                paragraph of this Note G below for additional background.) Pursuant
                to the
                subscription agreement, the Company was to obtain shareholder approval
                to
                increase its authorized shares of common stock to 400,000,000 shares
                and
                file an amendment to its articles of incorporation by December 20,
                2006.
                Failing this, the holders of the convertible notes are entitled to
                liquidated damages that will accrue at the rate of two percent of
                the
                amount of the purchase price of the outstanding convertible notes
                per
                month during such default. The Company has also agreed to file
                registration statements covering the resale of 130% of the shares
                of
                common stock that may be issuable upon conversion of the convertible
                notes, and 100% of the shares of common stock issuable upon the exercise
                of the warrants. The first such registration statement was to be
                filed on
                or before January 2, 2007 and declared effective by March 31, 2007.
                Because the Company is in violation of these authorized share and
                registration requirements, liquidated damages have been accruing
                at the
                rate of $58,925 per month since December 20, 2006. (See Note R for
                subsequent authorized common stock increase.) While the investors
                have not
                declared the notes currently in default, the full amount of the notes
                at
                December 31, 2006 has been classified as
                current.





(5)
            
            See
                Note C for a discussion of the May 2005 private placement and the
                August
                2005 subscription agreement.





No
      interest was paid on any of the convertible notes described above during the
      years ended December 31, 2006, 2005 and 2004, except as described in
      the Section 3(a)(10) agreement above affecting the interest owed to the
      July/October 2005 and January/February 2006 convertible note
      holders.





The
      Company had insufficient authorized common shares to satisfy the warrant
      obligations associated with the convertible notes issued in January and February
      2006 on the dates the warrants were issued. Therefore, in accordance with
      Emerging Issues Task Force Issue 00-19 (“EITF 00-19”), the $3,526,077 initial
      value of these warrants at their issuance dates was recorded as a debt discount
      and a warrant liability on the Company's consolidated balance sheet. In
      addition, $770,314 of the proceeds received from the May 2006 warrant repricing
      and exercise discussed in the sixth preceding paragraph above were allocated
      to
      these warrants, and recorded as a warrant liability on the Company's balance
      sheet. Also, the May 2006 warrant repricing to $15.60 per share triggering
      contractual “favored nations” price ratchets on a number of our existing
      convertible debt and warrant agreements, reducing their effective conversion
      and
      exercise prices to $15.60 per share. The effect was to increase the number
      of
      fully diluted shares of common stock at the time to approximately 6.45 million
      (129 million pre-split), relative to the Company's then-authorized 100 million
      common shares. The Company's total warrants then outstanding were approximately
      1.4 million (28 million pre-split). Per EITF 00-19, the Company classified
      all
      remaining warrants as a liability, transferring $5,406,284 from additional
      paid-in capital to fair value liability for warrants on its consolidated balance
      sheet. The warrant liabilities have since been marked-to-market, resulting
      in a
      $5,102,731 liability at December 31, 2006, and a corresponding credit to
      earnings for the year ended December 31, 2006 of $7,226,430,
      respectively.





**NOTE
      H - NONREGISTRATION PENALTIES AND OTHER STOCK-BASED
      PAYABLES**





At
      December 31, 2006, nonregistration penalties and other stock-based payables
      consisted of the following (none existed at December 31,
      2005):





65





2006Nonregistration
                penalties payable:In
                cash
            
            $
            1,658,858In
                common stock and warrants
            
            
            1,342,299Common
                stock payable to officer
            
            
            732,678Common
                stock payable to directors
            
            
            210,000Common
                stock payable to investors
            
            
            365,345Common
                stock payable for other services rendered
            
            
            439,200Total
            
            $
            4,748,380





As
      discussed in Note G - Convertible Notes and Warrants Payable, the Company is
      in
      violation of the registration requirements of a number of its existing financing
      agreements. As such, liquidated damages payable in a combination of stock and
      cash amounted to $3,001,157 as of December 31, 2006.





As
      discussed in Note L, the Company's Chief Operating Officer exercised options
      to
      purchase 150,000 shares of common stock. Since the Company had insufficient
      authorized common shares at December 31, 2006, only 48,239 shares were issued,
      and the balance of 101,761 shares (valued at $732,678) will be issued upon
      authorization of sufficient common shares. Common stock payable to directors,
      investors and others for services rendered will be issued upon authorization
      of
      sufficient common shares. (See Note R for subsequent shareholder approval of
      increased common shares.)





**NOTE
      I - NOTES AND ADVANCES FROM INVESTORS**





Notes
      and
      advances from investors of $616,667 and $3,000,000 at December 31, 2006 and
      2005, respectively, represent funds loaned to or deposited with the Company
      in
      anticipation of the issuance of future notes payable. The $616,667 at December
      31, 2006 represents funds advanced to the Company in November and December
      2006,
      in anticipation of the issuance of convertible notes payable, which were issued
      in February 2007 (see Note R). The $3,000,000 at December 31, 2005 represents
      funds deposited with the Company in anticipation of the issuance of convertible
      notes payable, which were issued in January 2006 (see Note G).





These
      notes and advances are unsecured. The $616,667 notes at December 31, 2006 bore
      interest at 18%. The $3,000,000 advance at December 31, 2005 was not interest
      bearing.





**NOTE
      J - ACQUISITIONS**





On
      May
      31, 2005, the Company acquired 100% of Caerus and its wholly owned subsidiaries
      Volo Communications, Inc. (“Volo”), Caerus Networks, Inc., and Caerus Billing,
      Inc. in exchange for approximately 720,000 of the Company's common shares
      (excluding 100,000 escrowed common shares, 33,333 of which were issued in
      November 2006).





The
      goodwill, intangible assets and property recorded for the acquisition of Caerus
      represent the fair market value of liabilities as of the date of acquisition,
      plus approximately $15.9 million, which represents the value of the Company's
      common stock and options issued pursuant to the acquisition.





On
      October 5, 2005, the Company acquired substantially all of the operating assets
      and liabilities of WQN, for a total purchase price of $9.8 million. The
      acquisition was financed with the issuance of $3.7 million of convertible debt
      ($3.2 million net of discount), 62,500 shares of the Company's common stock,
      and
      warrants to purchase 250,000 shares of the Company's common stock at $0.001
      per
      share. Since the tangible assets related to this acquisition were sold in June
      2007, this business is being classified as discontinued operations for all
      financial statements presented.





The
      condensed balance sheet of the Caerus acquisition, reflecting the net fair
      value
      amounts assigned to each major asset and liability, as of its acquisition date
      is as follows:





66





Caerus,
                Inc.Current
                assets
            
            $
            617,000Property
                and equipment, net
            
            
            7,869,000Other
                assets
            
            
            131,000Accounts
                payable and other current liabilities
            
            
            (14,674,000
            )Note
                payable
            
            
            (4,832,000
            )Net
                liabilities assumed
            
            
            (10,889,000
            )Goodwill
            
            
            15,418,000Intangible
                assets - other
            
            
            13,800,000Intangible
                assets
            
            
            29,218,000Net
                fair value assets acquired
            
            $
            18,329,000










The
      goodwill amount for Caerus, Inc. was restated to reflect a reduction of
      $2,360,000, which represented contingent consideration (escrowed common shares
      -
      see Note J) related to the Caerus acquisition.





**NOTE
      K - LITIGATION**





**MCI**





On
      April
      8, 2005, the Company's subsidiary, Volo Communications, filed suit against
      MCI
      WorldCom Network Services, Inc. d/b/a UUNET ("MCI WorldCom"). Volo alleges
      that
      MCI WorldCom engaged in a pattern and practice of over-billing Volo for the
      telecommunications services it provided pursuant to the parties' Services
      Agreement, and that MCI WorldCom refused to negotiate such overcharges in good
      faith. Volo also seeks damages arising out of MCI WorldCom's fraudulent practice
      of submitting false bills by, among other things, re-routing long distance
      calls
      over local trunks to avoid access charges, and then billing Volo for access
      charges that were never incurred.





On
      April
      4, 2005, MCI WorldCom declared Volo in default of its obligations under the
      Services Agreement, claiming that Volo owes a past due amount of $8,365,980,
      and
      threatening to terminate all services to Volo within five days. By this action
      Volo alleges claims for (1) breach of contract; (2) fraud in the inducement;
      (3)
      primary estoppel; and (4) deceptive and unfair trade practices. Volo also
      seeks a declaratory judgment that (1) MCI WorldCom is in breach of the Services
      Agreement; (2) $8,365,980 billed by MCI WorldCom is not "due and payable" under
      that agreement; and (3) MCI WorldCom's default letter to Volo is in violation
      of
      the Services Agreement. Volo seeks direct, indirect and punitive damages in
      an
      amount to be determined at trial.





On
      May
      26, 2005, MCI WorldCom filed an Answer, Affirmative Defenses, Counterclaim
      and
      Third-Party Complaint naming Caerus as a third-party defendant. MCI WorldCom
      asserts a breach of contract claim against Volo, a breach of guarantee claim
      against Caerus, and a claim for unjust enrichment against both parties, seeking
      an amount to be determined at trial. On July 11, 2005, Volo and Caerus answered
      the counterclaim and third-party complaint, and filed a third-party counterclaim
      against MCI WorldCom for declaratory judgment, fraud in the inducement, and
      breach of implied duty of good faith and fair dealing. Volo and Caerus seek
      direct, indirect and punitive damages in an amount to be determined at
      trial.





Extensive
      discovery took place throughout 2006, with multiple depositions taking place,
      written discovery requests being exchanged, and extensive document productions
      being held.





On
      December 20, 2006, the Court granted MCI WorldCom summary judgment dismissing
      Caerus' claim for slander of credit. On January 7, 2007, the Court issued a
      scheduling order setting a trial date for June 18, 2007, with several interim
      deadlines. On February 28, 2007, the Court denied MCI WorldCom's motion for
      summary judgment of dismissal of the claims of Volo and Caerus for declaratory
      relief, denied Caerus' motion for clarification or reargument of the dismissal
      of the slander of credit claim and denied Volo's and Caerus' motions in the
      alternative to amend their complaints.




On
      January 2, 2007, an Amended Case Management and Scheduling Order was entered
      which imposed a May 18, 2007 discovery cutoff; a June 5, 2007 pre-trial
      conference; and a June 18, 2007 time-certain trial. On January 11, 2007, MCI
      WorldCom and Volo/Caerus participated in a Court-ordered mediation conference.
      The parties engaged in further settlement discussions in February and March
      2007, which ultimately led to an agreement to terms to settle the litigation
      and
      the signing of a mutually acceptable settlement term sheet on March 27, 2007.
      The term sheet contains a due diligence provision that, upon completion under
      certain circumstances, permits MCI WorldCom to decide whether or not to proceed
      with the settlement. The parties' contemplate finalizing and executing mutually
      acceptable settlement documents reflecting the confidential settlement term
      sheet before the case is be dismissed.




67




In
      the
      event the parties withdraw from the settlement, the Company is currently unable
      to assess the likelihood of a favorable or unfavorable outcome. In that event,
      it is not clear whether or not the Court will hold the parties to the
      previously-ordered June 2007 trial.





**Netrake
      Corporation**





The
      Company and its subsidiaries Caerus and Volo were involved in disputes with
      Netrake Corporation ("Netrake") arising from an equipment purchase contract
      under which Volo agreed to purchase approximately $2.0 million of Netrake's
      telephonic equipment and software. Through mediation, these disputes were
      settled July 27, 2006, primarily requiring Volo to return equipment purchased
      in
      connection with the contract and to make an immaterial monetary payment to
      Netrake. In conjunction with this settlement, the Company recognized a $408,343
      litigation gain during the year ended December 31, 2006, primarily related
      to
      the excess of accounts payable over the net book value of the equipment
      returned.





**Cross
      Country Capital Partners, L.P.**





On
      or
      about September 25, 2006, Cross Country Capital Partners, L.P. (“Cross Country”)
      filed suit against the Company in the District Court, 116 th Judicial
      Circuit, Dallas County, Texas. Cross Country asserts a claim for breach of
      contract in connection with a securities purchase agreement entered into with
      the Company. Cross Country also seeks specific performance of the securities
      purchase agreement at issue. Cross Country seeks unspecified damages and
      attorneys' fees, which fees are provided for in the securities purchase
      agreement and under Texas law. On or about December 14, 2006, the Company filed
      its Answer denying any wrongdoing and asserting numerous affirmative defenses.
      The Company intends to vigorously defend this matter but is unable to assess
      the
      outcome of this litigation or its impact on the Company's financial condition
      and results of operations.





**Other**





The
      Company and Mr. Ivester, a shareholder and former Chief Executive Officer of
      the
      Company, entered into a 3-year consulting agreement on October 18, 2005, which
      the Company terminated in October 2006. Pursuant to the consulting agreement,
      Mr. Ivester provided general business strategy, financing and product
      development advice. Mr. Ivester received $200,000 per year for his services
      under the consulting agreement, as well as a $2,500 per month vehicle allowance.
      Mr. Ivester was eligible to receive bonuses and participate in the Company's
      stock option plan, as determined by the board of directors. The Company also
      owed Mr. Ivester $305,212 as of December 31, 2006 under a demand note payable
      bearing interest at 3.75%. On March 16, 2007, the Company agreed to settle
      all
      of Mr. Ivester's claims under his consulting agreement and his demand note
      payable, in return for cash payments totaling $75,000, and the issuance of
      25,000 shares of the Company's common stock. In conjunction with this
      settlement, the Company recognized a $85,212 litigation gain during the year
      ended December 31, 2006, primarily related to the excess of the demand note
      payable over the fair value of the cash and stock settlement.




In
      February 2006, the Company settled claims against it pertaining to the exchange
      of its common shares for Caerus shares pursuant to the Caerus merger agreement
      dated May 31, 2005. The settlement required a cash payment of $710,000, which
      was recognized as a litigation charge during the year ended December 31,
      2006.





In
      March
      2007, the Company settled claims against it brought by a former employee and
      two
      investors, requiring cash payments totaling $132,000, and the issuance of 23,750
      shares of the Company's common stock. In conjunction with this settlement,
      the
      Company recognized a $290,750 litigation charge during the year ended December
      31, 2006.





The
      Company is currently a defendant in other lawsuits and disputes arising in
      the
      ordinary course of business, and has accrued related litigation charges totaling
      $561,305 for the year ended December 31, 2006. The **** Company
      believes that resolution of all known contingencies is uncertain, and there
      can
      be no assurance that future costs related to such litigation would not exceed
      the amounts accrued in its consolidated financial statements, which may in
      turn
      materially adversely affect the Company's financial position or results of
      operations.





**NOTE
      L - STOCK BASED COMPENSATION**





A
      total
      of 200,000 shares of common stock have been reserved for issuance under the
      Company's 2004 Employee Stock Option Plan (the “2004 Plan”). In addition, on
      March 16, 2007 the Company obtained shareholder approval of the Company's 2006
      Equity Incentive Plan (the “2006 Plan”). The 2006 Plan provides that key
      employees, consultants and non-employee directors of the Company or an affiliate
      may be granted: (1) options to acquire up to 500,000 shares of the Company's
      common stock; (2) shares of restricted common stock; (3) stock appreciation
      rights; (4) performance-based awards; (5) “Dividend Equivalents”; and (6) other
      stock-based awards. The activity in the 2004 plan (no activity in the 2006
      Plan)
      for the year ended December 31, 2006 is as follows:




68




Number
            
            Exercise PriceRange
            
            Wtd. Avg.Exercise PriceOptions
                outstanding at December 31, 2005
            
            
            187,329
            
            $17.00
                - $31.20
            
            $
            24.20Options
                      returned to the plan due to employee
                      terminations
            
            
            (139,129
            )
            $17.00
                - $31.20
            
            $
            25.80Options
                granted
            
            
            150,000
            
            $7.20
            
            $
            7.20Options
                exercised
            
            
            (165,983
            )
            $7.20
                - $31.20
            
            $
            8.51Options
                outstanding at December 31, 2006
            
            
            32,217
            
            $17.00
                - $31.20
            
            $
            22.20





In
      September 2006, the Company entered into employment agreements with its Chief
      Executive Officer (“CEO”) and Chief Operating Officer (“COO”). These agreements
      provided for, among other things, the award of 500,000 stock options each,
      upon
      sufficient underlying shares of common stock being authorized and available,
      and
      subject to the board of directors' approval. The options were to be exercisable
      to purchase 500,000 shares of the Company's common stock each for Messrs.
      Cataldo and Lewis at an exercise price of $0.20 per share for a period of five
      (5) years. The options were to contain a cashless exercise provision and cost
      free piggyback registration rights with respect to the common stock underlying
      the options. Messrs. Cataldo and Lewis were also to receive sufficient
      additional options under the same terms to assure that they have the right
      to
      exercise options to maintain a minimum of 5% and 8% beneficial ownership,
      respectively, of the Company's issued and outstanding common stock. In lieu
      of
      these stock options, the board of directors on January 24, 2007
      resolved to issue stock grants for 500,000 common shares each, subject
      to sufficient increased shares of common stock being authorized and available
      for issuance, which in turn is subject to shareholder approval. The stock grants
      are to have the same 5% and 8% anti-dilution provisions and piggyback
      registration rights as the options were to have. (See Note R for subsequent
      authorization of sufficient increased common stock.)





On November
      8, the Company's COO was granted options to purchase 150,000 shares of the
      Company's common stock at $7.20 per share (closing market price on November
      6,
      2006) under the Company's 2004 Stock Option Plan. On November 9, 2006, the
      Company settled claims the COO had against the Company for alleged breaches
      of
      his employment agreement, and for nonregistration of the Company's common shares
      he holds pursuant to the Caerus merger agreement dated May 31, 2005, for
      $1,080,000. Also on November 9, 2006, the COO exercised his options to purchase
      150,000 common shares, and the proceeds were credited toward the settlement
      of
      his claims. The $1,080,000 settlement expense has been recognized in the
      Company's results of operations as compensation expense for the year ended
      December 31, 2006.





Separate
      from the CEO and COO options noted in the preceding paragraphs, at December
      31,
      2006 the Company had outstanding commitments to issue stock options under either
      the 2004 Plan or the 2006 Plan to purchase 32,217 shares of common stock, at
      exercise prices ranging from $17.00 to $31.20 per share, and at a weighted
      average exercise price of $22.20 per share.





The
      Company recorded compensation expense of $7,913,904, $894,333 and $1,103,309
      for
      the years ended December 31, 2006, 2005, and 2004, respectively, in connection
      with options, warrants and stock granted to employees. As of December 31, 2006,
      approximately $8,361,649 in total compensation cost related options, warrants
      and stock grants remains to be expensed in future periods.





The
      value
      of options and warrants was estimated using the Black-Scholes pricing model.
      The
      Black-Scholes pricing calculations were made using volatilities at either
      one-year or three-year, monthly or weekly, trailing measures, as appropriate,
      and risk-free rates as determined by the nearest maturity Treasury yield as
      of
      respective valuation dates.





**NOTE
      M - WARRANTS**





Through
      December 31, 2006 the Company has issued to employees, institutional investors,
      and financial services firms warrants to purchase the Company's common stock.
      During the years ended December 31, 2006, 2005, and 2004, the Company issued
      441,331, 220,000, and 0 shares, respectively, of common stock in exchange for
      these warrants. As of December 31, 2006, the Company had outstanding 789,039
      warrants, excluding those warrants issued in conjunction with convertible debt
      and common stock issuances discussed in Notes C and G, to purchase its common
      stock exercise prices ranging from $5.20 to $52.00 per share, and at a weighted
      average exercise price of $21.80 per share. At December 31, 2006, the fair
      value
      of these outstanding warrants was $1,250,155, which was recorded as a liability
      on the Company's consolidated balance sheet.





**NOTE
      N - COMMITMENTS**





The
      Company is obligated under non-cancelable operating leases for its office
      facilities, and apartments used for business purposes by its employees. Future
      minimum lease payments under the Company's non-cancelable operating leases
      as of
      December 31, 2006 are as follows:




69




Year
                ending December 31,2007
            
            $
            208,1592008
            
            
            34,8652009
            
            
            -2010
            
            
            -Total
            
            $
            243,024





Rent
      expense for these leases for the years ended December 31, 2006, 2005, and 2004
      was $185,125, $129,755, and $41,957, respectively **.**





**NOTE
      O - RELATED PARTY TRANSACTIONS**





As
      of
      December 31, 2006 and 2005, the amount due from related parties of $31,227
      and
      $161,530, respectively, consisted of an account receivable from Shawn M. Lewis,
      the Company's Chief Operating Officer, and from WQN, a shareholder of the
      Company.





In
      December 2004 the Company issued a $560,000 note payable to a shareholder,
      bearing interest at 3.75%, with an original maturity date of December 2005.
      In
      January 2005 the Company issued another note payable for $1,040,000 to the
      same
      shareholder under similar terms. At December 31, 2006 and 2005, the outstanding
      balance of these notes was $0 and $1,572,894, respectively. The December 31,
      2006 amount reflects the March 2007 settlement discussed in Note K.





Interest
      paid under these notes was $12,208, $50,613, and $0 during the years ended
      December 31, 2006, 2005, and 2004, respectively.





**NOTE
      P - DISCONTINUED OPERATIONS AND FINANCIAL STATEMENT
      RECLASSIFICATIONS**





On
      April
      19, 2006, the Company sold its wholly-owned subsidiary, DTNet Technologies,
      to
      the Company's former Chief Operating Officer (the “Purchaser”) pursuant to a
      stock purchase agreement. The consideration for the sale consisted primarily
      of
      (1) the return for cancellation of warrants to purchase 10,000 shares of the
      Company's common stock held by the Purchaser; and (2) the return for
      cancellation of 10,000 shares of the Company's common stock held by the
      Purchaser. Because DTNet Technologies' operations were the primary component
      of
      the Company's former hardware sales business segment, the Company recorded
      an
      impairment charge of $839,101 in its statement of operations for the year ended
      December 31, 2006. The remaining $198,000 of goodwill for this former segment
      approximated the excess of the sales proceeds received over DTNet Technologies'
      carrying value (excluding goodwill) and was written off in conjunction with
      the
      sale of DTNet Technologies.





Effective
      October 12, 2006, the Company terminated its Marketing and Distribution
      Agreement with Phone House, Inc. dated September 1, 2004 and amended February
      16, 2006, effectively discontinuing this business segment. The Agreement called
      for the wholesale distribution, marketing and selling of prepaid telephone
      calling cards by Phone House, Inc., under license from the Company. The Company
      recognized a related impairment loss of $936,122 for the year ended December
      31,
      2006, primarily related to inventory and accounts receivable write-offs, and
      has
      filed suit in Los Angeles County against the primary Phone House, Inc. employee
      to recover same.





Effective
      June 27, 2007, the Company entered into an Asset Purchase Agreement (the
      "Purchase Agreement") with WQN, Inc., a Texas corporation (the “Purchaser”),
      pursuant to which the Company sold substantially all of the tangible operating
      assets utilized by its Dallas, Texas subsidiary, VoIP Solutions, Inc. (the
      "Assets"), to the Purchaser.  The Company’s patents were not sold. Pursuant
      to the Purchase Agreement, the Purchaser acquired the Assets for a purchase
      price consisting of (1) a cash payment of $400,000; (2) 4% of the defined
      monthly revenues related to the Assets in excess of $200,000 during the first
      year following execution of the Purchase Agreement; (3) 3% of the defined
      monthly revenues related to the Assets in excess of $150,000 during the second
      year following execution of the Purchase Agreement; and (4) 2% of the defined
      monthly revenues related to the Assets in excess of $100,000 during the third
      year following execution of the Purchase Agreement.





The
      following summarizes the combined operating results of DTNet Technologies,
      the
      calling card business of Phone House, Inc., and the Dallas, Texas assets of
      VoIP
      Solutions, Inc., for the years ended December 31, 2006, 2005 and 2004 (through
      the respective dates of sale or termination), and their respective financial
      position as of December 31, 2006 and 2005, classified as discontinued operations
      for all periods presented.




70





Statement
                of Operations
            
            Year ended December 31,2006
            
            2005
            
            2004Revenues
            
            $
            23,052,166
            
            $
            9,186,030
            
            $
            807,908Cost
                of sales
            
            
            20,028,689
            
            
            8,497,539
            
            
            617,547Gross
                profit
            
            
            3,023,477
            
            
            688,491
            
            
            190,361Compensation
                and benefits
            
            
            957,236
            
            
            582,919
            
            
            -Asset
                impairment charges
            
            
            1,775,223
            
            
            4,173,452
            
            
            -Other
                operating expenses
            
            
            1,753,694
            
            
            938,753
            
            
            744,593Interest
                expense
            
            
            501,075
            
            
            160,800Net
                loss
            
            $
            (1,963,751
            )
            $
            (5,167,433
            )
            $
            (554,232
            )





December 31,Balance
                Sheet
            
            2006
            
            2005Current
                assets
            
            $
            406,315
            
            $
            2,159,925Property
                and equipment, net
            
            
            255,948
            
            
            468,037Goodwill
                and other intangible assets
            
            
            6,695,788
            
            
            7,955,891Other
                assets
            
            
            5,282
            
            
            106,347Total
                assets
            
            
            7,363,332
            
            
            10,690,200Less
                current liabilities
            
            
            4,996,325
            
            
            4,814,947Net
                assets of discontinued operations
            
            $
            2,367,007
            
            $
            5,875,253





As
      a
      result of the June 27, 2007 sale of substantially all of the tangible operating
      assets utilized by the Company’s Dallas, Texas division, we have reclassified
      our financial position, results of operations, and cash flows related to this
      division since the date of its acquisition in October 2005 to reflect
      discontinued operations accounting treatment. The following tables set forth
      the
      impact of this reclassification on certain amounts previously reported in our
      consolidated financial statements as of and for the years ended December 31,
      2006 and 2005.





Year
                EndedDecember 31, 2006
            
            December 31, 2005Previously
            
            
            
            PreviouslyStatement
                of Operations Data
            
            Reported
            
            Reclassified
            
            Reported
            
            ReclassifiedRevenues
            
            $
            14,676,948
            
            $
            5,933,248
            
            $
            8,945,868
            
            $
            6,321,115Cost
                of sales
            
            
            14,685,010
            
            
            8,624,876
            
            
            10,245,516
            
            
            7,834,124Gross
                profit (loss)
            
            
            (8,062
            )
            
            (2,691,628
            )
            
            (1,299,648
            )
            
            (1,513,009
            )Operating
                expenses
            
            
            31,015,685
            
            
            28,849,396
            
            
            21,063,041
            
            
            20,361,386Other
                expenses
            
            
            8,192,812
            
            
            7,691,737
            
            
            1,432,305
            
            
            1,271,505Net
                loss before discontinued operations
            
            
            (39,216,559
            )
            
            (39,232,761
            )
            
            (23,794,994
            )
            
            (23,145,900
            )Loss
                from discontinued operations
            
            
            (1,979,953
            )
            
            (1,963,751
            )
            
            (4,518,339
            )
            
            (5,167,433
            )Net
                loss
            
            $
            (41,196,512
            )
            $
            (41,196,512
            )
            $
            (28,313,333
            )
            $
            (28,313,333
            )




71




December 31, 2006
            
            December 31, 2005Previously
            
            
            
            PreviouslyBalance
                Sheet Data
            
            Reported
            
            Reclassified
            
            Reported
            
            ReclassifiedCurrent
                assets
            
            $
            1,277,238
            
            $
            871,091
            
            $
            5,035,536
            
            $
            4,284,006Property
                and equipment, net
            
            
            6,860,233
            
            
            6,604,285
            
            
            10,141,872
            
            
            9,687,470Goodwill
                and other intangible assets
            
            
            32,687,822
            
            
            25,992,034
            
            
            36,044,271
            
            
            29,125,481Net
                assets of discontinued operations
            
            
            -
            
            
            2,367,007
            
            
            1,767,475
            
            
            5,875,253Other
                assets
            
            
            99,828
            
            
            94,546
            
            
            349,205
            
            
            242,858Total
                assets
            
            $
            40,925,121
            
            $
            35,928,963
            
            $
            53,338,359
            
            $
            49,215,068Current
                liabilities
            
            $
            37,657,636
            
            $
            32,661,478
            
            $
            26,227,191
            
            $
            22,103,900Other
                liabilities
            
            
            222,669
            
            
            222,669
            
            
            245,248
            
            
            245,248Total
                shareholders' equity
            
            
            3,044,816
            
            
            3,044,816
            
            
            26,865,920
            
            
            26,865,920Total
                liabilities and shareholders' equity
            
            $
            40,925,121
            
            $
            35,928,963
            
            $
            53,338,359
            
            $
            49,215,068





**NOTE
      Q - INCOME TAXES**





The
      components of the Company's consolidated income tax provision are as
      follows:





Year ended December 31,2006
            
            2005
            
            2004Current
                benefit
            
            $
            6,415,293
            
            $
            7,025,848
            
            $
            2,040,000Deferred
                benefit (expense)
            
            
            2,178,602
            
            
            (304,845
            )
            
            -Subtotal
            
            
            8,593,894
            
            
            6,721,003
            
            
            2,040,000Less
                valuation allowances
            
            
            (8,593,894
            )
            
            (6,721,003
            )
            
            (2,040,000
            )Net
            
            $
            -
            
            $
            -
            
            $
            -





The
      reconciliation of the income tax provision at the statutory rate to the reported
      income tax expense is as follows:





Year
                ended December 31,2006
            
            2005
            
            2004Computed
                at statutory rate
            
            
            34
            %
            
            34
            %
            
            34
            %Options,
                warrants and stock-related expenses
            
            
            -16
            %
            
            -4
            %
            
            -Change
                in fair value liability for warrants
            
            
            6
            %
            
            -
            
            
            -Goodwill
                impairments and intangible asset amortization
            
            
            -3
            %
            
            -6
            %
            
            -Valuation
                allowance
            
            
            -21
            %
            
            -24
            %
            
            -34
            %Total
            
            
            -
            
            
            -
            
            
            -





At
      December 31, 2006, the Company's net deferred tax assets consisted of the
      following:





Net
                operating loss carryforwards
            
            $
            14,859,630Excess
                tax over book depreciation expense
            
            
            (634,033
            )Excess
                book over tax amortization of debt discounts
            
            
            1,974,657Discontinued
                operations impairment charge
            
            
            318,281Noncash
                litigation charges
            
            
            225,662Subtotal
            
            
            16,744,198Less
                valuation allowances
            
            
            (16,744,198
            )Total
            
            $
            -





The
      Company's net operating loss carryforwards for federal income tax purposes
      were
      approximately $43,200,000 as of December 31, 2006. These carryforwards expire
      in
      2018 ($4,200,000), 2019 ($20,600,000), and 2020 ($18,400,000),
      respectively.





72




**NOTE
      R - SUBSEQUENT EVENTS**





**Cedar
      Note Assignment and Restructure**





The
      Company as of December 31, 2006 owed the sum of $2.4 million to Cedar Boulevard
      Lease Funding LLC (“Cedar”) pursuant to a subordinated loan and security
      agreement (the “Loan Agreement”). As previously disclosed, the Company failed to
      make a payment due December 1, 2006 under the Loan Agreement and was declared
      in
      default by the lender as of December 15, 2006 and was provided until December
      20, 2006 to cure the default. Subsequently, the lender extended the time to
      cure
      the default until January 3, 2007. The lender's default notice to the
      Company had demanded the entire principal amount of the loan plus unpaid
      interest, approximately $2.4 million as of that date. On January 3, 2007 the
      Company received a default notice pursuant to the Loan Agreement. On January
      10,
      2007 Cedar agreed to waive the prior default based upon the Company agreeing
      to
      make accelerated payments through May 2007, and to maintain the loan's interest
      rate at 17.5% per annum for the remainder of the loan's amended term. 
Under the Loan Agreement, Cedar was granted a security interest in all of the
      Company's assets.





On
      February 1, 2007 Cedar assigned its rights under the Loan Agreement, including
      the note payable (the “Note”) with a current principal balance of $1,917,581 and
      the related security interest, to a group of institutional investors
      (the “Investors”). In conjunction with the assignment, the Company paid a
      fee of $200,000 to Cedar. Also following the assignment, the Note's terms were
      amended to allow conversion of any unpaid principal balance into the Company's
      restricted common stock at $5.20 per share, subject to sufficient increased
      authorized common shares being approved by the Company's shareholders. The
      Company is also not required to register these shares. The Note was also amended
      to include “favored nations” rights such that for future securities offerings by
      the Company at a price per share less than this $5.20 per share, the Note's
      conversion rate would be adjusted to the lower offering price. In conjunction
      with the Company's financing discussed below, on February 16, 2006 the Note's
      common stock conversion rate was reduced to $3.60 per share.





**Convertible
      Note and Warrant Financing**





On
      February 16, 2007, VoIP, Inc. (the “Company”) issued and sold $3,462,719 in
      secured convertible notes (the “Convertible Notes”) to a group of institutional
      investors, for a net purchase price of $2,770,175 (after a 20% original issue
      discount) in a private placement. $900,000 of the proceeds (before closing
      costs
      of $67,512) were paid in cash to the Company at closing, and $1,870,175 of
      the
      proceeds were used to repay fourteen outstanding promissory notes (including
      related accrued interest and a 10% premium on the promissory notes' total
      principal of $1,666,667) held by five of the investors in the private placement.
      The investors also received five-year warrants to purchase a total of 961,867
      shares of the Company's common stock at an effective exercise price of $3.60
      per
      share.





The
      Convertible Notes are secured by a subordinated lien on the Company's assets,
      are not interest bearing, and are due on February 16, 2008. The note holders
      may
      at their election convert all or part of the Convertible Notes into shares
      of
      the Company's common stock at the conversion rate of $3.60 per share, subject
      to
      adjustment as provided in the notes. The investors also received “favored
      nations” rights such that for future securities offerings by the Company at a
      price per share less than the above conversion rate or warrant exercise price,
      the investors' conversion rate and warrant exercise price would be adjusted
      to
      the lower offering price.





Pursuant
      to the related subscription agreement, two of the investors are to receive
      due
      diligence fees totaling $346,272, in the form of convertible notes (“Due
      Diligence Notes”) having the same terms and conversion features as the
      Convertible Notes. Also pursuant to the Subscription Agreement, the Company
      agreed to issue a total of 200,000 common shares to the former holders of the
      above-referenced promissory notes, in lieu of and in payment for accrued damages
      associated with these promissory notes. Said common share issuance is required
      no later than April 15, 2007.




Also
      pursuant to the Subscription Agreement, the Company must obtain the
      authorization and reservation of its common stock on behalf of the investors
      of
      not less than 200% of the common shares issuable upon the conversion of the
      Convertible Notes and Due Diligence Notes, and 100% of the common shares
      issuable upon the exercise of the warrants by April 15, 2007. Failing this
      authorization and reservation, the holders of the Convertible Notes and Due
      Diligence Notes will be entitled to liquidated damages that will accrue at
      the
      rate of two percent of the amount of the purchase price of the outstanding
      Convertible Notes and Due Diligence Notes for each thirty days or pro rata
      portion thereof during such default.





**Shareholders
      Meeting**





At
      the
      annual shareholders meeting held on March 16, 2007, the following actions were
      approved:




1.
            The
                2006 VoIP, Inc. 2006 Equity Incentive Plan was
                approved.





2.
            25,000,000
                shares of preferred stock were
                authorized.





3.
            The
                authorized shares of the Company's common stock were increased from
                100,000,000 to 400,000,000 shares.




73




At
      a
      special shareholders meeting held on August 16, 2007, shareholders approved
      the
      reverse stock split of the Company's outstanding common stock, at a ratio of
      1-for-20 shares. In addition, the Company's stock symbol was changed to VOIC
      and
      continues to trade on the OTC Bulletin Board. Under the terms of the reverse
      split, for every twenty shares of issued and outstanding common stock, a
      shareholder received one share of common stock. Accordingly, all share and
      per-share information in these consolidated financial statements and related
      footnotes have been adjusted to retroactively reflect this reverse stock split.
      Further, the previously reported common stock in the Company's consolidated
      balance sheets was reduced by a factor of twenty, with corresponding increases
      in additional paid-in capital.





**WQN,
      Inc. Convertible Note**





On
      March
      16, 2007, WQN notified the Company that it is exercising its right to convert
      its note and related accrued interest into approximately 1,100,427 shares of
      the
      Company's common stock.




74


**VOIP,
      INC. AND SUBSIDIARIES**


**UNAUDITED
      PRO FORMA CONDENSED COMBINED FINANCIAL STATEMENTS**





The
      Following unaudited pro forma condensed combined financial statements are
      derived from and should be read in conjunction with the historical consolidated
      financial statements and related notes of VOIP, INC. ("VOIP" or the "Company"),
      and CAERUS, INC. ("CAERUS").





On
      June
      1, 2005, the Company, and Caerus announced the closing of the merger of Volo
      Acquisition Corp., a wholly-owned subsidiary of the Company with and into
      Caerus, with Caerus as the surviving corporation (the "Merger"). The Merger
      was
      completed pursuant to an Agreement and Plan of Merger (the "Merger Agreement'),
      executed on May 31, 2005.





The
      unaudited pro forma condensed combined statements of operation for the year
      ended December 31, 2005 assumes that the merger of Caerus and the Company were
      consummated at the beginning of the respective periods.





The
      unaudited pro forma condensed combined statements of operations has been
      prepared based on currently available information and assumptions that are
      deemed appropriate by the Company's management. The pro forma information is
      for
      informational purposes only and is not intended to be indicative of the actual
      consolidated results that would have been reported had the transactions occurred
      on the dates indicated, nor does the information represent a forecast of the
      consolidated financial position at any future date or the combined financial
      results of the Company and Caerus for any future period.





75





**VoIP,
      Inc**


**Pro
      Forma Condensed Combined Statement of Operations
      (Unaudited)**


**Year
      Ended December 31, 2005**





VoIP,
                Inc
            
            Caerus,
                Inc
            
            Adjustments
            
            ConsolidatedRevenues
            
            $
            4,273,028
            
            
            11,312,596
            
            $
            -
            
            $
            15,585,624Cost
                of sales
            
            
            3,908,523
            
            
            14,814,908
            
            
            -
            
            
            18,723,431Gross
                profit
            
            
            364,505
            
            
            (3,502,312
            )
            
            -
            
            
            (3,137,807
            )Operating
                expenses
            
            
            15,198,094
            
            
            8,583,676
            
            
            3,095,691
            
            
            26,877,461Loss
                  from continuing operationsbefore
                  income taxes
            
            
            (14,833,589
            )
            
            (12,085,988
            )
            
            (3,095,691
            )
            
            (30,015,268
            )Gain
                on sale of fixed assets
            
            
            (206,184
            )
            
            
            
            
            
            
            
            (206,184
            )Interest
                expense
            
            
            1,238,938
            
            
            786,389
            
            
            -
            
            
            2,025,327Loss
                  before income taxes and results ofdiscontinued
                  operations
            
            
            (15,866,343
            )
            
            (12,872,377
            )
            
            (3,095,691
            )
            
            (31,834,411
            )Provision
                for income taxes
            
            
            -
            
            
            -
            
            
            -
            
            
            -Net
                loss before discontinued operations
            
            
            (15,866,343
            )
            
            (12,872,377
            )
            
            (3,095,691
            )
            
            (31,834,411
            )Loss
                  from discontinued operations,net
                  of income taxes
            
            
            (4,518,339
            )
            
            -
            
            
            -
            
            
            (4,518,339
            )Net
                Loss
            
            $
            (20,384,682
            )
            $
            (12,872,377
            )
            $
            (3,095,691
            )
            $
            (36,352,750
            )Basic
                and diluted loss per share:Loss
                before discontinued operations
            
            
            
            
            
            
            
            
            
            
            $
            (16.56
            )Loss
                  from discontinued operations,net
                  of income taxes
            
            
            
            
            
            
            
            
            
            
            
            (2.35
            )Net
                Loss
            
            
            
            
            
            
            
            
            
            
            $
            (18.90
            )Weighted
                average number of shares outstanding
            
            
            
            
            
            
            
            
            
            
            
            1,922,944




The
        accompanying notes are an integral part of this pro forma condensed combined
        statement of operations.




76


**VOIP,
      INC. AND SUBSIDIARIES**


**NOTES
      TO UNAUDITED PRO FORMA CONDENSED COMBINED**


**FINANCIAL
      STATEMENTS**





(1)
      VoIP,
      INC. Basis of Presentation





Historical
      financial information for VoIP, Inc. for the year ended December 31, 2005 has
      been derived from VoIP, Inc.'s historical statements.





(2)
      Caerus, Inc. Basis of Presentation





Historical
      financial information for Caerus, Inc. for the year ended December 31, 2005
      has
      been derived from Caerus, Inc.'s historical statements.





(3)
      VoIP,
      Inc. and Caerus, Inc. Merger





On
      June
      1, 2005, the Company and Caerus, Inc. announced the closing of the merger of
      Volo Acquisition Corp., a wholly-owned subsidiary of the Company with and into
      Caerus, Inc. with Caerus, Inc. as the surviving corporation (the "Merger"). The Merger was completed pursuant to an Agreement
      and Plan of Merger (the "Merger Agreement'), executed on May 31, 2005 by the
      conversion of all Caerus, Inc. capital stock into 821,724 shares of common
      stock, par value $0.001, of the Company.





(4)
      Pro
      Forma Statements of Operations Adjustments





Adjustments
      to the pro forma Statements of Operations represent amortization of intangible
      assets recorded in connection with the acquisitions.




77


**REPORT
      OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS**





Board
      of
      Directors


Caerus,
      Inc.


Altamonte
      Springs, Florida





We
      have
      audited the accompanying consolidated balance sheets of Caerus, Inc. as of
      December 31, 2004 and 2003, and the related consolidated statements of
      operations, changes in stockholders' equity (deficit), and cash flows for the
      year ended December 31, 2004 and for period May 15, 2002 (date of inception)
      through December 31, 2003. These consolidated financial statements are the
      responsibility of the Company's management. Our responsibility is to express
      an
      opinion on these consolidated financial statements based on our
      audits.





We
      conducted our audits in accordance with auditing standards generally accepted
      in
      the United States of America. Those standards require that we plan and perform
      the audits to obtain reasonable assurance about whether the financial statements
      are free of material misstatement. An audit includes examining, on a test basis,
      evidence supporting the amounts and disclosures in the financial statements.
      An
      audit also includes assessing the accounting principles used and significant
      estimates made by management, as well as evaluating the overall financial
      statement presentation. We believe that our audits provide a reasonable basis
      for our opinion.





In
      our
      opinion, the consolidated financial statements referred to above present fairly,
      in all material respects, the consolidated financial position of Caerus, Inc.
      as
      of December 31, 2004 and 2003, and the results of its operations and cash flows
      for the year ended December 31, 2004 and for the period May 15, 2002 (date
      of
      inception) through December 31, 2003 in conformity with accounting principles
      generally accepted in the United States of America.





The
      accompanying financial statements have been prepared assuming the Company will
      continue as a going concern. As discussed in Note 1 to the consolidated
      financial statements, the Company has incurred significant losses and negative
      cash flows from operations, has a working capital deficit, and has significant
      unresolved litigation as discussed in Note 8 to the financial statements. These
      matters, among other things, raise substantial doubt about the Company's ability
      to continue as a going concern. Management's plans related to these matters
      are
      also discussed in Note 1. These financial statements do not include any
      adjustments that might result from the outcome of this uncertainty.





*/s/
                Moore Stephens Lovelace, P.A.**Certified
                Public Accountants**Orlando,
                Florida**July
                25, 2005*





78





**CAERUS,
      INC.**


**CONSOLIDATED
      BALANCE SHEETS**


**December
      31, 2004 and 2003**




**ASSETS**2004
            
            2003CURRENT
                ASSETSCash
                and cash equivalents
            
            $
            19,414
            
            $
            25,078Restricted
                cash
            
            
            60,224
            
            
            196Accounts
                receivable
            
            
            2,098,598
            
            
            358,522Note
                receivable - related party
            
            
            -
            
            
            179,974Supplies,
                deposits and prepaid expenses
            
            
            70,999
            
            
            350,199TOTAL
                CURRENT ASSETS
            
            
            2,249,235
            
            
            913,969PROPERTY
                AND EQUIPMENTTelecommunications
                equipment and computers
            
            
            6,390,973
            
            
            732,205Furniture
                and fixtures
            
            
            61,960
            
            
            21,624Leasehold
                improvements
            
            
            163,808
            
            
            146,358Purchased
                and developed software
            
            
            473,228
            
            
            598,2437,089,969
            
            
            1,498,430Less
                accumulated depreciation and amortization
            
            
            (824,580
            )
            
            (183,408
            )NET
                PROPERTY AND EQUIPMENT
            
            
            6,265,389
            
            
            1,315,022OTHER
                ASSETSDeferred
                loan origination costs, net
            
            
            285,075
            
            
            -Lease
                deposit and other
            
            
            28,959
            
            
            65,000TOTAL
                ASSETS
            
            $
            8,828,658
            
            $
            2,293,991**LIABILITIES
                AND STOCKHOLDERS' EQUITY (DEFICIT)**CURRENT
                LIABILITIESAccounts
                payable and accrued expenses
            
            $
            7,137,293
            
            $
            452,094Note
                payable
            
            
            6,006,899
            
            
            -Convertible
                notes payable - related party
            
            
            1,830,000
            
            
            1,050,000Deferred
                revenue and customer deposits
            
            
            38,750
            
            
            60,576TOTAL
                CURRENT LIABILITIES
            
            
            15,012,942
            
            
            1,562,670STOCKHOLDERS'
                EQUITY (DEFICIT)Common
                stock - $.01 par value; 50,000,000 shares authorized;14,940,508
                and 11,948,367 shares issued and outstanding, respectively
            
            
            149,405
            
            
            119,484Preferred
                stock - $.01 par value; 25,000,000 shares authorized;-0-
                shares issued and outstanding
            
            
            -
            
            
            -Additional
                paid-in capital
            
            
            4,618,253
            
            
            2,952,184Accumulated
                deficit
            
            
            (10,951,942
            )
            
            (2,340,347
            )TOTAL SHAREHOLDERS' EQUITY (DEFICIT)
            
            
            (6,184,284
            )
            
            731,321TOTAL
                LIABILITIES AND SHAREHOLDERS' EQUITY (DEFICIT)
            
            $
            8,828,658
            
            $
            2,293,991




The
      accompanying notes are an integral part of the consolidated financial
      statements.




79




**CAERUS,
      INC.**


**CONSOLIDATED
      STATEMENTS OF OPERATIONS**


**For
      The Year Ended December 31, 2004, and**


**The
      Period May 15, 2002 (Date of Inception) Through December 31,
      2003**


2004
              
              2002-2003(DevelopmentStage)SALES
              
              $
              14,379,365
              
              $
              1,191,287COST
                  OF SALESNetwork
                  and termination costs
              
              
              15,103,149
              
              
              900,681Testing
                  and sales concessions
              
              
              662,052
              
              
              -TOTAL
                  COST OF SALES
              
              
              15,765,201
              
              
              900,681GROSS
                  PROFIT (LOSS)
              
              
              (1,385,836
              )
              
              290,606OPERATING
                  EXPENSESEquipment
                  and computer expenses
              
              
              603,189
              
              
              97,068Office
                  expenses
              
              
              228,108
              
              
              206,215Labor-related
                  expenses
              
              
              2,973,070
              
              
              1,214,240Professional
                  fees
              
              
              814,243
              
              
              400,872Marketing
              
              
              217,835
              
              
              16,689Litigation
                  settlement
              
              
              326,205
              
              
              -Rent,
                  utilities and security
              
              
              246,545
              
              
              355,481Taxes
                  and licenses
              
              
              55,527
              
              
              25,390Travel,
                  lodging and entertainment
              
              
              163,555
              
              
              90,928Depreciation
                  and amortization
              
              
              641,172
              
              
              183,409Asset
                  impairment charge
              
              
              299,122
              
              
              -TOTAL
                  EXPENSES
              
              
              6,568,571
              
              
              2,590,292LOSS
                  FROM OPERATIONS
              
              
              (7,954,407
              )
              
              (2,299,686
              )OTHER
                  EXPENSESInterest
                  expense, net
              
              
              (657,238
              )
              
              (19,654
              )Other
                  expense, net
              
              
              50
              
              
              (21,007
              )NET
                  LOSS
              
              $
              (8,611,595
              )
              $
              (2,340,347
              )




The
      accompanying notes are an integral part of the consolidated financial
      statements.




80





**CAERUS,
      INC.**


**CONSOLIDATED
      STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)**


**For
      The Year Ended December 31, 2004, and**


**The
      Period May 15, 2002 (Date of Inception) Through December 31,
      2003**




Common Stock
            
            Additional
            
            
            
            Total$.01 Par Value
            
            Paid-In
            
            Accumulated
            
            Stockholders'Shares
            
            Amount
            
            Capital
            
            Deficit
            
            Equity (Deficit)BALANCE
                - MAY 15, 2002
            
            
            -
            
            $
            -
            
            $
            -
            
            $
            -
            
            $
            -ISSUANCE
                OF FOUNDER STOCK
            
            
            5,400,000
            
            
            54,000
            
            
            -
            
            
            -
            
            
            54,000SALE
                OF COMMON STOCK
            
            
            6,186,592
            
            
            61,866
            
            
            2,721,909
            
            
            -
            
            
            2,783,775ISSUANCE
                OF COMMON STOCKFOR
                SERVICES
            
            
            150,000
            
            
            1,500
            
            
            81,750
            
            
            -
            
            
            83,250ISSUANCE
                OF COMMON STOCKFOR
                PROPERTY AND EQUIPMENT
            
            
            211,775
            
            
            2,118
            
            
            148,525
            
            
            -
            
            
            150,643NET
                LOSS
            
            
            -
            
            
            -
            
            
            -
            
            
            (2,340,347
            )
            
            (2,340,347
            )BALANCE
                - DECEMBER 31, 2003
            
            
            11,948,367
            
            
            119,484
            
            
            2,952,184
            
            
            (2,340,347
            )
            
            731,321ISSUANCE
                OF COMMON STOCK
            
            
            712,071
            
            
            7,121
            
            
            273,139
            
            
            -
            
            
            280,260ISSUANCE
                OF COMMON STOCKFOR
                DEBT
            
            
            2,280,070
            
            
            22,800
            
            
            1,097,200
            
            
            -
            
            
            1,120,000ISSUANCE
                OF STOCK WARRANTS IN CONNECTION WITH SECURED NOTE PAYABLE
            
            
            -
            
            
            -
            
            
            218,813
            
            
            -
            
            
            218,813EMPLOYEE
                STOCK OPTIONS - COMPENSATION EXPENSE RECOGNIZED
            
            
            -
            
            
            -
            
            
            76,917
            
            
            -
            
            
            76,917NET
                LOSS
            
            
            -
            
            
            -
            
            
            -
            
            
            (8,611,595
            )
            
            (8,611,595
            )BALANCE
                - DECEMBER 31, 2004
            
            
            14,940,508
            
            $
            149,405
            
            $
            4,618,253
            
            $
            (10,951,942
            )
            $
            (6,184,284
            )




The
      accompanying notes are an integral part of the consolidated financial
      statements.




81




**CAERUS,
      INC.**


**CONSOLIDATED
      STATEMENTS OF CASH FLOWS**


**For
      The Year Ended December 31, 2004, and**


**The
      Period May 15, 2002 (Date of Inception) Through December 31,
      2003**




2004
            
            2002-2003(DevelopmentStage)CASH
                FLOWS FROM OPERATING ACTIVITIESNet
                loss
            
            $
            (8,611,595
            )
            $
            (2,340,347
            )Adjustments
                to reconcile net loss to net cash used in operating
                activities:Litigation
                settlement
            
            
            326,205
            
            
            -Depreciation
                and amortization
            
            
            641,172
            
            
            183,408Asset
                impairment charge
            
            
            299,122
            
            
            -Amortization
                of deferred loan fees
            
            
            56,613
            
            
            -Stock
                issued to Founder
            
            
            -
            
            
            54,000Stock
                issued for services
            
            
            -
            
            
            83,250Expense
                related to employee stock options
            
            
            76,917
            
            
            -Forgiveness
                of related-party loan
            
            
            415,323
            
            
            -Changes
                in:Restricted
                cash
            
            
            (60,028
            )
            
            (196
            )Accounts
                receivable
            
            
            (2,066,281
            )
            
            (358,522
            )Supplies,
                deposits and prepaid expenses
            
            
            279,200
            
            
            (415,199
            )Other
                assets
            
            
            36,041
            
            
            -Accounts
                payable and accrued expenses
            
            
            6,685,199
            
            
            452,094Deferred
                revenue
            
            
            (21,826
            )
            
            60,576NET
                CASH USED IN OPERATING ACTIVITIES
            
            
            (1,943,938
            )
            
            (2,280,936
            )CASH
                FLOWS FROM INVESTING ACTIVITIESAdditions
                to property and equipment
            
            
            (5,890,661
            )
            
            (1,347,787
            )Additions
                to related-party loan
            
            
            (235,349
            )
            
            (179,974
            )NET
                CASH USED IN INVESTING ACTIVITIES
            
            
            (6,126,010
            )
            
            (1,527,761
            )CASH
                FLOWS FROM FINANCING ACTIVITIESProceeds
                from borrowings
            
            
            8,900,000
            
            
            1,050,000Repayment
                of note payable
            
            
            (993,101
            )
            
            -Proceeds
                from issuance of common stock
            
            
            280,260
            
            
            2,783,775Payments
                for loan origination costs
            
            
            (122,875
            )
            
            -NET
                CASH PROVIDED BY FINANCING ACTIVITIES
            
            
            8,064,284
            
            
            3,833,775NET
                CHANGE IN CASH
            
            
            (5,664
            )
            
            25,078CASH
                AND CASH EQUIVALENTS - BEGINNING OF PERIOD
            
            
            25,078
            
            
            -CASH
                AND CASH EQUIVALENTS - END OF PERIOD
            
            $
            19,414
            
            $
            25,078





The
      accompanying notes are an integral part of the consolidated financial
      statements.





82




**Caerus,
      Inc. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**





For
      The
      Year Ended December 31, 2004 and For The Period May 15, 2002 (Date of Inception)
      Through December 31, 2003




**NOTE
      1 - DESCRIPTION OF BUSINESS**





Caerus,
      Inc. and subsidiaries (collectively referred to as the "Company") were
      incorporated on May 15, 2002 and are wholesale providers of advanced
      telecommunications technologies and services to carriers and service providers,
      including Inter Exchange Carriers ("IXCs"), Competitive Local Exchange Carriers
      ("CLECs"), Internet Service Providers, Cable Operators and Enhanced Voice and
      Data Service Providers. Through its wholesale-only model, the Company has
      positioned itself as a "carrier's carrier" and offers protocol-agnostic packet
      switched technologies to address the gap between traditional communications
      and
      "next generation" platforms.





During
      the period May 15, 2002 (date of inception) to December 31, 2003, the Company
      was in the process of developing its resources, enhancing its proprietary
      technology, building a nationwide network with five physical interconnection
      points (cities), working with potential customers on testing its network, and
      attracting key engineering professionals; accordingly, the Company was
      considered to be a development stage enterprise. In January 2004, the Company
      became fully operational and management determined that the Company was no
      longer in a development stage.





The
      Company offers a comprehensive suite of Internet Protocol ("IP")-based broadband
      packet voice services, IP and Time Division Multiplexing ("TDM")
      origination/termination services, IP PBX-hosted services, and unified messaging
      services that include enhanced voice and data solutions. The suite of services
      is complemented by a Service Creation Environment that enables the Company
      to
      develop custom applications and features "on the fly" for its
      customers.





The
      consolidated financial statements include the accounts of the Company and its
      wholly owned subsidiaries. All significant intercompany balances and
      transactions have been eliminated.





The
      Company has incurred significant losses and negative cash flows from operations
      since its inception. Additionally, the Company has a working capital deficit
      of
      $12,763,707 and an accumulated deficit of $10,951,942 at December 31, 2004.
      Management continues to undertake steps as part of a plan to attempt to improve
      liquidity and operating results with the goal of sustaining Company operations.
      These steps include seeking (a) to increase high-margin sales; and (b) to
      control overhead costs and operating expenses. Management plans, in this regard,
      to continue the implementation of a stabilized and fully operational network,
      adding recurring-revenue customers, attracting an experienced management team
      capable of building a profitable company, and securing funding to meet current
      obligations.





There
      can
      be no assurance that the Company can successfully accomplish these steps.
      Accordingly, the Company's ability to continue as a going concern is uncertain
      and dependent upon continuing to achieve improved operating results and cash
      flows or obtaining additional financing. These consolidated financial statements
      do not include any adjustments to the amounts and classification of assets
      and
      liabilities that might be necessary should the Company be unable to continue
      in
      business.





**NOTE
      2 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES**





**Cash
      and Cash Equivalents**





For
      financial presentation purposes, the Company considers short-term, highly liquid
      investments with original maturities of three months or less to be cash
      equivalents.





**Restricted
      Cash and Letters of Credit**





Certain
      cash is restricted to support standby letters of credit which, in turn, support
      operating license bonds required by several states' regulatory agencies. These
      standby letters of credit are generally in force for one year with automatic
      one-year extensions. Maximum draws available to the beneficiary as of December
      31, 2004 were $60,000. If the Company was required to obtain replacement standby
      letters of credit as of December 31, 2004 for those currently outstanding,
      it is
      the Company's opinion that the replacement costs would not significantly vary
      from the present fee structure.





**Accounts
      Receivable**





Accounts
      receivable result from the sale of the Company's services, net of estimated
      allowances. The Company estimates an allowance for doubtful accounts based
      on a
      specific-identification basis. The Company had no allowance for doubtful
      accounts as of December 31, 2004 and 2003.




83




**Property
      and Equipment**





Property
      and equipment are recorded at cost. Depreciation and amortization are calculated
      on a straight-line basis over the assets' useful lives, which range from three
      to ten years. Leasehold improvements are amortized over the estimated useful
      lives of the improvements, or the term of the lease, if shorter. Maintenance
      and
      repairs are expensed as incurred, while renewals and betterments are
      capitalized. Upon the sale or other disposition of property, the cost and
      related accumulated depreciation are removed from the accounts, and any gain
      or
      loss is recognized in operations.





Under
      the
      Statement of Position ("SOP") 98-1, "Accounting for the Cost of Computer
      Software Developed or Obtained for Internal Use," the Company expenses computer
      software costs related to internal-use software that is incurred in the
      preliminary project stage. When the capitalization criteria of SOP 98-1 have
      been met, costs of developing or obtaining internal-use computer software are
      capitalized. The Company capitalized approximately $772,350 of costs incurred
      for internally developed software during the period from inception through
      December 31, 2004. Amortization of internal-use software over a 5-year estimated
      useful life commenced upon the software being placed in service beginning
      January 1, 2004. Amortization of internal-use software for the periods ended
      December 31, 2004 and 2003 was approximately $77,000 and $-0-, respectively.
      During 2004, the Company suspended a number of software development projects
      and, accordingly, recognized a related asset impairment charge of $299,122
      in
      2004.





**Deposits**





Deposits
      consist primarily of an equipment deposit, a refundable office lease deposit
      and
      various other deposits outstanding with service providers.





**Deferred
      Revenue**





Deferred
      revenue represents fees for services that have not yet met the criteria to
      be
      recognized as revenue.





**Revenue
      Recognition**





Revenue
      is recognized when earned. Revenue related to long distance, carrier access
      service and certain other usage-driven charges are billed monthly in arrears,
      and the associated revenues are recognized during the month of
      service.





**Income
      Taxes**





The
      Company utilizes the asset and liability method of accounting for income taxes.
      Under this method, deferred income taxes are recorded to reflect the tax
      consequences in future years of differences between the tax basis of assets
      and
      liabilities and their financially reported amounts at each year-end, based
      on
      enacted laws and statutory rates applicable to the periods in which differences
      are expected to affect taxable income. As of December 31, 2004, the Company
      had
      a deferred tax asset of approximately $3,000,000, the components of which
      consisted primarily of the Company's net losses, fixed asset depreciation and
      stock-based compensation. Also at December 31, 2004, the Company had a net
      operating loss carryforward of approximately $11,000,000 for federal income
      tax
      purposes that will begin to expire in 2022, and that is subject to significant
      limitations based upon the occurrence of certain changes in ownership of the
      Company.





A
      valuation allowance is provided against the future benefits of deferred tax
      assets if it is determined that it is more likely than not that the future
      tax
      benefits associated with the deferred tax asset will not be realized. Due to
      recurring losses since inception and the resultant uncertainty of the
      realization of the tax loss carryforward, the Company has established a 100%
      valuation allowance against the carryforward benefit. Accordingly, no
      provision/benefit for income taxes has been included in these consolidated
      financial statements.





**Concentration
      of Credit Risk**





Financial
      instruments that may subject the Company to concentrations of credit risk
      consist principally of cash and cash equivalents and accounts receivable. The
      Company has investment policies and procedures that are reviewed periodically
      to
      minimize credit risk.





One
      customer represented approximately 98% and 90% of the Company's accounts
      receivable as of December 31, 2004 and 2003, respectively, and approximately
      91%
      and 95% of the Company's revenues for the year ended December 31, 2004 and
      for
      the period May 15, 2002 (date of inception) through December 31, 2003,
      respectively. The loss of this customer would have a significant adverse affect
      on the Company's operations.





**Concentration
      of Supplier Risk**





One
      supplier represented approximately 86% of the Company's accounts payable as
      of
      December 31, 2004, and approximately 94% of the Company's cost of sales for
      the
      year ended December 31, 2004 (see Note 8).




84





**Stock-based
      Compensation**





The
      Company uses the fair value method of Statement of Financial Accounting
      Standards No. 123R, "Accounting for Stock Based Compensation" in accounting
      for
      its stock options. This standard states that compensation cost is measured
      at
      the grant date based on the value of the award and is recognized over the
      service period, which is usually the vesting period. The fair value for each
      option granted is estimated on the date of the grant using the minimum value
      method.





**Estimates**





The
      preparation of these consolidated financial statements in conformity with
      accounting principles generally accepted in the United States of America
      requires management to make estimates and assumptions that affect the reported
      amounts of assets and liabilities and disclosure of contingent assets and
      liabilities at the date of the financial statements. Estimates also affect
      the
      reported amounts of revenues and expenses during the reporting period. Actual
      results could differ from those estimates. Significant management estimates
      affect the carrying value of, among other things, internal-use software, cost
      of
      goods sold (see Note 7), the estimating of the fair value of the Company's
      common stock (see Note 3), and the evaluation of existing disputes and claims
      (see Notes 7 and 8).





**Reclassifications**





Certain
      reclassifications have been made to the 2003 financial statements to conform
      to
      the 2004 presentation.





**NOTE
      3 - CONVERTIBLE NOTES PAYABLE - RELATED PARTY**





During
      2003, the Company issued two one-year convertible notes to a stockholder of
      the
      Company, $1,050,000 and $70,000 of which were funded in the periods ended
      December 31, 2003 and 2004, respectively. These notes accrued interest at 12%
      per annum, with all interest and principal due in September and December 2004.
      These notes, which had certain anti-dilution provisions and which were
      collateralized by substantially all of the assets of the Company, were converted
      into common stock in May 2004 (see Note 6) and the convertible notes were
      cancelled and the principal amount was satisfied in full.





The
      Company determined the conversion rates based upon its evaluation of the
      Company's common stock on the issuance dates. The Company's evaluations were
      based upon, among other things, peer company valuations, industry and market
      conditions, the Company's current financial position, terms and conditions
      of
      funding available to the Company at the time of issuance, etc.





During
      2004, the Company issued two one-year convertible notes to a stockholder of
      the
      Company, totaling $1,830,000. These notes accrue interest at 12% per annum,
      with
      monthly principal and interest payments originally scheduled through August
      and
      November 2004. Restrictive covenants pertaining to the note payable discussed
      in
      Note 4 to these financial statements precluded payment of scheduled principal
      and interest on these notes; therefore, these notes are currently due. However,
      the same covenants preclude payment until the note described in Note 4 to these
      financial statements is paid in full. These one-year notes are collateralized
      by
      substantially all of the assets of the Company (see Note 8).





Interest
      expense incurred with respect to these notes during the year ended December
      31,
      2004 and the period May 15, 2002 (date of inception) through December 31, 2003,
      was $122,223 and $19,653, respectively.





Interest
      payments made with respect to these notes during the year ended December 31,
      2004 and the period May 15, 2002 (date of inception) through December 31, 2003,
      were $42,560 and $-0-, respectively.





**NOTE
      4 - NOTE PAYABLE**





In
      June
      2004, the Company secured a $15,000,000 debt facility and drew down the first
      $7,000,000 traunch primarily for the purpose of funding network equipment
      purchases. These borrowings are repayable over a three-year period and bear
      interest at 12.5% per annum. Additional borrowings under this facility are
      contingent upon, among other things, the Company raising certain levels of
      additional equity financing. The loan agreement contains customary covenants
      and
      restrictions and provides the lender the right to a perfected first-priority,
      secured interest in all of the Company's assets, as well as rights to preferred
      stock warrants (see Notes 6 and 8).





Interest
      paid under this debt facility during the year ended December 31, 2004, was
      $484,867.





The
      Company is currently in violation of several of the restrictive covenants in
      this debt facility. Under its provisions, the lender has the right to call
      the
      related note payable due. Accordingly, the full amount of the note at December
      31, 2004 has been classified as current.





**NOTE
      5 - NOTE RECEIVABLE - RELATED PARTY**





During
      the period May 15, 2002 (date of inception) through December 31, 2004, the
      Company advanced $415,323 to an officer of the Company. In 2005, these advances
      were characterized as compensation and were forgiven; accordingly, their
      carrying value was reduced to zero at December 31, 2004. In addition, the
      Company agreed to pay the related federal income tax withholding of
      approximately $104,000 on behalf of the related party, which was accrued at
      December 31, 2004.




85





**NOTE
      6 - STOCKHOLDERS' EQUITY**





In
      June
      2002, the Company increased its authorized shares to 100,000 shares of $0.01
      par
      value common stock. In July 2002, the Company increased its authorized shares
      to
      3,000,000 shares of $0.01 par value common stock and approved a 2-for-1 common
      stock split. In October 2002, the Company increased its authorized shares to
      6,000,000 shares of $0.01 par value common stock. In July 2003, the Company
      approved an additional 3-for-1 common stock split and an increase in the
      authorized shares of common stock to 18,000,000. The Articles of Amendment
      for
      this amendment were not filed with the state of Delaware until 2004. The
      accompanying consolidated financial statements and related notes present all
      of
      these amendments as if they were affected for all periods
      presented.





In
      2002,
      5,400,000 shares of common stock were issued to the founder of the Company.
      These shares were recorded at their par value.





In
      2002,
      the Company issued 150,000 shares of its common stock for legal services
      provided to the Company, which were recorded at their estimated fair value
      of
      $83,250.





During
      the period May 15, 2002 (date of inception) through December 31, 2003, the
      Company issued 5,965,957 shares of its common stock and received net proceeds
      of
      $2,783,775. Offering costs related to these sales consisted of the issuance
      of
      an additional 220,635 shares of the Company's common stock.





During
      the period May 15, 2002 (date of inception) through December 31, 2003, the
      Company issued 211,775 shares of its common stock in consideration for leasehold
      improvements and equipment, of which 190,211 of the shares were issued to the
      founder of the Company. These shares were recorded at their estimated fair
      value
      of $150,643.





In
      May
      2004, $1,120,000 of convertible notes payable to a shareholder were converted
      into 2,280,070 shares of common stock.





In
      May
      and August 2004, the Company issued 500,000 and 212,071 shares of its common
      stock for cash of $100,000 and $180,260, respectively.





In
      May
      2004, the Company authorized the issuance of up to 25,000,000 shares of $.01
      par
      value preferred stock, the terms of which will be decided upon by the Company's
      board of directors.





In
      August
      2004, the Company approved increasing the authorized common stock to 50,000,000
      shares. However, the related state filing has yet to be effected.





**Rights
      to Convert to Preferred Stock**





At
      December 31, 2004, related parties held 12,989,445 shares of common stock that
      had the right to be converted into preferred shares; however, as of December
      31,
      2004, no shares of preferred stock had been issued by the Company (see Note
      8).





**Stock
      Options**





During
      October 2004, the Board approved the Company's 2004 Stock Option Plan (the
      "Plan"), whereby 4,000,000 shares of the Company's common stock were reserved
      for issuance under the Plan to selected directors, officers, employees and
      consultants of the Company. As of December 31, 2004, options to purchase
      2,164,969 shares of common stock for $0.85 per share were issued and outstanding
      under the Plan. These options expire ten years from the date of issuance. They
      vest from 36 to 48 months of employment following the date of option issuance.
      These options had an estimated fair value of $330,599 at the date of grant,
      using the minimum-value method with the following assumptions:





Expected
                life (in years)
            
            
            10.0Risk-free
                interest rate
            
            
            2.0
            %Dividend
                yield
            
            
            0.0
            %





Related
      2004 compensation expense was $76,917, determined by amortizing the options'
      estimated fair value at grant date over their vesting period. The weighted
      average remaining contractual life of the options outstanding at December 31,
      2004 was 9.8 years (see Note 8). The Company had no stock options outstanding
      at
      December 31, 2003.




**Stock
      Warrants**





In
      2004,
      the Company granted a series of warrants to purchase shares of preferred stock,
      the specific terms of which had yet to be determined, at an exercise price
      of
      $0.85 per share, in conjunction with the long-term note payable issuance (see
      Note 4). These warrants expire at the earlier of ten years from their issuance
      date, or five years after a potential initial public securities offering. At
      the
      warrant holder's election, these warrants may be exercised on a non-cash basis
      whereby the warrant holder uses the surplus of the preferred stock's then-fair
      market value per share over the $0.85 exercise price as payment for the
      preferred stock purchased under these warrants.




86




These
      warrants had estimated fair values totaling $218,813 at their grant dates,
      recognized as additional paid-in capital and deferred loan origination costs.
      Additional information pertaining to these warrants issued and outstanding
      at
      December 31, 2004 is as follows:





Date
                Granted
            
            SharesJune,
                2004
            
            
            1,235,294August,
                2004
            
            
            766,020October,
                2004
            
            
            383,010Total
                Issued and Outstanding
            
            
            2,384,324





Also
      in
      conjunction with the long-term note payable issuance (see Note 4), the Company
      granted warrants to purchase up to $1.0 million of common or preferred stock
      that may be issued in conjunction with any future securities offering of at
      least $5.0 million, upon the same price and conditions as afforded to
      third-party investors in said potential securities offering.





In
      August
      2004, the Company issued warrants to purchase 150,000 shares of common stock
      to
      a former employee whose employment was terminated in June 2004. Such warrants
      are exercisable at $0.85 per share, and expire on June 26, 2006. The Company
      had
      no stock warrants outstanding at December 31, 2003.




**NOTE
      7 - OTHER COMMITMENTS AND CONTINGENCIES**





**Operating
      Leases**





In
      August
      2002, the Company entered into an operating lease for office space, which
      expires in February 2008. Approximate minimum future lease payments due under
      this operating lease, are as follows:




Year
                Ending
              December
                31,
            
            Amount2005
            
            $
            196,0002006
            
            $
            202,0002007
            
            $
            208,0002008
            
            $
            35,000





During
      the year ended December 31, 2004 and the period May 15, 2002 (date of inception)
      through December 31, 2003, $172,700 and $234,000, respectively, were charged
      to
      operations for rent expense related to this operating lease.





**Legal
      and Regulatory Proceedings**





The
      Company's 100%-owned subsidiary, Volo Communications, Inc., settled its breach
      of contract dispute related to a 2003 "take or pay" sales contract with the
      Company. In connection with this settlement, the Company wrote off its
      previously recorded account receivable of $326,205 in 2004.





**Vendor
      Dispute**





Certain
      transport and termination costs incurred by the Company are recorded at vendor
      invoice amount less any amounts that have been formally disputed, for which
      the
      Company expects to receive a credit. Disputed amounts are based upon
      management's detailed review of vendor call records and contract provisions;
      accordingly, the recorded transport and termination costs represent management's
      estimates of what is ultimately due and payable. During the year ended December
      31, 2004, and the period May 15, 2002 (date of inception) through December
      31,
      2003, $4,500,000 and $2,500,000, respectively, of one vendor's charges were
      formally disputed. As of December 31, 2004, approximately $4,759,000 remained
      in
      dispute and are, therefore, not included in the accompanying financial
      statements (see Note 8). Differences between the disputed amounts and final
      settlements, if any, are reported in operations in the year of
      settlement.




**Other**





Telecommunications
      industry revenues are subject to statutory and regulatory changes,
      interpretations of contracts, etc., all of which could materially affect our
      revenues. Generally, our customers have sixty days from the invoice date to
      dispute any billed charges. Management reviews all billings for compliance
      with
      applicable rules, regulations and contract terms and believes that it is in
      compliance therewith; accordingly, no allowance has been recorded in the
      accompanying financial statements for potential disputed charges.




87




**NOTE
      8 - SUBSEQUENT EVENTS**





**Capital
      Stock Transactions**





In
      February 2005, the Company issued 511,750 shares of Series B preferred stock
      for
      $818,800 cash. In May 2005, 7,289,445 shares of common stock were converted
      into
      5,944,669 shares of Series A preferred stock. Both Series A and Series B
      preferred stock are convertible into common stock, and they carry voting rights
      equal to the equivalent number of common shares into which they are convertible.
      Also, both Series A and Series B preferred stock contain equal and ratable
      dividend and liquidation preferences over common stock.





**Litigation**





On
      April 8, 2005, Volo Communications, Inc. (“Volo”) (a wholly-owned
      subsidiary of Caerus, Inc.) filed suit against MCI Worldcom Network Services,
      Inc. d/b/a UUNET (“MCI”). Volo alleges that MCI engaged in a pattern and
      practice of over-billing Volo for the telecommunications services it provided
      pursuant to the parties' Services Agreement, and that MCI refused to negotiate
      such overcharges in good faith. Volo also seeks damages arising out of MCI's
      alleged fraudulent practice of submitting false bills by, among other things,
      re-routing long distance calls over local trunks to avoid access charges, and
      then billing Volo for access charges that were never incurred. On April 4,
      2005, MCI declared Volo in default of its obligations under the Services
      Agreement, claiming that Volo owes a past due amount of $8,365,980 through
      March, 2005, and threatening to terminate all services to Volo within 5 days.
      On
      April 12, 2005, MCI terminated all services to Volo. By these actions, Volo
      alleges claims for (1) breach of contract; (2) fraud in the
      inducement; (3) primary estoppel; and (4) deceptive and unfair trade
      practices. Volo also seeks a declaratory judgment that (1) MCI is in breach
      of the Services Agreement; (2) $8,365,980 billed by MCI is not “due and
      payable” under that agreement; and (3) MCI's default letter to Volo is in
      violation of the Services Agreement. Volo seeks direct, indirect and punitive
      damages in an amount to be determined at trial.





On
      May 26, 2005, MCI filed an Answer, Affirmative Defenses, Counterclaim and
      Third-Party Complaint naming Caerus, Inc. as a third-party defendant. MCI
      asserts a breach of contract claim against Volo, a breach of guarantee claim
      against Caerus, Inc., and a claim for unjust enrichment against both parties,
      seeking an amount to be determined at trial. On July 11, 2005, Volo and
      Caerus, Inc. answered the counterclaim and third-party complaint, and filed
      a
      third-party counterclaim against MCI for declaratory judgment, fraud in the
      inducement, and breach of implied duty of good faith and fair dealing. Volo
      and
      Caerus, Inc. seek damages in an amount to be determined at trial. MCI has filed
      a motion to strike certain of Caerus' affirmative defenses and a motion to
      dismiss Caerus' counterclaims. Discovery should commence shortly. While
      management is optimistic about the outcome of this litigation, it is currently
      unable to assess the ultimate likelihood of a favorable or unfavorable outcome;
      accordingly, no related provision or liability has been made in the accompanying
      financial statements.





**Merger**





On
      May
      31, 2005, the Company consummated an Agreement and Plan of Merger ("Merger
      Agreement") with VoIP, Inc. ("VoIP") (OTCBB:VOII.OB), whereby 100% of Caerus,
      Inc.'s common and preferred stock, stock options and warrants were exchanged
      for
      the common stock of a wholly-owned subsidiary of VoIP. The VoIP subsidiary's
      name was then changed to Caerus, Inc. Also in conjunction with this merger,
      the
      holder of the $1,830,000 notes payable at December 31, 2004 referred to in
      Note
      3 agreed to exchange those notes plus accrued interest for an equivalent number
      of shares of VoIP common stock valued at $1.23 per share.




88





**SIGNATURES**





Pursuant
      to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
      1934, the registrant has duly caused this report to be signed on its behalf
      by
      the undersigned, thereunto duly authorized, in the City of Altamonte Springs,
      State of Florida, on October 11, 2007.




**VOIP,
                INC.**By:
            */s/
                Anthony J. Cataldo*Anthony
                J. CataldoChief
                Executive OfficerDate:
            October
                11, 2007




Pursuant
      to the requirements of the Securities Exchange Act of 1934, this report has
      been
      signed below by the following persons on behalf of the registrant and in the
      capacities and on the dates indicated.




By:
            */s/
                Anthony J. Cataldo*Anthony
                J. CataldoChief
                Executive Officer and ChairmanDate:
            October
                11, 2007






By:
            */s/
                Shawn Lewis*Shawn
                M. LewisChief
                Operating OfficerDate:
            October
                11, 2007






By:
            */s/
                Robert Staats*Robert
                V. StaatsChief
                Accounting OfficerDate:
            October
                11, 2007






By:
            */s/
                Gary Post*Gary
                PostDirectorDate:
            October
                11, 2007






By:
            */s/
                Stuart Kosh*Stuart
                KoshDirectorDate:
            October
                11, 2007




89




By:
            */s/
                Sade Panahi*Sade
                PanahiDirectorDate:
            October
                11, 2007




90