UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
  FORM
10-Q/A
  Amendment
No. 1
  x
              
              QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934For
      the quarterly period ended June 30, 2009OR ̈
              
              TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934For
      the transition period from ________________ to
      ________________
 
 Commission
file number:  000-25755
 
 WORLDGATE
COMMUNICATIONS, INC.
 (Exact
name of registrant as specified in its charter)
 
 Delaware
              
              23-2866697(State
      or other jurisdiction of
              
              (I.R.S.
      Employerincorporation
      or organization)
              
              Identification
      No.)3190
      Tremont Avenue
                Trevose,
      Pennsylvania
              
              19053(Address
      of principal executive offices)
              
              (Zip
      Code)
 
 (215)
354-5100
 (Registrant’s
telephone number, including area code)
 
 [None]
 (Former
name, former address and former fiscal year, if changed since last
report)
 
 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   ̈
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
 Yes  ̈                                      No   ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the
Securities Exchange Act of 1934.
 
 Large
      accelerated filer o
              
              
              Accelerated
      filer  oNon-accelerated
      filer  o
              (Do
      not check if a smaller reporting company)
              
              Smaller
      reporting company  x
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the SecuritiesExchange Act
of
1934). Yes  ̈                 No  x
 
 Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.
 
 Class
                  
                  Outstanding
      at March 24, 2010Common
      Stock, $0.01 par value per share
                  
                  338,627,636
      shares
  
 
 EXPLANATORY
NOTE
 
 WorldGate
Communications, Inc. (the “Company”) is filing this Amendment No.1 on Form
10-Q/A to amend its Quarterly Report on Form 10-Q as of and for the three and
six months ended June 30, 2009, as filed with the Securities and Exchange
Commission (the “SEC”) on August 14, 2009 (the “Original Filing”). The purpose
of this Amendment is to amend and restate Part I, Item 1and Part I, Item 2,
which set forth the accounting for the closing on April 6, 2009 of the
transactions contemplated by the Securities Purchase Agreement, dated December
12, 2008 (“Securities Purchase Agreement”), between WGI Investor LLC (“WGI”) and
the Company and for the Commercial Relationship with ACN Digital Phone Service,
LLC (“ACN”).
  On March
29, 2010, the Board of Directors of the Company determined that the Company’s
quarterly financial statements for the fiscal quarters ended June 30, 2009 and
September 30, 2009 should no longer be relied upon.  After reviewing
comments from the SEC, the issues raised in management’s discussions with the
staff of the SEC, the literature cited by the SEC, and the documentation
relating to certain transactions with WGI and ACN described below, the Company
has determined that it should revise its original accounting for the following
transactions:  (1) the closing on April 6, 2009 of the transactions
contemplated by the Securities Purchase Agreement, including the issuance to WGI
of an aggregate of 202,462,155 shares of the Company’s common stock and the
issuance to WGI of a warrant to purchase up to approximately 140.0 million
shares of Company’s common stock in certain circumstances and (2) the Master
Purchase Agreement pursuant to which ACN committed to purchase from the Company
300,000 video phones over a two-year period.  Related to these
transactions, the Company also reviewed, but did not revise, its original
accounting for the following transactions: (a) the payment by ACN to the Company
of $1,200,000 to fund certain software development costs and (b) the issuance to
ACN of a warrant to purchase up to 38,219,897 shares of the Company’s common
stock at an exercise price of $0.0425 per share, which vests incrementally based
on ACN’s purchases of video phones.
 
 The
Company had previously determined that the value received by WGI pursuant to the
closing on April 6, 2009 of the transactions contemplated by the Securities
Purchase Agreement exceeded the fair value received by the Company by
approximately $74,463,000 and the Company initially accounted for $60,000,000 of
such excess in fair value as a deferred revenue incentive asset and the balance
of such excess in fair value as a $14,463,000 expense.  The Company has now
determined that the value received by WGI in connection with the closing of such
transactions should be reflected as an equity transaction valued at
approximately $7,199,000 (which is the sum of the fair value of the
consideration given by WGI to the Company in exchange for the securities issued
by the Company to WGI).  As a result, the three and six months
ended June 30, 2009 arebeing restated to reflect the reversal of the
entries originally recorded for this excess in fair value, including (a) the
reversal of an expense of approximately $14,463,000, (b) the reversal of the
recording of a deferred revenue incentive asset of $60,000,000 and (c) the
reversal of a credit originally recorded to the additional paid in capital
account on the Company’s consolidated balance sheet.
 
 In
addition, the deferred revenue incentive asset of $60,000,000 would have offset
$60,000,000 of future revenue from ACN pursuant to the Master Purchase
Agreement.  As a result of the revision described above, there will be no
deferred revenue incentive asset of $60,000,000 and therefore no offset of such
amounts against future revenue from ACN pursuant to the Master Purchase
Agreement.  Any future revenue from ACN pursuant to the Master Purchase
Agreement will be recognized as revenue consistent with applicable general
accepted accounting principles, including an offset to such revenue related to
the issuance to ACN of a warrant to purchase up to 38,219,897 shares of the
Company’s common stock as such warrant becomes exercisable pursuant to its
terms.
  Accordingly, changes have
been made to the applicable line items associated with expense, net loss, net
loss per common share, deferred revenue incentive asset, additional paid in
capital and retained earnings/(accumulated deficit).The impact of
the restatements will have the primary effects of (1) reducing the Company’s
reported net loss for the three month period ended June 30, 2009 from
approximately $18,802,000 to approximately $4,339,000 and (2) reducing the
Company’s reported assets by $60,000,000 with a corresponding reduction to the
Company's stockholders’ equity.
  Consistent
with the Company’s prior analysis, the Company will continue to treat the
payment by ACN to the Company of $1,200,000 to fund certain software development
costs as deferred revenue which will be recognized upon completion of the
development of the Company’s next generation video phone.
 
 In
addition, this Amendment No. 1 on Form 10-Q/A also includes the Agreement of
Lease, dated April 2, 2009, between 3190 Tremont LLC and WorldGate Service, Inc.
regarding our lease of office space at 3190 Tremont Avenue, Trevose, PA
19053.
  Except as
described above, no additions or modifications have been made to this Amendment
No.1 to reflect facts or events occurring subsequent to the date of the Original
Filing or the Amended Filing. Information not affected by the restatement is
unchanged and reflects the disclosures at the time of the Original
Filing.  Therefore, this Amendment No. 1 should be read in conjunction
with the Company’s other filings made with the Securities and Exchange
Commission subsequent to the Original Filing.
  2
 
 WORLDGATE
COMMUNICATIONS, INC.
 
 QUARTERLY
REPORT ON FORM 10-Q/A
 FOR
THE THREE MONTHS ENDED JUNE 30, 2009
 
 TABLE
OF CONTENTS
 
 PART
      I. FINANCIAL INFORMATION
                  4ITEM
      1.  FINANCIAL STATEMENTS
                  4ITEM
      2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
      AND RESULTS OF OPERATIONS
                  25ITEM
      3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
                  31ITEM
      4T.  CONTROLS AND PROCEDURES
                  31PART
      II. OTHER INFORMATION
                  32ITEM
      1.  LEGAL PROCEEDINGS
                  32ITEM
      2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS
                  32ITEM
      3.  DEFAULTS UPON SENIOR SECURITIES
                  33ITEM
      4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS
                  33ITEM
      5.  OTHER INFORMATION
                  33ITEM
      6.  EXHIBITS
                  33
  3
  PART
I. FINANCIAL INFORMATION
 ITEM
1.  FINANCIAL STATEMENTS
 
 WORLDGATE
COMMUNICATIONS, INC.
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 (Dollars
In Thousands, Except Share Amounts)
  June
      30,
                      2009
                  
                  
                  December 31,
                      2008
      *(Unaudited
                    &Restated)ASSETSCurrent
      assets:Cash
      and cash equivalents
                  
                  $
                  1,209
                  
                  
                  $
                  429Trade
      accounts receivables, less allowance for doubtful accounts of $157 at June
      30, 2009 and $0 at December 31,   2008
                  
                  
                  918
                  
                  
                  
                  1,019Other
      receivables
                  
                  
                  1
                  
                  
                  
                  1Inventory,
      net
                  
                  
                  1,048
                  
                  
                  
                  1,176Prepaid
      and other current assets
                  
                  
                  282
                  
                  
                  
                  160Total
      current assets
                  
                  
                  3,458
                  
                  
                  
                  2,785Property
      and equipment, net
                  
                  
                  869
                  
                  
                  
                  234Deposits
      and other assets
                  
                  
                  0
                  
                  
                  
                  66Total
      assets
                  
                  $
                  4,327
                  
                  
                  $
                  3,085LIABILITIES
      AND STOCKHOLDERS’ DEFICIENCYCurrent
      liabilities :Accounts
      payable
                  
                  $
                  2,311
                  
                  
                  $
                  1,750Accrued
      expenses
                  
                  
                  657
                  
                  
                  
                  1,420Accrued
      compensation and benefits
                  
                  
                  91
                  
                  
                  
                  173Accrued
      severance
                  
                  
                  690
                  
                  
                  
                  0Detachable
      warrants
                  
                  
                  413
                  
                  
                  
                  4,360Warranty
      reserve
                  
                  
                  18
                  
                  
                  
                  17Deferred
      revenues and income
                  
                  
                  2,201
                  
                  
                  
                  1,762Notes
      Payable
                  
                  
                  96
                  
                  
                  
                  0Convertible
      debentures payable (net of unamortized discount of $0 at June 30, 2009 and
      $2,287 at December 31, 2008
                  
                  
                  0
                  
                  
                  
                  1,793Total
      current liabilities
                  
                  
                  6,477
                  
                  
                  
                  11,275Commitments
      and contingenciesStockholders’
      deficiency:Preferred
      Stock, $.01 par value, 13,492,450 shares authorized; 0 shares issued at
      June 30, 2009 and December 31, 2008
                  
                  
                  0
                  
                  
                  
                  0Common
      Stock, $.01 par value; 700,000,000 and 200,000,000 shares authorized at
      June 30, 2009 and December 31, 2008, respectively; and 325,048,500 shares
      issued and outstanding at June 30,2009 and 118,906,345 at December 31,
      2008..
                  
                  
                  3,251
                  
                  
                  
                  1,189Additional
      paid-in capital
                  
                  
                  266,082
                  
                  
                  
                  261,478Accumulated
      deficit
                  
                  
                  (271,483
                  )
                  
                  
                  (270,857
                  )Total
      stockholders’ deficiency
                  
                  
                  (2,150
                  )
                  
                  
                  (8,190
                  )Total
      liabilities and stockholders’ deficiency
                  
                  $
                  4,327
                  
                  
                  $
                  3,085
 
 *
Condensed from audited financial statement
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  4
 
 WORLDGATE
COMMUNICATIONS, INC.
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 (Dollars
In Thousands, Except Share And Per Share Amounts)
 
 Three
      Months ended June 30,
                
                
                Six
      Months ended June 30,2009
      Restated
                
                
                2008
                
                
                2009
      Restated
                
                
                2008Net
      revenues:Product
      revenues
                
                $
                16
                
                
                $
                812
                
                
                $
                365
                
                
                $
                831Service
      revenues
                
                
                89
                
                
                
                164
                
                
                
                182
                
                
                
                259Other
      revenues
                
                
                38
                
                
                
                279
                
                
                
                833
                
                
                
                279Total
      net revenues
                
                
                143
                
                
                
                1,255
                
                
                
                1,380
                
                
                
                1,369Cost
      of revenues
                
                
                5
                
                
                
                837
                
                
                
                919
                
                
                
                875Gross
      margin
                
                
                138
                
                
                
                418
                
                
                
                461
                
                
                
                494Engineering
      and development (excluding depreciation and amortization amounts of $65
      and $43 for the three months ended June 30, 2009 and 2008, respectively,
      and $90 and $93 for the six months ended June 30, 2009 and 2008,
      respectively)
                
                
                763
                
                
                
                498
                
                
                
                1,405
                
                
                
                1,075Sales
      and marketing (excluding depreciation and amortization amounts of $9 and
      $13 for the three months ended June 30, 2009 and 2008, respectively, and
      $17 and $28 for the six months ended June 30, 2009 and 2008,
      respectively).
                
                
                67
                
                
                
                140
                
                
                
                105
                
                
                
                359General
      and administrative (excluding depreciation and amortization amounts of $6
      and $25 for the three months ended June 30, 2009 and 2008, respectively,
      and $12 and $59 for the six months ended June 30, 2009 and 2008,
      respectively)
                
                
                1,576
                
                
                
                978
                
                
                
                2,441
                
                
                
                1,877Depreciation
      and amortization
                
                
                80
                
                
                
                81
                
                
                
                119
                
                
                
                180Total
      expenses from operations
                
                
                2,486
                
                
                
                1,697
                
                
                
                4,070
                
                
                
                3,491Loss
      from operations
                
                
                (2,348
                )
                
                
                (1,279
                )
                
                
                (3,609
                )
                
                
                (2,997
                )Other
      Income (expense)Interest
      and other income
                
                
                0
                
                
                
                4
                
                
                
                8
                
                
                
                10Change
      in fair value of derivative warrants and conversion
options
                
                
                284
                
                
                
                (1,674
                )
                
                
                4,209
                
                
                
                (1,807
                )Income
      from service fee contract termination
                
                
                0
                
                
                
                1,056
                
                
                
                348
                
                
                
                1,056Amortization
      of debt discount
                
                
                (2,235
                )
                
                
                (707
                )
                
                
                (2,918
                )
                
                
                (926
                )Loss
      on equipment disposal
                
                
                0
                
                
                
                (295
                )
                
                
                0
                
                
                
                (295
                )Interest
      and other expense
                
                
                (40
                )
                
                
                (99
                )
                
                
                (113
                )
                
                
                (186
                )Total
      other (expense) income, net
                
                
                (1,991
                )
                
                
                (1,715
                )
                
                
                1,534
                
                
                
                (2,148
                )Net
      loss
                
                $
                (4,339
                )
                
                $
                (2,994
                )
                
                $
                (2,075
                )
                
                $
                (5,145
                )Net
      loss per common share:Basic
      and Fully Diluted
                
                $
                (0.01
                )
                
                $
                (0.05
                )
                
                $
                (0.01
                )
                
                $
                (0.09
                )Weighted
      average common shares outstanding:Basic
      and Fully Diluted
                
                
                308,784,420
                
                
                
                58,740,660
                
                
                
                214,369,909
                
                
                
                57,844,501
 
 The accompanying notes are an integral
part of these condensed consolidated financial statements.
  5
 
 WORLDGATE
COMMUNICATIONS, INC.
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 (in
Thousands)
 
 Six Months ended June 30,2009Restated
                
                
                2008Cash
      flows from operating activities:Net
      loss
                
                $
                (2,075
                )
                
                $
                (5,145
                )Adjustments
      to reconcile net loss to net cashused in
      operating activities:Depreciation
      and amortization
                
                
                119
                
                
                
                180Amortization
      of debt discount
                
                
                2,918
                
                
                
                926Bad
      debt expense
                
                
                157
                
                
                
                0Change
      in fair value of derivative warrants and conversion
options
                
                
                (4,209
                )
                
                
                1,807Loss
      on disposal of fixed assets
                
                
                1
                
                
                
                295Inventory
      reserve
                
                
                600
                
                
                
                0Non-cash
      stock based compensation
                
                
                290
                
                
                
                251Changes
      in operating assets and liabilities:Trade
      accounts receivable
                
                
                (56
                )
                
                
                75Other
      receivables
                
                
                1
                
                
                
                603Inventory
                
                
                (472
                )
                
                
                351Prepaid
      and other current assets
                
                
                (122
                )
                
                
                (108
                )Deposits
      and other assets
                
                
                66
                
                
                
                55Accounts
      payable
                
                
                60
                
                
                
                529Accrued
      expenses and other current liabilities
                
                
                283
                
                
                
                (732
                )Accrued
      severance
                
                
                690
                
                
                
                0Accrued
      compensation and benefits
                
                
                (82
                )
                
                
                67Warranty
      reserve
                
                
                1
                
                
                
                (21
                )Deferred
      revenues and other income
                
                
                439
                
                
                
                213Net
      cash used in operating activities
                
                
                (1,391
                )
                
                
                (654
                )Cash
      flows used in investing activities:Capital
      expenditures
                
                
                (256
                )
                
                
                0Proceeds
      from the sale of fixed assets
                
                
                0
                
                
                
                4Net
      cash (used in) provided by investing activities
                
                
                (256
                )
                
                
                4Cash
      flows from financing activities:Proceeds
      from issuance of common stock
                
                
                1,581
                
                
                
                1Proceeds
      from the issuance of notes
                
                
                846
                
                
                
                0Net
      cash provided by financing activities
                
                
                2,427
                
                
                
                1Net
      increase (decrease) in cash and cash equivalents
                
                
                780
                
                
                
                (649
                )Cash
      and cash equivalents, beginning of period
                
                
                429
                
                
                
                1,081Cash
      and cash equivalents, end of period
                
                $
                1,209
                
                
                $
                432Non-cash
      investing and financing activities:Cumulative
      effect on a change in accounting principle on (See Note
7):Detachable
      warrants
                
                $
                885
                
                
                $
                0Additional
      Paid in Capital
                
                
                (1,751
                )
                
                
                0Accumulated
      deficit
                
                
                1,449
                
                
                
                0Conversion
      of convertible debenture to common stock
                
                
                0
                
                
                
                648Common
      stock issued in payment of convertible debentures
                
                
                4,080
                
                
                
                0Common
      stock issued in payment of accrued interest
                
                
                1,046
                
                
                
                0Common
      stock issued in payment of warrant derivative
                
                
                623
                
                
                
                0Common
      stock issued in payment of notes
                
                
                750
                
                
                
                0
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  6
  WORLDGATE
COMMUNICATIONS, INC.
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 (Dollars
In Thousands, Except share and per Share Amounts)
 
 1.
              Basis
      of Presentation.
  The unaudited condensed consolidated
financial statements of WorldGate Communications, Inc. (“WorldGate” or the
“Company”) for the three and six months ended June 30, 2009 and 2008 presented
herein have been prepared by the Company pursuant to the rules and regulations
of the Securities and Exchange Commission for quarterly reports on Form 10-Q.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with United States generally accepted
accounting principles (“GAAP”) have been condensed or omitted pursuant to such
rules and regulations. In addition, the December 31, 2008 condensed consolidated
balance sheet was derived from the audited financial statements, but does not
include all disclosures required by GAAP. These financial statements should be
read in conjunction with the audited financial statements for the year ended
December 31, 2008 and the notes thereto included in the Company’s Annual Report
on Form 10-K. The accounting policies used in preparing these unaudited
condensed consolidated financial statements are materially consistent with those
described in the audited December 31, 2008 financial statements.
  The financial information in this
Report reflects, in the opinion of management, all adjustments of a normal
recurring nature necessary to present fairly the results for the interim
periods. Quarterly operating results are not necessarily indicative of the
results that may be expected for other interim periods or the year ending
December 31, 2009.
  The preparation of financial statements
in conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities, as of the date of the financial statements, and the reported amount
of revenues and expenses during the reporting period. Actual results could
differ from those estimates. Judgments and estimates of uncertainties are
required in applying the Company’s accounting policies in many areas. Following
are some of the areas requiring significant judgments and estimates: revenue
recognition, inventory valuation, deferred revenues, stock-based compensation,
valuation of derivative liabilities, related warrants and deferred tax asset
valuation allowance.
  2.
              Restatement for Interim
      Period
 The
Company has restated its financial statements as of June 30, 2009 and for the
three and six months ended June 30, 2009 to reclassify the excess in fair value
related to the closing on April 6, 2009 of the transactions contemplated by the
Securities Purchase Agreement, dated December 12, 2008 (“Securities Purchase
Agreement”), between WGI Investor LLC (“WGI”) and the Company, and for the
Commercial Relationship with ACN Digital Phone Service, LLC (“ACN”). The Company
initially determined that the value received by WGI exceeded the fair value
received by the Companyby approximately $74,463
andinitially accounted for $60,000 of the total excess in fair value of
the transaction as a deferred revenue asset and the balance of excess in fair
value as a $14,463 expense.  The Company has now determined that while
WGI and ACN share common ownership they are not deemed to be entities under
common control as defined solely in Emerging Issue Task Force (“EITF”) No.
02-5.
  As such,
the WGI transaction should be reflected as an equity transaction valued at
approximately $7,199 (which is the sum of the
fair value of the consideration given by WGI to the Company in exchange for the
securities issued by the Company to WGI).  As a result, the
three and six months ended June 30, 2009 are being restated to reflect the
reversal of the entries originally recorded for this excess in fair value,
including the reversal of a expense of approximately $14,463, the reversal of
the recording of a deferred revenue asset of $60,000 and the reversal of a
credit originally recorded to the additional paid in capital account on the
Company’s balance sheet.
 Accordingly,
changes have been made to the applicable line items associated with expense, net
loss, net loss per common share, deferred revenue incentive asset, additional
paid in capital and retained earnings. The deferred revenue incentive asset
would have offset $60,000 of future revenue from ACN pursuant to the Master
Purchase Agreement.  As a result of this restatement, there will be no
deferred revenue asset of $60,000,000 and therefore no offset of such amounts
against future revenue from ACN pursuant to the Master Purchase
Agreement.  Any future revenue from ACN pursuant to the Master
Purchase Agreement will be recognized as revenue consistent with applicable
general accepted accounting principles, including an offset to such revenue
related to the issuance to ACN of a warrant to purchase up to 38,219,897 shares
of the Company’s common stock as such warrant becomes exercisable pursuant to
its terms.
 
 The
effect of the restatement on specific amounts provided in the consolidated
financial statements is as follows:
 
 As of June 30, 2009Consolidated Balance Sheet
                        
                        As previously reported
                        
                        
                        As restatedRevenue
      incentive asset – current portion
                        
                        $
                        4,200
                        
                        
                        $
                        0Total
      current assets
                        
                        
                        7,658
                        
                        
                        
                        3,458Revenue
      incentive asset – long term portion
                        
                        
                        55,800
                        
                        
                        
                        0Total
      Assets
                        
                        
                        64,327
                        
                        
                        
                        4,327Accumulated
      deficit
                        
                        
                        (285,946
                        )
                        
                        
                        (271,483
                        )Total
      stockholders’ equity (deficiency)
                        
                        
                        57,850
                        
                        
                        
                        (2,150
                        )Total
      liabilities and stockholders equity
                        
                        
                        64,327
                        
                        
                        
                        4,327
  7
 
 For the three Months ended June 30, 2009Consolidated Statement of Operations
                              
                              As previously reported
                              
                              
                              As restatedExcess
      fair value transferred to WGI
                              
                              $
                              14,463
                              
                              
                              $
                              0Total
      expenses from operations
                              
                              
                              16,949
                              )))
                              
                              
                              2,486
                              )Net
      loss from operations
                              
                              
                              (16,811
                              )
                              
                              
                              (2,348
                              )Net
      loss
                              
                              
                              (18,802
                              )
                              
                              
                              (4,339
                              )Net
      loss per common share:Basic
      and diluted
                              
                              
                              (0.06
                              )
                              
                              
                              (0.01
                              )
  For the six Months ended June 30, 2009Consolidated Statement of Operations
                      
                      As previously reported
                      
                      
                      As restatedExcess
      fair value transferred to WGI
                      
                      
                      14,463
                      
                      
                      
                      0Total
      expenses from operations
                      
                      
                      18,533
                      
                      
                      
                      4,070Net
      loss from operations
                      
                      
                      (18,072
                      )
                      
                      
                      (3,609
                      )Net
      loss
                      
                      
                      (16,538
                      )
                      
                      
                      (2,075
                      )Net
      loss per common share:Basic
      and diluted
                      
                      
                      (0.08
                      )
                      
                      
                      (0.01
                      )
 
 3.
              Liquidity
      and Going Concern Considerations.
  Cash and Cash Flow. As of June
30, 2009, the Company had cash and cash equivalents of $1,209. The Company’s
cash used in operations was $529 and $1,391, respectively, during the three and
six months ended June 30, 2009. The $2,650 of aggregate funds the Company
received as a result of (a) the closing on April 6, 2009 of the transactions
contemplated by the Securities Purchase Agreement, dated December 12, 2008 (“
Securities Purchase Agreement”), between WGI Investor LLC (“WGI”) and the
Company and (b) the Commercial Relationship with ACN Digital Phone Service, LLC
(“ACN”) described below, including $1,200 of payments received for development
efforts, and the net proceeds from the exercise of certain warrants totaling
$881 contributed to the generation of funds during the three months ended June
30, 2009 and have provided financing for the on-going operations of the
Company.
  Liabilities. The Company had
$6,477 of liabilities and none of its assets are pledged as collateral as of
June 30, 2009. These liabilities include $2,968 of accounts payable and accrued
expenses, $690 of accrued severance, $2,201 of deferred revenues and income, and
$413 of detachable warrants related to the Company’s private placement of
preferred stock in June 2004.
  Short Term Cash Requirements.
At June 30, 2009, the Company’s short term cash requirements and obligations
include payment for finished, excess and obsolete inventory, accounts payable
from continuing operations and operating expenses. During the quarter ended June
30, 2009, the Company’s convertible debt and the interest related to this
convertible debt was converted to equity pursuant to the closing on April 6,
2009 of the transactions contemplated by the Securities Purchase
Agreement.
  Net Losses and Impact on
Operations. The Company has incurred recurring net losses and has an
accumulated deficit of $271,483, stockholders’ deficiency of $2,150 and a
working capital deficit of $3,019 as of June 30, 2009. During 2007 the Company
experienced severe cash shortfalls, deferred payment of some of its operating
expenses, and elected to shut down its operations for a period of time during
the first quarter of 2008. Further curtailments of its operations may be
necessary in the future. These factors raise substantial doubt about the
Company’s ability to continue as a going concern as of June 30, 2009. The
financial statements do not include any adjustments that might be necessary
should the Company be unable to continue as a going concern.
  8
  Aequus. In October 2008,
Aequus Technologies Corp. (“Aequus”) failed to pay to WorldGate $953 owed to
WorldGate for the purchase of video phones, and as a result the Company
terminated its reseller agreement with Aequus. The Company has most of the units
sold to Aequus in its possession and will attempt to sell the units elsewhere to
recover the $953 while continuing to resolve its dispute with Aequus. There can
be no assurance that WorldGate will be able to sell the units and recover the
$953 owed by Aequus. The Company continues to believe that the Video Relay
Services and Video Remote Interpreting markets provide an attractive opportunity
for the sale of video phones and has initiated shipments of video phones with
other Video Relay Services / Video Remote Interpreting service
providers.
  On
January 27, 2009, the Company resolved the outstanding NRE Arbitration with
Aequus, and in full satisfaction of the outstanding arbitration claim Aequus
agreed to terminate any obligation on the Company’s part to provide certain
prepaid engineering services pursuant to the March 31, 2008 Agreement with
Aequus (Aequus had prepaid approximately $900 for these engineering services of
which $725 was allocated to the settlement).
 
 Vendor Payable. On January 28,
2009, in exchange for a vendor’s agreement to reduce an outstanding obligation
to the vendor, the Company issued a promissory note in the amount of $30, to
this vendor. $20 of this note was paid on April 1, 2009 and $10 of the note was
paid on July 15, 2009.
  Advance of Purchase Price by WGI
Investor. On February 4, 2009 and March 24, 2009, the Company, in
exchange for cash received, issued promissory notes for $550 and $200
respectively to WGI. Both notes were an advance of the cash consideration
payable by WGI at the closing of the transactions contemplated by the Securities
Purchase Agreement. The notes had a maturity date of May 1, 2009 and had
interest payable at six percent per annum. On April 6, 2009, upon closing of the
transactions contemplated by the Securities Purchase Agreement, the two notes
were cancelled pursuant to their terms.
  WGI and ACN
Transactions.  On April 6, 2009, the Company completed a
private placement of securities to WGI pursuant to the terms of the Securities
Purchase Agreement.  In connection with the transaction, the Company
issued to WGI an aggregate of 202,462,155 shares of its common stock, par value
of $0.01 per share (“Common Stock”) , representing approximately 63% of the
total number of issued and outstanding shares of Common Stock, as well as a
warrant to purchase up to approximately 140.0 million shares of Common Stock in
certain circumstances (the “Anti-Dilution Warrant”) in exchange for (i) cash
consideration of $1,450 (of which $750 had been previously advanced to the
Company by WGI), (ii) the cancellation of convertible debentures held by WGI
under which approximately $5,100 in principal and accrued interest was
outstanding and (iii) the cancellation of certain outstanding warrants held by
WGI.  In December 2008, WGI had acquired from YA Global Investments,
L.P. (“YA Global”) the convertible debentures that the Company had previously
issued to YA Global and the outstanding warrants to purchase Common Stock then
held by YA Global.  The Company expects to use the proceeds from the
closing on April 6, 2009 of the transactions contemplated by the Securities
Purchase Agreement primarily for working capital purposes.
 
 The
Anti-Dilution Warrant entitles WGI to purchase up to 140.0 million shares of
Common Stock at an exercise price of $0.01 per share to the extent the Company
issues any capital stock upon the exercise or conversion of (i) any warrants,
options and other purchase rights that were outstanding as of April 6, 2009
(“Existing Contingent Equity”), (ii) up to 19.7 million shares underlying future
options, warrants or other purchase rights issued by the Company after April 6,
2009 (“Future Contingent Equity”), or (iii) the ACN Warrant described
below.  The Anti-Dilution Warrant is designed to ensure that WGI may
maintain 63% of the issued and outstanding shares of the Company’s capital stock
in the event that any of the Company’s capital stock is issued in respect to the
Existing Contingent Equity, the Future Contingent Equity or the ACN Warrant as
defined below.  The term of the Anti-Dilution Warrant is ten years
from the date of issuance, and the shares subject to the Anti-Dilution Warrant
will be decreased proportionally upon the expiration of Existing Contingent
Equity, Future Contingent Equity and the ACN Warrant.  WGI is a
private investment fund whose ownership includes owners of ACN Inc., a direct
seller of telecommunications services and a distributor of video
phones. ACN, Inc. is the parent company of ACN Digital Phone Service
LLC.  Concurrently with the closing on April 6, 2009 of the
transactions contemplated by the Securities Purchase Agreement, the Company
entered into a commercial relationship with ACN pursuant to which the Company
will design and sell video phones to ACN (the “Commercial
Relationship”).  As part of the Commercial Relationship, the Company
entered into two agreements, a Master Purchase Agreement pursuant to which ACN
has committed to purchase three hundred thousand videophones over a two-year
period and a Software Development and Integration and Manufacturing Assistance
Agreement pursuant to which ACN has committed to provide the Company with $1,200
to fund certain software development costs.   During the quarter ended
June 30, 2009, the Company received the $1,200 for software development costs
from ACN.  In connection with the Commercial Relationship, the Company
granted ACN a warrant to purchase up to approximately 38.2 million shares of its
Common Stock at an exercise price of $0.0425 per share (the “ACN
Warrant”).  The ACN Warrant will vest incrementally based on ACN’s
purchases of video phones under the Commercial Relationship.
  ACN, Inc. is the parent company of ACN
Digital Phone Service LLC. WGI is a private investment fund whose ownership
includes owners of ACN, a direct seller of telecommunications services and a
distributor of video phones. Concurrently with the closing on April 6, 2009 of
the transactions contemplated by the Securities Purchase Agreement, the Company
entered into a commercial relationship with ACN pursuant to which the Company
will design and sell video phones to ACN (the “Commercial Relationship”). As
part of the Commercial Relationship, the Company entered into two agreements, a
Master Purchase Agreement pursuant to which ACN has committed to purchase three
hundred thousand videophones over a two-year period and a Software Development
and Integration and Manufacturing Assistance Agreement pursuant to which ACN has
committed to provide the Company with $1,200 to fund certain software
development costs. During the quarter ended June 30, 2009, the Company received
the $1,200 for software development costs from ACN. In connection with the
Commercial Relationship, the Company granted ACN a warrant to purchase up to
approximately 38.2 million shares of its Common Stock at an exercise price of
$0.0425 per share (the “ACN Warrant”). The ACN Warrant will vest incrementally
based on ACN’s purchases of video phones under the Commercial
Relationship.
  9
 
 Exercise of Warrants.On June
23, 2009, the Company amended the exercise price and other provisions of certain
Series A Warrants to Purchase Common Stock of WorldGate Communications, Inc.
issued June 23, 2004 and certain Series B Warrants to Purchase Common Stock of
WorldGate Communications, Inc. issued June 23, 2004 (collectively, the “2004 Warrants”),
representing rights to purchase, in the aggregate, 8,771,955 shares of Common
Stock and that would have expired on June 23, 2009. The exercise price of the
2004 Warrants was amended to $0.25 per share of Common Stock and the expiration
date of the 2004 Warrants was amended to August 7, 2009.
 
 On June
23, 2009, the Company also amended the exercise price and other provisions of
certain Warrants to Purchase Common Stock of WorldGate Communications, Inc.
issued August 3, 2005 (collectively, the “2005 Warrants”), representing rights
to purchase, in the aggregate, 513,333 shares of Common Stock and that expire on
August 3, 2010. The exercise price of the 2005 Warrants was amended to $0.25 per
share of Common Stock.
  As of
June 30, 2009, 3,166,667 of the 2004 Warrants and all of the 2005 Warrants were
exercised, resulting in the Company issuing 3,680,000 shares of Common Stock and
in return the Company received $920 in gross aggregate cash proceeds ($881 net
proceeds). After June 30, 2009 and through August 7, 2009, additional 2004
Warrants were exercised (including a significant number of 2004 Warrants held by
an affiliate of Antonio Tomasello) resulting in the Company issuing 5,525,288
shares of Common Stock and in return the Company received $1,401 in cash
proceeds. The Company incurred $39 of fees pursuant to the transfer of the 2004
Warrants and 2005 Warrants from the original warrant holders that were not
interested in exercising the warrants to new warrant holders. As of August 7,
2009, all 2004 Warrants had either expired or been exercised. As of August 7,
2009, 879,359 of the warrants issued August 3, 2005 remain
outstanding.
  WGI
Warrant. Upon closing on April 6, 2009 of the transactions contemplated by the
Securities Purchase Agreement, the Company issued to WGI a warrant to purchase
up to 140.0 million shares of Common Stock (the “Anti-Dilution Warrant”), at an
exercise price of $0.01 per share under certain circumstances, including if the
Company issues any capital stock upon the exercise or conversion of any warrants
that were outstanding as of April 6, 2009 (“Existing Contingent Equity”). As of
June 30, 2009, the 3,680,000 shares of Common Stock issued in connection with
the exercise of the 2004 Warrants and 2005 Warrants resulted in WGI having the
right to purchase an aggregate of 6,265,946 shares of Common Stock at an
exercise price of $0.01 per share under the Anti-Dilution Warrant. After June
30, 2009 and through August 7, 2009, the additional 5,525,288 shares of Common
Stock issued in connection with the exercise of the 2004 Warrants and 2005
Warrants resulted in WGI having the right to purchase in aggregate 9,544,138 of
additional shares of Common Stock at an exercise price of $0.01 per share under
the Anti-Dilution Warrant.
  Employment Agreements. In
connection with the closing on April 6, 2009 of the transactions contemplated by
the Securities Purchase Agreement, the Company also entered into employment
agreements with members of senior management, including Hal Krisbergh, Randall
Gort, Joel Boyarski and James McLoughlin.The employment
agreements entered into with the Company’s executive officers have a term of one
year (unless terminated earlier by either party) and provide for the execution
by the employee of a non-compete and confidentiality agreement with the Company.
The employment agreements set an annual base salary of $336 for Mr. Krisbergh,
$200 for Mr. Gort, $195 for Mr. Boyarski and $190 for Mr. McLoughlin. The
agreements also provide for the payment of quarterly bonuses during the period
of employment, based on individual performance objectives to be set by the
Company’s compensation committee, with 100% of the target quarterly bonus
amounts guaranteed for Q2 2009 and 50% guaranteed for Q3 2009, with the
remaining amounts for Q3 and Q4 2009 earned to the extent that the individual
performance objectives have been met. The employment agreements also contemplate
a future grant of options under a new stock incentive plan, as and when such
plan is adopted by the board of directors, in the following anticipated amounts:
Hal Krisbergh: 1,080,000 shares; Randall Gort: 1,080,000 shares; Joel Boyarski:
900,000 shares; and James McLoughlin: 900,000 shares. While the employment
arrangements under these agreements are “at-will,” the agreements provide that
in the event the employee is terminated by the Company without cause, upon the
execution by the employee of a general release in a form acceptable to the
Company, the employee will be entitled to certain continued health benefits as
well as severance in the amount equal to the greater of (i) the employee’s
monthly base salary amount, plus any cash bonus amounts (including guaranteed
amounts earned or accrued through the termination date), multiplied by the
number of months remaining in the term or (ii) the employee’s monthly base
salary amount, plus any cash bonus amounts (including guaranteed amounts earned
or accrued through the termination date), multiplied by six.
  Departure of Officers. On
April 9, 2009, Harold M. Krisbergh tendered his resignation as Chief Executive
Officer and as a director of the Company and Randall J. Gort tendered his
resignation as Senior Vice President, Chief Legal Officer and Secretary of the
Company. On May 15, 2009 James McLoughlin tendered his resignation as Senior
Vice President, Sales and Marketing. In connection with their respective
resignations, the Company entered into severance agreements with each of Messrs.
Krisbergh, Gort, and McLoughlin pursuant to which the Company agreed to provide
them with certain severance benefits, including continuation of their salary
through April 6, 2010, payment of accrued bonus amounts, continuation of certain
health benefits for the severance period, and an extension of the period during
which vested options may be exercised. These severance agreements provide a
general release in favor of the Company and its affiliates.
  10
  Increase in Officer’s Compensation.As of June 30, 2009, the Company increased its annual compensation
obligations for officers and senior executives of the Company by $605 as a
result of hiring additional members of senior management and the termination and
severance payments of Messrs. Krisbergh, Gort, and McLoughlin described above.
In August 2009, the Company added an additional officer increasing the annual
compensation by $220. The severance compensation for Messrs. Krisbergh, Gort,
and McLoughlin will cease on April 7, 2010. As of June 30, 2009, the Company
accrued $626 in officer’s compensation and severance.
  Mototech Agreement.On July 8,
2009, the Company entered into a letter agreement with Mototech, Inc. (“Mototech”) to settle
all past due obligations owed by the Company to Mototech. Mototech had performed
various services for the Company, including manufacturing and engineering
development, through various historical transactions, which resulted in a claim
by Mototech for approximately $1,400 in unpaid fees and expenses from the
Company. Pursuant to the letter agreement,
  ·
              all
      obligations of the Company to Mototech were terminated and the Company was
      released from all liabilities or obligations to Mototech, including all
      amounts due or owing to Mototech;
  ·
              the
      Company agreed to pay $600 in cash to Mototech pursuant to the following
      payment schedule: (a) $50 was paid on July 20, 2009; (b) $100 to be paid
      on or prior to August 30, 2009; (c) $150 to be paid on or prior to
      September 30, 2009; and (d) $300 to be paid on or prior to October 30,
      2009;
  ·
              the
      Company issued to Mototech 3,200,000 unregistered shares of Common Stock,
      subject to the following conditions: (a) no such shares can be sold prior
      to the date that is 9 months after the issuance of such shares and (b)
      when such shares are permitted to be sold, no more than 25,000 of such
      shares may be sold in any single day;
and
  ·
              the Company issued to Mototech an
      unregistered warrant to purchase 1,000,000 shares of Common Stock (the
      “Mototech Warrant”) with the following terms: (a) exercise price of $0.35
      per share; (b) immediate vesting of the entire warrant; and (c) expiration
      date of the earlier of (i) July 8, 2014, (ii) a change of control of the
      Company or (iii) the twentieth (20th) day following the Company’s delivery
      of notice to Mototech of the occurrence of a period of ten (10)
      consecutive trading days during which the quoted bid price of the Common
      Stock has been greater than a price equal to one hundred fifty percent
      (150%) of the exercise price of the
  warrant.
  As a
result of the Mototech transaction the Company reduced its accounts payable by
$1,439, recorded accrued expenses of $600 for the cash to be paid and increased
stockholder equity by $839 for the common stock and warrants
issued.
  Future Cash Flows and
Financings. The Company’s ability to generate cash is dependent upon the
sale of its products and services and on obtaining cash through the private or
public issuance of debt or equity securities. Given that the Company’s video
phone business involves the development of a new product line with no market
penetration in an underdeveloped market sector, no assurances can be given that
sufficient sales, if any, will materialize. The lack of success of the Company’s
sales efforts could also have an adverse ability to raise additional
financing.
  Based on
management’s internal forecasts and assumptions regarding its short term cash
requirements, the Company currently believes that it will have sufficient cash
on hand to meet its obligations into the fourth quarter of 2009. However, there
can be no assurance given that these assumptions are correct or that the revenue
projections associated with product sales and services to ACN will materialize
to a level that will provide the Company with sufficient capital to operate its
business.
  The
Company continues to evaluate possibilities to obtain additional financing
through public or private equity or debt offerings or from other sources. In
addition, the Company plans to explore additional service and distribution sales
opportunities. There can be no assurance given, however, that the Company’s
efforts will be successful or that any additional financing will be available
and can be consummated on terms acceptable to the Company, if at all. There can
also be no assurance given that any additional sales can be achieved through
additional service and distribution opportunities. If the Company is unable to
obtain sufficient funds, the Company may be required to reduce the size of the
organization or suspend operations which could have a material adverse impact on
its business prospects.
  11
  4.
              Recent
      Accounting Pronouncements.
  In
December 2007, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standard (“SFAS”) No. 141R, “Business
Combinations,” which replaces SFAS No. 141, “Business Combinations.” SFAS No.
141R establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent considerations, and certain acquired contingencies. SFAS No. 141R
also requires acquisition-related transaction expenses and restructuring costs
to be expensed as incurred rather than capitalized as a component of the
business combination. SFAS No. 141R is applicable prospectively to business
combinations for which the acquisition date is on or after January 1, 2009. The
adoption of SFAS No. 141R will have an impact on accounting for businesses
acquired after the effective date of this pronouncement.
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements—An Amendment of ARB No. 51.” SFAS No. 160
establishes accounting and reporting standards for the noncontrolling interest
in a subsidiary (previously referred to as minority interests). SFAS 160 also
requires that a retained noncontrolling interest upon the deconsolidation of a
subsidiary be initially measured at its fair value. Upon the adoption of SFAS
No. 160, the Company will be required to report any noncontrolling interests as
a separate component of consolidated stockholders’ equity. The Company will also
be required to present any net income allocable to noncontrolling interest and
net income attributable to the stockholders of the Company separately in its
consolidated statements of operations. SFAS No. 160 is effective for fiscal
years, and interim periods within those fiscal years, beginning on or after
January 1, 2009. The implementation of SFAS No. 160 would require retroactive
adoption of the presentation and disclosure requirements for existing minority
interests, with all other requirements of SFAS No. 160 to be applied
prospectively. As the Company does not have noncontrolling interests in any
subsidiary, the adoption of SFAS No. 160 did not have any impact upon the
Company’s consolidated financial position or results of operations.
  In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and
Hedging Activities: an amendment of FASB Statement No. 133,” which amends and
expands the disclosure requirements of SFAS 133 to require qualitative
disclosure about objectives and strategies for using derivatives, quantitative
disclosures about fair value amounts of and gains and losses on derivative
instruments, and disclosures about credit-risk-related contingent features in
derivative agreements. This statement is effective beginning January 1, 2009.
The adoption of SFAS 161 did not have a material impact upon the Company’s
consolidated financial position or results of operations.
  In June
2008, the FASB ratified EITF No. 07-5, “Determining Whether an Instrument (or an
Embedded Feature) is Indexed to an Entity’s Own Stock” (“EITF 07-5”). EITF 07-5
provides that an entity should use a two-step approach to evaluate whether an
equity-linked financial instrument (or embedded feature) is indexed to its own
stock, including evaluating the instrument’s contingent exercise and settlement
provisions. EITF 07-5 is effective for financial statements issued for fiscal
years beginning after December 15, 2008. Early application is not permitted.
Upon adoption of EITF 07-5 on January 1, 2009, the Company has determined that
certain warrants issued on August 11, 2006 and October 13, 2006 were not
equity-linked financial instruments, and accordingly, were derivative
instruments. The Company has recorded the fair value of these instruments and
the resulting cumulative effect of this change in accounting method, as of
January 1, 2009 (See Note 7).
  In April
2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and
Level of Activity for the Asset or Liability Have Significantly Decreased and
Identifying Transactions That Are Not Orderly” (“FSP FAS 157-4”). FSP FAS 157-4
provides guidance on estimating fair value when market activity has decreased
and on identifying transactions that are not orderly. Additionally, entities are
required to disclose in interim and annual periods the inputs and valuation
techniques used to measure fair value. FSP FAS 157-4 is effective for interim
and annual periods ending after June 15, 2009. The adoption of FSP FAS 157-4 did
not have a material impact on the Company’s consolidated financial position or
results of operations.
 
 In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), which
establishes general standards of accounting for and disclosure of events that
occur after the balance sheet date but before financial statements are issued or
are available to be issued. The Company is required to adopt SFAS 165
prospectively to both interim and annual financial periods ending after June 15,
2009. The adoption of SFAS 165 did not have a material impact on the Company’s
consolidated financial position or results of operations.
 
 In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation No.
46(R)” (“SFAS No. 167”). SFAS No. 167 is intended to improve financial reporting
by enterprises involved with variable interest entities and to address (1) the
effects on certain provisions of FASB Interpretation No. 46 (revised December
2003), Consolidation of Variable Interest Entities , as a result of the
elimination of the qualifying special-purpose entity concept in SFAS No. 166,
and (2) constituent concerns about the application of certain key provisions of
Interpretation 46(R), including those in which the accounting and disclosures
under the Interpretation do not always provide timely and useful information
about an enterprise’s involvement in a variable interest entity. SFAS No. 167 is
effective as of the beginning of each reporting entity’s first annual reporting
period that begins after November 15, 2009, for interim periods within that
first annual reporting period, and for interim and annual reporting periods
thereafter. The adoption of SFAS No. 167 is not expected to have a material
impact on the Company’s consolidated financial position or results of
operations.
  12
 
 In June
2009, the FASB issued SFAS No. 168, “The FASB Accounting Standards Codification
and the Hierarchy of Generally Accepted Accounting Principles” (“SFAS 168”).
SFAS 168 establishes the FASB Accounting Standards Codification,
(“Codification”) as the single source of authoritative GAAP to be applied by
nongovernmental entities, except for the rules and interpretive releases of the
SEC under authority of federal securities laws, which are sources of
authoritative GAAP for SEC registrants. All guidance contained in the
Codification carries an equal level of authority. SFAS 168 is effective for
interim and annual periods ending after September 15, 2009. The adoption of SFAS
168 is not expected to have a material impact on the Company’s consolidated
financial position or results of operations.
 
 5.
              Inventory.
  The Company’s inventory consists
primarily of finished goods equipment to be sold to customers. The cost is
determined on a first-in, first-out cost basis. A periodic review of inventory
quantities on hand is performed in order to determine and record a provision for
excess and obsolete inventories. Factors related to current inventories such as
technological obsolescence and market conditions were considered in determining
estimated net realizable values. A provision is recorded to reduce the cost of
inventories to the estimated net realizable values. To motivate trials and sales
of the Ojo, which is the Company’s main product, the Company has historically
subsidized, and may in the future continue to subsidize, certain of its product
sales to customers that result in sales of inventory below cost. Any significant
unanticipated changes in the factors noted above could have an impact on the
value of the Company’s inventory and its reported operating results. At June 30,
2009 and December 31, 2008, the Company’s inventory balance was $1,048 and
$1,176, respectively (net of a reserve of $600 and $0, respectively for excess
and obsolete inventory that is not expected to be utilized in the continued
development of the video phone). Under an agreement with Aequus dated March 31,
2008, Aequus purchased $1,153 of units which were agreed to be held by the
Company until shipped to Aequus customers. Included in the inventory balance
reported on the balance sheet as of June 30, 2009 are remaining Aequus units not
yet shipped to Aequus customers totaling $765.
  6.
              Stock
      Based Compensation.
  The
Company accounts for stock based compensation in accordance with the provisions
of SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No. 123(R)”). SFAS
No. 123(R) requires that all stock based compensation be recognized as an
expense in the financial statements, and that such cost be measured at the fair
value of the award. SFAS No. 123(R) also requires that excess tax benefits
related to stock option exercises be reflected as financing cash inflows instead
of operating inflows. As a result, the Company’s net loss before taxes for the
three and six months ended June 30, 2009 included approximately $226 and $290,
respectively, of stock based compensation. The three and six months ended June
30, 2008 included approximately $126 and $251, respectively, of stock based
compensation. The stock based compensation expense is included in general and
administrative expense in the condensed consolidated statements of
operations.
  Consistent
with the requirements of SFAS 123(R), the Company has selected a
“with-and-without” approach regarding the accounting for the tax effects of
share-based compensation awards. This approach is consistent with intraperiod
allocation guidance in SFAS No. 109, “Accounting for Income Taxes,” and EITF
Topic D-32, “Intraperiod Tax Allocation of the Tax Effect of Pretax Income from
Continuing Operations.”
  On May
26, 2009, the Company’s Board of Directors (the “Board”) approved the terms of
Amendment No. 1 (the “Amendment”) to the Company’s 2003 Equity Incentive Plan
(the “Plan”). The Amendment, among other things, increased the maximum number of
shares of Common Stock that may be issued or transferred under the Plan to
26,500,000 and increased the maximum amount of shares that may be issued in any
fiscal year to any single participant in the Plan underlying an option award to
2,000,000 shares. The Board determined that it was advisable and in the best
interests of the Company to increase the maximum number of shares available
under the Plan so as to enable the Company to be able to provide meaningful
equity incentives to eligible participants in light of the significant increase
(from 118,906,345 on March 16, 2009 to 321,368,500 on May 5, 2009) in the number
of shares of Common Stock that are now outstanding as a result of the closing on
April 6, 2009 of the transactions contemplated by the Securities Purchase
Agreement.
  Upon the
approval of the Amendment, pursuant to authority delegated to them, the members
of the Compensation and Stock Option Committee of the Board who are “outside
directors” as defined in Treas. Reg. Section 1.162-27(e)(3) and “non-employee
directors” as defined in Rule 16(b)-3 of the Securities and Exchange Act of
1934, as amended, approved grants of non-qualified stock options to purchase an
aggregate of 13,261,500 shares of Common Stock to certain employees and
consultants of the Company. Each such option has an exercise price equal to the
fair market value of the underlying stock as of the date of the grants (which
was $0.28 and $0.32, respectively, per share based on the closing price on the
Over the Counter Bulletin Board on May 26, 2009 and June 30, 2009), vests in
four equal annual installments commencing on the first anniversary of the date
of grant and has a ten year term. These options had a weighted average grant
date fair value of $0.28 per share determined using the Black Scholes fair value
option model.
  13
  A summary of awards under the Company’s 2003
Equity Incentive Plan is presented below:
  Stock Options
                              
                              
                              Weighted-Average
                                Exercise Price
                              
                              
                              Aggregate
                                Intrinsic ValueOutstanding,
      January 1, 2009
                              
                              
                              6,080,364
                              
                              
                              $
                              0.27
                              
                              
                              $
                              0Granted
                              
                              
                              13,261,500
                              
                              
                              $
                              0.28Exercised
                              
                              
                              0
                              
                              
                              
                              0Cancelled/forfeited
                              
                              
                              (319,431
                              )
                              
                              $
                              0.27Outstanding,
      June 30, 2009
                              
                              
                              19,022,433
                              
                              
                              $
                              0.28
                              
                              
                              $
                              1,543,493Exercisable,
      June 30, 2009
                              
                              
                              4,081,585
                              
                              
                              $
                              0.32
                              
                              
                              $
                              706,553
 
 As of
June 30, 2009, there was a total of $3,925 of unrecognized compensation
arrangements granted under the Plan. The cost is expected to be recognized
through 2013.
  Options
granted during the six months ended June 30, 2009 vest over four years and
expire ten years from the date of grant under the Plan. The weighted-average
exercise price of the options granted was $0.28. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes fair value
option valuation model. The weighted-average assumptions used for these grants
were: expected volatility of 194%; average risk-free interest rates of 2.40%;
dividend yield of 0%; and expected life of 6.25 years.
  The
following table summarizes information about stock options outstanding at June
30, 2009:
  Stock Options Outstanding
                    
                    
                    Stock Options ExercisableRange of Exercise Prices
                    
                    Shares
                    
                    
                    Weighted-
                      Average
                      Remaining
                      Contractual
                      Life (Years)
                    
                    
                    Weighted-
                      Average
                      Exercise
                      Price
                    
                    
                    Shares
                    
                    
                    Weighted-
                      Average
                      Exercise
                      Price$0.00
      - $0.39
                    
                    
                    18,341,441
                    
                    
                    
                    8.89
                    
                    
                    $
                    0.23
                    
                    
                    
                    3,463,093
                    
                    
                    $
                    0.11$0.40
      - $0.59
                    
                    
                    56,500
                    
                    
                    
                    7.55
                    
                    
                    
                    0.49
                    
                    
                    
                    31,500
                    
                    
                    
                    0.49$0.60
      - $0.89
                    
                    
                    289,492
                    
                    
                    
                    5.48
                    
                    
                    
                    0.60
                    
                    
                    
                    289,492
                    
                    
                    
                    0.60$0.90
      - $1.34
                    
                    
                    6,500
                    
                    
                    
                    3.07
                    
                    
                    
                    1.20
                    
                    
                    
                    6,500
                    
                    
                    
                    1.20$1.35
      - $2.01
                    
                    
                    81,500
                    
                    
                    
                    4.79
                    
                    
                    
                    1.72
                    
                    
                    
                    56,500
                    
                    
                    
                    1.78$2.02
      - $3.02
                    
                    
                    193,000
                    
                    
                    
                    3.73
                    
                    
                    
                    2.39
                    
                    
                    
                    193,000
                    
                    
                    
                    2.39$3.03
      - $4.53
                    
                    
                    54,000
                    
                    
                    
                    5.71
                    
                    
                    
                    3.60
                    
                    
                    
                    41,500
                    
                    
                    
                    3.59Total
                    
                    
                    19,022,433
                    
                    
                    
                    8.74
                    
                    
                    $
                    0.28
                    
                    
                    
                    4,081,585
                    
                    
                    $
                    0.32
 
 An
aggregate of 1,151,000 restricted shares were granted on October 3, 2007 and
December 20, 2007 to certain senior executives that vest upon the achievement of
certain performance criteria:
  ·
              10%
      of the shares vest upon achieving each of a 10%, 20%, 30%, 40% and 50%
      increase for the Company in total gross revenue in a quarter over its
      third quarter 2007 total gross revenue of $1,532 as shown on its statement
      of operations as reported in the SEC
filings;
  ·
              25%
      of the shares vest upon the Company achieving (1) a quarterly operating
      cash break-even (defined as zero or positive “net cash provided by
      operations” consistent with or as reported on the Consolidated Statement
      of Cash Flows and (2) a 10% net income as a percent of
      revenue.
  During
2008, 318,000 of these restricted shares were forfeited, leaving a balance of
outstanding restricted shares of 833,000 at December 31, 2008 with an aggregate
fair value of $198 on their dates of grant of October 3, 2007 and December 20,
2007. The criteria for these restricted shares were amended to clarify that the
criteria is intended to refer to transactions and revenue, operating cash flow
and income generated in the ordinary course of the Company’s business, and not
to extraordinary transactions. During the three month period ended June 30,
2009, 525,000 additional restricted shares were forfeited by executives whose
employment with the Company ended. As of June 30, 2009, it was determined that
it was more likely than not that the remaining 308,000 outstanding restricted
shares, with a fair value of $83, would vest. As such, the Company began
amortizing the fair value of these shares over the expected period that they
will vest and recorded compensation expense of $9 for these
grants.
  14
  The
following table is the summary of the Company’s nonvested restricted shares as
of June 30, 2009.
  Restricted
                      SharesNonvested
      as of January 1, 2009
                    
                    
                    833,000Granted
                    
                    
                    0Vested
                    
                    
                    0Cancelled/forfeited
                    
                    
                    (525,000
                    )Nonvested
      as of June 30, 2009
                    
                    
                    308,000
  7.
              Accounting
      for Secured Convertible Debentures and Related
  Warrants.
  As
discussed in Note 3, the Company completed a transaction with WGI on April 6,
2009 in which the convertible debentures described below were
cancelled.
  General Terms of Convertible
Debentures. On August 11, 2006 and October 13, 2006, the Company
completed a private placement with an institutional investor of convertible
debentures in the aggregate principal amount of $11,000. The Company received
$6,000 ($5,615, net of transaction costs) upon the closing of the transaction on
August 11, 2006 (the “First Tranche”) and the remaining $5,000 ($4,700, net of
transaction costs) was received on October 13, 2006 (the “Second Tranche”). The
convertible debentures had a maturity of three years, an interest rate of 6% per
annum, and were convertible at the option of the investors into Common Stock at
a conversion price equal to the lesser of $1.75 per share or 90% of the average
of the five lowest daily volume weighted closing price (“VWAP”) of the Common
Stock during the fifteen trading days immediately preceding the conversion date
(subject to adjustment in the event of stock dividends, splits and certain
distributions to stockholders, fundamental transactions, and future dilutive
equity transactions). Interest is payable at maturity, and the Company may elect
to pay the interest amount in cash or shares of its Common Stock. The Company
also granted the holder of convertible debentures a security interest in
substantially all of its assets. Upon any liquidation, dissolution or winding up
of the Company, the holders of the convertible debentures would have been
entitled to receive the principal amount of the convertible debentures, together
with accrued and unpaid interest, prior to any payment to the holders of the
Company’s common and preferred stock.
  Amendment To Convertible
Debentures. On May 18, 2007, the Company and the holder amended the terms
of the convertible debentures to remove the investor’s ability, upon conversion
of the debenture, to demand cash in lieu of shares of Common Stock and to
clarify that the Company may issue restricted shares if there is no effective
registration statement at the time of conversion. This amendment of the terms of
the convertible debenture resulted in the Company reclassifying the derivative
conversion option liability embedded in the convertible debentures from debt to
equity.
  Restrictions on Convertible
Debentures. The holder could not make any conversions below $1.75 per
share (i) which would exceed $500 in principal amount in any calendar month or
(ii) which would result in the issuance of more than 840,000 shares of Common
Stock per calendar month (provided that this maximum share limit will be waived
by the Company unless it elects to pay the holder in cash the difference in
value between 840,000 shares and the number of shares the holder wishes to
convert, up to the $500 per month conversion limit). If the Company was in
default under the convertible debentures, these limitations would be waived. The
holder was also not restricted in making conversions at $1.75 per share.
  In no
case, however, may the holder convert the convertible debentures if it would
result in beneficial ownership by the holder of more than 9.99% of the Company’s
outstanding Common Stock (though this provision can be waived by the holder upon
65 days prior notice).
  In
addition, with respect to all of the convertible debentures, the aggregate
number of shares to be issued upon conversion, exercise of the warrants
(described below), payment for commitment shares (described below), and payment
of liquidated damages (described below) has been limited to 61,111,111 shares of
Common Stock. In December 2008, the share limitation of the aggregate number of
shares to be issued was increased to 75,368,811 shares of Common
Stock.
  Accounting for Convertible
Debentures. The Company initially accounted for conversion options
embedded in the convertible debentures in accordance with SFAS No. 133
“Accounting for Derivative Instruments and Hedging Activities” (“SFAS 133”) and
EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to, and
Potentially Settled in, a Company’s Own Stock” (“EITF 00-19”) SFAS 133 generally
requires companies to bifurcate conversion options embedded in convertible
debentures from their host instruments and to account for them as free standing
derivative financial instruments in accordance with EITF 00-19. EITF 00-19
states that if the conversion option requires net cash settlement in the event
of circumstances that are not solely within the Company’s control that they
should be classified as a liability measured at fair value on the balance
sheet.
  15
  Effective
January 1, 2007, the Company adopted the provisions of EITF Issue No. 06-7,
“Issuer’s Accounting for a Previously Bifurcated Conversion Option in a
Convertible Debt Instrument When the Conversion Option No Longer Meets the
Bifurcation Criteria in Financial Accounting Standards Board (“FASB”) Statement
No. 133, Accounting for Derivative Instruments and Hedging Activities” (“EITF
06-7”). Under EITF 06-7, at the time of issuance, an embedded conversion option
in a convertible debt instrument may be required to be bifurcated from the debt
instrument and accounted for separately by the issuer as a derivative under SFAS
133, based on the application of EITF 00-19. Subsequent to the issuance of the
convertible debt, facts may change and cause the embedded conversion option to
no longer meet the conditions for separate accounting as a derivative
instrument, such as when the bifurcated instrument meets the conditions of Issue
00-19 to be classified in stockholders’ equity. Under EITF 06-7, when an
embedded conversion option previously accounted for as a derivative under SFAS
133 no longer meets the bifurcation criteria under that standard, an issuer
shall disclose a description of the principal changes causing the embedded
conversion option to no longer require bifurcation under SFAS 133 and the amount
of the liability for the conversion option reclassified to stockholders’
equity.
  Prior to
the May 18, 2007 amendment of the convertible debenture, subject to the share
limitation, as discussed above, the actual number of shares of Common Stock that
would be required if a conversion of the convertible debentures was made through
the issuance of Common Stock could not be predicted. If the Company’s
requirements to issue shares under these convertible debentures had exceeded the
share limitation, or if it was not listed or quoted for trading on the OTCBB,
the Company could have been required to settle the conversion of the convertible
debentures with cash instead of its Common Stock.
  Through
May 18, 2007, the Company accounted for the conversion options using the fair
value method at the end of each quarter, with the resultant gain or loss
recognition recorded against earnings. On May 18, 2007 the Company and the
investor amended the terms of the secured convertible debentures to remove the
investor’s ability, upon conversion of the debentures, to demand cash in lieu of
shares of Common Stock and to clarify that the Company may issue restricted
shares if there is no effective registration statement at the time of
conversion. This amendment of the terms of the convertible debentures permitted
the Company to reclassify $5,384 of the embedded derivative conversion option
liability to stockholders’ equity. The discount on the convertible debentures of
$5,240 was based on amortization until October 2009.
  At
the closing of the First Tranche, the sum of the fair values of the conversion
feature and the warrants was $5,714 in the aggregate, which exceeded the net
proceeds of $5,615. The difference of $99 was charged to the provision for fair
value adjustment, upon issuance during the third quarter of 2006. Accordingly,
the Company recorded a discount equal to the face value of the convertible
debentures, which will be amortized using the effective interest rate method
over the three year term. The Common Stock issued as fees in the transaction was
recorded at a net value of $0, as there was no residual value
remaining.
  At
October 13, 2006, in connection with the closing of the Second Tranche, the
convertible feature of the convertible debentures was recorded as a derivative
liability of $3,449 and the warrants were recorded as additional paid in capital
of $230. For the Second Tranche issuance on October 13, 2006, the Company
recorded a discount of $3,979, which is being amortized using the effective
interest method over the three year term.
  From
January 1, 2009 through closing on April 6, 2009 of the transactions
contemplated by the Securities Purchase Agreement when the debentures were
cancelled, there were no conversions of the debentures. As a result during the
three and six months ended June 30, 2009 there were no issuances of Common Stock
related to the debentures. During the three and six months ended June 30, 2008,
$646 and $647, respectively in face value of the convertible debentures was
converted, resulting in the issuance of 6,116,010 and 6,116,581 shares of Common
Stock, respectively. As a result of the amortization and conversion, $2,235 and
$2,918, respectively, of the discount on the convertible debenture has been
charged to discount amortization for three and six months ended June 30, 2009,
which includes the effects of the closing on April 6, 2009 of the transactions
contemplated by the Securities Purchase Agreement. During the three and six
months ended June 30, 2008, $707 and $926, respectively, of the discount on the
convertible debenture has been charged to discount amortization.As of June 30, 2009, there was
no debt or interest outstanding as a result of the cancellation of the
convertible debenture and interest as part of the closing on April 6, 2009 of
the transactions contemplated by the Securities Purchase
Agreement.
  16
  Adoption
of EITF 07-5.On January 1, 2009, in connection with the adoption of EITF 07-5, the
Company determined that warrants issued on August 11, 2006 and October 13, 2006
were not indexed to the Company’s own stock, as defined. Accordingly, the
Company determined that these warrants were derivative instruments, and on
January 1, 2009, recorded derivative liabilities of $479 and $406 for each of
the August 11, 2006 and October 13, 2006 warrants, respectively. At January 1,
2009, the Company determined the fair value of the warrant derivative liability
using the Black-Scholes valuation model, applying the actual Common Stock price
on January 1, 2009 ($0.38), applicable volatility rate (242%), and the period
close risk-free interest rate (0.27%) for the instruments’ remaining contractual
lives of 2.61 years for the August 2006 tranche and 2.78 years for the October
2006 tranche. In connection with recording the warrant derivative liabilities,
the Company determined the cumulative effect of a change in accounting principle
as if they were recorded at inception, and increased the debt discount related
to the October 13, 2006 tranche by $584, reduced additional paid in capital by
$1,752 for the previously recorded equity value of the warrants and decreased
accumulated deficit by $1,449 for inception to adoption date mark to market and
discount amortization adjustments.
  The
following warrants were issued under the August 2006 tranche and the October
2006 tranche and were cancelled as part of the closing on April 6, 2009
of the transactions contemplated by the Securities Purchase
Agreement:
  Tranche
                            
                            Exercise Price
                            
                            
                            Warrant SharesAugust
      2006
                            
                            $
                            1.85
                            
                            
                            
                            624,545$
                            2.35
                            
                            
                            
                            600,000$
                            2.60
                            
                            
                            
                            190,909October
      2006
                            
                            $
                            1.85
                            
                            
                            
                            520,455$
                            2.35
                            
                            
                            
                            500,000$
                            2.60
                            
                            
                            
                            159,091
 
 8.
              Accounting
      for Derivative Instruments.
  The
Company accounts for certain warrants, including the warrants issued as part of
the June 2004 private placement of preferred stock and the warrants issued as
part of the August and October 2006 private placement of convertible debentures,
as a derivative liability using the fair value method at the end of each
quarter, with the resultant gain or loss recognition recorded against earnings.
The August and October 2006 warrants were cancelled as part of the closing on
April 6, 2009 of the transactions contemplated by the Securities Purchase
Agreement (See Note 3). The Company recognized a total non-cash gain of $284 and
$4,209, respectively, for the three and six months ended June 30, 2009 and a
non-cash expense of $1,674 and $1,807, respectively, for the three and six
months ended June 30, 2008, for these derivative warrants, based on the
following criteria, each of which impact on the fair value of the derivative,
using the Black-Scholes valuation model:
  June
      2004 Private Placement
                            WarrantsCriteria
                          
                          June 30, 2009
                          
                          
                          June 30, 2008Closing
      Common Stock price
                          
                          $
                          0.32
                          
                          
                          $
                          0.19Applicable
      volatility rates
                          
                          
                          86
                          %
                          
                          
                          192
                          %Risk-free
      interest rates
                          
                          
                          0.17
                          %
                          
                          
                          2.36
                          %Contractual
      life of instrument
                          
                          0.10
      years
                          
                          
                          1.00
      years
  17
 
 The
following table summarizes the derivative instruments (warrants) liability for
the three and six months ended June 30, 2009 (See Note 7):
  June 2004 Private
                      Placement
                    
                    
                    August and October
                      2006 Private Placement
                    
                    
                    TotalOutstanding,
      December 31, 2008
                    
                    $
                    4,360
                    
                    
                    $
                    0
                    
                    
                    $
                    4,360Cumulative
      effect of the change in accounting principal, January 1, 2009 (See Note
      7)
                    
                    
                    0
                    
                    
                    
                    885
                    
                    
                    
                    885Net
      cash gain in fair value:Three
      months ended March 31, 2009
                    
                    
                    (3,665
                    )
                    
                    
                    (260
                    )
                    
                    
                    (3,925
                    )Three
      months ended June 30, 2009
                    
                    
                    (282
                    )
                    
                    
                    (2
                    )
                    
                    
                    (284
                    )Total
      six months ended June 30, 2009
                    
                    
                    (3,947
                    )
                    
                    
                    (262
                    )
                    
                    
                    (4,209
                    )Cancellation
      of Warrants April 6, 2009
                    
                    
                    0
                    
                    
                    
                    (623
                    )
                    
                    
                    (623
                    )Outstanding,
      June 30, 2009
                    
                    $
                    413
                    
                    
                    $
                    0
                    )
                    
                    $
                    413
 
 9.
              Accounting
      for the WGI / ACN transaction
 
 The Company accounts for stock and
warrants issued to third parties, including customers, in accordance with the
provisions of the Emerging Issues Task Force (“EITF “) 96-18, “Accounting for
Equity Instruments That Are Issued to Other Than Employees for Acquiring, or in
Conjunction with Selling, Goods or Services,” and EITF 01-9, “Accounting for
Consideration Given by a Vendor to a Customer (Including a Reseller of the
Vendor’s Products)” (“EITF 01-9”).
  On April
6, 2009, the Company completed a private placement of securities to WGI pursuant
to the terms of the Securities Purchase Agreement.  In connection with
the transaction, the Company was issued the following elements of value: (i)
cash consideration of $1,450, (ii) the cancellation of convertible debentures
held by WGI under which $4,080 in principal and $1,046 in accrued interest was
cancelled and (iii) the cancellation of certain outstanding warrants held by WGI
with a fair value of $623.
  The total
fair value of these elements received by the Company was determined by the
Company to be approximately $7,199.  In connection with the closing on
April 6, 2009 of the transactions contemplated by the Securities Purchase
Agreement, WGI received (i) 202,462,155 shares of Common Stock and (ii) a ten
year Anti-Dilution Warrant, with an exercise price of $0.01, to purchase up to
approximately 140.0 million shares of Common Stock in certain
circumstances.  The Company determined that the most relevant and
clearly determinable fair value of the closing on April 6, 2009 of the
transactions contemplated by the Securities Purchase Agreement is equivalent to
the consideration given by WGI to the Company rather than the fair value of the
202,462,155 shares of Common Stock and Anti-Dilution Warrant issued to WGI in
such transactions based principally upon the closing stock
price.
  In
addition, in connection with the Commercial Relationship entered into with ACN
on April 6, 2009, the Company granted ACN the ACN Warrant. The ACN Warrant will
vest incrementally based on ACN’s purchases of videophones under the Commercial
Relationship. Under the provisions of EITF 96-18, the Company will record a
charge for the fair value of the portion of the warrant earned from the point in
time when shipments of units are initiated to ACN through the vesting date.
Final determination of fair value of the warrant occurs upon actual vesting.
EITF 01-9 requires that the fair value of the warrant be recorded as a reduction
of revenue to the extent of cumulative revenue recorded from that
customer.
  10.
              Fair
      Value of Financial Instruments.
  SFAS No.
157, “Fair Value Measurements” (“SFAS 157”), defines fair value, establishes a
framework for
 measuring
fair value in accordance with generally accepted accounting principles, and
expands disclosures about 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. SFAS 157 applies to all assets and
liabilities that are measured and reported on a fair value basis.
 
 SFAS 157
establishes a three-tier fair value hierarchy which prioritizes the inputs used
in measuring fair
 value as
follows:
 
 Level 1 –
Observable inputs such as quoted prices in active markets;
 Level 2 –
Inputs, other than the quoted prices in active markets, that are observable
either directly or indirectly;
and
 Level 3 –
Unobservable inputs in which there is little or no market data, which require
the reporting entity to
develop its own assumptions.
 
 The
Company does not have any liabilities categorized as Level 1or Level 2 as of
June 30, 2009. The Company had Level 3 derivative liabilities valued at $413 as
of June 30, 2009.
  18
 
 The following is a reconciliation of
the beginning and ending balances for the Company’s derivative liabilities
measured at fair value on a recurring basis using significant unobservable
inputs (Level 3) during the six months ended
 June 30,
2009:
 
 Fair Value Measurements Using Significant
      Unobservable Inputs (Level 3):Description
                          
                          DerivativesLiabilities:Balance,
      January 1, 2009
                          
                          $
                          4,360Cumulative
      effect of the change in accounting Principal, January 1, 2009 (See Note
      7)
                          
                          
                          885Cancelation
      of debenture April 6, 2009
                          
                          
                          (623
                          )Total
      gain in fair value included in operations
                          
                          
                          (4,209
                          )Balance,
      June 30, 2009
                          
                          $
                          413
 
 The change in fair value recorded for
Level 3 liabilities for the periods above are reported in other income (expense)
on the consolidated statement of operations.
 
 11.
              Commitments
      and Contingencies.
  The
Company’s prior five year lease was signed on September 1, 2005 and covered
42,500 square feet at an annual rate of $11.40 per square foot with a 3%
increase annually, cancelable by either party with eight months notice, with a
termination by tenant which included a six month termination fee. In March 2009,
the parties agreed in principle to a new lease effective retroactive to April 1,
2008 (and the cancellation of the current lease with no termination cost) for a
smaller space within the current facility consisting of approximately 17,000
square feet at an annual fee of $7 per square foot. The Company relocated into
this smaller space in April 2008. This new lease was executed in April 2009 and
is cancelable by either party upon 90 days notice with no termination costs.
Total rent expense for the three and six months ended June 30, 2009 amounted to
approximately $46 and $88, respectively, and for the three and six months ended
June 30, 2008 amounted to approximately $43 and $164, respectively.
  In
December 2008, the Company entered into a 60 month lease for office equipment.
As of June 30, 2009, there remains an aggregate of $39 to be paid over the
remaining period of the terms of the leases.
  The future minimum contractual rental
commitments under non-cancelable leases for each of the fiscal years ending
December 31 are as follows:
  2009
      (July 1 to December 31,2009)
                    
                    $
                    62010
                    
                    
                    112011
                    
                    
                    112012
                    
                    
                    11Total
                    
                    $
                    39
  12
              Net
      Loss per Share (Basic and Diluted).
  The Company displays earnings per share
in accordance with SFAS No. 128, “Earnings Per Share.” SFAS No. 128 requires
dual presentation of basic and diluted earnings per share (“EPS”). Basic EPS
includes no dilution and is computed by dividing net loss attributable to common
shareholders by the weighted average number of common shares outstanding for the
period. Diluted EPS includes under the “if converted method” of SFAS No. 128 the
potential dilution that could occur if securities or other contracts to issue
Common Stock were exercised or converted into Common Stock. Outstanding stock
options, warrants and other potential stock issuances are not included in the
computation when they are not in the money and their effect would be
anti-dilutive. The following table presents the shares used in the computation
of fully diluted loss per share for the three and six months ended June 30, 2009
and 2008:
  19
  For the three months ended June 30,2009
      Restated
                      
                      
                      2008Numerator
      for diluted EPS calculation:Net
      loss
                      
                      $
                      (4,339
                      )
                      
                      $
                      (2,994
                      )Denominator
      for diluted EPS calculation:Basic
      and Fully Diluted weighted average common shares
    outstanding
                      
                      
                      308,784,420
                      
                      
                      
                      58,740,660Basic
      and Fully Diluted EPS*
                      
                      $
                      (0.01
                      )
                      
                      $
                      (0.05
                      )For
      the six months ended June 30,2009
      Restated
                      
                      
                      2008Numerator
      for diluted EPS calculation:Net
      loss
                      
                      $
                      (2,075
                      )
                      
                      $
                      (5,145
                      )Denominator
      for diluted EPS calculation:Basic
      and Fully Dilutive weighted average common shares
    outstanding
                      
                      
                      214,369,907
                      
                      
                      
                      57,844,501Basic
      and Fully Dilutive EPS*
                      
                      $
                      (0.01
                      )
                      
                      $
                      (0.09
                      )
 
 * The
Company had net losses during the three and six month periods ended June 30,
2009 and 2008 and as such the basic and fully diluted earnings per share
calculations use the same share amounts in determining the earning per share
value (adding the fully dilutive shares to the denominator would be antidilutive
to the calculations).
 
 Potential
common shares excluded from net loss per share for the three and six months
ended June 30, 2009, were 200,705,382 and 71,477,947 for the three and six
months ended June 30, 2008 because their effect would be anti-dilutive.
Potential common shares comprise shares of Common Stock issuable upon the
exercise of stock options, unvested restricted stock and warrants, and upon the
conversion of convertible debentures irrespective of whether such securities are
in the money.
 
 13.
              Warrants.
 
 A summary
of the Company’s warrant activity for the three months ended June 30, 2009 is as
follows:
 
 Warrants
                        
                        
                        Weighted Average
                          Exercise Price
                        
                        
                        Weighted
                          Average
                          Remaining
                          Contract
                          LifeOutstanding,
      April 1, 2009
                        
                        
                        20,035,811
                        
                        
                        $
                        0.94
                        
                        
                        
                        1.02GrantedWGI
      Anti-Dilution Warrant
                        
                        
                        140,009,750
                        
                        
                        
                        0.01ACN
      Warrant
                        
                        
                        38,219,897
                        
                        
                        
                        0.0425Total
      Granted
                        
                        
                        178,229,647
                        
                        
                        
                        0.02Expired/cancelled
                        
                        
                        (6,944,563
                        )
                        
                        
                        (1.06
                        )Exercised
                        
                        
                        (3,680,000
                        )
                        
                        
                        (0.25
                        )Outstanding,
      June 30, 2009
                        
                        
                        187,640,895
                        
                        
                        $
                        0.06
                        
                        
                        
                        9.33Exercisable,
      June 30, 2009
                        
                        
                        9,411,248
  20
 
 14.
              Stockholders’
      Equity (Deficiency).
  The following summarizes the
transactions in stockholders’ equity (deficiency) from January 1, 2009 through
June 30, 2009:
 
 Common
                      Stock
                    
                    
                    Additional
                      Paid in
                      Capital
                    
                    
                    Accumulated
                      Deficit
                    
                    
                    TotalBalance
      as of January 1, 2009
                    
                    $
                    1,189
                    
                    
                    $
                    261,478
                    
                    
                    $
                    (270,857
                    )
                    
                    $
                    (8,190
                    )Cumulative
      effect of a change in accounting principle
                    
                    
                    0
                    
                    
                    
                    (1,751
                    )
                    
                    
                    1,449
                    
                    
                    
                    (302
                    )Balance
      as of January 1, 2009
                    
                    
                    1,189
                    
                    
                    
                    259,727
                    
                    
                    
                    (269,408
                    )
                    
                    
                    (8,492
                    )Non-cash
      stock based compensation
                    
                    
                    
                    
                    
                    
                    290
                    
                    
                    
                    
                    
                    
                    
                    290Issuance
      of Common Stock upon exercise of warrants
                    
                    
                    37
                    
                    
                    
                    844
                    
                    
                    
                    
                    
                    
                    
                    881April
      6, 2009 Issuance of Common Stock and Anti-Dilution Warrant
                    
                    
                    2,025
                    
                    
                    
                    (1,325
                    )
                    
                    
                    
                    
                    
                    
                    700April
      6, 2009 Cancellation of convertible debt and accrued
    interest
                    
                    
                    
                    
                    
                    
                    5,923
                    
                    
                    
                    
                    
                    
                    
                    5,923April
      6, 2009 Cancellation of the derivative warrants
                    
                    
                    
                    
                    
                    
                    623
                    
                    
                    
                    
                    
                    
                    
                    623Net
      loss for the six months ended June 30, 2009
                    
                    
                    0
                    
                    
                    
                    0
                    
                    
                    
                    (2,075
                    )
                    
                    
                    (2,075
                    )Balance
      as of June 30, 2009
                    
                    $
                    3,251
                    
                    
                    $
                    266,082
                    
                    
                    $
                    (271,483
                    )
                    
                    $
                    (2,150
                    )
 
 15.
              Revenue
      Recognition.
  Revenue
is recognized when persuasive evidence of an arrangement exists, the price is
fixed or determinable, the collectibility is reasonably assured, and the
delivery and acceptance of the equipment has occurred or services have been
rendered. Management exercises judgment in evaluating these factors in light of
the terms and conditions of its customer contracts and other existing facts and
circumstances to determine appropriate revenue recognition. Due to the Company’s
limited commercial sales history, its ability to evaluate the collectibility of
customer accounts requires significant judgment. The Company continually
evaluates accounts of its equipment customers and service customers for
collectibility at the date of sale and on an ongoing basis.
  Revenues
are also offset by a reserve for any price refunds and consumer rebates
consistent with the EITF Issue 01-9, “Accounting for Consideration Given by a
Vendor to a Customer.”
  Video Phone Sales.
During the three and six months ended June 30, 2009, the Company did not ship
any product to customers with a right of return. During the three and six months
ended June 30, 2008, the Company shipped approximately 0 and 9 units,
respectively, with a sales value of $0 and $2, respectively, to customers with a
right of return. These customers may exercise their right of return only if they
do not sell the units to their respective customers. Revenue and cost for these
units were deferred in accordance with SFAS 48 “Revenue Recognition when a Right
of Return Exists.”
  Aequus Revenue. From
June 2007 through March 2008 the Company shipped its video phone product to
Aequus. As part of its June 2007 agreement with Aequus, the Company began to
recognize product revenue at the time of shipment of its video phone. In
addition, the Company also began to receive service fee revenues based on a
percentage of the fees earned by Aequus and for which the customer has received
service. The Company recognizes this service fee revenue upon confirmation from
Aequus of the fees they have earned. The Company also receives service fee
revenues from end consumers which are recognized after the services have been
performed.
  On March
31, 2008, the Company entered into a new agreement with Aequus and Snap
Telecommunications Inc. (“Snap!VRS”). This new agreement provides for the (i)
resolution of a dispute with Aequus regarding amounts the Company claimed were
owed to the Company by Aequus and the termination by the Company of video phone
service to Aequus, (ii) payment to the Company by Aequus of approximately $5,000
in scheduled payments over ten months commencing March 31, 2008, (iii) agreement
to arbitrate approximately $1,354 claimed by the Company to be owed by Aequus
and (iv) purchase of an additional $1,475 of video phones by Aequus.
  21
  ·
              $5,000 of Payments to the
      Company. The $5,000 of payments in the agreement are related to
      multiple deliverables to Aequus that have standalone value with objective
      and reliable evidence of fair value, and include the following: (i) a
      specified amount of non recurring engineering (“NRE”, with a fair value of
      $900), (ii) support and transition training to Aequus to operate its own
      data center (“Training,” with an estimated fair value of $358), (iii)
      continued use of the WorldGate video phone service center during the
      transition (with an estimated fair value of $230), and (iv) the
      elimination of previously agreed service fees (“contract termination fee”,
      with a residual fair value of $3,512). These deliverables are all separate
      units of accounting in accordance with EITF No. 00-21, “Revenue
      Arrangements with Multiple
Deliverables.”
  The
Company recognized revenue for the NRE and training and support as the service
was provided. For the three and six months ended June 30, 2009 such revenue was
$0 and $796, respectively. For the three and six months ended June 30, 2008,
revenue of $279 was recognized for NRE and training and support. The revenue of
$796 in the quarter ended June 30, 2009 includes $725 related to the settlement
of the dispute with Aequus wherein the settlement eliminated $725 of the
Company’s $900 obligation to provide NRE to Aequus and was credited to NRE
services provided under a previous agreement with Aequus. The Training was
expected to be performed over approximately 7 months. Revenue from the use of
the video phone service center was recognized on a straight-line basis over the
expected period of use, which was approximately 7 months. Since collectibility
was not reasonably assured, the contract termination fee was recognized as other
income on a straight line basis over the ten months that the $5,000 was paid.
For the three months ended June 30, 2009 and 2008, other income was recorded for
the contract termination fee of $0 and $1,056, respectively. For the six months
ended June 30, 2009 and 2008, other income was recorded for the contract
termination fee of $348 and $1,056, respectively. The Company had received
payment of $1,475 toward the purchase of video phone units and all of the $5,000
agreed payments in 2008 and the first quarter of 2009.
  ·
              Arbitration. On January
      27, 2009, the Company resolved the outstanding arbitration with Aequus,
      and in full satisfaction of the outstanding arbitration claim Aequus
      agreed to terminate any obligation on the part of the Company to provide
      certain prepaid engineering services pursuant to the March 31, 2008
      Agreement with Aequus (Aequus had prepaid approximately $900 for these
      engineering services of which $725 was allocated to the settlement which
      is recorded as revenue during the three months ended March 31,
      2009).
  ·
              Purchase of Units. Units
      purchased per the March 31, 2008 agreement with Aequus are initially held
      by the Company pending shipment to Aequus customers. Revenue for these
      units held by the Company pending shipment to the ultimate customer is
      deferred, per the SEC Staff Accounting Bulletin Topic 13A(3)(a) (Bill and
      Hold Arrangements). Revenue for the units held is recognized as and when
      the units are shipped to the Aequus customers. For the three months ended
      June 30, 2009 and 2008, the Company shipped $0 and $790, respectively, to
      Aequus customers. For the six months ended June 30, 2009 and 2008, the
      Company shipped $0 and $790, respectively, to Aequus
      customers.
  ACN Revenues. On
April 6, 2009, the Company entered into a Software Development and Integration
and Manufacturing Assistance Agreement pursuant to which ACN has committed to
provide the Company with $1,200 to fund certain software development costs.
During the quarter ended June 30, 2009 the Company received the $1,200 from ACN.
The Company recorded these funds as deferred revenue as of June 30, 2009,
pursuant to the Software Development and Integration and Manufacturing
Assistance Agreement’s terms which partially compensates the Company for its
development of a video phone and licensing thereof. The Company will recognize
revenue from this funding upon completion of the development in accordance with
SOP 81-1 “Accounting for Performance of Construction Type and Certain Production
Type Contracts.”
  16.
                Risks
      and uncertainties.
  The
Company depends on relationships with third parties such as contract
manufacturing companies, chip design companies and others who may be sole source
providers of key components and services critical for the product the Company is
developing in its video phone business. The components and raw materials used in
the Company’s Ojo video phone product, as well as the vendors providing the
parts necessary for the Ojo, are constantly changing which may continue to
result in the discontinuation and/or the unavailability of certain parts
possibly resulting in significant additional product development to accommodate
changes in vendor and replacement parts and may render some parts as excess and
obsolete. This could increase the risk of additional obsolescence and or
development cost for the Company in pursuing large volume customers. Parts are
sourced based, among other factors, on reliability, price and
availability.
  22
  At
the present time Mototech is the Company’s sole manufacturer of its video
phones. If Mototech or other providers of components and/or manufacturing
services do not produce these components or provide their services on a timely
basis, if the components or services do not meet the Company’s specifications
and quality control standards, or if the components or services are otherwise
flawed, the Company may have to delay product delivery, or recall or replace
unacceptable products. In addition, such failures could damage the Company’s
reputation and could adversely affect its operating results. As a result, the
Company could lose potential customers and any revenues that it may have at that
time may decline dramatically.
  17.
              Accounting
      for the Uncertainty in Income
Taxes.
  The
Company has adopted the provisions of FASB Interpretation No. 48, “Accounting
for Uncertainty in Income Taxes - an interpretation of FASB Statement No.
109”(“FIN 48”), on January 1, 2007. FIN 48 clarifies the accounting for
uncertainty in income taxes recognized in an enterprise’s financial statements
in accordance with SFAS No. 109, “Accounting for Income Taxes,” and prescribes a
recognition threshold and measurement process for financial statement
recognition and measurement of a tax position taken or expected to be taken in a
tax return. FIN 48 also provides guidance on recognition, classification,
interest and penalties, accounting in interim periods, disclosure and
transition.
  The
Company has identified its federal tax return and its state tax return in
Pennsylvania as “major” tax jurisdictions, as defined in FIN 48. Based on the
Company’s evaluation, it concluded that there are no significant uncertain tax
positions requiring recognition in the Company’s financial statements. The
Company’s evaluation was performed for tax years ended 2005 through 2008, the
only periods subject to examination. The Company believes that its income tax
positions and deductions would be sustained on audit and does not anticipate any
adjustments that would result in a material change to its financial
position.
  The
Company’s policy for recording interest and penalties associated with audits is
not to record such items as a component of income before income taxes. Penalties
are recorded in other expense and interest paid or received is recorded in
interest expense or interest income, respectively, in the statement of
operations. There were no amounts accrued for penalties or interest as of or
during the three and six months ended June 30, 2009 and 2008. The Company does
not expect its unrecognized tax benefit position to change during the next
twelve months. Management is currently unaware of any issues under review that
could result in significant payments, accruals or material deviations from its
position.
  18.
              Net
      Operating Losses and Changes of
Ownership
  The
Company’s ability to utilize its net operating loss carryforwards and credit
carryforwards will be subject to annual limitations as a result of prior,
current or future changes in ownership and tax law as defined under Section 382
of the Internal Revenue Code (IRC) of 1986. Such limitations are based on the
Company’s market value at the time of an ownership change multiplied by the
long-term tax-exempt rate supplied by the Internal Revenue Service.
  October 2008 Change of
Control. Upon completing an analysis as required by IRC Section 382, it
was determined that during October 2008, as a result of the aggregation of
shares related to the conversion of the convertible debenture into shares of
Common Stock by the convertible debenture holder, the Company experienced a
change of ownership as defined in Section 382. Prior to the change, the Company
had a net operating loss carryforward (NOL) of approximately $237,441. Due to
the annual limitations imposed by Section 382, the Company will be unable to
utilize approximately $234,952 of this net operating loss and the remaining
amount of approximately $2,489 will be subject to an annual utilization
limitation of approximately $124 for 20 years. The total NOL available to offset
future taxable income as of December 31, 2008 is approximately $2,754, which
includes losses incurred for the period up to the change of control of
approximately $2,489 (subject to annual limitations) and losses incurred
subsequent to the change in control to December 31, 2008 of approximately $265,
which will likely not be subject to an annual limitation.
  April 2009 Change of Control.
Upon completing an analysis as required by Section 382, it was determined that
during April 2009, as a result of the private placement pursuant to which WGI
acquired shares of Common Stock representing 63% of the outstanding Common
Stock, the Company experienced a second change of ownership as defined in
Section 382. As a result of the second change, the NOL limitation attributable
to the first change of approximately $124 annually will remain in place limiting
approximately $2,489 of NOL. The post October 2008 change of control loss of
approximately $265 would be able to be fully utilized going forward with no
likely limitations.
  The state
net operating loss projected to be lost is approximately $187,356 resulting in
approximately $2,754 remaining to be carried forward subject to similar annual
limitations. The state net operating losses are also limited by state law and
subject to maximum utilization limits. The federal research and experimentation
credit (R&D), which provides tax credit for certain R&D efforts, will
also be subject to an annual limitation. Due to the limitation pursuant to
Section 382, all but approximately $25 of the credit is lost. The federal
credits remaining will expire in 2028. All state research and experimentation
credit carryovers have been refunded and no state credit
remains.
  23
  Results
of the Company’s net operating and credit carryforwards are expressed within the
table below:
  FEDERAL
                    
                    
                    STATE
                    
                    
                    FEDERALNOL
                    
                    
                    NOL
                    
                    
                    R&DNOL
      and credit prior to October change
                    
                    
                    237,441
                    
                    
                    
                    189,845
                    
                    
                    
                    4111Unavailable
      losses/credit as a result of the October 2008 change in
      control
                    
                    
                    234,952
                    
                    
                    
                    187,356
                    
                    
                    
                    4111Loss/credit
      Available after October change subject to annual
    limitations
                    
                    
                    2,489
                    
                    
                    
                    2,489
                    
                    
                    noneNOL/Credit
      attributable to period subsequent to October change in
      control
                    
                    
                    265
                    
                    
                    
                    265
                    
                    
                    
                    25Total  NOL
      and credits subject to limitation
                    
                    
                    2,754
                    
                    
                    
                    2754
                    
                    
                    
                    25
  Future
issuances of Common Stock and subsequent losses may further affect this analysis
which might cause an additional limitation on our ability to utilize the
remaining net operating loss carryforwards.
  19.
              Subsequent
      Events
  Mototech Agreement.On July 8,
2009, the Company entered into a letter agreement with Mototech, Inc. (“Mototech”) to settle
all past due obligations owed by the Company to Mototech. Mototech had performed
various services for the Company, including manufacturing and engineering
development, through various historical transactions, which resulted in a claim
by Mototech for approximately $1,400 in unpaid fees and expenses from the
Company. Pursuant to the letter agreement,
  ·
              all
      obligations of the Company to Mototech were terminated and the Company was
      released from all liabilities or obligations to Mototech, including all
      amounts due or owing to Mototech;
  ·
              the
      Company agreed to pay $600 in cash to Mototech pursuant to the following
      payment schedule: (a) $50 was paid on July 20, 2009; (b) $100 to be paid
      on or prior to August 30, 2009; (c) $150 to be paid on or prior to
      September 30, 2009; and (d) $300 to be paid on or prior to October 30,
      2009;
  ·
              the
      Company issued to Mototech 3,200,000 unregistered shares of Common Stock,,
      subject to the following conditions: (a) no such shares can be sold prior
      to the date that is 9 months after the issuance of such shares and (b)
      when such shares are permitted to be sold, no more than 25,000 of such
      shares may be sold in any single day;
and
  ·
              the
      Company issued to Mototech an unregistered warrant to purchase 1,000,000
      shares of Common Stock (the “Mototech Warrant”) with the following terms:
      (a) exercise price of $0.35 per share; (b) immediate vesting of the entire
      warrant; and (c) expiration date of the earlier of (i) July 8, 2014, (ii)
      a change of control of the Company or (iii) the twentieth (20th) day
      following the Company’s delivery of notice to Mototech of the occurrence
      of a period of ten (10) consecutive trading days during which the quoted
      bid price of the Common Stock has been greater than a price equal to one
      hundred fifty percent (150%) of the exercise price of the
      warrant.
  As part
of closing on April 6, 2009 of the transactions contemplated by the Securities
Purchase Agreement (See note 3), the
Company issued to WGI a warrant to purchase up to 140.0 million shares of Common
Stock (the “Anti-DilutionWarrant”), at an
exercise price of $0.01 per share under certain circumstances, including if the
Company issues any capital stock upon the exercise or conversion of up to 19.7
million shares underlying options, warrants or other purchase rights issued by
the Company after April 6, 2009 (“Future Contingent Equity”). Any shares of
Common Stock issued in connection with any exercise of the Mototech Warrant
would result in shares becoming exercisable under the Anti-Dilution Warrant
equaling 1.7027027 multiplied by the number of shares of Common Stock issued in
connection with any exercise of the Mototech Warrant.
 
 Warrant Amendment. On July 15,
2009, the Company amended the exercise price of the Warrant to Purchase Common
Stock of WorldGate Communications, Inc., dated September 24, 2007 (the “2007
Warrant”), representing rights to purchase 2,564,102 shares of Common Stock,
held by Antonio Tomasello and that expires on September 23,
2012.
  24
  The
exercise price of the 2007 Warrant was amended from $0.49 per share to (a) $0.25
per share of Common Stock if the 2007 Warrant is exercised in full prior to
September 15, 2009, (b) $0.31 per share of Common Stock if the 2007 Warrant is
exercised in full on or after September 15, 2009 but prior to November 15, 2009,
or (c) $0.39 per share of Common Stock if the 2007 Warrant is exercised in full
on or after November 15, 2009 or is exercised in part at any time.
 
 Appointment of new Chief Executive
Officer and President. On July 31, 2009, the Company entered into a
letter agreement (the “Letter Agreement”) with George E. Daddis Jr., pursuant to
which Mr. Daddis agreed to serve as Chief Executive Officer and President of the
Company, effective August 3, 2009.
  Pursuant
to the Letter Agreement, the Company agreed (1) to pay Mr. Daddis $220,000 per
year , (2) to grant Mr. Daddis an option to purchase 2,000,000 shares of Common
Stock of the Company at an exercise price of $0.34 per share and which vests 25%
per year beginning on July 31, 2010, and (3) to pay Mr. Daddis severance
payments in the amount of six (6) months’ salary and benefits continuation
should (i) the Company terminate his employment for any reason without Cause as
defined or (ii) Mr. Daddis terminates his employment with the Company for Good
Reason as defined.
  On August
3, 2009, Robert Stevanovski resigned as the Company’s interim Chief Executive
and President effective immediately.
 
 The Company has evaluated events that
occurred subsequent to June 30, 2009 through August 14, 2009, the date of which
the financial statements for the period ended June 30, 2009 were issued. Except
as disclosed above, management concluded that no other events required
disclosure in these financial statements.
 
 ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS (Dollar amounts contained in this Item 2 are in thousands, except
for share and per share amounts)
 
 FORWARD-LOOKING
AND CAUTIONARY STATEMENTS
 
 We may
from time to time make written or oral forward-looking statements, including
those contained in the following Management’s Discussion and Analysis of
Financial Condition and Results of Operations. The words “estimate,” “project,”
“believe,” “intend,” “expect,” and similar expressions are intended to identify
forward-looking statements, although not all forward-looking statements contain
these identifying words. In order to take advantage of the “safe harbor”
provisions of the Private Securities Litigation Reform Act of 1995, we are
hereby identifying certain important factors that could cause our actual
results, performance or achievement to differ materially from those that may be
contained in or implied by any forward-looking statement made by or on our
behalf. The factors, individually or in the aggregate, that could cause such
forward-looking statements not to be realized include, without limitation, the
following: (1) difficulty in developing and implementing marketing and business
plans, (2) industry competition factors and other uncertainty that a market for
our products will develop, (3) challenges associated with distribution channels,
including both the retail distribution channel and high speed data operators
(e.g., uncertainty that they will offer our products, inability to predict the
manner in which they will market and price our products and existence of
potential conflicts of interests and contractual limitations impeding their
ability to offer our products), (4) continued losses, (5) difficulty or
inability to raise additional financing on terms acceptable to us, (6) departure
of one or more key persons, (7) changes in regulatory requirements, (8)
delisting of our Common Stock, par value $0.01 per share (“Common Stock”) from
the OTCBB and (9) other risks identified in our filings with the Securities and
Exchange Commission, including the risks identified in “Item 1A. Risk Factors”
in our Annual Report on Form 10-K for the fiscal year ended December 31, 2008.
We caution you that the foregoing list of important factors is not intended to
be, and is not, exhaustive. We do not undertake to update any forward-looking
statement that may be made from time to time by us or on our behalf, other than
as required by the federal securities law.
 
 General
  We are
currently in the process of transforming the Company from a manufacturer of high
quality consumer video phones, into a service operating company that also
provides “turn-key” digital video phone services (meaning a complete,
ready-to-use digital video phone services solution) directly to end using
customers. Inherent in this strategy is a monthly recurring revenue stream that
would be based on the particular services provided by us to each company we
partner with. Also key to this strategy is that it enables many non-traditional
companies and organizations who have a very broad distribution reach, but do not
have an infrastructure to provide telephone and video services, to provide their
distribution networks with a video phone service solution. We are currently in
the process of developing a new video phone needed for the transition to a
digital video phone serviceand will make the
video phone available to ACN as well as to all of our customers. The first
prototypes are expected be available in the fourth quarter of 2009 with customer
availability expected in the second quarter of 2010.
  25
 
 We expect
some companies will look to us to wholesale to them select services from the
platform as they are already providing services such as billing, customer care
and customer order entry. Our wholesale offering will include our video phone,
provisioning, network and technical support services. Our platform will be
modular so customers can choose the services that best fit their
needs.
 
 While we
expect revenues related to the new business model to begin in late 2009, or
early next year, the extent and timing of future revenues for our digital video
phone services depends on several factors, including the rate of market
acceptance of our products, the degree of competition from similar products, and
our ability to access funding necessary to provide the time runway to roll out
product and services. We cannot predict to what extent our service business will
produce revenues, or when, or if, we will reach profitability.
 
 Relationship with
AequusTechnologies. In the spring of 2006, we entered into a multiyear
agreement with Aequus Technologies Corp. (“Aequus”) to purchase Ojo video phones
through its wholly owned subsidiary Snap Telecommunications Inc. (“Snap!VRS”), a
provider of Video Relay Services (“VRS”) and Video Remote Interpreting (“VRI”)
services for the deaf and hard of hearing. In the spring of 2007, we announced
an expansion of our relationship with Aequus and Snap!VRS agreeing to work
collaboratively to develop the preferred VRS phone for the VRS community. From
2006, we were reliant on the Aequus relationship as our primary customer
relationship.
 
 On
February 4, 2008, we disclosed that we were in a dispute with Aequus over the
payment of significant monies that we believed Aequus owed to us. The refusal by
Aequus to pay such monies had contributed to a shortfall in our available
operating cash needed to continue operations, and accordingly, on January 30,
2008, we shut down our operations. This was a first step to winding down our
business, which would occur if we were not able to secure payment of the monies
believed to be owed to us by Aequus and/or secure new financing.
 
 On March
31, 2008, we entered into a new agreement with Aequus and Snap!VRS. This new
agreement provides for the (i) resolution of a dispute with Aequus regarding
amounts we claimed were owed to us by Aequus and the termination by us of video
phone service to Aequus, (ii) payment to us by Aequus of approximately $5,000 in
scheduled payments over ten months commencing March 31, 2008, (iii) agreement to
arbitrate approximately $1,354 claimed by us to be owed by Aequus and (iv)
purchase of an additional $1,475 of video phones by Aequus.
  In
October 2008, Aequus failed to pay $953 owed to us for the purchase of video
phones, and as a result we terminated our reseller agreement with Aequus. We
have most of the units sold to Aequus in our possession and we are attempting to
sell the units elsewhere to recover the $953while continuing to resolve our
dispute with Aequus. We continue to believe that the VRS and VRI markets provide
an attractive opportunity for the sale of video phones and have initiated
shipments of video phones to other VRS/VRI providers. In addition, on January
27, 2009, we resolved arbitration proceedings with Aequus, and in full
satisfaction of the outstanding $1,354 arbitration claim, Aequus agreed to
terminate any obligation on our part to provide certain prepaid engineering
services pursuant to a previous agreement with Aequus. As a result of the
arbitration, we retained $725 of the approximately $900 prepaid by Aequus for
these engineering services.
  Relationship with WGI and ACN.
On April 6, 2009, we completed a private placement of securities to WGI Investor
LLC (“WGI”), pursuant to the terms of a Securities Purchase Agreement, dated
December 12, 2008 (the “Securities Purchase Agreement”), between WGI and the
Company. In connection with the closing on April 6, 2009 of the transactions
contemplated by the Securities Purchase Agreement, we issued to WGI an aggregate
of 202,462,155 shares of our Common Stock, representing approximately 63% of the
total number of issued and outstanding shares of our Common Stock, as well as a
warrant to purchase up to approximately 140.0 million shares of our Common Stock
in certain circumstances (the “Anti-Dilution Warrant”) in exchange for (i) cash
consideration of $1,450 (of which $750 had been previously advanced to us by
WGI), (ii) the cancellation of convertible debentures held by WGI under which
approximately $5,100 in principal and accrued interest was outstanding, and
(iii) the cancellation of certain outstanding warrants held by WGI. In December
2008, WGI had acquired from YA Global Investments, L.P. (“YA Global”) the
convertible debentures that we had previously issued to YA Global and the
outstanding warrants to purchase our Common Stock then held by YA Global. We
expect to use the proceeds from the closing on April 6, 2009 of the transactions
contemplated by the Securities Purchase Agreement primarily for working capital
purposes.
 
 The
Anti-Dilution Warrant entitles WGI to purchase up to 140.0 million shares of
Common Stock at an exercise price of $0.01 per share to the extent the Company
issues any capital stock upon the exercise or conversion of (i) any warrants,
options and other purchase rights that were outstanding as of April 6, 2009
(“Existing Contingent Equity”), (ii) up to 19.7 million shares underlying future
options, warrants or other purchase rights issued by the Company after April 6,
2009 (“Future Contingent Equity”), or (iii) the ACN Warrant described below. The
Anti-Dilution Warrant is designed to ensure that WGI may maintain 63% of the
issued and outstanding shares of the Company’s capital stock in the event that
any of the Company’s capital stock is issued in respect to the Existing
Contingent Equity, the Future Contingent Equity or the ACN Warrant. The term of
the Anti-Dilution Warrant is ten years from the date of issuance, and the shares
subject to the Anti-Dilution Warrant will be decreased proportionally upon the
expiration of Existing Contingent Equity, Future Contingent Equity and the ACN
Warrant.
  26
  WGI is a
private investment fund whose ownership includes owners of ACN Inc., which is
the parent company of ACN Digital Phone Service, LLC (“ACN”).  ACN,
Inc., is a direct seller of telecommunications services and a distributor of
video phones.  Concurrently with the closing of the closing on April
6, 2009 of the transactions contemplated by the Securities Purchase Agreement,
we entered into a commercial relationship with ACN pursuant to which we will
design and sell video phones to ACN (the “Commercial
Relationship”).  As part of the Commercial Relationship, we entered
into two agreements, a Master Purchase Agreement pursuant to which ACN has
committed to purchase three hundred thousand videophones over a two-year period
and a Software Development and Integration and Manufacturing Assistance
Agreement pursuant to which ACN committed and paid $1,200 to fund certain
software development costs.  In connection with the Commercial
Relationship, we granted ACN a warrant to purchase up to approximately 38.2
million shares of our Common Stock at an exercise price of $0.0425 per share
(the “ACN Warrant”).  The ACN Warrant will vest incrementally based on
ACN’s purchases of video phones under the Commercial
Relationship.
  Critical
Accounting Policies and Estimates.
 
 Our condensed consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States. These generally accepted accounting principles
require 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 and the reported amounts of
net revenues and expenses during the reporting period. Actual results could
differ from those estimates.
 
 Our significant accounting policies are
described in the Management’s Discussion and Analysis section and the notes to
the consolidated financial statements included in our annual report on Form 10-K
for the fiscal year ended December 31, 2008. Judgments and estimates of
uncertainties are required in applying our accounting policies in many areas.
Following are some of the areas requiring significant judgments and estimates:
revenue recognition, inventory valuation, stock based compensation, deferred
revenues, deferred tax asset valuation allowances and valuation of derivative
liabilities and related warrants. Management has discussed the development and
selection of these policies with the Audit Committee of our Board of Directors,
and the Audit Committee of the Board of Directors has reviewed our disclosures
of these policies. There have been no material changes to the critical
accounting policies or estimates reported in the Management’s Discussion and
Analysis section or the audited financial statements for the year ended December
31, 2008 as filed with the Securities and Exchange Commission.
 
 Results
of Operations:
  Three and Six Months Ended June 30,
2009 and June 30, 2008.
 
 Revenues.
 
 For the three months ended June 30,
                    
                    
                    For the six months ended June 30,2009
                    
                    
                    2008
                    
                    
                    Change
                    
                    
                    2009
                    
                    
                    2008
                    
                    
                    ChangeProduct
      revenues
                    
                    $
                    16
                    
                    
                    $
                    812
                    
                    
                    $
                    (796
                    )
                    
                    
                    (98
                    )%
                    
                    $
                    365
                    
                    
                    $
                    831
                    
                    
                    $
                    (466
                    )
                    
                    
                    (56
                    )%Service
      revenues
                    
                    $
                    89
                    
                    
                    $
                    164
                    
                    
                    $
                    (75
                    )
                    
                    
                    (46
                    )%
                    
                    $
                    182
                    
                    
                    $
                    259
                    
                    
                    $
                    (77
                    )
                    
                    
                    (30
                    )%Other
      revenues
                    
                    $
                    38
                    
                    
                    $
                    279
                    
                    
                    $
                    (241
                    )
                    
                    
                    (86
                    )%
                    
                    $
                    833
                    
                    
                    $
                    279
                    
                    
                    $
                    554
                    
                    
                    
                    199
                    %Total
      net revenues
                    
                    $
                    143
                    
                    
                    $
                    1,255
                    
                    
                    $
                    (1,112
                    )
                    
                    
                    (89
                    )%
                    
                    $
                    1,380
                    
                    
                    $
                    1,369
                    
                    
                    $
                    11
                    
                    
                    
                    1
                    %
 
 Product Revenue.
Product revenue consists of the sale of Ojo video phones. For the three months
ended June 30, 2009 compared with the three months ended June 30, 2008, the
decrease in product revenue primarily reflects reduced shipments of product to
Aequus. For the six months ended June 30, 2009 compared with the six months
ended June 30, 2008, the decrease in product revenue primarily reflects reduced
shipments of product to Aequus, partially offset by $322 of product shipments to
another customer during the six months ended June 30, 2009.
 
 Service Revenue.
Service revenue consists of subscription service revenues and service provided
to service operators. For the three and six months ended June 30, 2009 compared
with the three and six months ended June 30, 2008, the decrease in service
revenue primarily reflects the reduction in service provided to
Aequus.
 
 Other Revenue. Other
revenue consists of non-recurring engineering and other non recurring services.
For the three months ended June 30, 2009 compared with the three months ended
June 30, 2008, the decrease in other revenue primarily reflects the reduction in
realized revenues from non recurring engineering services, support and
transition training and service center usage provided to Aequus under the March
31, 2008 agreement. For the six months ended June 30, 2009 compared with the six
months ended June 30, 2008, the increase in other revenue primarily reflects the
increased revenue in the quarter ended March 31, 2009 that included $725 related
to the settlement of a dispute with Aequus wherein the settlement eliminated
$725 of the Company’s $900 obligation to provide NRE to Aequus and that was
credited to NRE services provided under the March 31, 2008 agreement with
Aequus.
  27
 
 Net Revenue. For the
three months ended June 30, 2009 compared with the three months ended June 30,
2008, the decrease in net revenue primarily reflects the decrease in product,
service and other revenues related to revenue realized from Aequus. For the six
months ended June 30, 2009 compared with the six months ended June 30, 2008, the
increase in other revenue primarily reflects the increased revenue in the
quarter ended March 31, 2009 that included $725 related to the settlement of a
dispute with Aequus which was partially offset by the decrease in product and
service revenue from Aequus as noted above which was the result of the
conclusion of the March 31, 2008 agreement in January 2009.
 
 Cost of Revenues and Gross
Margin
 
 For the three months ended June 30,
                      
                      
                      For the six months ended June 30,2009
                      
                      
                      2008
                      
                      
                      Change
                      
                      
                      2009
                      
                      
                      2008
                      
                      
                      ChangeTotal
      net revenues
                      
                      $
                      143
                      
                      
                      $
                      1,255
                      
                      
                      $
                      (1,112
                      )
                      
                      
                      (89
                      )%
                      
                      $
                      1,380
                      
                      
                      $
                      1,369
                      
                      
                      $
                      11
                      
                      
                      
                      1
                      %Cost
      of product revenues
                      
                      $
                      5
                      
                      
                      $
                      678
                      
                      
                      $
                      (673
                      )
                      
                      
                      (99
                      )%
                      
                      $
                      919
                      
                      
                      $
                      716
                      
                      
                      $
                      203
                      
                      
                      
                      28
                      %Cost
      of service revenues
                      
                      $
                      0
                      
                      
                      $
                      0
                      
                      
                      $
                      0
                      
                      
                      
                      N/A
                      
                      
                      $
                      0
                      
                      
                      $
                      0
                      
                      
                      $
                      0
                      
                      
                      
                      N/ACost
      of other revenues
                      
                      $
                      0
                      
                      
                      $
                      159
                      
                      
                      $
                      (159
                      )
                      
                      
                      (100
                      )%
                      
                      $
                      0
                      
                      
                      $
                      159
                      
                      
                      $
                      (159
                      )
                      
                      
                      (100
                      )%Total
      cost of revenues
                      
                      $
                      5
                      
                      
                      $
                      837
                      
                      
                      $
                      (832
                      )
                      
                      
                      (99
                      )%
                      
                      $
                      919
                      
                      
                      $
                      875
                      
                      
                      $
                      44
                      
                      
                      
                      5
                      %Gross
      margin
                      
                      $
                      138
                      
                      
                      $
                      418
                      
                      
                      $
                      (280
                      )
                      
                      
                      (67
                      )%
                      
                      $
                      461
                      
                      
                      $
                      494
                      
                      
                      $
                      (33
                      )
                      
                      
                      (7
                      )%
 
 Cost of Revenues. The
cost of revenues consists of product and delivery costs relating to the
deliveries of video phones, and direct costs related to non-recurring
engineering services revenues. For the three months ended June 30, 2009 compared
with the three months ended June 30, 2008, the decrease in cost of revenues
primarily reflects decreased costs related to reduced product shipments of $674,
and decreased other revenue engineering services costs of $159. For the six
months ended June 30, 2009 compared with the six months ended June 30, 2008, the
increase in cost of revenues primarily reflects the recording of a $600
inventory reserve for certain excess and obsolete inventory that may not be
utilized in the future development of our video phones.
 
 Gross Margin. For the
three months ended June 30, 2009 compared with the three months ended June 30,
2008, the decrease in gross margin primarily reflects the reduction of product
revenues and the decrease in engineering services, partially offset by the
result of an improved product mix to higher margin service and engineering
service revenues. For the six months ended June 30, 2009 compared with the six
months ended June 30, 2008, gross margin was reduced by $600 relating to the
establishment of an inventory reserve for certain excess and obsolete inventory.
Before this adjustment, gross margin for the six months ended June 30, 2009 was
$1,061, or 77%, compared to $494, or 36%, for the same period in 2008. This
improvement in gross margin was primarily the result of the increase in revenue
from the non-recurring engineering , training and service center usage revenues
recognized from our agreement with Aequus, with the respective costs of these
increased revenues having been previously incurred and recorded in 2008 (See
Note 15 of the accompanying financial statements), engineering services provided
to ACN for software development (See Note 15 of the accompanying financial
statements), and increased selling prices and lower unit costs of the product
shipped during the six months ended June 30, 2009 compared to the same period in
2008.
 
 Expenses From Operations.
 
 For the three months ended June 30,
                      
                      
                      For the six months ended June 30,2009
      Restated
                      
                      
                      2008
                      
                      
                      Change
                      
                      
                      2009
      Restated
                      
                      
                      2008
                      
                      
                      ChangeEngineering
      and development
                      
                      $
                      763
                      
                      
                      $
                      498
                      
                      
                      $
                      265
                      
                      
                      
                      53
                      %
                      
                      $
                      1,405
                      
                      
                      $
                      1,075
                      
                      
                      $
                      330
                      
                      
                      
                      31
                      %Sales
      and marketing
                      
                      $
                      67
                      
                      
                      $
                      140
                      
                      
                      $
                      (73
                      )
                      
                      
                      (52
                      )%
                      
                      $
                      105
                      
                      
                      $
                      359
                      
                      
                      $
                      (254
                      )
                      
                      
                      (71
                      )%General
      and administrative
                      
                      $
                      1,576
                      
                      
                      $
                      978
                      
                      
                      $
                      598
                      
                      
                      
                      61
                      %
                      
                      $
                      2,441
                      
                      
                      $
                      1,877
                      
                      
                      $
                      564
                      
                      
                      
                      30
                      %Depreciation
      and amortization
                      
                      $
                      80
                      
                      
                      $
                      81
                      
                      
                      $
                      (1
                      )
                      
                      
                      (1
                      )%
                      
                      $
                      119
                      
                      
                      $
                      180
                      
                      
                      $
                      (61
                      )
                      
                      
                      (34
                      )%
  28
 
 Engineering and
Development. Engineering and development expenses primarily consist of
compensation, and the cost of design, programming, testing, documentation and
support of our video phone product. For the three and six months ended June 30,
2009 compared with the three and six months ended June 30, 2008, the increase in
engineering and development expenses primarily reflects that in 2008 certain
direct engineering development costs charged to cost of revenues that were
related to revenues reported for NRE services performed for Aequus during the
three and six months ended June 30, 2008 for non recurring engineering services,
support and transition training and service center usage provided to Aequus
under the March 31, 2008 agreement .
 
 Sales and Marketing.
Sales and marketing expenses consist primarily of compensation (which includes
compensation to manufacturer’s representatives and distributors), attendance at
conferences and trade shows, travel costs, advertising, promotions and other
marketing programs (which include expenditures for co-op advertising and new
market development) related to the continued sales of our video phone product
For the three and six months ended June 30, 2009 compared with the three and
months ended June 30, 2008, the decrease in sales and marketing expenses is
primarily the result of reduced marketing, customer service and promotional
expenditures and reduced compensation costs.
 
 General and
Administrative. General and administrative expenses consist primarily of
expenditures for administration, office and facility operations, as well as
finance and general management activities, including legal, accounting and
professional fees. For the three and six months ended June 30, 2009 compared
with the three and six months ended June 30, 2008, the increase in general and
administrative expenses is primarily the result of the accrual of $626 in
compensation and severance expenses related to officers that were terminated.
The terminated officer’s compensation will cease on April 7, 2010. In addition
the six months ended June 30, 2009, included a bad debt reserve of $157 relating
to certain product shipped and invoiced to a customer that has not been
paid.
 
 Other Income and Expenses.
 
 For the three months ended June 30,
                    
                    
                    For the six months ended June 30,2009
                    
                    
                    2008
                    
                    
                    Change
                    
                    
                    2009
                    
                    
                    2008
                    
                    
                    ChangeInterest
      and other income
                    
                    $
                    0
                    
                    
                    $
                    4
                    
                    
                    $
                    (4
                    )
                    
                    
                    (100
                    )%
                    
                    $
                    8
                    
                    
                    $
                    10
                    
                    
                    $
                    (2
                    )
                    
                    
                    (20
                    )%Change
      in fair value of derivative warrants and conversion
options
                    
                    $
                    284
                    
                    
                    $
                    (1,674
                    )
                    
                    $
                    1,958
                    
                    
                    
                    117
                    %
                    
                    $
                    4,209
                    
                    
                    $
                    (1,807
                    )
                    
                    $
                    6,016
                    
                    
                    
                    333
                    %Income
      from service fee contract termination
                    
                    $
                    0
                    
                    
                    $
                    1,056
                    
                    
                    $
                    (1,056
                    )
                    
                    
                    (100
                    )%
                    
                    $
                    348
                    
                    
                    $
                    1,056
                    
                    
                    $
                    (708
                    )
                    
                    
                    (67
                    )%Amortization
      of debt discount
                    
                    $
                    (2,235
                    )
                    
                    $
                    (707
                    )
                    
                    $
                    1528
                    
                    
                    
                    216
                    %
                    
                    $
                    (2,918
                    )
                    
                    $
                    (926
                    )
                    
                    $
                    1,992
                    
                    
                    
                    215
                    %Loss
      on equipment disposal
                    
                    $
                    0
                    
                    
                    $
                    (295
                    )
                    
                    $
                    (295
                    )
                    
                    
                    (100
                    )%
                    
                    $
                    0
                    
                    
                    $
                    (295
                    )
                    
                    $
                    (295
                    )
                    
                    
                    (100
                    )%Interest
      and other expense
                    
                    
                    (40
                    )
                    
                    
                    (99
                    )
                    
                    $
                    (59
                    )
                    
                    
                    (60
                    )%
                    
                    
                    (113
                    )
                    
                    
                    (186
                    )
                    
                    $
                    (73
                    )
                    
                    
                    (39
                    )%
 
 Interest and Other
Income. Interest and other income consisted of interest earned on cash
and cash equivalents. During the three and six months ended June 30, 2009, we
earned interest on an average cash balance of approximately $732 and $576,
respectively. During the three and six months ended June 30, 2008, we earned
interest on an average cash balance of approximately $490 and $562,
respectively.
 
 Change in fair value of
derivative warrants and conversion options. The fair value adjustments
of our derivative warrants and conversion options issued in our June 2004
private placement of our Series A Convertible Preferred Stock and Warrants and
our August 11, 2006 and October 13, 2006 private placements of secured
convertible debentures and warrants are primarily a result of changes in our
common stock price during each reporting period and anti-dilution provisions
that increased the number of outstanding warrants and reduced the warrant
exercise price as of June 30, 2008 (See Note 8 of the accompanying financial
statements).
 
 Income from Service Fee
Contract Termination.Income from service fee contract termination consists of payments from
Aequus for the elimination of previously agreed service fees with Aequus, which
we realized over a ten month period ending January 2009 (See Note 15 of the
accompanying financial statements).
 
 Amortization of Debt
Discount. Amortization of debt discount consists of the amortization of
the secured convertible debentures issued in the August 11, 2006 and October 13,
2006 private placements. The increase of amortization of debt discount for the
three and six months ended June 30, 2009, when compared to the same periods in
2008, is primarily the result of the application of the effective interest rate
method to determine the monthly amortization of the discount over the term of
the convertible debentures. This method increases the periodic amortization
charged as the convertible debentures reach maturity (See Note 7 of the
accompanying financial statements). On the closing on April 6, 2009 of the
transactions contemplated by the Securities Purchase Agreement, the convertible
debentures were terminated and the remaining unamortized discount on the
convertible debentures of $2,235 was charged to income and included in
amortization of debt discount expense.
  29
 
 Loss on Equipment
Disposal. During the three months ended June 30, 2008, certain equipment,
furniture and fixtures were sold and disposed of during the Company’s move to
smaller facilities. The net loss realized during the three and six months ended
June 30, 2008 was $295. There was no loss or gain realized during the three and
six months ended June 30, 2009.
  Interest and Other
Expense. The
reduction in interest expense for the three and six months ended June 30, 2009,
when compared to the same periods in 2008, primarily consisted of the
elimination in 2009 of accrued interest ($1,046) on the secured convertible
debentures issued in the August 11, 2006 and October 13, 2006 private placements
upon the closing on April 6, 2009 of the transactions contemplated by the
Securities Purchase Agreement (See Note 3 of the accompanying financial
statements).
 
 Income Taxes. We have
incurred net operating losses since inception and accordingly had no current
income tax provision and have not recorded any income tax benefit for those
losses, since realization of such benefit is currently uncertain.
 
 Liquidity
and Capital Resources
 
 Sources of Liquidity.
As of June 30, 2009, our primary sources of liquidity consisted of proceeds from
notes issued, the sale of Common Stock and the exercise of warrants, the sale of
Ojo video phones and engineering development services. Cash and cash equivalents
are invested in investments that are highly liquid, are of high quality
investment grade and have original maturities of less than three months. As of
June 30, 2009, we had cash and cash equivalents of $1,209.
 
 Cash Used in
Operations. We utilized cash from operations of $529 and $1,391,
respectively, during the three and six months ended June 30, 2009 and $132 and
$654, respectively, during the three and six months ended June 30, 2008. Our
short term cash requirements and obligations include inventory, accounts payable
and capital expenditures from continuing operations and operating expenses
during these periods in 2009 and 2008.
 
 Cash Used in Investing
Activities. Cash used in investing activities for the three and six
months ended June 30, 2009 was primarily a result of capital expenditures of
$229 and $256, respectively, for investments in equipment for product
development and manufacture. Cash used in investing activities for the three and
six months ended June 30, 2008 was primarily a result of capital expenditures of
$4 and $4, respectively for investments in equipment for product development and
manufacture.
 
 Cash Provided by Financing
Activities. Cash provided by financing activities during the three and
six months ended June 30, 2009 was $1,647 and $2,427, respectively. Cash
provided by financing activities during the three and six months ended June 30,
2008 was $0 and $1, respectively. During the three months ended June 30, 2009,
we received cash of $1,450 from stock issuances and $881 from the exercise of
warrants (See Note 3 of the accompanying financial statements).
 
 Operations and Liquidity.
  We have
incurred recurring net losses and have an accumulated deficit of $271,483,
stockholder’s deficency of $2,150 and a working capital deficit of $3,019 as of
June 30, 2009. We have also experienced severe cash shortfalls, deferred payment
of some of our operating expenses, and shut down operations for a period of time
in early 2008 to conserve our cash. At least in the short term we do not expect
to generate sufficient cash from operations and will likely need to secure
additional cash financing and to increase product sales. No assurances can be
given that we will be able to obtain the necessary cash for us to continue as a
going concern. These factors raise substantial doubt about our ability to
continue as a going concern. The accompanying financial statements do not
include any adjustments that might be necessary should we be unable to continue
as a going concern.
 
 We had
$6,477 of liabilities and none of our assets are pledged as collateral as of
June 30, 2009. These liabilities include $2,968 of accounts payable and accrued
expenses, $2,201 of deferred revenues and income, and $413 of detachable
warrants related to the Company’s private placement of preferred stock in June
2004 which were extended to August 7, 2009.
 
 In
December 2008, WGI acquired from YA Global Investments, L.P. (“YA Global”) the
secured convertible debentures we previously issued to YA Global and the
outstanding warrants to purchase our Common Stock then held by YA Global. On the
closing on April 6, 2009 of the transactions contemplated by the Securities
Purchase Agreement we issued and sold to WGI a total of 202,462,155 shares of
our Common Stock, representing approximately 63% of our outstanding stock, as
well as a warrant to purchase up to approximately 140.0 million shares of our
Common Stock in certain circumstances, in exchange for (i) total cash
consideration of $1,450, (ii) the cancellation of debentures held by WGI under
which approximately $5,100 in principal and accrued interest was outstanding at
June 30, 2009, and (iii) the cancellation of certain of our outstanding warrants
to purchase an aggregate of 2,595,000 shares of our Common Stock held by
WGI.
  30
 
 In
October 2008, Aequus Technologies Corp. (“Aequus”) failed to pay to us $953 owed
to us for the purchase of video phones, and as a result we terminated our
reseller agreement with Aequus. We have most of the units sold to Aequus in our
possession and we are attempting to sell the units elsewhere to recover the
$953while
continuing to resolve our dispute with Aequus. There can be no assurance that we
will be able to sell the units and recover the $953 owed by Aequus. We continue
to believe that the VRS and VRI markets provide an attractive opportunity for
the sale of video phones and have initiated sales with other VRS/VRI service
providers.
 
 On
January 27, 2009, we resolved the outstanding NRE Arbitration with Aequus, and
in full satisfaction of the outstanding arbitration claim Aequus agreed to
terminate any obligation on our part to provide certain prepaid engineering
services pursuant to the March 31, 2008 Agreement with Aequus (Aequus had
prepaid approximately $900 for these engineering services of which $725 was
allocated to the settlement).
 
 Our
ability to generate cash is dependent upon the sale of our Ojo product, our
ability to enter into arrangements to provide services, and on obtaining cash
through the private or public issuance of debt or equity securities. Given that
our video phone business involves the development of a new video phone necessary
for the digital video phone service with no market penetration in an
underdeveloped market sector, no assurances can be given that sufficient sales,
if any, will materialize. The lack of success of our sales efforts could also
have an adverse ability to raise additional financing.
 
 Based on
management’s internal forecasts and assumptions, including regarding our short
term cash requirements, we currently believe that we will have sufficient cash
on hand to meet our obligations into the fourth quarter of 2009. However, there
can be no assurance given that these assumptions are correct or that the revenue
projections associated with product sales and services to ACN will materialize
to a level that will provide us with sufficient capital to operate our
business.
 
 We
continue to evaluate possibilities to obtain additional financing through public
or private equity or debt offerings, asset securitizations, or from other
sources. In addition the Company plans to explore additional service and
distribution sales opportunities.There can be no
assurance given, however, that our efforts will be successful or that any
additional financing will be available and can be consummated on terms
acceptable to us, if at all.There can also be
no assurance given that any additional sales can be achieved through additional
service and distribution opportunities. If we are unable to obtain sufficient
funds we may be required to further reduce the size of the organization or
suspend operations which could have a material adverse impact on our business.
 
 ITEM 3.
  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
 Not required.
 
 ITEM 4T.
  CONTROLS AND PROCEDURES.
 
 Evaluation of Disclosure
Controls and Procedures.
 
 The
Company maintains disclosure controls and procedures (as defined in Rule
13a-15(e) and 15d-15(e) of Securities Exchange Act of 1934) that are designed to
ensure that information required to be disclosed in reports that it files or
submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the Securities and
Exchange Commission’s rules and forms, and that such information is accumulated
and communicated to its management, including its Chief Executive Officer and
Chief Financial Officer, as appropriate to allow timely decisions regarding the
required disclosures. In designing and evaluating the disclosure controls and
procedures, the Company recognizes that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives.
 
 As
previously reported in our Form 10-K for the year ended December 31, 2008, we
carried out an evaluation, under the supervision and with the participation of
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of its disclosure controls and
procedures as of December 31, 2008. The Company’s Chief Executive Officer and
Chief Financial Officer determined that the Company had a material weakness
related to the lack of internal GAAP expertise to assist with the accounting and
reporting of complex financial transactions. The limited Company resources as
well as the Company’s focus and efforts toward keeping the Company solvent
contributed to the material weakness. As a result, the Chief Executive Officer
and Chief Financial Officer concluded that as of December 31, 2008, its
disclosure controls and procedures were not designed properly and were not
effective in ensuring that the information required to be disclosed by the
Company in the reports that we file and submit under the Securities Exchange Act
of 1934 is recorded, processed, summarized and reported within the time periods
specified in the Commission’s rules and forms.
  31
 
 We carried out an
evaluation, under the supervision and with the participation of management,
including our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of June 30, 2009. As a result of the evaluation, the Chief
Executive Officer and Chief Financial Officer concluded that, as of June 30,
2009, its disclosure controls and procedures were not effective as the material
weakness identified at December 31, 2008 still existed. While the Company
pursued remedies to the material weakness in accounting for complex transactions
through the engagement of external expertise, management believes that further
integration of expertise into the Company’s accounting of complex transactions
is still required.
 
 Change in Internal Control
over Financial Reporting.
 
 No change
in our internal control over financial reporting occurred during our most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting. The Company is
also still in the process of implementing a financial system that it believes
will improve the internal control over financial reporting and will eliminate
any identified deficiencies.
 
 PART
II. OTHER INFORMATION
 
 ITEM 1.
  LEGAL PROCEEDINGS.
 
 Although
from time to time we may be involved in litigation as a routine matter in
conducting our business, we are not currently involved in any litigation which
we believe is material to our operations or balance sheet. During the three
months ended March 2008 we were involved in a dispute with Aequus Technologies.
We entered into an agreement with Aequus, effective March 31, 2008, that
provided for the resolution of a dispute with Aequus regarding amounts we
claimed were owed to us by Aequus including, (i) payment to us by Aequus of $5
million in scheduled payments over the ten months ending January 2009, (ii)
agreement to arbitrate approximately $1.4 million that we claimed were owed to
us by Aequus for NRE costs, and (iii) purchase of an additional $1.5 million of
video phones by Aequus. In October 2008, however, Aequus failed to pay us
approximately $953 that we were owed for the purchase of video phones, and as a
result we terminated our reseller agreement with Aequus. We are reviewing our
possible remedies to recover the $953, including selling Aequus inventory we
hold in our possession.
 
 On
January 27, 2009, we resolved the outstanding NRE Arbitration with Aequus, and
in full satisfaction of the outstanding arbitration claim Aequus agreed to
terminate any obligation on our part to provide certain prepaid engineering
services pursuant to the March 31, 2008 Agreement with Aequus (Aequus had
prepaid approximately $900,000 for these engineering services of which $725,000
was allocated to the settlement).
 
 ITEM 2.
  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
 
 On June 23, 2009, the Company amended
the exercise price and other provisions of certain Series A Warrants to Purchase
Common Stock of WorldGate Communications, Inc. issued June 23, 2004 and certain
Series B Warrants to Purchase Common Stock of WorldGate Communications, Inc.
issued June 23, 2004 (collectively, the “2004 Warrants”), representing rights to
purchase, in the aggregate, 8,771,955 shares of Common Stock and that would have
expired on June 23, 2009. The exercise price of the 2004 Warrants was amended to
$0.25 per share of Common Stock and the expiration date of the 2004 Warrants was
amended to August 7, 2009.
 
 On June
23, 2009, the Company also amended the exercise price and other provisions of
certain Warrants to Purchase Common Stock of WorldGate Communications, Inc.
issued August 3, 2005 (collectively, the “2005 Warrants”), representing rights
to purchase, in the aggregate, 513,333 shares of Common Stock and that expire on
August 3, 2010.  The exercise price of the 2005 Warrants was amended to
$0.25 per share of Common Stock.
  As of
June 30, 2009, 3,166,667 of the 2004 Warrants and all of the 2005 Warrants were
exercised, resulting in the Company issuing 3,680,000 shares of Common Stock and
in return the Company received $920 in aggregate cash proceeds.  After
June 30, 2009 and through August 7, 2009, additional 2004 Warrants were
exercised (including a significant number of 2004 Warrants held by an affiliate
of Antonio Tomasello), resulting in the Company issuing 5,525,288 shares of
Common Stock and in return the Company received $1,401 in cash
proceeds.  The Company incurred $39 of fees pursuant to the transfer
of the 2004 Warrants and 2005 Warrants from the original warrant holders that
were not interested in exercising the warrants to new warrant
holders.  The Company expects to use the aggregate net proceeds of
$2,282 from the exercise of the 2004 Warrants and 2005 Warrants primarily for
working capital purposes.
  32
 
 ITEM
3.  DEFAULTS UPON SENIOR SECURITIES.
 
 None
 
 ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
 None.
 
 ITEM
5.  OTHER INFORMATION.
 
 None.
 
 ITEM
6.  EXHIBITS.
  The
following is a list of exhibits filed as part of this report on Form
10-Q/A.  Where so indicated, exhibits that were previously filed are
incorporated by reference.  For exhibits incorporated by reference,
the location of the exhibit in the previous filing is indicated
parenthetically.
  4.1
                                              
                                              Warrant,
      dated April 6, 2009, issued to ACN Digital Phone Service,
    LLC*4.2
                                              
                                              Warrant,
      dated April 6, 2009, issued to WGI Investor LLC*4.3
                                              
                                              Form
      of Amendment No. 1 to Warrant and Exercise Agreement with respect to the
      2004 Warrants (Incorporated by reference to Exhibit 10.1 to our Current
      Report on Form 8-K filed June 26, 2009)4.4
                                              
                                              Form
      of Amendment No. 1 to Warrant with respect to the 2004 Warrants
      (Incorporated by reference to Exhibit 10.2 to our Current Report on
      Form 8-K filed June 26, 2009)4.5
                                              
                                              Form
      of Amendment No. 1 to Warrant and Exercise Agreement with respect to the
      2005 Warrants (Incorporated by reference to Exhibit 10.3 to our Current
      Report on Form 8-K filed June 26, 2009)10.1
                                              
                                              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and Joel
      Boyarski*10.2
                                              
                                              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and Harold
      Krisbergh*10.3
                                              
                                              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and
      Randall J. Gort*10.4
                                              
                                              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and James
      McLoughlin*10.5
                                              
                                              Resignation
      Letter, dated as of April 8, 2009, from Harold Krisbergh to WorldGate
      Communications, Inc. *10.6
                                              
                                              Resignation
      Letter, dated as of April 8, 2009, from Randall J. Gort to WorldGate
      Communications, Inc.*10.7
                                              
                                              Resignation
      Letter, dated as of May 15, 2009, from James McLoughlin to WorldGate
      Communications, Inc.*10.8
                                              
                                              ACN
      Consumer Communications Equipment Master Purchase Agreement, dated as of
      April 6, 2009, between ACN Digital Phone Service, LLC and Ojo Video Phones
      LLC*10.9
                                              
                                              Software
      Development and Integration and Manufacturing Assistance Agreement, dated
      as of April 6, 2009, between ACN Digital Phone Service, LLC and Ojo Video
      Phones LLC*10.10
                                              
                                              Registration
      Rights and Governance Agreement, dated as of April 6, 2009, by and among
      WorldGate Communications, Inc., WGI Investor LLC, and ACN Digital Phone
      Service, LLC*10.11
                                              
                                              Amendment
      No.1 to the WorldGate Communications, Inc. 2003 Equity Incentive Plan
      (Incorporated by reference to Exhibit 10.1 to our Current Report on
      Form 8-K filed May 28, 2009)10.12
                                              
                                              Form
      A of the Non-Qualified Stock Option Grant (Incorporated by reference to
      Exhibit 10.2 to our Current Report on Form 8-K filed May 28,
      2009)
  33
 
 10.13
                        
                        Form
      B of the Non-Qualified Stock Option Grant (Incorporated by reference to
      Exhibit 10.3 to our Current Report on Form 8-K filed May 28,
      2009)10.14
                        
                        Lease
      Amendment, dated April 2, 2009, between WorldGate Service, Inc. and 3190
      Tremont LLC*31.1
                        
                        Certification
      of Chief Executive Officer Pursuant to Rule 13a-14(a)*31.2
                        
                        Certification
      of Chief Financial Officer Pursuant to Rule 13a-14(a)*32.1
                        
                        Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted
      by Section 906 of the Sarbanes-Oxley Act of 2002**32.2
                        
                        Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted
      by Section 906 of the Sarbanes-Oxley Act of
  2002**
 
 
 * Filed
herewith
 **
Furnished herewith
  34
 
 SIGNATURES
 
 Pursuant to the requirements 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.
 
 WORLDGATE
      COMMUNICATIONS, INC.Dated:        
      March 31, 2010
              
              /s/ George E. Daddis Jr.George E. Daddis Jr.Chief Executive Officer(Principal
      Executive Officer)Dated:        
      March 31, 2010
              
              /s/ Joel BoyarskiJoel
      BoyarskiVice
      President and Chief Financial Officer(Principal
      Financial and Accounting Officer)
  35