**UNITED
      STATES**


**SECURITIES
      AND EXCHANGE COMMISSION**


**Washington,
      D.C. 20549**





**FORM
      10-K**


(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 oNO 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 $14,676,948.





At
      June
      30, 2006, the last business day of the registrant’s most recently completed
      second fiscal quarter, there were 70,509,102 shares of registrant’s common stock
      outstanding, 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 98,609,701 and no shares of par value
      $0.001 common stock and par value $0.001 preferred stock, respectively.





Company
      Symbol-VOII







**TABLE
                  OF CONTENTS****Page 
                  No.****PART
                  I****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****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**
              **30****Item
                  8.**
              **Financial
                  Statements and Supplementary Data**
              **30****Item
                  9.**
              **Changes
                  in and Disagreements With Accountants on Accounting and Financial
                  Disclosure**
              **31****Item
                  9A.**
              **Controls
                  and Procedures**
              **31****Item
                  9B.**
              **Other
                  Information**
              **33****PART
                  III****Item
                  10.**
              **Directors,
                  Executive Officers and Corporate Governance**
              **33****Item
                  11.**
              **Executive
                  Compensation**
              **35****Item
                  12.**
              **Security
                  Ownership of Certain Beneficial Owners and Management and Related
                  Stockholder****Matters**
              **41****Item
                  13.**
              **Certain
                  Relationships and Related Transactions**
              **44****Item
                  14.**
              **Principal
                  Accounting Fees and Services**
              **44****PART
                  IV****Item
                  15.**
              **Exhibits
                  and Financial Statement Schedules**
              **46**
 
 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 12,500,000
      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, 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 our former Chief Operating
      Officer.





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”).




4




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. Prior to softswitches, existing 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. We also operate a smaller
      combination Time Division Multiplexing (“TDM”)/IP network located in Dallas,
      Texas.




**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. We also
      sell VoIP products such as EasyTalk and Rocket VoIP that are targeted at
      individual consumers.





*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.





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.




5




*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 provide 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.





*EasyTalk*





EasyTalk,
      our automated number identification (“ANI”) retail product, marketed through our
      website, is a long distance service with “ease of use” features for consumers.
      We believe that EasyTalk is a step beyond calling cards. Our network is
      programmed to automatically recognize our customers’ phone numbers and to
      provide callers from these numbers immediate access to long-distance services.
      No calling card or PIN number is required. Consumer features include PIN-less
      dialing, fast *1 recharge of the service, speed dial, and quick query of current
      balance. As of December 31, 2006 we had approximately 25,000 EasyTalk customers,
      and revenues generated from this product offering amounted to approximately
      $5.5
      million for the year ended December 31, 2006.





*Rocket
      VoIP*





Our
      Rocket VoIP retail product allows customers to use, through a media terminal
      adapter we provide, their high speed Internet connection to place local, long
      distance and international calls. As of December 31, 2006 we had approximately
      3,000 Rocket VoIP customers, and revenues generated for this product offering
      amounted to approximately $600,000 for the year ended
      December 31, 2006.





*Other
      Products*





We
      also
      sell various PIN and ANI products to consumers via our website.





**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.





6





**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;


· 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;


· expanding
      our market share for our retail calling services;


· 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;


· the
      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 who
      have
      greater resources and larger customer bases than we have, and have been in
      operation for many years. We also compete in the growing market of discount
      telecommunications services including "pure play" VoIP service providers,
      prepaid calling cards, call-back services, dial-around or 10-10 calling and
      collect calling services. 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.





7





**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.





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 Federal Communications Commission, or 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.




8




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.




Interconnected
      VoIP providers, like us,
      are required to offer the 911 emergency calling capabilities similar to those
      available to subscribers of traditional switched phone lines. We were also
      required to distribute stickers and labels warning customers of the limitations
      associated with accessing emergency services through an interconnected VoIP
      service, as well as to notify and to obtain affirmative acknowledgement from
      customers that customers were aware of the differences between the emergency
      calling capabilities offered by interconnected VoIP providers as compared to
      traditional, wireline providers of telephone service. These requirements pertain
      to our Rocket VoIP customers described on page 6. The FCC’s Enforcement Bureau
      released an order stating that the Enforcement Bureau will not pursue
      enforcement against interconnected VoIP providers that have received affirmative
      acknowledgement from at least 90% of their subscribers, which we have
      received.




Like
      many
      interconnected VoIP providers, we cannot offer VoIP E911 services that route
      emergency calls in a manner consistent with the FCC rules for all of its
      customers. We are addressing this issue with our VoIP E911 solution providers.
      The FCC may determine that our VoIP E911 solution for certain customers does
      not
      satisfy the requirements of the VoIP E911 order because, in some instances,
      Volo
      will not be able to connect subscribers directly to a PSAP. Volo recently
      received correspondence from the FCC requesting additional information about
      its
      911 compliance. We understand that a number of interconnected VoIP providers
      received similar correspondence. A response is due on April 11, 2007. We cannot
      predict what action the FCC may take after reviewing our responses. Should
      the
      FCC engage in any type of enforcement action, such as disconnecting customers,
      paying monetary fines, or any other type of enforcement action, such actions
      could have a material adverse effect on our financial position, results of
      operations and cash flows.




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.




**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.**




9




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 1,535,219
      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 269 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 $37.9 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;


·
            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.**




10




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 $21.2 million in
      goodwill and approximately $11.5 million in other intangible assets recorded
      in
      connection with our acquisitions. We recorded significant additional amounts
      of
      goodwill and intangible assets as a result of our acquisition in October 2005
      of
      substantially all of the assets relating to the VoIP business of WQN, and 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 31, 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.




**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 $20.0 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.




11




**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. Approximately 39% 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, and from the sales of
      retail VoIP services to consumers. 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.





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.




12




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.





**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.





**Online
      credit card fraud can harm our business.**





The
      sale
      of our products and services over the Internet exposes us to credit card fraud
      risks. Some of our products and services can be ordered or established (in
      the
      case of new accounts) over the Internet using a major credit card for payment.
      As is prevalent in retail telecommunications and Internet services industries,
      we are exposed to the risk that some of these credit card accounts are stolen
      or
      otherwise fraudulently obtained. In general, we are not able to recover
      fraudulent credit card charges from such accounts. In addition to the loss
      of
      revenue from such fraudulent credit card use, we also remain liable to third
      parties whose products or services are engaged by us (such as termination fees
      due telecommunications providers) in connection with the services which we
      provide. In addition, depending upon the level of credit card fraud we
      experience, we may become ineligible to accept the credit cards of certain
      issuers. We are currently authorized to accept American Express, Visa,
      MasterCard, and Discover. The loss of eligibility for acceptance of credit
      cards
      could significantly and adversely affect our business. We will attempt to manage
      fraud risks through our internal controls and our monitoring and blocking
      systems. If those efforts are not successful, fraud could cause our revenue
      to
      decline significantly and our business, financial condition and results of
      operations to be materially and adversely affected.





**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.




13




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 businesses 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;


·
            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.




14





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. We also compete
      against discount telecommunications services including prepaid calling cards,
      call-back services, dial-around or 10-10 calling and collect calling services.
      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, 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.





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.




15




**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. We currently license
      third party technology for products acquired through the WQN
      acquisition.





**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.





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.




16




**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 $0.18 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;


·
            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, 98,609,701 common shares were issued and outstanding, and
      approximately 242.1 million additional shares 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 76.6 million common
      shares 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
              
              
              -
              
              
              2,486,970
              
              
              -
              
              
              2,486,970
              
              
              -
              
              
              -
              
              
              -
              
              
              1,535,219
              
              
              4,022,189July
                  and October 2005 convertiblenotes
                  and warrants
              
              
              2,714,130
              
              
              3,713,542
              
              
              -
              
              
              6,427,672
              
              
              12,730,778
              
              
              -
              
              
              12,730,778
              
              
              10,016,678
              
              
              29,175,128January
                  and February 2006 convertiblenotes
                  and warrants
              
              
              46,406,121
              
              
              9,074,104
              
              
              -
              
              
              55,480,225
              
              
              10,514,238
              
              
              -
              
              
              10,514,238
              
              
              6,165,068
              
              
              72,159,531November
                  2005 financingagreement
              
              
              -
              
              
              2,225,000
              
              
              -
              
              
              2,225,000
              
              
              -
              
              
              -
              
              
              -
              
              
              4,736,111
              
              
              6,961,111WQN,
                  Inc.
              
              
              21,978,113
              
              
              -
              
              
              -
              
              
              21,978,113
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              21,978,113October
                  06 convertible notesand
                  warrants
              
              
              16,143,750
              
              
              10,378,125
              
              
              -
              
              
              26,521,875
              
              
              16,143,750
              
              
              -
              
              
              16,143,750
              
              
              -
              
              
              42,665,625February 1,
                  2007 convertible notes
              
              
              10,653,227
              
              
              -
              
              
              -
              
              
              10,653,227
              
              
              -
              
              
              
              
              
              -
              
              
              -
              
              
              10,653,227February 16,
                  2007 convertible notes
              
              
              23,244,394
              
              
              21,320,661
              
              
              -
              
              
              44,565,055
              
              
              23,244,394
              
              
              
              
              
              23,244,394
              
              
              -
              
              
              67,809,449Nov/Dec
                  06 & Jan 07 bridge notes
              
              
              -
              
              
              2,421,894
              
              
              -
              
              
              2,421,894
              
              
              -
              
              
              -
              
              
              -
              
              
              4,000,000
              
              
              6,421,8942004
                  Stock Option Plan
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              4,000,000
              
              
              4,000,000
              
              
              -
              
              
              4,000,0002006
                  Stock Option Plan
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              10,000,000
              
              
              10,000,000
              
              
              -
              
              
              10,000,000Securities
                  owned by consulting andother
                  professional firms
              
              
              -
              
              
              4,349,327
              
              
              305,646
              
              
              4,654,973
              
              
              -
              
              
              
              
              
              -
              
              
              2,170,000
              
              
              6,824,973Current
                  and former officer andemployee
                  securities 4
              
              
              -
              
              
              6,225,000
              
              
              1,562,500
              
              
              7,787,500
              
              
              -
              
              
              -
              
              
              -
              
              
              23,435,218
              
              
              31,222,718Securities
                  owned by or owed toshareholders
              
              
              -
              
              
              3,892,385
              
              
              -
              
              
              3,892,385
              
              
              -
              
              
              -
              
              
              -
              
              
              979,282
              
              
              4,871,667**Totals**
              
              
              **121,139,735**
              
              
              **66,087,008**
              
              
              **1,868,146**
              
              
              **189,094,889**
              
              
              **62,633,160**
              
              
              **14,000,000**
              
              
              **76,633,160**
              
              
              **53,037,576**
              
              
              **318,765,625**


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
          on page
          71 for subsequent authorized common stock increase.)
 4In
            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. We also have offices and
      facilities in Dallas, Texas. Following is a description of these facilities,
      all
      of which are leased, as of December 31, 2006.


Location
              
              Purpose
              
              Approx.
                  Sq. Ft.
              
              Annual
                  Rent151
                  S. Wymore Rd, Suite 3000
              
              
              Network
                  facilities and
              
              
              11,500
              
              $
              208,000Altamonte
                  Springs, FL 32714
              
              
              corporate
                  offices14911
                  Quorum Dr., Suite 140
              
              
              Offices
              
              
              3,124
              
              $
              60,000Dallas,
                  Texas 75254





**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.




18




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.
 
 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.


**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 “VOII.” 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
              
              $
              0.47
              
              $
              0.299/30/06
              
              
              0.68
              
              
              0.266/30/06
              
              
              1.29
              
              
              0.493/31/06
              
              
              2.62
              
              
              1.2812/31/05
              
              
              2.07
              
              
              1.279/30/05
              
              
              2.30
              
              
              0.956/30/05
              
              
              1.65
              
              
              1.033/31/05
              
              
              4.08
              
              
              1.61




**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 98,609,701 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
              
              $
              8,945,868
              
              $
              14,676,948Gross
                  profit (loss)
              
              
              -
              
              
              -
              
              
              265,687
              
              
              (1,299,648
              )
              
              (8,062
              )Operating
                  expenses
              
              
              -
              
              
              -
              
              
              5,573,575
              
              
              21,063,041
              
              
              31,015,685Loss
                  from continuing operations
              
              $
              -
              
              $
              -
              
              $
              (5,307,888
              )
              $
              (23,794,994
              )
              $
              (39,216,559
              )Net
                  loss
              
              $
              (61,926
              )
              $
              (352,968
              )
              $
              (5,862,120
              )
              $
              (28,313,333
              )
              
              ($41,196,512
              )Net
                  loss per share:Loss
                  from continuing operations
              
              $
              -
              
              $
              -
              
              $
              (0.36
              )
              $
              (0.62
              )
              $
              (0.52
              )Net
                  loss
              
              $
              (0.04
              )
              $
              (0.20
              )
              $
              (0.40
              )
              $
              (0.74
              )
              $
              (0.55
              )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
              )
              
              (6,494
              )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
              
              
              10,141,872
              
              
              6,860,233Goodwill
                  and other intangible assets
              
              
              -
              
              
              -
              
              
              1,713,301
              
              
              36,044,271
              
              
              32,687,822Total
                  assets
              
              
              530,230
              
              
              259,459
              
              
              8,672,548
              
              
              53,338,359
              
              
              40,925,121Long
                  term obligations
              
              
              -
              
              
              -
              
              
              -
              
              
              245,248
              
              
              222,669Total
                  liabilities
              
              
              68,970
              
              
              151,167
              
              
              1,027,727
              
              
              26,472,439
              
              
              37,880,305Total
                  shareholders' equity
              
              
              461,260
              
              
              108,292
              
              
              7,644,821
              
              
              26,865,920
              
              
              3,044,816Book
                  value per share
              
              $
              0.30
              
              $
              0.06
              
              $
              0.32
              
              $
              0.45
              
              $
              0.03Cash
                  dividends per share
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -
              
              $
              -





(1)
            Operations
                relating to Millennia Tea Masters, DTNet Technologies and Phone House,
                Inc. were discontinued in 2004, 2005 and 2006, 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
              
              2005
                  (1)(2)(3)(Restated)Goodwill
                  and other intangible assets
              
              $
              32,687,822
              
              $
              36,044,271Total
                  assets
              
              
              40,925,121
              
              
              53,338,359Notes
                  and loans payable, current
              
              
              2,574,835
              
              
              4,685,236Total
                  liabilities
              
              
              37,880,305
              
              
              26,472,439Shareholders'
                  equity
              
              
              3,044,816
              
              
              26,865,920


**Statement
                  of Operations Data:**
              
              For
                  the Year Ended December 31,2006
              
              2005
                  (1)(2)
              
              2004
                  (2)Revenues
              
              $
              14,676,948
              
              $
              8,945,868
              
              $
              1,020,285Cost
                  of sales
              
              
              14,685,010
              
              
              10,245,516
              
              
              754,598Gross
                  profit (loss)
              
              
              (8,062
              )
              
              (1,299,648
              )
              
              265,687Operating
                  expenses
              
              
              31,015,685
              
              
              21,063,041
              
              
              5,573,575Loss
                  from continuing operations
              
              
              (31,023,747
              )
              
              (22,362,689
              )
              
              (5,307,888
              )Other
                  expenses, net
              
              
              8,192,812
              
              
              1,432,305
              
              
              -Loss
                  before discontinued operations
              
              
              (39,216,559
              )
              
              (23,794,994
              )
              
              (5,307,888
              )Loss
                  from discontinued operations
              
              
              (1,979,953
              )
              
              (4,518,339
              )
              
              (554,232
              )Net
                  loss
              
              $
              (41,196,512
              )
              $
              (28,313,333
              )
              $
              (5,862,120
              )Per
                  common share:Loss
                  before discontinued operations
              
              $
              (0.52
              )
              $
              (0.62
              )
              $
              (0.36
              )Net
                  loss
              
              $
              (0.55
              )
              $
              (0.74
              )
              $
              (0.40
              )


(1)
              Includes
                  the results of Caerus, Inc. and subsidiaries (“Caerus”) subsequent to
                  their acquisition in May 2005, and the results of WQN, Inc’s (“WQN”)
                  operations subsequent to acquiring substantially all of the assets
                  of
                  WQN’s VoIP business in October
                  2005.
 (2)
              Adjusted
                  to reflect discontinued operations classification pertaining to
                  the sale
                  of our DTNet Technologies subsidiary in April 2006, and 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.
 (3)
              Our
                  consolidated balance sheet at December 31, 2005 was restated to
                  reduce
                  both goodwill and stockholders’ equity by $2,360,000, which represented
                  contingent consideration (escrowed common shares - see Note J to
                  our
                  consolidated financial statements on page 66) related to the Caerus
                  acquisition. According to Statement of Financial Accounting Standards
                  No.
                  141, such contingent consideration should not have been included
                  in the
                  Caerus purchase price determination. Our consolidated statements
                  of
                  operations and cash flows for the year ended December 31, 2005
                  were not
                  affected.


**Comparability
      of Results**





The
      comparability of our results of operations is greatly impacted by the
      acquisition in May 2005 of Caerus and by the purchase in October 2005 of
      substantially all of the VoIP-related assets and business of WQN. The following
      table presents our pro forma results of operations for the year ended December
      31, 2005, assuming these business combinations had occurred at the beginning
      of
      2005.


Revenues
              
              $
              42,744,118Net
                  loss
              
              
              (41,217,317
              )Net
                  loss per share
              
              
              (1.07
              )**Revenues**


22




**Revenues**





Our
      consolidated revenues for the years ended December 31, 2006 and 2005
      (reclassified to exclude revenues from discontinued operations) were $14.7
      million and $8.9 million, respectively. Our consolidated loss before
      discontinued operations was $39.2 million ($0.52 per share) for the year ended
      December 31, 2006, as compared to a loss before discontinued operations of
      $23.8
      million ($0.62 per share) for the year ended December 31, 2005. The
      increases in our revenues and loss from 2005 to 2006 reflect the inclusion
      of
      the results of Caerus and the VoIP business of WQN from the dates of their
      acquisitions, coupled with increased financing activities. Revenues generated
      from the combined Caerus and WQN businesses were $14.5 million and $7.3 million
      in 2006 and 2005, respectively. Substantially all of the Caerus revenues for
      2006 (which represents 39% of our 2006 consolidated revenues) were generated
      by
      one customer. Revenues other than Caerus and WQN declined by $1.4 million due
      to
      our decreased emphasis on non-core markets in 2006, including hardware sales.
      Our results for 2006 and 2005 include losses before discontinued operations
      of
      $13.3 million and $8.6 million, respectively, generated by the combined Caerus
      and WQN businesses.





Our
      consolidated revenues for the years ended December 31, 2005 and 2004
      (reclassified to exclude revenues from discontinued operations) were $8.9
      million and $1.0 million, respectively. Our consolidated loss before
      discontinued operations was $23.8 million ($0.62 per share) for the year ended
      December 31, 2005, as compared to a loss before discontinued operations of
      $5.3
      million ($0.36 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 and the VoIP business of WQN, Inc. from the dates of their
      acquisitions. Revenues generated from the combined Caerus and WQN businesses
      were $7.3 million in 2005. Substantially all of the Caerus revenues for 2005
      (which represents 52% of our 2005 consolidated revenues) were generated by
      one
      customer. Our 2005 results include losses before discontinued operations of
      $8.6
      million generated by the combined Caerus and WQN businesses.





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





Consolidated
      cost of sales was $14.7 million and $10.2 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 and WQN from the dates of their acquisitions. Cost of sales from
      the
      combined Caerus and WQN businesses was $14.5 million and $8.7 million in 2006
      and 2005, respectively. The
      negative gross profit of $1.3 million (15% of revenues) in 2005 reflects costs
      paid to third party vendors that exceeded the revenues we charged to terminate
      the calls of our customers. We improved this negative gross margin in 2006
      to a
      substantial break-even by using lower cost routes and negotiating more favorable
      pricing. 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 $10.2 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 and WQN from the dates of their acquisitions. Cost of sales from
      the
      combined Caerus and WQN businesses was $8.7 million in 2005. The
      negative gross profit of $1.3 million (15% 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 $31.0 million and $21.1 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 $5.9 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 $5.0 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 $2.1 million in 2006, due primarily to a full year of
      amortization of intangible assets relating to the acquisition of Caerus and
      WQN
      assets in 2005.





We
      incurred significantly greater corporate operating expenses in 2005 ($21.2
      million) than in 2004 ($5.6 million) (reclassified to exclude revenues from
      discontinued operations), due to the increased size and complexity of our
      operations, resulting from the acquisition of Caerus and WQN assets in 2005.
      Included in 2005 operating expenses are $7.3 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, $3.1 million of depreciation and amortization, and $4.0 million
      of
      general and administrative expenses.




23




**Other
      Expenses, Net**





Consolidated
      net other expenses were $8.2 million and $1.4 million for the years ended
      December 31, 2006 and 2005 (reclassified to exclude operating expenses
      from discontinued operations), respectively. Amortization of debt discounts,
      the
      primary component of our reported interest expense, increased by $5.9 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 30 were allocated to these warrants, and recorded as a warrant liability
      on our balance sheet. Also, the May 2006 warrant repricing to $0.78 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 $0.78 per share. The effect was to increase
      the number of fully diluted shares of common stock to approximately 129 million,
      relative to our authorized 100 million common shares. Our total warrants then
      outstanding were approximately 28 million. 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.





Consolidated
      net other expenses were $1.4 million and $0 for the years ended
      December 31, 2005 and 2004 (reclassified to exclude operating expenses
      from discontinued operations), respectively. The expenses for 2005 include
      $1.6
      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 200,000 shares of our common stock
      held
      by the Purchaser; and (2) the return for cancellation of 200,000 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.





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




24


2006
              
              2005
              
              2004Revenues
              
              $
              14,308,466
              
              $
              6,561,277
              
              $
              807,908Cost
                  of sales
              
              
              13,968,554
              
              
              6,086,147
              
              
              617,547Gross
                  profit
              
              
              339,912
              
              
              475,130
              
              
              190,361Compensation
                  and benefits
              
              
              358,189
              
              
              402,110
              
              
              -Asset
                  impairment charges
              
              
              1,775,223
              
              
              4,173,452
              
              
              -Other
                  operating expenses
              
              
              186,453
              
              
              417,907
              
              
              744,593Net
                  loss
              
              $
              (1,979,953
              )
              $
              (4,518,339
              )
              $
              (554,232
              )





**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 and the termination of our Marketing and Distribution Agreement
      with Phone House, Inc., both 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 $40.9 million, down from $53.3 million at December 31, 2005. The
      decrease is due in part to $5.2 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, $1.8 million of net assets from discontinued
      operations at December 31, 2005 did not exist as such at December 31, 2006,
      because the 2006 amount was a net liability from discontinued
      operations.





Goodwill
      and other intangible assets comprised 80% of our consolidated total assets
      at
      December 31, 2006, attributable primarily to the acquisitions of Caerus and
      WQN
      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 $36.4 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 $0.26 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 $0.18 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.




25


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 $0.80 per share. These investors also received five-year warrants to purchase
      964,322 shares of our common stock for $1.37612 per share, five-year warrants
      to
      purchase 964,322 shares of our common stock for $1.6503 per share, and one-year
      warrants to purchase 1,928,644 shares of our common stock for $1.60 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 $0.80
      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 $0.78 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 $0.80. 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 $0.26 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 $0.18 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 $1.318 per share. These investors also received five-year warrants to
      purchase 4,537,052 shares of our common stock for $1.45889 per share, and
      one-year warrants to purchase 4,537,052 shares of the our common stock for
      $1.5915 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 $1.318 per share or 85% of the weighted average price
      of
      the stock on the OTCBB, but not less than $1.00 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 $1.00 per share or 85% of the weighted
      average price of the stock on the OTCBB, but not less than $0.80 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 $0.26 per share,
      and the outstanding warrants were re-priced to $0.475 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 $0.18 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 166,368 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 10,378,125 shares of our common stock at an exercise price of $0.407
      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 $0.28 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 $0.18 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 71 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.




26




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 19,237,328 shares of our common stock at an
      effective exercise price of $0.18 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
      $0.18 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 4,000,000 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 20,917,153 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 $0.26; 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 $0.475; and 5)  certain investors agreed
      to surrender their claims associated with warrants issued in May 2006 in
      exchange for 2,500,000 shares of our common stock through the issuance of freely
      trading securities issued pursuant to Section 3(a)(10) of the Securities
      Act.





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
      71, 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.




27




In
      connection with a private placement memorandum dated May 20, 2005, we issued
      2,242,500 shares of our common stock for $0.80 per share, and warrants to
      purchase 2,207,751 common shares at prices from $1.60 to $2.23 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
      226,500 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 1,375,000 shares of our common stock for $0.80
      per
      share, and warrants to purchase 2,225,000 common shares at prices ranging from
      $1.37 to $1.60 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 $0.18 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 5,850,000
      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 98,609,701 common
      shares were issued and outstanding, and approximately 141 million additional
      shares were contingently issuable upon the exercise of stock options and
      warrants, conversion of convertible securities, and increased authorized common
      shares. An additional 24 million 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 192 million shares,
      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 17). 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.





**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:




28


Contractual
                  Obligations
              
              Total
              
              Less
                  than
                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
              
              $
              -





**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, and from monthly recurring charges associated with Internet
      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 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. As of December 31, 2006 and 2005, the balance
      of
      the allowance for uncollectible accounts was $113,653 and $177,489,
      respectively.





*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.




29




*Discontinued
      Operations.*****Our operations formerly consisted of
      three segments: Telecommunication Services, Hardware Sales and Calling Card
      Sales. However, with our sale of DTNet Technologies and the termination of
      our
      Marketing and Distribution Agreement with Phone House, Inc. both 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 on page 69, 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, 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 $0.78 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
      $0.78 per share. The effect was to increase the number of our fully diluted
      shares to approximately 129 million, relative to our authorized 100 million
      shares. Our total warrants then outstanding were approximately 28 million.
      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 $0.25 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 $0.18 or $0.11 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.





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





The
      financial statements required by this item begin at page
      53 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.




30




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,
                  2004
              
              J
                  un
                  30,
                2004
              
              Sep
                    30,
                  2004
              
              Dec
                  31 ,
                2004
              
              Mar
                  31,
                2005
              
              J
                  un
                  30,
                2005
              
              Sep
                  30,
                2005
              
              Dec
                  31,
                2005
              
              Mar
                  31,
                2006
              
              J
                    un
                    30,
                  2006
              
              Sep
                    30,
                  2006
              
              Dec
                  31 ,
                2006(2)(Unaudited)Revenues
              
              $
              -
              
              $
              39,945
              
              
              333,309
              
              $
              647,031
              
              $
              1,006,111
              
              
              1,589,857
              
              
              1,776,155
              
              $
              4,573,745
              
              $
              4,700,400
              
              $
              4,267,641
              
              $
              2,670,961
              
              $
              3,037,946Gross
                  profit (loss)
              
              
              -
              
              
              11,379
              
              
              (24,615
              )
              
              278,924
              
              
              8,222
              
              
              528,602
              
              
              (922,381
              )
              
              (914,091
              )
              
              (719,030
              )
              
              142,723
              
              
              473,292
              
              
              94,952Income
                  (loss) fromcontinuing
                  operations
              
              
              (22,324
              )
              
              (417,024
              )
              
              (5,499,670
              )
              
              631,130
              
              
              (1,559,518
              )
              
              (3,482,529
              )
              
              (8,833,168
              )
              
              (9,919,778
              )
              
              (12,833,962
              )
              
              (5,160,815
              )
              
              (11,246,808
              )
              
              (9,974,974
              )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 fromcontinuing
                  operations
              
              $
              (0.01
              )
              $
              (0.03
              )
              $
              (0.28
              )
              $
              (0.01
              )
              $
              (0.06
              )
              $
              (0.13
              )
              $
              (0.21
              )
              $
              (0.17
              )
              $
              (0.20
              )
              $
              (0.08
              )
              $
              (0.16
              )
              $
              (0.10
              )Net
                  loss
              
              $
              (0.01
              )
              $
              (0.03
              )
              $
              (0.29
              )
              $
              0.02
              
              $
              (0.06
              )
              $
              (0.13
              )
              $
              (0.21
              )
              $
              (0.25
              )
              $
              (0.21
              )
              $
              (0.08
              )
              $
              (0.17
              )
              $
              (0.10
              )


(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 and Phone
                    House,
                    Inc. were discontinued in 2004, 2005 and 2006, respectively.
                    Operatingresults
                    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.





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.




31




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.





(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




32





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**





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 and Director
              
              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
  33


***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.





***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. ****





**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.




34




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.




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.




35




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 10,000,000 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 10,000,000 shares
      of
      our common stock each for Messrs. Cataldo and Lewis at an exercise price of
      $0.01 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 10,000,000 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.





36





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.


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 3,000,000 common shares at
                $0.36 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 3,000,000 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.




37




(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 100,000 options and 100,000
                warrants, subject to approval by our board of directors. The options
                and
                warrants will each be exercisable to purchase 100,000 shares of our
                common
                stock at $1.02 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 300,000
                common
                shares. Mr. Post's employment agreement also provided for the award
                of
                options and warrants to purchase a total of 3,000,000 shares of the
                Company's common stock at $1.00 a share until May 2011. On December
                12,
                2006 these options and warrants were converted to warrants to purchase
                3,000,000 of our common shares at $0.475 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.




38


**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 WarrantExercisable
                
                Unexercisable
                
                Price
                
                Expiration
                    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
                
                
                190,625
                
                
                59,375
                
                $
                1.02
                
                
                5/17/11*Chief
                    Accounting Officer*
                
                
                62,500
                
                
                38,500(9
                )
                $
                1.12
                
                
                6/3/10Gary
                    Post(3)
                
                
                3,000,000
                
                
                -
                
                $
                0.475
                
                
                12/12/16*Former
                    President, Chief Executive**Officer
                    and Chairman**(6)*Michael
                    Adler(4)
                
                
                500,000
                
                
                -
                
                $
                1.56
                
                
                10/18/10*Former
                    Chairman and Chief*
                
                
                500,000
                
                
                -
                
                $
                1.50
                
                
                10/18/10*Executive
                    Officer**(7)*David
                    Sasnett(5)
                
                
                450,000
                
                
                
                
                $
                1.53
                
                
                10/18/10*Former
                    Chief Financial Officer**(8)*





(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 3,000,000 shares of the Company's common stock
                at
                $1.00 a share until May 2011. On December 12, 2006 these options
                and
                warrants were converted to warrants to purchase 3,000,000 of the
                Company's
                common shares at $0.475 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 59,375 and 38,500 options vest ratably until May
                2009
                and June 2008, respectively.





39




**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)
              
              
              3,000,000
              
              $
              -
              
              
              -
              
              $
              -*Chief
                  Operating Officer;**Chief
                  Technology Officer*Robert
                  V. Staats
              
              
              -
              
              $
              -
              
              
              -
              
              $
              -*Chief
                  Accounting Officer*Gary
                  Post(3)
              
              
              -
              
              $
              -
              
              
              300,000
              
              $
              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)*




(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 3,000,000
                common shares at $0.36 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 3,000,000 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 300,000 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.





40




**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.
  Name
                  of Director
              
              Stock
                  AwardsAnthony
                  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 300,000
                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 $0.35
                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.





**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 on page 68 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.




41


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
              
              
              644,350
              
              $
              1.11
              
              
              13,355,650Equity
                  compensation plans not
                approved
                  by shareholders
              
              
              8,156,247
              
              
              1.00
              
              
              -Total
              
              
              8,800,597
              
              $
              1.01
              
              
              13,355,650




The
      above
      table excludes the 10,000,000 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 98,609,701 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)
              
              
              27,816,227
              
              
              23.1
              %14911
                  Quorum Drive, Suite 140Dallas,
                  Texas 75240Nicholas
                  A. Iannuzzi, Jr.
              
              
              307,355
              
              
              *Stuart
                  Kosh (4)
              
              
              2,968,750
              
              
              3.0
              %Shawn
                  Lewis (5,6)
              
              
              7,035,857
              
              
              7.0
              %Gary
                  Post (7)
              
              
              3,600,000
              
              
              3.5
              %Robert
                  Staats (8)
              
              
              253,125
              
              
              *Anthony
                  Cataldo (6)
              
              
              0
              
              
              *All
                  directors and executive officers as a
              
              
              14,165,087
              
              
              13.3
              %group
                  (6 persons) (9)
  *
                  Less than one percent.





(1)
            We
                have issued and outstanding 98,609,701 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 98,609,701 shares of common stock issued and outstanding as
                of March
                15, 2007.





(3)
            Consists
                of 5,787,429 shares of common stock and 22,028,798 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 $0.18 per share.





(4)
            Consists
                of (a) 1,962,500 shares of common stock; (b) currently exercisable
                options
                to purchase 156,250 shares of common stock; and (c) warrants to purchase
                850,000 shares of common stock.





(5)
            Consists
                of 7,035,857 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
                10,000,000 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 10,000,000 shares of our
                common
                stock each for Messrs. Cataldo and Lewis at an exercise price of
                $0.01 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 10,000,000 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 600,000 shares of common stock and warrants to purchase 3,000,000
                shares of common stock.





(8)
            Consists
                of warrants to purchase 150,000 shares of common stock and currently
                exercisable options to purchase 103,125 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. (“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
      500,000 shares of the our common stock.





On
      November 8, 2006, Mr. Lewis, our Chief Operating Officer and Chief Technology
      Officer, was granted options to purchase 3,000,000 common shares at $0.36 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 3,000,000 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)
              
              
              -
              
              
              -




(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.




44




(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.





45


**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(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
  46
  (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(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
  47
  (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(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
  48
  (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(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
  49
  (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(36)
              
              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(36)
              
              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(36)
              
              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(36)
              
              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(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
  50
  (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(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
                  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.





/s/
      Berkovits, Lago & Company, LLP




Fort
      Lauderdale, Florida


March 
      23, 2007




52


**VoIP,
                  Inc.****Consolidated
                  Balance Sheets**
  December
                  312006
              
              2005ASSETS
              
              
              
              (Restated)Current
                  assets:Cash
                  and cash equivalents
              
              $
              90,172
              
              $
              3,228,745Accounts
                  receivable, net of allowance for doubtful accountof
                  $113,653 and $177,489, respectively
              
              
              439,818
              
              
              471,649Due
                  from related parties
              
              
              31,227
              
              
              161,530Inventory
              
              
              -
              
              
              238,292Prepaid
                  expenses and deposits
              
              
              716,021
              
              
              935,320Total
                  current assets
              
              
              1,277,238
              
              
              5,035,536Property
                  and equipment, net
              
              
              6,860,233
              
              
              10,141,872Goodwill
                  and other intangible assets
              
              
              32,687,822
              
              
              36,044,271Net
                  assets of discontinued operations
              
              
              -
              
              
              1,767,475Other
                  assets
              
              
              99,828
              
              
              349,205TOTAL
                  ASSETS
              
              $
              40,925,121
              
              $
              53,338,359LIABILITIES
                  AND SHAREHOLDERS' EQUITYCurrent
                  liabilities:Accounts
                  payable
              
              $
              8,219,743
              
              $
              10,488,745Accrued
                  expenses
              
              
              4,853,007
              
              
              2,149,514Loans
                  payable
              
              
              2,574,835
              
              
              4,685,236Convertible
                  notes payable
              
              
              9,576,592
              
              
              3,399,798Fair
                  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
              
              
              -
              
              
              1,572,894Net
                  liabilities from discontinued operations
              
              
              354,398
              
              
              -Other
                  current liabilities
              
              
              557,153
              
              
              931,004Total
                  current liabilities
              
              
              37,657,636
              
              
              26,227,191Other
                  liabilities
              
              
              222,669
              
              
              245,248TOTAL
                  LIABILITIES
              
              
              37,880,305
              
              
              26,472,439Shareholders'
                  equity:Common
                  stock - $0.001 par value;100,000,000
                  shares authorized;98,609,701
                  and 59,523,397 sharesissued
                  and outstanding, respectively
              
              
              98,610
              
              
              59,523Additional
                  paid-in capital
              
              
              78,942,818
              
              
              61,606,497Accumulated
                  deficit
              
              
              (75,996,612
              )
              
              (34,800,100
              )Total
                  shareholders' equity
              
              
              3,044,816
              
              
              26,865,920TOTAL
                  LIABILITIES AND SHAREHOLDERS' EQUITY
              
              $
              40,925,121
              
              $
              53,338,359
  The
                  accompanying notes are an integral part of these consolidated financial
                  statements.




53




**VoIP
                  Inc.****Consolidated
                  Statements of Operations**
  Year
                  Ended December 312006
              
              2005
              
              2004Revenues
              
              $
              14,676,948
              
              $
              8,945,868
              
              $
              1,020,285Cost
                  of sales
              
              
              14,685,010
              
              
              10,245,516
              
              
              754,598Gross
                  profit (loss)
              
              
              (8,062
              )
              
              (1,299,648
              )
              
              265,687Operating
                  expensesCompensation
                  and related expenses
              
              
              13,184,377
              
              
              7,328,685
              
              
              3,800,336Commissions
                  and fees to third parties
              
              
              2,573,386
              
              
              4,823,786
              
              
              400,787Professional,
                  legal and consulting expenses
              
              
              6,852,584
              
              
              1,858,088
              
              
              430,432Depreciation
                  and amortization
              
              
              5,168,467
              
              
              3,111,042
              
              
              70,988General
                  and administrative expenses
              
              
              3,236,871
              
              
              3,941,440
              
              
              871,032Total
                  operating expenses
              
              
              31,015,685
              
              
              21,063,041
              
              
              5,573,575Loss
                  from continuing operations before income taxes
              
              
              (31,023,747
              )
              
              (22,362,689
              )
              
              (5,307,888
              )Other
                  (income) expenses:Interest
                  expense
              
              
              7,715,400
              
              
              1,638,489
              
              
              -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 expenses
              
              
              8,192,812
              
              
              1,432,305
              
              
              -Loss
                  before income taxes and results ofdiscontinued
                  operations
              
              
              (39,216,559
              )
              
              (23,794,994
              )
              
              (5,307,888
              )Provision
                  for income taxes
              
              
              -
              
              
              -
              
              
              -Net
                  loss before discontinued operations
              
              
              (39,216,559
              )
              
              (23,794,994
              )
              
              (5,307,888
              )Loss
                  from discontinued operations,net
                  of income taxes
              
              
              (1,979,953
              )
              
              (4,518,339
              )
              
              (554,232
              )Net
                  loss
              
              $
              (41,196,512
              )
              $
              (28,313,333
              )
              $
              (5,862,120
              )Basic
                  and diluted loss per share:Loss
                  before discontinued operations
              
              $
              (0.52
              )
              $
              (0.62
              )
              $
              (0.36
              )Loss
                  from discontinued operations,net
                  of income taxes
              
              
              (0.03
              )
              
              (0.12
              )
              
              (0.04
              )Net
                  loss per share
              
              $
              (0.55
              )
              $
              (0.74
              )
              $
              (0.40
              )Weighted
                  average number of shares outstanding
              
              
              75,329,007
              
              
              38,458,871
              
              
              14,597,312
  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
                  
                  2004CASH
                      FLOWS FROM OPERATING ACTIVITIESContinuing
                      operations:Net
                      loss
                  
                  $
                  (39,216,559
                  )
                  $
                  (23,794,994
                  )
                  $
                  (5,307,888
                  )Adjustments
                      to reconcile net loss to net cashused
                      in operating activities:Depreciation
                      and amortization
                  
                  
                  5,168,467
                  
                  
                  3,140,401
                  
                  
                  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
                  
                  
                  6,266,190
                  
                  
                  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
                  
                  
                  31,831
                  
                  
                  861,934
                  
                  
                  202,731Due
                      from related parties
                  
                  
                  130,303
                  
                  
                  (161,530
                  )
                  
                  -Inventory
                  
                  
                  238,292
                  
                  
                  495,241
                  
                  
                  171,800Prepaid
                      expenses and deposits
                  
                  
                  219,298
                  
                  
                  (583,783
                  )
                  
                  54,531Accounts
                      payable and accrued expenses
                  
                  
                  2,768,766
                  
                  
                  (4,474,899
                  )
                  
                  (1,113,607
                  )Other
                      current liabilities
                  
                  
                  (393,851
                  )
                  
                  870,948
                  
                  
                  (378,670
                  )Net
                      cash used in continuing operating activities
                  
                  
                  (12,366,745
                  )
                  
                  (17,668,683
                  )
                  
                  (2,368,342
                  )Discontinued
                      operations:Loss
                      from discontinued operations
                  
                  
                  (1,979,953
                  )
                  
                  (4,518,339
                  )
                  
                  (554,232
                  )Goodwill
                      impairment charge
                  
                  
                  839,101
                  
                  
                  4,173,452
                  
                  
                  -Provision
                      for assets & liabilties of discontinued operations
                  
                  
                  1,136,122
                  
                  
                  412,420
                  
                  
                  (408,000
                  )Net
                      cash provided by (used in) discontinued operating activities
                  
                  
                  (4,730
                  )
                  
                  67,533
                  
                  
                  (962,232
                  )Net
                      cash used in operating activities
                  
                  
                  (12,371,475
                  )
                  
                  (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 (Note J)
                  
                  
                  -
                  
                  
                  (1,290,727
                  )
                  
                  -Cash
                      from acquisitions
                  
                  
                  -
                  
                  
                  -
                  
                  
                  104,872(Purchase)
                      or disposition of other assets
                  
                  
                  249,377
                  
                  
                  267,940
                  
                  
                  (71,100
                  )Net
                      cash provided by (used in) continuing investing activities
                  
                  
                  230,855
                  
                  
                  (3,605,614
                  )
                  
                  (93,769
                  )Discontinued
                      operations:Net
                      assets - DTNet and Phone House (Note P)
                  
                  
                  (237,350
                  )
                  
                  (1,303,738
                  )
                  
                  573,363Net
                      cash provided by (used in) discontinued investing activities
                  
                  
                  (237,350
                  )
                  
                  (1,303,738
                  )
                  
                  573,363Net
                      cash provided by (used in) investing activities
                  
                  
                  (6,494
                  )
                  
                  (4,909,352
                  )
                  
                  479,594CASH
                      FLOWS FROM FINANCING ACTIVITIESProceeds
                      from issuance of notes payable and advances
                  
                  
                  13,337,094
                  
                  
                  10,656,104
                  
                  
                  360,000Proceeds
                      from common stock issuances
                  
                  
                  3,689,726
                  
                  
                  11,719,614
                  
                  
                  3,628,618Issuance
                      of stock for note conversions
                  
                  
                  -
                  
                  
                  2,465,286
                  
                  
                  -Repayment
                      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
                  
                  $
                  90,172
                  
                  $
                  3,228,745
                  
                  $
                  1,141,137
  The
                      accompanying notes are an integral part of these consolidated
                      financial
                      statements.
  55
 **VoIP,
                      Inc.****Consolidated
                      S tatements of Changes in S hareholders'
                      Equity****Years
                      Ended December 31, 2006, 2005 and
                      2004**
  Common
                        Stock
                      Shares
                  
                  Common
                        Stock
                      Amount
                  
                  Additional
                        Paid-
                      in
                        Capital
                  
                  Accumulated
                      Deficit
                  
                  TotalBalance
                      as of December 31, 2003
                  
                  
                  1,730,939
                  
                  $
                  1,731
                  
                  $
                  731,208
                  
                  $
                  (624,647
                  )
                  $
                  108,292Common
                      stock issued
                  
                  
                  12,500,000
                  
                  
                  12,500
                  
                  
                  -
                  
                  
                  -
                  
                  
                  12,500Common
                      stock issued to investors for cash received
                  
                  
                  5,520,566
                  
                  
                  5,521
                  
                  
                  3,610,598
                  
                  
                  -
                  
                  
                  3,616,119Common
                      stock issued for services
                  
                  
                  907,477
                  
                  
                  907
                  
                  
                  493,259
                  
                  
                  -
                  
                  
                  494,166Common
                      Stock issued for acquisition of DTNet Tech.
                  
                  
                  2,500,000
                  
                  
                  2,500
                  
                  
                  4,747,500
                  
                  
                  -
                  
                  
                  4,750,000Common
                      Stock issued for acquisition of Voip Americas
                  
                  
                  1,000,000
                  
                  
                  1,000
                  
                  
                  1,099,000
                  
                  
                  -
                  
                  
                  1,100,000Warrants
                      issued to two comp any officers
                  
                  
                  -
                  
                  
                  -
                  
                  
                  3,320,763
                  
                  
                  -
                  
                  
                  3,320,763Warrants
                      issued for intellectual property
                  
                  
                  100,000
                  
                  
                  100
                  
                  
                  105,000
                  
                  
                  -
                  
                  
                  105,100Loss
                      for the y ear
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (5,862,120
                  )
                  
                  (5,862,120
                  )Balance
                      December 31, 2004
                  
                  
                  24,258,982
                  
                  
                  24,259
                  
                  
                  14,107,328
                  
                  
                  (6,486,767
                  )
                  
                  7,644,820Common
                      Stock issued for services
                  
                  
                  2,994,592
                  
                  
                  2,995
                  
                  
                  3,377,479
                  
                  
                  -
                  
                  
                  3,380,474Common
                      stock issued to investors for cash received
                  
                  
                  6,740,038
                  
                  
                  6,740
                  
                  
                  8,022,598
                  
                  
                  -
                  
                  
                  8,029,338Common
                      stock issued for cash received, pursuant toexercise
                      of warrants
                  
                  
                  3,292,778
                  
                  
                  3,293
                  
                  
                  3,919,360
                  
                  
                  -
                  
                  
                  3,922,653Common
                      stock issued for debt conversions
                  
                  
                  4,054,536
                  
                  
                  4,054
                  
                  
                  2,461,232
                  
                  
                  -
                  
                  
                  2,465,286Common
                      Stock issued for acquisition of Caerus, Inc. (restated)
                  
                  
                  16,932,471
                  
                  
                  16,932
                  
                  
                  17,598,068
                  
                  
                  -
                  
                  
                  17,615,000Options
                      issued for acquisition of Caerus, Inc.
                  
                  
                  -
                  
                  
                  -
                  
                  
                  355,000
                  
                  
                  -
                  
                  
                  355,000Common
                      Stock issued for acquisition of WQN
                  
                  
                  1,250,000
                  
                  
                  1,250
                  
                  
                  1,298,250
                  
                  
                  -
                  
                  
                  1,299,500Value
                      of warrants issued for acquisition of WQN
                  
                  
                  -
                  
                  
                  -
                  
                  
                  5,200,000
                  
                  
                  -
                  
                  
                  5,200,000Value
                      of warrants and conversion features of debt issue
                  
                  
                  -
                  
                  
                  -
                  
                  
                  3,085,832
                  
                  
                  -
                  
                  
                  3,085,832Stock
                      compensation - amortization
                  
                  
                  -
                  
                  
                  -
                  
                  
                  242,101
                  
                  
                  
                  
                  
                  242,101Option
                      and warrant compensation - amortization
                  
                  
                  -
                  
                  
                  -
                  
                  
                  1,939,249
                  
                  
                  -
                  
                  
                  1,939,249Loss
                      for the y ear
                  
                  
                  -
                  
                  
                  -
                  
                  
                  -
                  
                  
                  (28,313,333
                  )
                  
                  (28,313,333
                  )Balance
                      December 31, 2005 (restated)
                  
                  
                  59,523,397
                  
                  
                  59,523
                  
                  
                  61,606,497
                  
                  
                  (34,800,100
                  )
                  
                  26,865,920Common
                      Stock issued for services
                  
                  
                  4,658,595
                  
                  
                  4,659
                  
                  
                  3,272,337
                  
                  
                  
                  
                  
                  3,276,996Common
                      stock issued for cash received, pursuant toexercise
                      of warrants
                  
                  
                  8,826,609
                  
                  
                  8,826
                  
                  
                  2,339,725
                  
                  
                  
                  
                  
                  2,348,551Common
                      stock issued for debt conversions
                  
                  
                  16,230,505
                  
                  
                  16,230
                  
                  
                  1,811,728
                  
                  
                  
                  
                  
                  1,827,958Common
                      stock issued for nonregistration andother
                      penalties, and interest
                  
                  
                  8,584,278
                  
                  
                  8,585
                  
                  
                  3,320,657
                  
                  
                  
                  
                  
                  3,329,242Common
                      stock issued for acquisition of Caerus, Inc.
                  
                  
                  666,667
                  
                  
                  667
                  
                  
                  259,333
                  
                  
                  
                  
                  
                  260,000Common
                      stock issued for cash received, pursuant to
                  
                  
                  319,650
                  
                  
                  320
                  
                  
                  330,753
                  
                  
                  
                  
                  
                  331,073exercise
                      of optionsCommon
                      stock acquired, DTNet sale
                  
                  
                  (200,000
                  )
                  
                  (200
                  )
                  
                  (383,800
                  )
                  
                  
                  
                  
                  (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
                  
                  
                  98,609,701
                  
                  $
                  98,610
                  
                  $
                  78,942,818
                  
                  $
                  (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 12,500,000 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 (“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.





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 and the termination of its Marketing and Distribution
      Agreement with Phone House, Inc., both 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. As of December 31, 2006 and 2005
      the
      balance of the allowance for uncollectible accounts amounted to $133,653 and
      $177,489, respectively.




**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 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
      are 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 statements 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 are charged
      to
      operating expenses based on the fair value of the stock at the date the stock
      rights are granted.




**Restatement**





The
      Company’s consolidated balance sheet at December 31, 2005 was restated to reduce
      both goodwill and stockholders’ equity by $2,360,000, which represented
      contingent consideration (escrowed common shares - see Note J) related to the
      Caerus acquisition. According to Statement of Financial Accounting Standards
      No.
      141 (“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.





**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.




59




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 do not expect the adoption of this Statement
      to
      have a material impact on its financial statements.





**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 2,242,500 shares of its common stock for $0.80 per share, and warrants
      to
      purchase 2,207,751 common shares at prices from $1.60 to $2.23 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
      1,482,500 shares and 226,500 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 1,375,000 shares of its common stock
      for
      $0.80 per share, and warrants to purchase 2,225,000 common shares at prices
      ranging from $1.37 to $1.60 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 $0.18 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 5,850,000 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.




60




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.




The
      Company's authorized common stock consisted of 100,000,000 common shares at
      December 31, 2006, of which 98,609,701 common shares were issued and
      outstanding, and approximately 141 million additional shares were
      contingently issuable upon the exercise of stock options and warrants, or
      conversion of convertible securities. An additional 24 million 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 192 million 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
                
                $
                8,766,749
                
                $
                9,381,372Furniture
                    & Fixtures
                
                
                91,647
                
                
                171,705Software
                
                
                666,842
                
                
                1,667,864Vehicles
                
                
                15,269
                
                
                15,269Leasehold
                    improvements
                
                
                105,075
                
                
                248,952Total
                
                
                9,645,582
                
                
                11,485,162Less
                    accumulated depreciation
                
                
                (2,785,349
                )
                
                (1,343,290
                )Total
                
                $
                6,860,233
                
                $
                10,141,872
  Depreciation
                    expense for the years ended December 31, 2006, 2005 and 2004
                    amounted to
                    $1,844,020, $1,208,331, 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 $21.2
      million in goodwill and approximately $11.5 million in other intangible assets
      recorded in connection with its acquisition in October 2005 of substantially
      all
      of the assets relating to the VoIP business of WQN, and 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
              
              
              
              
              $
              21,228,339
              
              $
              20,946,341Other
                  intangible assets:Useful
                  Life (Years)Technology
              
              
              4.0
              
              $
              6,000,000
              
              $
              6,000,000Customer
                  relationships
              
              
              5.0
                  - 6.0
              
              
              8,325,000
              
              
              8,325,000Trade
                  names
              
              
              9.0
              
              
              1,700,000
              
              
              1,700,000Non-compete
                  agreement
              
              
              1.0
              
              
              500,000
              
              
              500,000Other
                  intangible assets
              
              
              Indefinite
              
              
              200,000
              
              
              200,000Subtotal
              
              
              
              
              
              16,725,000
              
              
              16,725,000Accumulated
                  amortization
              
              
              
              
              
              (5,265,517
              )
              
              (1,627,070
              )Other
                  intangible assets, net
              
              
              
              
              
              11,459,483
              
              
              15,097,930Total
                  goodwill and other intangible assets
              
              
              
              
              $
              32,687,822
              
              $
              36,044,271





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 $3,324,447, $1,627,070 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.





62


**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:


Convertible
                  Notes Payable
              
              Fair
                  Value Liability for Warrants2006
              
              2005
              
              2006
              
              2005Payable
                  to WQN, Inc. (1)
              
              $
              3,700,000
              
              $
              3,700,000
              
              $
              -
              
              $
              -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
              
              
              15,447,520
              
              
              5,196,804
              
              
              5,102,731
              
              
              -Less
                  discounts
              
              
              (5,870,928
              )
              
              (1,797,006
              )
              
              -
              
              
              -Total
              
              $
              9,576,592
              
              $
              3,399,798
              
              $
              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. While WQN has not declared the note
                  in default,
                  the full amount of the note at December 31, 2006, has been
                  classified as current.
 
 (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 $0.80 per share.
                  These
                  investors also received five-year warrants to purchase 964,322
                  shares of
                  the Company's common stock for $1.37612 per share, five-year warrants
                  to
                  purchase 964,322 shares of the Company's common stock for $1.6503
                  per
                  share, and one-year warrants to purchase 1,928,644 shares of the
                  Company's
                  common stock for $1.60 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 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 $0.80 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 $0.78
                  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 $0.80. 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 $0.26 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 $0.18
                  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
                    $1.318 per
                    share. These investors also received five-year warrants to purchase
                    4,537,052 shares of the Company's common stock for $1.45889 per
                    share, and
                    one-year warrants to purchase 4,537,052 shares of the Company's
                    common
                    stock for $1.5915 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 $1.318 per
                    share or
                    85% of the weighted average price of the stock on the OTCBB,
                    but not less
                    than $1.00 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 $1.00 per share or
                    85% of the
                    weighted average price of the stock on the OTCBB, but not less
                    than $0.80
                    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 $0.26 per share, and the outstanding warrants were
                    re-priced to
                    $0.475 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 $0.18 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 166,368 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 20,917,153 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 $0.26;
                  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 $0.475; and 5)  certain investors agreed to surrender
                  their claims associated with warrants issued in May 2006 in exchange
                  for
                  2,500,000 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.
 
 (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 10,378,125
                    shares of
                    the Company's common stock at an exercise price of $0.407 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 $0.28 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 $0.18 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.
 
 64


(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 $0.78 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 $0.78 per share. The effect was to increase the number of
      fully diluted shares of common stock at the time to approximately 129 million,
      relative to the Company's then-authorized 100 million common shares. The
      Company's total warrants then outstanding were approximately 28 million. 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 and 2005, nonregistration penalties and other stock-based
      payables consisted of the following:


2006
              
              2005Nonregistration
                  penalties payable:In
                  cash
              
              $
              1,658,858
              
              $
              -In
                  common stock and warrants
              
              
              1,342,299
              
              
              -Common
                  stock payable to officer
              
              
              732,678Common
                  stock payable to directors
              
              
              210,000
              
              
              -Common
                  stock payable to investors
              
              
              347,419
              
              
              -Common
                  stock payable for other services rendered
              
              
              439,200
              
              
              -Total
              
              $
              4,730,454
              
              $
              -


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 3,000,000 shares of common stock. Since the Company had insufficient
      authorized common shares at December 31, 2006, only 964,782 shares were issued,
      and the balance of 2,035,218 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).




65




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 14,400,000 of the Company's common shares
      (excluding 2,000,000 escrowed common shares, 666,667 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), 1,250,000 shares of the Company's common stock,
      and 5,000,000 warrants to purchase the Company's common stock at $0.001 per
      share.





Condensed
      balance sheets of the Caerus and WQN acquisitions, reflecting the net fair
      value
      amounts assigned to each major asset and liability, as of their respective
      acquisition dates are as follows:


Caerus,
                  Inc.
              
              WQN,
                  Inc.(Restated)Current
                  assets
              
              $
              617,000
              
              $
              3,775,000Property
                  and equipment, net
              
              
              7,869,000
              
              
              508,000Other
                  assets
              
              
              131,000
              
              
              463,000Accounts
                  payable and other current liabilities
              
              
              (14,674,000
              )
              
              (2,031,000
              )Note
                  payable
              
              
              (4,832,000
              )
              
              -Net
                  liabilities assumed
              
              
              (10,889,000
              )
              
              2,715,000Goodwill
              
              
              15,418,000
              
              
              4,120,000Intangible
                  assets - other
              
              
              13,800,000
              
              
              2,925,000Intangible
                  assets
              
              
              29,218,000
              
              
              7,045,000Net
                  fair value assets acquired
              
              $
              18,329,000
              
              $
              9,760,000




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.




66




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.
 
 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 500,000 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.




67





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
      475,000 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 4,000,000 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 10,000,000 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:


Number
              
              Exercise
                  Price
                Range
              
              Wtd.
                    Avg.Exercise PriceOptions
                  outstanding at December 31, 2005
              
              
              3,746,562
              
              
              $0.85
                  - $1.56
              
              $
              1.21Options
                  returned to the plan dueto
                  employee terminations
              
              
              (2,782,562
              )
              
              $0.85
                  - 1.56
              
              $
              1.29Options
                  granted
              
              
              3,000,000
              
              
              $0.36
              
              $
              0.36Options
                  exercised
              
              
              (3,319,650
              )
              
              $0.36
                  - $1.56
              
              $
              0.43Options
                  outstanding at December 31, 2006
              
              
              644,350
              
              
              $0.85
                  - $1.56
              
              $
              1.11




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 10,000,000 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 10,000,000 shares of the Company's common stock
      each
      for Messrs. Cataldo and Lewis at an exercise price of $0.01 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 10,000,000 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 3,000,000 shares of the
      Company's common stock at $0.36 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
      3,000,000 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.




68




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 644,350 shares of common stock,
      at
      exercise prices ranging from $0.85 to $1.56 per share, and at a weighted average
      exercise price of $1.11 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
      8,826,609, 4,400,000 and 0 shares, respectively, of common stock in exchange
      for
      these warrants. As of December 31, 2006, the Company had outstanding 15,780,776
      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 $0.26 to $2.60 per share, and at a weighted
      average exercise price of $1.09 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:




Year
                  ending December 31,2007
              
              $
              268,5562008
              
              
              98,3862009
              
              
              43,7362010
              
              
              -Total
              
              $
              410,678


Rent
      expense for these leases for the years ended December 31, 2006, 2005, and 2004
      was $233,355, $144,833
      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**





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 200,000 shares of the
      Company's common stock held by the Purchaser; and (2) the return for
      cancellation of 200,000 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.




69




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.





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




2006
              
              2005
              
              2004Revenues
              
              $
              14,308,466
              
              $
              6,561,277
              
              $
              807,908Cost
                  of sales
              
              
              13,968,554
              
              
              6,086,147
              
              
              617,547Gross
                  profit
              
              
              339,912
              
              
              475,130
              
              
              190,361Compensation
                  and benefits
              
              
              358,189
              
              
              402,110
              
              
              -Asset
                  impairment charges
              
              
              1,775,223
              
              
              4,173,452
              
              
              -Other
                  operating expenses
              
              
              186,453
              
              
              417,907
              
              
              744,593Net
                  loss
              
              $
              (1,979,953
              )
              $
              (4,518,339
              )
              $
              (554,232
              )





**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
              
              $
              6,259,445
              
              $
              7,025,848
              
              $
              2,040,000Deferred
                  benefit (expense)
              
              
              2,334,449
              
              
              (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
              
              
              -
              
              
              -
              
              
              -




70


At
                  December 31, 2006, the Company's net deferred tax assets consisted
                  of the
                  following:
  Net
                  operating loss carryforwards
              
              $
              14,703,783Excess
                  tax over book depreciation expense
              
              
              (634,033
              )Excess
                  book over tax amortization of debt discounts
              
              
              2,130,505Discontinued
                  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.




**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 $0.26 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 $0.26 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 $0.18 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 19,237,328
      shares of the Company's common stock at an effective exercise price of $0.18
      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 $0.18 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 4,000,000 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.




71





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
      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.





**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
      22,008,524 shares of the Company’s common stock.




72





**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"),
      CAERUS, INC. ("CAERUS"), and WQN, Inc. (“WQN”).





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.





On
      October 6, 2005, the Company purchased substantially all of the assets of WQN,
      Inc. relating to WQN’s “Voice over Internet Protocol” business. Such assets
      consist of WQN’s properties and infrastructure for its services platform for
      both retail and wholesale voice over Internet business.





The
      unaudited pro forma condensed combined statements of operation for the year
      ended December 31, 2005 assumes that the mergers of Caerus, WQN 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, Caerus and WQN for any future period.




73


**VoIP,
                  Inc****Pro
                  Forma Condensed Combined Statement of Operations
                  (Unaudited)****Year
                  Ended December 31, 2005**
  VoIP,
                  Inc
              
              Caerus,
                  Inc
              
              WQN,
                  Inc
              
              Adjustments
              
              ConsolidatedRevenues
              
              $
              4,273,028
              
              
              11,312,596
              
              $
              27,158,494
              
              $
              -
              
              $
              42,744,118Cost
                  of sales
              
              
              3,908,523
              
              
              14,814,908
              
              
              25,796,559
              
              
              -
              
              
              44,519,990Gross
                  profit
              
              
              364,505
              
              
              (3,502,312
              )
              
              1,361,935
              
              
              -
              
              
              (1,775,872
              )Operating
                  expenses
              
              
              15,198,094
              
              
              8,583,676
              
              
              5,018,437
              
              
              3,660,556
              
              
              32,460,763Loss
                  from continuing operationsbefore
                  income taxes
              
              
              (14,833,589
              )
              
              (12,085,988
              )
              
              (3,656,502
              )
              
              (3,660,556
              )
              
              (34,236,635
              )Gain
                  on sale of fixed assets
              
              
              (206,184
              )
              
              
              
              
              
              
              
              
              
              
              (206,184
              )Interest
                  expense
              
              
              1,238,938
              
              
              786,389
              
              
              -
              
              
              643,200
              
              
              2,668,527Loss
                  before income taxes and results ofdiscontinued
                  operations
              
              
              (15,866,343
              )
              
              (12,872,377
              )
              
              (3,656,502
              )
              
              (4,303,756
              )
              
              (36,698,978
              )Provision
                  for income taxes
              
              
              -
              
              
              -
              
              
              -
              
              
              -
              
              
              -Net
                  loss before discontinued operations
              
              
              (15,866,343
              )
              
              (12,872,377
              )
              
              (3,656,502
              )
              
              (4,303,756
              )
              
              (36,698,978
              )Loss
                  from discontinued operations,net
                  of income taxes
              
              
              (4,518,339
              )
              
              -
              
              
              -
              
              
              -
              
              
              (4,518,339
              )Net
                  Loss
              
              $
              (20,384,682
              )
              $
              (12,872,377
              )
              $
              (3,656,502
              )
              $
              (4,303,756
              )
              $
              (41,217,317
              )Basic
                  and diluted loss per share:Loss
                  before discontinued operations
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (0.95
              )Loss
                  from discontinued operations,net
                  of income taxes
              
              
              
              
              
              
              
              
              
              
              
              
              
              
              (0.12
              )Net
                  Loss
              
              
              
              
              
              
              
              
              
              
              
              
              
              $
              (1.07
              )Weighted
                  average number of shares outstanding
              
              
              
              
              
              
              
              
              
              
              
              
              38,458,871
 74





**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)
      Historical financial information for WQN, Inc. for the year ended December
      31,
      2005 has been derived from WQN, Inc.’s historical financial
      statements.





(4)
      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 16,434,470 shares of common
      stock, par value $0.001, of the Company.





(5)
      On
      October 6, 2005, the Company purchased substantially all of the assets of WQN,
      Inc. relating to WQN’s “Voice over Internet Protocol” business. Such assets
      consist of WQN’s properties and infrastructure for its services platform for
      both retail and wholesale voice over Internet business.





(6)
      Pro
      Forma Statements of Operations Adjustments





Adjustments
      to the pro forma Statements of Operations represent amortization of intangible
      assets and interest expense related to convertible debt recorded in connection
      with the acquisitions.




75


**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*





76


**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.




77


**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.




78


**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
              
              
              -
              
              
              150,643-NET
                  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.




79


**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.








80





**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.




81





**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).




82




**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.




83




**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.




84





**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.





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.




85




**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.





**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.




86




**REPORT
      OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM**









To
      the
      Board of Directors




WQN,
      Inc.
      and Subsidiaries









We
      have
      audited the accompanying consolidated balance sheets of WQN, Inc. (a Delaware
      corporation) formerly known as WorldQuest Networks, Inc. and subsidiaries (“the
      Company”) as of December 31, 2004 and 2003, and the related consolidated
      statements of operations, changes in stockholders’ equity, and cash flows for
      the years then ended. 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 audit 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 audit 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 WQN, Inc. and subsidiaries as
      of
      December 31, 2004 and 2003, and the results of its operations and its cash
      flows
      for the years then ended in conformity with accounting principles generally
      accepted in the United States of America.




As
      more
      fully discussed in Note 20 to the financial statements, the Company sold
      substantially all of its operating assets and liabilities to an unrelated
      third-party.




/s/
      Berkovits, Lago & Company, LLP




Fort
        Lauderdale, Florida
 October
        16, 2006




87


**WQN,
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        BALANCE SHEETS**
  December
                  31,2004
              
              2003**ASSETS**Current
                  assets:Cash
                  and cash equivalents
              
              $
              9,942,280
              
              $
              17,931,820Investment
                  in partnership
              
              
              2,944,243
              
              
              -Accounts
                  receivable, net of allowances of $25,000 in 2004 and 2003
              
              
              689,885
              
              
              553,251Notes
                  receivable
              
              
              2,408,679
              
              
              -Prepaid
                  expenses and other current assets
              
              
              806,068
              
              
              557,577Total
                  current assets
              
              
              16,791,155
              
              
              19,042,648Property
                  and equipment, net
              
              
              597,522
              
              
              1,039,783Note
                  receivable
              
              
              204,167
              
              
              -Other
                  assets, net
              
              
              972,794
              
              
              101,192Total
                  assets
              
              $
              18,565,638
              
              $
              20,183,623**LIABILITIES
                  AND STOCKHOLDERS’ EQUITY**Current
                  liabilities:Accounts
                  payable
              
              $
              1,630,088
              
              $
              1,108,152Accrued
                  expenses
              
              
              457,459
              
              
              471,746Deferred
                  revenue
              
              
              444,988
              
              
              254,121Promissory
                  note
              
              
              300,000
              
              
              -Total
                  current liabilities
              
              
              2,832,535
              
              
              1,834,019Promissory
                  note
              
              
              -
              
              
              300,000Stockholders’
                  equity:Preferred
                  stock, par value $0.01 per share:Authorized
                  shares—10,000,000; none issued and outstanding
              
              
              -
              
              
              -Common
                  stock, par value $.01 per share:Authorized
                  shares—50,000,000; issued and outstanding shares — 6,830,062 at December
                  31, 2004 and — 6,386,199 at December 31, 2003
              
              
              68,301
              
              
              63,862Additional
                  capital
              
              
              43,180,859
              
              
              41,994,594Accumulated
                  deficit
              
              
              (27,516,057
              )
              
              (24,008,852
              )Total
                  stockholders’ equity
              
              
              15,733,103
              
              
              18,049,604Total
                  liabilities and stockholders’ equity
              
              $
              18,565,638
              
              $
              20,183,623
 
 The
        accompanying notes are an integral part of these consolidated financial
        statements.
  88
  **WQN,
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF OPERATIONS**
  Year
                  ended December 31,2004
              
              2003Retail
                  telephony revenue
              
              $
              9,036,354
              
              $
              9,152,320Wholesale
                  telephony revenue and other
              
              
              6,227,452
              
              
              206,572Total
                  revenue
              
              
              15,263,806
              
              
              9,358,892Cost
                  of revenue
              
              
              13,536,886
              
              
              7,008,908Gross
                  profit
              
              
              1,726,920
              
              
              2,349,984Operating
                  expenses:Selling,
                  general and administrative
              
              
              3,901,045
              
              
              4,517,784Merger
                  expenses
              
              
              1,311,945
              
              
              -Depreciation
                  and amortization
              
              
              796,426
              
              
              921,900Total
                  operating expenses
              
              
              6,009,416
              
              
              5,439,684Operating
                  loss
              
              
              (4,282,496
              )
              
              (3,089,700
              )Interest
                  income, net
              
              
              287,709
              
              
              202,187Loss
                  from partnership investment
              
              
              (55,757
              )
              
              -Loss
                  from continuing operations
              
              
              (4,050,544
              )
              
              (2,887,513
              )Income
                  (loss) from discontinued operations
              
              
              543,339
              
              
              (457,879
              )Net
                  loss
              
              $
              (3,507,205
              )
              $
              (3,345,392
              )Income
                  (loss) per share - basic and diluted:Continuing
                  operations
              
              $
              (0.61
              )
              $
              (0.45
              )Discontinued
                  operations
              
              
              0.08
              
              
              (0.07
              )Income
                  (loss) per share
              
              $
              (0.53
              )
              $
              (0.52
              )Weighted-average
                  common shares outstanding - basic and diluted
              
              
              6,642,005
              
              
              6,386,199
  The
        accompanying notes are an integral part of these consolidated financial
        statements.
 
 89
  **WQN,
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY**
  Common
                  Stock
              
              Additional
                  Capital
              
              Accumulated
                  DeficitShares
              
              Amount
              
              TotalBalance
                  at December 31, 2002
              
              
              6,386,199
              
              $
              63,862
              
              $
              41,994,594
              
              $
              (20,663,460
              )
              $
              21,394,996Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (3,345,392
              )
              
              (3,345,392
              )Balance
                  at December 31, 2003
              
              
              6,386,199
              
              
              63,862
              
              
              41,994,594
              
              
              (24,008,852
              )
              
              18,049,604Issuance
                  of warrants
              
              
              -
              
              
              -
              
              
              76,000
              
              
              -
              
              
              76,000Exercise
                  of stock options
              
              
              443,863
              
              
              4,439
              
              
              1,110,265
              
              
              -
              
              
              1,114,704Net
                  loss
              
              
              -
              
              
              -
              
              
              -
              
              
              (3,507,205
              )
              
              (3,507,205
              )Balance
                  at December 31, 2004
              
              
              6,830,062
              
              $
              68,301
              
              $
              43,180,859
              
              $
              (27,516,057
              )
              $
              15,733,103
  The
        accompanying notes are an integral part of these consolidated financial
        statements.
 
 90
  **WQN,
        INC. AND SUBSIDIARIES**
 **CONSOLIDATED
        STATEMENTS OF CASH FLOWS**
 
 Year
                  ended December 31,2004
              
              2003**Operating
                  Activities**Net
                  loss
              
              $
              (3,507,205
              )
              $
              (3,345,392
              )**Adjustments
                  to reconcile net loss to net cash used in operating
                  activities:**Gain
                  on sale of operations
              
              
              (777,114
              )
              
              -Depreciation
                  and amortization
              
              
              796,426
              
              
              921,900Loss
                  on disposition of property and equipment, net
              
              
              76,522
              
              
              18,541(Income)
                  loss in investment in partnership
              
              
              55,757
              
              
              -Changes
                  in operating assets and liabilities net of effects of
                  acquisitions:Accounts
                  receivable and notes receivable
              
              
              (227,585
              )
              
              4,243Accounts
                  payable and accrued expenses
              
              
              283,649
              
              
              237,297Deferred
                  revenue
              
              
              190,867
              
              
              15,185Other
                  assets
              
              
              (1,122,886
              )
              
              (235,772
              )Net
                  cash used in operating activities of continuing operations
              
              
              (4,231,569
              )
              
              (2,383,998
              )**Investing
                  Activities**Additions
                  to property and equipment
              
              
              (436,423
              )
              
              (405,389
              )Proceeds
                  from the sale of subsidiary net of disposed cash
              
              
              417,915
              
              
              -Payments
                  received on note from the sale of subsidiary
              
              
              145,833
              
              
              -Loan
                  to Ntera Holdings, Inc.
              
              
              (2,000,000
              )
              
              -Purchase
                  of partnership interest
              
              
              (3,000,000
              )
              
              -Net
                  cash used in investing activities
              
              
              (4,872,675
              )
              
              (405,389
              )**Financing
                  Activities**Proceeds
                  from exercise of stock options
              
              
              1,114,704
              
              
              -Decrease
                  in cash and cash equivalents
              
              
              (7,989,540
              )
              
              (2,789,387
              )Cash
                  and cash equivalents at beginning of year
              
              
              17,931,820
              
              
              20,721,207Cash
                  and cash equivalents at end of year
              
              $
              9,942,280
              
              $
              17,931,820Supplemental
                  Disclosures of Cash Flow Information:Interest
                  paid
              
              $
              4,538
              
              $
              4,692Non-cash
                  note receivable from sale of subsidiary
              
              $
              700,000
              
              $
              -
  The
        accompanying notes are an integral part of these consolidated financial
        statements.
  91
  **WQN,
        INC. AND SUBSIDIARIES**
  **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS**
 **Years
        ended December**  **31,
        2004 and 2003**
  **1.
        Organization and Description of Business**
  We
        are a
        Voice Over Internet Protocol (“VoIP”) telephony company providing international
        long distance services. VoIP enables voice communications over the Internet
        by
        compressing voice into data packets that can be efficiently transmitted over
        data networks and then converted back into voice at the receiving end. Our
        customers utilize our enhanced VoIP services platform to make and receive
        calls
        using their home phone, business phone, personal computer and mobile
        phone.
  Our
        business currently includes the provision of enhanced Internet-based and
        other
        telephony services under various brand names to individual consumers primarily
        seeking to make international calls; the provision of enhanced Internet-based
        and other telephony services to resellers, corporations and service providers
        under their brand names and carrier transmission services whereby we sell
        our
        excess capacity to other long-distance carriers. We also distribute telephony
        services including prepaid long- distance and prepaid wireless through a
        network
        of over 90 private distributors. Through this network we estimate that our
        products are sold through over 10,000 retail outlets of which more than 5,000
        retail outlets are located in Southern California. We expect to begin selling
        our proprietary VoIP products through this distribution channel beginning
        in
        2005.
  As
        of
        December **** 31,
        2004,
        Eagle Venture Capital, LLC (“Eagle Venture”) owned approximately 2.6 million, or
        38%, of our outstanding shares of common stock. Eagle Venture is primarily
        owned
        by B. Michael Adler, our founder and Chief Executive Officer.
 
 In
        November 2004, we changed our name to WQN, Inc. from WorldQuest Networks,
        Inc. (see Note 18).
 
 **2.
        Significant Accounting Policies**
  *Use
        of Estimates*
 
 The
        preparation of financial statements in conformity with generally accepted
        accounting principles 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 liabilities at the date of the
        financial statements and the reported amounts of revenues and expenses during
        the reporting period. Management believes the estimates used in preparing
        the
        financial statements are reasonable; however, actual results could differ
        from
        these estimates.
 
 *Principles
        of Consolidation*
 
 The
        consolidated financial statements include the accounts of the Company, its
        subsidiaries and joint ventures in which the Company owns a controlling
        interest. Investments in 20% to 50% owned partnerships and affiliates are
        accounted for on the equity method. All significant intercompany balances
        and
        transactions have been eliminated in consolidation.
 
 *Reclassifications*
 
 Certain
        reclassifications have been made to the 2003 financial statements to conform
        to
        the 2004 presentation.
 
 *Cash
        Equivalents*
 
 Cash
        equivalents include money market mutual funds and other highly liquid
        investments purchased with maturities of three months or less.
 
 *Depreciation
        and Amortization*
 
 Property
        and equipment are recorded at cost and depreciated using the straight-line
        method over the estimated useful lives of the assets. Amortization of capital
        leases and leasehold improvements is provided on a straight line basis over
        the
        lives of the related assets or the life of the lease, whichever is shorter,
        and
        is included with depreciation expense. Maintenance repairs are charged to
        operations as incurred. Gains and losses on the disposition of property and
        equipment are recorded in the period incurred.
 
 Depreciation
        expense totaled $500,778 and $820,709 for 2004 and 2003, respectively.
        Amortization expense totaled $295,648 for 2004 and $101,191 for 2003 for
        continuing operations and $107,297 for 2004 and $153,863 for 2003 for
        discontinued operations.
  92
  **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  *Impairment
        of Long-lived Assets*
 
 The
        Company evaluates long-lived assets, including intangible assets, for impairment
        whenever events or changes in circumstances indicate the carrying amount
        of an
        asset may not be recoverable and the undiscounted cash flows to be generated
        by
        these assets are less than the carrying amounts of these assets. For the
        year
        ended December **** 31,
        2004
        the Company determined that certain stored value equipment could no longer
        be
        used and recorded a non-cash impairment charge of approximately
        $60,000.
 
 *Website
        Development Costs*
 
 Costs
        related to the planning and post implementation phases of our website
        development efforts are expensed. Direct costs incurred in the development
        phase
        are capitalized and amortized over the product **’** s
        estimated useful life of one to three years and are included in depreciation
        expense. Costs associated with minor enhancements and maintenance for the
        website are expensed. Website development costs capitalized for the years
        ended
        December **** 31,
        2004
        and 2003 were $243,986 and $190,000, respectively.
 
 *Income
        Taxes*
 
 Income
        taxes are determined using the liability method, which gives consideration
        to
        the future tax consequences associated with differences between the financial
        accounting and tax basis of assets and liabilities. This method also gives
        immediate effect to changes in income tax laws.
 
 *Revenue
        Recognition*
 
 Retail
        telephony revenue is recorded net of estimated returns and allowances and
        is
        recognized as calling services are used. Wholesale traffic revenue is recognized
        as calls are processed. Revenue on the distribution of telephony products
        is
        included in wholesale telephony revenue, is recorded net of estimated returns
        and allowances and is recognized when the products are shipped to the customer.
        Distribution products are processed by other carriers therefore no future
        service is provided by the Company.
 
 *Intangible
        Assets*
 
 Intangible
        assets consist primarily of acquired customer lists and are included in other
        assets. Amortization is provided for by the straight-line method over the
        assets
        estimated life ranging from 2 to 4 **** years.
        At
        December **** 31,
        2004
        intangible assets totaled $972,794 net of accumulated amortization of $337,136.
        The estimated aggregate amortization for each of the succeeding years is
        as
        follows: 2005 - $362,395, 2006 - $295,269, 2007 - $253,711, 2008 -
        $61,419.
 
 *Investment
        in Partnership*
 
 The
        Company **’** s
        investment in partnership is accounted for on the partnership basis of
        accounting. Gains and losses are included in income (loss) **** from
        partnership investment. The Company can receive a distribution on its partner
        capital account by giving the partnership 60 **** days
        written notice.
 
 *Notes
        Receivable*
 
 Notes
        receivable represent balances due from third parties related to the sale
        of its
        wholly-owned subsidiary buyindiaonline.com, Inc. and the merger agreement
        with
        Ntera Holdings. Interest earned on notes receivable are recognized over the
        term
        of the note and is included in interest income, net.
 
 *Advertising
        Costs*
 
 The
        Company expenses advertising costs as incurred. Advertising expense for the
        years ended December **** 31,
        2004
        and 2003 was $467,000 and $334,000, respectively.
 
 93
  **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  *Stock-Based
        Compensation*
 
 The
        Company has elected to follow Accounting Principles Board Opinion
        No. **** 25,
        “Accounting for Stock Issued to Employees,” in the primary financial statements
        and has provided supplemental disclosures required by Statement of Financial
        Accounting Standards No. **** 123,
        “Accounting for Stock-Based Compensation” (“SFAS 123”) and by Statement of
        Financial Accounting Standards No. **** 148,
        “Accounting for Stock-Based Compensation **-** Transition and Disclosure an amendment of FASB Statement No. **** 123.”
        SFAS **** 123
        requires the disclosure of pro forma net loss and loss per share computed
        as if
        the Company had accounted for its employee stock options under the fair value
        method set forth in SFAS 123. The Company **’** s
        reported and pro forma net loss for the years ending December 31, 2004 and
        2003
        are as follows:
 
 **Year
                  ended December 31,****2004**
              
              **2003**Net
                  loss as reported
              
              $
              (3,507,205
              )
              $
              (3,345,392
              )Pro
                  forma stock-based employee compensation expense
              
              
              (202,499
              )
              
              (170,863
              )Pro
                  forma net loss
              
              $
              (3,376,470
              )
              $
              (3,516,255
              )Net
                  loss per share:As
                  reported - basic and diluted
              
              $
              (0.53
              )
              $
              (0.52
              )Pro
                  forma - basic and diluted
              
              $
              (0.56
              )
              $
              (0.55
              )
  The
        fair
        value of options granted was estimated at the date of grant using the
        Black-Scholes option pricing model. The following weighted average assumptions
        used in the December **** 31,
        2004
        calculation were as follows: risk free interest rate of 3.5%, dividend yield
        of
        zero, volatility factor of 1.1, and average expected life of 4 **** years.
        The weighted average assumptions used in the December **** 31,
        2003
        calculation were as follows: risk free interest rate of 3.25%, dividend yield
        of
        zero, volatility of .85 and average expected life of 5 **** years.
        The options granted during 2004 and 2003 had a weighted average fair value
        of
        $1.50 and $1.40 per share, respectively.
 
 *Net
        Loss per Share*
 
 Basic
        and
        diluted net loss per share is computed using the Company **’** s
        net
        loss for each period presented divided by the average common shares outstanding
        during the period. Stock options and warrants convertible into 1,267,759
        and
        1,790,556 shares of the Company **’** s
        common
        stock for the years ended December **** 31,
        2004
        and 2003, respectively, are excluded from the calculation of diluted earning
        per
        share because the Company reported losses from continuing operations in those
        periods and their effect would be antidilutive.
 
 *Comprehensive
        Income*
 
 Comprehensive
        income is defined as the change in equity of a business enterprise during
        a
        period from transactions and other events and circumstances from non-owner
        sources. For the years ended December **** 31,
        2004
        and 2003, the Company had no transactions other than those reported in its
        statement of operations.
 
 *Fair
        Value of Financial Instruments*
 
 The
        Company **’** s
        financial instruments consist primarily of cash equivalents, accounts and
        notes
        receivable, accounts payable and long-term debt. At December **** 31,
        2004
        and 2003, the carrying amount of the Company **’** s
        financial instruments approximates their fair values. Management believes
        the
        Company **’** s
        debt
        approximates fair value due to its short maturity and its variable interest
        rate.
 
 *Concentration
        of Credit and Business Risks*
 
 Financial
        instruments that potentially subject the Company to concentrations of credit
        risk consist primarily of cash equivalents, accounts receivable and notes
        receivable. Accounts receivable consist of amounts owed by credit card
        processing companies relating to retail telephony sales, amounts owed by
        distributors for the purchase of telephony products and money transfer services.
        We bill our retail customers on a prepaid basis through credit cards. Credit
        is
        extended to some wholesale customers with terms that generally allow them
        to pay
        for our products within two weeks. All other wholesale customers pay for
        our
        products upfront.
  94
  **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  *Concentration
        of Credit and Business Risks (Continued)*
 
 Customers
        purchase the Company **’** s
        retail
        telephony products using major credit cards, which are reimbursed by credit
        card
        processing companies. The Company does not routinely perform on-going credit
        evaluations of its retail customers but does evaluate its credit card
        processors. The Company performs credit evaluations and establishes credit
        limits for its wholesale traffic and whole sale distribution customers,
        including requiring deposits when applicable.
 
 For
        the
        years ended December **** 31,
        2004
        and 2003, a substantial portion of our retail customers were calling from
        the
        United States to India. The India international telephony market continues
        to
        experience downward pricing pressures, which has resulted in a decrease in
        our
        average selling price to our retail customers. It is unlikely that this trend
        will reverse in the near future.
 
 At
        December **** 31,
        2004,
        one customer accounted for 19% of total accounts receivable and no receivables
        from credit card processing companies accounted for more than 10% of total
        accounts receivable. At December **** 31,
        2003,
        three credit card processing companies accounted for 35%, 13%, and 10% of
        total
        accounts receivable. At December **** 31,
        2004
        and 2003, accounts receivable are stated net of an allowance for doubtful
        accounts of $25,000. Bad debt expense for the years ended December **** 31,
        2004
        and 2003 was $189,000 and $83,000, respectively. For the year ended
        December **** 31,
        2004,
        the Company purchased data communication and telecommunication services from
        three suppliers, which accounted for 18%, 13% and 11% of cost of goods sold
        for
        telecommunication services. For the year ended December **** 31,
        2003,
        the Company purchased data communication and telecommunication services from
        three suppliers, which accounted for 35%, 18%, and 11% of cost of goods sold
        for
        telecommunication services.
 
 *New
        Accounting Pronouncements*
 
 In
        December **** 2004,
        FASB issued statement of Financial Accounting standards No. **** 123
        (revised 2004), Share-Based Payment (SFAS 123R), which will be effective
        in our
        first quarter of fiscal 2006. This standard sets forth the revised rules
        for the
        accounting treatment of employee stock options and other share-based payments.
        SFAS 123(R) requires the adoption a fair value-based method for measuring
        the
        compensation expense related to employee stock awards; this will lead to
        additional compensation expense. We currently use the intrinsic value method
        to
        measure compensation expense for stock-based awards to our employees. Under
        this
        standard, we do not recognize any compensation related to stock option grants
        we
        issue under our stock option plans. Note 2 to our Consolidated Financial
        Statements in this report provides our pro forma net loss and loss per share
        as
        if we had used a fair value-based method required under SFAS 123 to measure
        the
        compensation expense for employee stock awards during fiscal 2004 and 2003.
        The
        Company has not yet determined the full effect of implementing SFAS 123R
        on the
        financial statements.
  **3.
        Discontinued Operations**
  In
        July **** 2004,
        the
        Company sold all of the outstanding capital stock of its wholly-owned subsidiary
        buyindiaonline.com, Inc. (“Cash2India”) to a private company for approximately
        $1,552,000. The Cash2India business comprised the Company **’** s
        previously reported financial services segment and is accounted for as a
        discontinued operation in the accompanying condensed consolidated financial
        statements. Under the terms of the transaction, the Company received $852,000
        in
        cash, a promissory note for $700,000, and a warrant to purchase common stock
        in
        the acquiring company. The cash payment included consideration for $352,000
        in
        working capital associated with Cash2India at the time of the sale. The
        promissory note bears interest at 5% per annum, is secured by the capital
        stock
        of Cash2India, and is to be repaid in twenty-four consecutive monthly payments
        of $29,167 plus accrued interest. The balance of the promissory note and
        accrued
        interest was $554,167 as of December **** 31,
        2004.
        As a result of the transaction the Company recorded a gain on the disposition
        of
        Cash2India of approximately $777,000 in the third quarter of 2004. The net
        gain/(loss) from discontinued operations is comprised as follows:
  95
  **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  **3.
        Discontinued Operations (Continued)**
  Year
                  ended December 31,2004
              
              2003Revenue
              
              $
              340,027
              
              $
              556,462Cost
                  of revenue
              
              
              (134,969
              )
              
              (200,880
              )Gross
                  profit
              
              
              205,058
              
              
              (355,582
              )Operating
                  Expenses
              
              
              (438,833
              )
              
              (813,461
              )Net
                  loss
              
              
              (233,775
              )
              
              (457,879
              )Gain
                  on disposal
              
              
              777,114
              
              
              -Income
                  (loss) from discontinued operations
              
              $
              543,339
              
              $
              (457,879
              )
  The
        components of assets and liabilities of discontinued operations are as
        follows:
 
 2004
              
              2003Cash
                  and cash equivalents
              
              $
              -
              
              $
              514,635Accounts
                  receivable
              
              
              -
              
              
              409,717Prepaid
                  expenses and other current assets
              
              
              -
              
              
              71,988Property
                  and equipment, net
              
              
              -
              
              
              236,308Accounts
                  payable and accrued expenses
              
              
              -
              
              
              (210,658
              )$
              -
              
              $
              1,021,990
  **4.
        Merger Agreement with Ntera Holdings**
  On
        March **** 16,
        2004,
        the Company entered into an Agreement and Plan of Merger (the “Agreement”) with
        Ntera Holdings, Inc., a Delaware corporation (“Ntera”), providing for a
        transaction that would have resulted in a change of control of WQN. In
        connection with the Agreement, WQN extended to Ntera a bridge loan in the
        principal amount of $2 **** million
        bearing interest of 7% per annum, which is secured by the assets of Ntera.
        On
        September **** 2,
        2004,
        the Company terminated the Agreement with Ntera. Under the terms of the loan
        agreement, the full amount of the loan and accrued interest are due and payable
        within six months of the termination of the Agreement. The Company and Ntera
        have amended the repayment provisions of the loan agreement whereby Ntera
        will
        make installment payments to repay the loan and accrued interest by
        March **** 31,
        2005.
        The balance of the note and accrued interest at December **** 31,
        2004
        was $2,058,679, which is net of a payment of approximately $56,000 received
        during 2004 in the form of telecommunication services. During the first quarter
        of 2005, the Company received debt payments from Ntera totaling $1,650,000.
        The
        unpaid principal and interest as of March **** 1,
        2005
        from Ntera was $408,679 and is expected to be collected on its due date.
        The
        loan is secured by the assets of Ntera.
 
 **5.
        Value Communications Transaction**
  In
        April **** 2004,
        the
        Company purchased from Value Communications Corporation (“ValuCom”), a wholly
        owned subsidiary of Rediff.com India Limited, certain assets consisting
        primarily of ValuCom **’** s
        customer list, brand, trademarks, web sites, internally built software, and
        certain hardware for $500,000 in order to increase its customer base. The
        Company paid $200,000 of the total consideration at closing with the remaining
        $300,000 to be paid in twelve monthly installments of $25,000 commencing
        May **** 2004.
        In
        addition, the Company entered into an advertising agreement with Rediff.com,
        Inc. (“Rediff”) entitling WQN to marketing services including exclusive rights
        to prominent online advertising space on the Rediff.com U.S. website, the
        premier online destination for Indians in North America. Under the terms
        of the
        advertising agreement, the Company will pay Rediff $50,000 for twelve
        consecutive months commencing in May 2004 for the advertising services. The
        Company provided both ValuCom and Rediff irrevocable letters of credit for
        the
        Company **’** s
        remaining obligation under the agreements. The letters of credit are secured
        by
        deposits in money market funds and the amount of the letters of credit and
        the
        deposits are reduced as the monthly installments are paid. At
        December **** 31,
        2004,
        the Company **’** s
        obligation under both the agreements totaled $300,000. Substantially all
        of the
        ValuCom purchase consideration was allocated to customer lists, which is
        included in other assets and is being amortized over four years.
  96
  **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  **6.
        Distribution and Marketing Agreement**
  In
        September **** 2004,
        we
        entered into a distribution and marketing agreement with a privately held
        company. As a result of the agreement, the Company **’** s
        products will be sold in more than 5,000 retail outlets in the Southern
        California market. We sell telephony and other products to a network of
        distributors who then re-sell the product to the retail outlets. The revenues
        generated through this agreement are included in wholesale telephony revenues.
        In connection with the agreement, we paid the private company $50,000 and
        issued
        a warrant to purchase 40,000 shares of our common stock for a total
        consideration of approximately $126,000 as valued with the Black-Scholes
        pricing
        model which is included in other assets and is being amortized over the three
        year term of the agreement. The warrants exercise price is $0.01.
  **7.
        Investment in Partnership**
 
 In
        November **** 2004,
        the
        Company invested $3 **** million
        in a partnership managed by an affiliate of a director of the Company. The
        majority of the partnership assets are to be invested in private investments
        in
        public entities. The partnership investments will take the form of common
        equity, preferred equity, convertible debt and/or equity or debt securities.
        Although the partnership will endeavor to engage in hedging transactions
        in
        order to mitigate downside risk, there can be no assurance that the
        partnership **’** s
        investments will be successful and, as a result, the Company may lose all
        or
        some of its investment. The partnership agreement contains certain restrictions,
        including limits on the Company **’** s
        ability
        to withdraw capital from the partnership and limits on the transferability
        of
        the Company **’** s
        interests in the partnership. The Company can receive a distribution on its
        partner capital account by giving the partnership 60 **** days
        written notice. The Company records its proportionate share of earnings and
        losses from the partnership based on its share of the partnership and for
        the
        year ended December **** 31,
        2004
        recorded a loss from its partnership investment of $55,757.
 
 **8.
        Notes Receivable**
  Components
        of notes receivable are as follows:
 
 2004
              
              2003Loan
                  to Ntera Holdings, Inc.
              
              $
              2,058,679
              
              $
              -Note
                  from sale of Cash2India subsidiary
              
              
              554,167
              
              
              -Less
                  amounts classified as current
              
              
              (2,408,679
              )
              
              -Long-term
                  portion
              
              $
              204,167
              
              $
              -
 
 During
        2004, in connection with the Agreement and plan of merger with Ntera Holding
        Inc., WQN extended to Ntera a bridge loan in the principal amount of
        $2 **** million
        bearing interest of 7% per annum (see Note 4). The balance of the note and
        accrued interest at December **** 31,
        2004
        was $2,058,679. The full amount of the loan and accrued interest are to be
        repaid in installments by March **** 31,
        2005.
        During the first quarter of 2005 the Company has received debt payments from
        Ntera totaling $1,650,000. The unpaid principal and interest as of
        March **** 1,
        2005
        from Ntera was $408,679. The loan is secured by the assets of
        Ntera.
 
 In
        July **** 2004,
        the
        Company sold all of the outstanding capital stock of its wholly-owned subsidiary
        Cash2India and received as a component of the purchase price a promissory
        note
        for $700,000 (See Note 3). The promissory note bears interest at 5% per annum,
        is secured by the capital stock of Cash2India, and is to be repaid in
        twenty-four consecutive monthly payments of $29,167 plus interest. During
        2004,
        the Company received principal and interest payments of $159,290 and the
        balance
        of the promissory note and accrued interest was $554,167 as of December 31,
        2004.
  97
  
 **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  **9.
        Prepaid Expenses and Other Current Assets**
  Prepaid
        expenses and other current assets consist of the following as of
        December **** 31:
 
 2004
              
              2003Prepaid
                  telecommunication services
              
              $
              534,181
              
              $
              33,222Deposits
              
              
              151,781
              
              
              316,936Prepaid
                  expenses
              
              
              120,106
              
              
              207,419$
              806,068
              
              $
              557,577
  **10.
        Property and Equipment**
  **** Property
        and equipment consists of the following as of December **** 31:
 
 Estimated
                  Useful Life (Years)
              
              2004
              
              2003Leasehold
                  improvements
              
              
              2
                  to 5
              
              $
              78,134
              
              $
              78,134Computers
                  and network equipment
              
              
              2
                  to 5
              
              
              3,871,060
              
              
              3,797,148Furniture
                  and fixtures
              
              
              5
              
              
              86,308
              
              
              87,196Purchased
                  software and website development costs
              
              
              1
                  to 5
              
              
              865,755
              
              
              1,315,622Total
              
              
              
              
              
              4,901,257
              
              
              5,278,100Less:
                  accumulated depreciation and amortization
              
              
              
              
              
              (4,303,735
              )
              
              (4,238,317
              )Net
                  property and equipment
              
              
              
              
              $
              597,522
              
              $
              1,039,783
 
 Property
        and equipment balances at December **** 31,
        2003
        are inclusive of assets of our discontinued operation, Cash2India (see note
        3
        for a detail of the components of net assets of discontinued operations).
        For
        the years ended December **** 31,
        2004
        and 2003 the Company recorded losses of $16,522 and $18,541, respectively
        on the
        disposal of certain fixed assets.
 
 **11.
        Accrued Expenses**
  Accrued
        expenses consist of the following as of December **** 31:
 
 2004
              
              2003Accrued
                  franchise, property and sales taxes
              
              $
              44,471
              
              $
              130,608Accrued
                  payroll expenses
              
              
              67,467
              
              
              62,115ValuCom
                  payable
              
              
              300,000
              
              
              -Other
                  accrued expenses
              
              
              45,521
              
              
              279,023$
              457,459
              
              $
              471,746
  **12.
        Debt**
  Long-term
        debt consists of the following as of December **** 31:
 
 2004
              
              2003Promissory
                  note
              
              $
              300,000
              
              $
              300,000Less
                  current portion
              
              
              (300,000
              )
              
              -Long
                  term debt net of current portion
              
              $
              -
              
              $
              300,000
 
 98
 
 **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  **12.
        Debt (Continued)**
  In
        2001,
        the Company borrowed $300,000 from a financial institution under a term
        promissory note agreement (the “Note”). The Note bears interest at the financial
        institution **’** s
        prime
        rate as adjusted from time to time (5.25% at December **** 31,
        2004)
        less 2.25% per annum. The Note, originally due in October **** 2003
        was
        extended and is now due in October **** 2005.
        The
        Note is collateralized by a $300,000 certificate of deposit bearing interest
        of
        1.47 % per annum.
 
 **13.
        Related Party Transactions**
  The
        Company **’** s
        founder, Chief Executive Officer and President holds a controlling interest
        in
        Eagle Venture Capital, which owns approximately 2.6 **** million
        outstanding shares of the common stock of the Company as of December **** 31,
        2004
        and 2003.
 
 A
        consulting company managed by one of the Company **’** s
        directors holds warrants to acquire 100,000 shares of the Company **’** s
        common
        stock. The warrants have an exercise price of $6.00 per share and expire
        in
        2005.
 
 In
        November **** 2004,
        the
        Company invested $3 **** million
        in a partnership managed by an affiliate of a director of the Company (see
        Note 7). Certain other company directors and officers have also invested
        separately in the partnership.
 
 **14.
        Income Taxes**
  Deferred
        income taxes reflect the net tax effects of temporary differences between
        the
        carrying amounts of assets and liabilities for financial reporting purposes
        and
        the amounts used for income tax purposes. Significant components of deferred
        tax
        assets and liabilities are as follows as of December **** 31:
 
 2004
              
              2003Deferred
                  tax assets/(liability):Property
                  and equipment
              
              $
              21,265
              
              $
              (35,341
              )Capital
                  loss carry forward
              
              
              195,941
              
              
              195,941Other
              
              
              66,162
              
              
              29,075Net
                  operating loss carry forwards
              
              
              9,281,128
              
              
              9,292,073Total
                  deferred tax assets
              
              
              9,564,496
              
              
              9,481,748Valuation
                  allowance
              
              
              (9,564,496
              )
              
              (9,481,748
              )Net
                  deferred tax assets
              
              $
              -
              
              $
              -
 
 The
        Company has U.S. **** net
        operating loss carry forwards of approximately $25,104,000 as of
        December 31, 2004. The Company has not recognized a deferred tax asset in
        the accompanying balance sheets due to the uncertainty of future realization.
        Accordingly, no tax benefit has been recognized in the accompanying consolidated
        statements of operations. Net operating loss carry forwards associated with
        the
        sale of our Cash2India subsidiary of approximately $2,900,000 have not been
        included in the deferred tax assets at December 31, 2004. No other
        significant reconciling items exist between the actual effective tax rate
        and
        the expected effective tax rate. During 2004 and 2003, the valuation allowance
        increased by approximately $83,000 and $1,232,000, respectively. If unused,
        accumulated net operating losses expire as follows: 2011 - $214,000; 2012
        -
        $1,531,000; 2018 - $1,447,000; 2019 - $1,999,000; 2020 - $4,628,000; 2021
        -
        $8,210,000; 2022 - $3,828,000; 2023 - $3,247,000.
 
 **15.
        Stockholders’ Equity**
  *Common
        and Preferred Stock*
 The
        Company **’** s
        authorized share capital consists of 50,000,000 shares of common stock with
        par
        value of $0.01 per share, and 10,000,000 shares of preferred stock with par
        value of $0.01 per share.
  99
  **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  *Warrants*
 
 At
        December **** 31,
        2004
        and 2003, the Company had outstanding warrants to purchase 414,775 and 720,775
        shares of its common stock, respectively. These warrants expire
        March **** 2005
        through July 2006 and have a weighted average exercise price of $16.98 per
        share. At December **** 31,
        2004,
        all of the warrants were exercisable. The warrants outstanding include warrants
        granted to a consulting company managed by one of the Company **’** s
        directors to acquire 100,000 shares of common stock (see Note 13); warrants
        granted to representatives of the Company **’** s
        underwriters in connection with the Company **’** s
        initial
        public offering to acquire 275,000 shares of common stock; and warrants granted
        to various service providers and others to acquire 39,775 shares of common
        stock. In 2004, we issued warrants to purchase 40,000 shares of our common
        stock
        to a privately held company in connection with a distribution and marketing
        agreement (see Note 6).
 
 *Stock
        Options*
 The
        Company has stock option plans (the “Plans”) under which the Company may grant
        Directors and key employees options to purchase up to 1,750,000 shares of
        the
        Company **’** s
        common
        stock at an amount at least equal to the fair value of the Company **’** s
        common
        stock on the date of grant. The exercise and vesting period of each option
        is
        determined by the Company **’** s
        board
        of directors, but no option shall have a term longer than 10 **** years.
        Options granted under the Plans are non-qualified stock options. The following
        table summarizes the employee stock option transactions for the years ended
        December **** 31,
        2004
        and 2003 under the Plans:
 
 Number
                  of Shares
              
              Weighted
                  Average Exercise PriceOutstanding
                  at December 31, 2002
              
              
              886,080
              
              $
              4.05Granted
              
              
              55,000
              
              
              2.04Exercised
              
              
              —
              
              
              0.00Cancelled
              
              
              (39,166
              )
              
              3.82Outstanding
                  at December 31, 2003
              
              
              901,914
              
              $
              3.93Granted
              
              
              265,500
              
              
              2.65Exercised
              
              
              (275,996
              )
              
              2.51Cancelled
              
              
              (38,434
              )
              
              2.10Outstanding
                  at December 31, 2004
              
              
              852,984
              
              $
              4.11Options
                  exercisable:December
                  31, 2003
              
              
              794,258
              
              
              4.18December
                  31, 2004
              
              
              662,486
              
              $
              4.57
 
 A
        summary
        of stock options under the Plans outstanding as of December **** 31,
        2004
        are as follows:
 
 Options
                  Outstanding
              
              Options
                  ExercisableRange
                  of Exercise Prices
              
              Shares
              
              Weighted-Average
                  Remaining Life (Years)
              
              Weighted-Average
                  Exercise Price
              
              Shares
              
              Weighted
                  Average Exercise Price$1.00
                  - 1.99
              
              
              145,000
              
              
              6.59
              
              $
              1.31
              
              
              95,000
              
              $
              0.99$2.00
                  - 2.99
              
              
              426,984
              
              
              5.02
              
              
              2.25
              
              
              341,486
              
              
              2.19$3.00
                  - 3.99
              
              
              155,500
              
              
              3.46
              
              
              3.16
              
              
              100,500
              
              
              3.21$5.00
                  - 11.00
              
              
              25,000
              
              
              2.6
              
              
              5.75
              
              
              25,000
              
              
              5.75$13.00
                  - 14.00
              
              
              35,000
              
              
              1.9
              
              
              13.00
              
              
              35,000
              
              
              13.00$19.00
                  - 20.00
              
              
              60,000
              
              
              2.24
              
              
              19.13
              
              
              60,000
              
              
              19.13$21.00
                  - 22.00
              
              
              5,500
              
              
              2.22
              
              
              21.63
              
              
              5,500
              
              
              21.63Total
              
              
              852,984
              
              
              4.59
              
              
              4.11
              
              
              662,486
              
              
              4.57
 
 100
 
 **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  *Stock
        Options (Continued)*
 
 In
        December **** 1998,
        the
        Company issued options outside of the option plans to purchase 167,867 shares
        of
        its common stock to a former officer of the Company at an exercise price
        of
        $3.33 with a seven-year term. During 2004 all of these options were
        exercised.
 
 **16.
        Benefit Plan**
  The
        Company has a 401(k) benefit plan. The plan provides for voluntary employee
        contributions and the Company matches 15% of the first 8% of payroll contributed
        by the employee. Employees become 100% vested in employment contributions
        after
        2 **** years
        of
        service accruing 50% per year of service. For the years ended
        December **** 31,
        2004
        and 2003, the Company **’** s
        plan
        contributions were $3,400 and $5,400, respectively.
 
 **17.
        Commitments**
  The
        Company has operating leases relating principally to office facilities, which
        expire in 2006 and have future minimum lease commitments under operating
        leases
        with remaining non-cancelable lease terms in excess of one year at
        December **** 31,
        2004:
        2005 - $112,500; 2006 - $75,000. Rental expense under operating leases was
        approximately $113,000 and $138,000 for the years ended December 31, 2004
        and
        2003, respectively.
 
 In
        September **** 2004,
        the
        Company settled a dispute with a vendor from which it had previously purchased
        telecommunication services. Under the terms of the settlement, the Company
        agreed to purchase from the vendor a total of $960,000 in telecommunication
        services at rates less than the Company is paying for similar services over
        a
        fourteen month period. The Company must purchase a minimum of $80,000 per
        month
        in services beginning four months after the settlement date.
 
 **18.
        Contingencies**
  In
        December 1996, the Company applied to the United States Patent and
        Trademark Office to register the trademarks: “WorldQuest” and “WorldQuest
        Networks.” We received a registration for the trademark “WorldQuest” from the
        U.S. Patent and Trademark Office on November **** 23,
        1999.
        In October **** 1997,
        the
        Patent and Trademark Office issued a notice of publication regarding our
        application to register “WorldQuest Networks” as a trademark. In response to
        that notice, Qwest Communications filed a notice of opposition in
        September **** 1998.
        Qwest Communications instituted a cancellation proceeding in the Patent and
        Trademark Office for the registered trademark “WorldQuest.” In
        December **** 2001,
        a
        judgment was made in the Company **’** s
        favor
        whereby Qwest **’** s
        motion
        to cancel our “WorldQuest” trademark was dismissed, however, Qwest filed a
        motion appealing the judgment. In December **** 2002,
        Qwest filed a separate complaint stating that the Company **’** s
        prepaid
        cash card product infringes on the Qwest trademark. In February **** 2003,
        the
        companies settled all outstanding claims whereby WorldQuest received a cash
        payment and telecommunication services (primarily long distance termination)
        from Qwest and Qwest retained all rights to the trademarks in question. Pursuant
        to the term of a settlement agreement with Qwest Communications arising out
        of a
        trademark dispute, on November **** 9,
        2004
        the Company changed its name to WQN, Inc. from WorldQuest Networks,
        Inc.
 
 The
        Company is a defendant from time to time in lawsuits and disputes arising
        in the
        ordinary course of business. 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 be material
        to
        the Company’s financial position or results of operations.
 
 **19.
        Interest Income, Net**
  Interest
        income for the years ended December **** 31,
        2004
        and 2003 was $293,000 and $207,000, respectively. Interest income includes
        $114,778 interest on the Ntera loan and $13,457 interest on the loan received
        in
        connection with the sale of the Company **’** s
        financial service subsidiary. Interest expense for the years ended
        December **** 31,
        2004
        and 2003 was $5,000 and $5,000, respectively.
  **20.
        Subsequent Events**
 
 On
        October 5, 2005, the Company sold substantially all of its operating assets
        and
        liabilities to VoIP, Inc. Proceeds from the sale consisted of a $3.7 million
        note payable which is convertible into VoIP, Inc. common stock, 1,300,000
        shares
        of VoIP, Inc.'s common stock, and 5,000,000 warrants to purchase VoIP, Inc's
        common stock at $0.001 per share which were exercised in January
        2006.
 
 101
 
 **WQN,
        INC. AND SUBSIDIARIES**
 **NOTES
        TO CONSOLIDATED FINANCIAL STATEMENTS** — **(Continued)**
  **20.
        Subsequent Events (Continued)**
 
 On
        July
        3, 2006, the Company's securities were delisted from The Nasdaq National
        Market
        ("Nasdaq") Listing Qualifications Panel (the “Panel”). This action was a result
        of the Panel determining that the Company had not met the requirement that
        it be
        current in its required reporting obligations under Nasdaq Rule 430(c)(14),
        principally because of the Company's failure to file its Form 10-QSB for
        the
        quarter ended March 31, 2006 and because Nasdaq determined that the Company
        is a
        "public shell," which, in Nasdaq's determination, could be detrimental to
        the
        interests of the investing public under Nasdaq Rule 4300.
  102
  **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 April 2, 2007.
  **VOIP,
                INC.**By:
              */s/
                Anthony J. Cataldo*Anthony
                J. CataldoChief
                Executive OfficerDate:
              April 2,
                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 OfficerDate:
                April 2,
                  2007
 By:
                  */s/
                    Shawn Lewis*Shawn
                    M. LewisChief
                    Operating OfficerDate:
                  April 2,
                    2007
 By:
                        */s/
                          Robert Staats*Robert
                          V. StaatsChief
                          Accounting OfficerDate:
                        April 2,
                          2007
 By:
                              */s/
                                Gary Post*Gary
                                PostDirectorDate:
                              April 2,
                                2007
 By:
                                      */s/
                                        Stuart Kosh*Stuart
                                        KoshDirectorDate:
                                      April 2,
                                        2007
 By:
                                              */s/
                                                Nicholas A. Iannuzzi, Jr.*Nicholas
                                                A. Iannuzzi, Jr.DirectorDate:
                                              April 2,
                                                2007
  103