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 September 30, 2009ORo
            
            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  o





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 o     
                 No  o





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 Securities Exchange Act of 1934).


Yes o     
                     
               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
            
            338,627,6361
      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 nine months
ended September 30, 2009, as filed with the Securities and Exchange Commission
(the “SEC”) on November 16, 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 nine
months ended September 30, 2009 is being restated to reflect the Company’s
concurrent Amendment 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, which reflected 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 revisions 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 nine month period ended September 30, 2009 from
approximately $18,474,000 to approximately $4,011,000 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
 
 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 SEPTEMBER 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
                26ITEM
      3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
                31ITEM
      4T.  CONTROLS AND PROCEDURES.
                32PART
      II. OTHER INFORMATION
                33ITEM
      1.  LEGAL PROCEEDINGS
                33ITEM
      2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS
                33ITEM
      3.  DEFAULTS UPON SENIOR SECURITIES
                34ITEM
      4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
    HOLDERS
                34ITEM
      5.  OTHER INFORMATION
                34ITEM
      6.  EXHIBITS
                34


3


PART
I. FINANCIAL INFORMATION


ITEM
1.  FINANCIAL STATEMENTS





WORLDGATE
COMMUNICATIONS, INC.


CONDENSED
CONSOLIDATED BALANCE SHEETS


(Dollars
In Thousands, Except Share Amounts)





September 30,
                                2009
                              
                              
                              December 31,
                                2008 *(Unaudited
                                &Restated)ASSETSCurrent
      assets:Cash
      and cash equivalents
                              
                              $
                              1,043
                              
                              
                              $
                              429Trade
      accounts receivables, less allowance for doubtful accounts of $47 at
      September 30, 2009 and $0 at December 31, 2008
                              
                              
                              20
                              
                              
                              
                              1,019Other
      receivables
                              
                              
                              0
                              
                              
                              
                              1Inventory,
      net
                              
                              
                              1,087
                              
                              
                              
                              1,176Prepaid
      and other current assets
                              
                              
                              232
                              
                              
                              
                              160Total
      current assets
                              
                              
                              2,382
                              
                              
                              
                              2,785Property
      and equipment, net
                              
                              
                              846
                              
                              
                              
                              234Deposits
      and other assets
                              
                              
                              0
                              
                              
                              
                              66Total
      assets
                              
                              $
                              3,228
                              
                              
                              $
                              3,085LIABILITIES
      AND STOCKHOLDERS’ DEFICIENCYCurrent
      liabilities :Accounts
      payable
                              
                              $
                              1,094
                              
                              
                              $
                              1,750Accrued
      expenses
                              
                              
                              515
                              
                              
                              
                              1,420Accrued
      compensation and benefits
                              
                              
                              203
                              
                              
                              
                              173Accrued
      severance
                              
                              
                              453
                              
                              
                              
                              0Detachable
      warrants
                              
                              
                              0
                              
                              
                              
                              4,360Warranty
      reserve
                              
                              
                              9
                              
                              
                              
                              17Deferred
      revenues and income
                              
                              
                              1,291
                              
                              
                              
                              1,762Notes
      Payable
                              
                              
                              54
                              
                              
                              
                              0Convertible
      debentures payable (net of unamortized discount of $0 at September 30,
      2009 and $2,287 at December 31, 2008
                              
                              
                              0
                              
                              
                              
                              1,793Total
      current liabilities
                              
                              
                              3,619
                              
                              
                              
                              11,275Commitments
      and contingenciesStockholders’
      deficiency:Preferred
      Stock, $.01 par value, 13,492,450 shares authorized; 0 shares issued at
      September 30, 2009 and December 31, 2008....
                              
                              
                              0
                              
                              
                              
                              0Common
      Stock, $.01 par value; 700,000,000 and 200,000,000 shares authorized at
      September 30, 2009 and December 31, 2008, respectively; and 336,643,464
      shares issued and outstanding at September 30, 2009 and 118,906,345 at
      December 31, 2008..
                              
                              
                              3,366
                              
                              
                              
                              1,189Additional
      paid-in capital
                              
                              
                              269,662
                              
                              
                              
                              261,478Accumulated
      deficit
                              
                              
                              (273,419
                              )
                              
                              
                              (270,857
                              )Total
      stockholders’ deficiency
                              
                              
                              (391
                              )
                              
                              
                              (8,190
                              )Total
      liabilities and stockholders’ deficiency
                              
                              $
                              3,228
                              
                              
                              $
                              3,085




*
Condensed from audited financial statement








4




WORLDGATE
COMMUNICATIONS, INC.


CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS


(Unaudited)


(Dollars
In Thousands, Except Share And Per Share Amounts)





Three Months ended
                      
                      
                      Nine Months endedSeptember 30,
                      
                      
                      September 30,2009
                      
                      
                      2008
                      
                      
                      2009Restated
                      
                      
                      2008Net
      revenues:Product
      revenues
                      
                      $
                      8
                      
                      
                      $
                      938
                      
                      
                      $
                      373
                      
                      
                      $
                      1,769Service
      revenues
                      
                      
                      89
                      
                      
                      
                      176
                      
                      
                      
                      271
                      
                      
                      
                      435Other
      revenues
                      
                      
                      0
                      
                      
                      
                      133
                      
                      
                      
                      833
                      
                      
                      
                      412Total
      net revenues
                      
                      
                      97
                      
                      
                      
                      1,247
                      
                      
                      
                      1,477
                      
                      
                      
                      2,616Cost
      of revenues
                      
                      
                      14
                      
                      
                      
                      811
                      
                      
                      
                      932
                      
                      
                      
                      1,686Gross
      margin
                      
                      
                      83
                      
                      
                      
                      436
                      
                      
                      
                      545
                      
                      
                      
                      930Engineering
      and development (excluding depreciation and amortization amounts of $84
      and $28 for the three months ended September 30, 2009 and 2008,
      respectively, and $174 and $121 for the nine months ended September 30,
      2009 and 2008, respectively).
                      
                      
                      938
                      
                      
                      
                      631
                      
                      
                      
                      2,343
                      
                      
                      
                      1,707Sales
      and marketing (excluding depreciation and amortization amounts of $3 and
      $9 for the three months ended September 30, 2009 and 2008, respectively,
      and $20 and $38 for the nine months ended September 30, 2009 and 2008,
      respectively).
                      
                      
                      249
                      
                      
                      
                      73
                      
                      
                      
                      355
                      
                      
                      
                      431General
      and administrative (excluding depreciation and amortization amounts of $6
      and $6 for the three months ended September 30, 2009 and 2008,
      respectively, and $18 and $65 for the nine months ended September 30, 2009
      and 2008, respectively).
                      
                      
                      870
                      
                      
                      
                      797
                      
                      
                      
                      3,311
                      
                      
                      
                      2,674Depreciation
      and amortization
                      
                      
                      93
                      
                      
                      
                      43
                      
                      
                      
                      212
                      
                      
                      
                      224Total
      expenses from operations
                      
                      
                      2,150
                      
                      
                      
                      1,544
                      
                      
                      
                      6,221
                      
                      
                      
                      5,036Loss
      from operations
                      
                      
                      (2,067
                      )
                      
                      
                      (1,108
                      )
                      
                      
                      (5,676
                      )
                      
                      
                      (4,106
                      )Other
      Income (expense)Interest
      and other income
                      
                      
                      41
                      
                      
                      
                      6
                      
                      
                      
                      50
                      
                      
                      
                      16Change
      in fair value of derivative warrants and conversion
options
                      
                      
                      43
                      
                      
                      
                      843
                      
                      
                      
                      4,252
                      
                      
                      
                      157Income
      from service fee contract termination
                      
                      
                      47
                      
                      
                      
                      1,064
                      
                      
                      
                      395
                      
                      
                      
                      2,121Amortization
      of debt discount
                      
                      
                      0
                      
                      
                      
                      (706
                      )
                      
                      
                      (2,918
                      )
                      
                      
                      (1,632
                      )Loss
      on equipment disposal
                      
                      
                      0
                      
                      
                      
                      0
                      
                      
                      
                      0
                      
                      
                      
                      (295
                      )Interest
      and other expense
                      
                      
                      (1
                      )
                      
                      
                      (76
                      )
                      
                      
                      (114
                      )
                      
                      
                      (262
                      )Total
      other income (expense), net
                      
                      
                      130
                      
                      
                      
                      1,131
                      
                      
                      
                      1,665
                      
                      
                      
                      105Net
      (loss) income
                      
                      $
                      (1,937
                      )
                      
                      $
                      23
                      
                      
                      $
                      (4,011
                      )
                      
                      $
                      (4,001
                      )Net
      loss per common share:Basic
      and Fully Diluted
                      
                      $
                      (0.01
                      )
                      
                      $
                      0.00
                      
                      
                      $
                      (0.02
                      )
                      
                      $
                      (0.06
                      )Weighted
      average common shares outstanding:Basic
      and Fully Diluted
                      
                      
                      348,971,268
                      
                      
                      
                      69,445,002
                      
                      
                      
                      259,730,073
                      
                      
                      
                      61,739,560




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)





Nine
      Months ended September 30,2009Restated
                    
                    
                    2008Cash
      flows from operating activities:Net
      loss
                    
                    $
                    (4,011
                    )
                    
                    $
                    (4,001
                    )Adjustments
      to reconcile net loss to net cash used in operating
      activities:Depreciation
      and amortization
                    
                    
                    212
                    
                    
                    
                    224Amortization
      of debt discount
                    
                    
                    2,918
                    
                    
                    
                    1,632Bad
      debt expense
                    
                    
                    47
                    
                    
                    
                    0Change
      in fair value of derivative warrants and conversion
options
                    
                    
                    (4,252
                    )
                    
                    
                    (157
                    )Loss
      on disposal of fixed assets
                    
                    
                    0
                    
                    
                    
                    295Inventory
      reserve
                    
                    
                    600
                    
                    
                    
                    0Non-cash
      stock based compensation
                    
                    
                    714
                    
                    
                    
                    515Changes
      in operating assets and liabilities:Trade
      accounts receivable
                    
                    
                    952
                    
                    
                    
                    (1,026
                    )Other
      receivables
                    
                    
                    1
                    
                    
                    
                    6Inventory
                    
                    
                    (511
                    )
                    
                    
                    (139
                    )Prepaid
      and other current assets
                    
                    
                    (72
                    )
                    
                    
                    (40
                    )Deposits
      and other assets
                    
                    
                    66
                    
                    
                    
                    55Accounts
      payable
                    
                    
                    (118
                    )
                    
                    
                    1,031Accrued
      expenses and other current liabilities
                    
                    
                    141
                    
                    
                    
                    (726
                    )Accrued
      severance
                    
                    
                    453
                    
                    
                    
                    0Accrued
      compensation and benefits
                    
                    
                    30
                    
                    
                    
                    140Warranty
      reserve
                    
                    
                    (8
                    )
                    
                    
                    (31
                    )Deferred
      revenues and other income
                    
                    
                    (471
                    )
                    
                    
                    1,598Net
      cash used in operating activities
                    
                    
                    (3,309
                    )
                    
                    
                    (624
                    )Cash
      flows from investing activities:Capital
      expenditures
                    
                    
                    (525
                    )
                    
                    
                    (2
                    )Proceeds
      from the sale of fixed assets
                    
                    
                    0
                    
                    
                    
                    4Net
      cash (used in) provided by investing activities
                    
                    
                    (525
                    )
                    
                    
                    2Cash
      flows from financing activities:Proceeds
      from issuance of common stock
                    
                    
                    3,644
                    
                    
                    
                    1Proceeds
      from the issuance of notes
                    
                    
                    846
                    
                    
                    
                    0Payments
      on notes
                    
                    
                    (42
                    )
                    
                    
                    0Net
      cash provided by financing activities
                    
                    
                    4,448
                    
                    
                    
                    1Net
      increase (decrease) in cash and cash equivalents
                    
                    
                    614
                    
                    
                    
                    (621
                    )Cash
      and cash equivalents, beginning of period
                    
                    
                    429
                    
                    
                    
                    1,081Cash
      and cash equivalents, end of period
                    
                    $
                    1,043
                    
                    
                    $
                    460Non-cash
      investing and financing activities:Cumulative effect on a change in accounting principle on (See Note
      8):Detachable
      warrants
                    
                    $
                    885
                    
                    
                    $
                    0Additional
      Paid in Capital
                    
                    
                    (1,751
                    )
                    
                    
                    0Accumulated
      deficit
                    
                    
                    1,449
                    
                    
                    
                    0Conversion
      of convertible debenture to common stock
                    
                    
                    0
                    
                    
                    
                    1,409Common
      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
                    
                    
                    993
                    
                    
                    
                    0Common
      stock issued in payment of notes
                    
                    
                    750
                    
                    
                    
                    0Common
      stock issued in payment of obligation
                    
                    
                    839
                    
                    
                    
                    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. and its subsidiaries
(“WorldGate” or the “Company”) for the three and nine months ended September 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.  Some of the areas requiring significant judgments and estimates are
as follows: 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 September 30, 2009 and for
the nine months ended September 30, 2009 to reclassify the excess fair value
related 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 Issues Task Force 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
quarter ended September 30, 2009 is being restated to reflect
the  Company’s concurrent Amendment on Form 10-Q/A to amend its
Quarterly Report on Form 10-Q for the three and six months ended June30, 2009,
which reflected 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.


7





The
effect of the restatement on specific amounts provided in the consolidated
financial statements is as follows:




As of September 30, 2009Consolidated Balance Sheet
                    
                    As previously reported
                    
                    
                    As restatedRevenue
      incentive asset – current portion
                    
                    $
                    9,600
                    
                    
                    $
                    0Total
      current assets
                    
                    
                    11,982
                    
                    
                    
                    2,382Revenue
      incentive asset – long term portion
                    
                    
                    50,400
                    
                    
                    
                    0Total
      Assets
                    
                    
                    63,228
                    
                    
                    
                    3,228Additional
      paid in capital
                    
                    
                    344,125
                    
                    
                    
                    269,662Accumulated
      deficit
                    
                    
                    (287,882
                    )
                    
                    
                    (273,419
                    )Total
      stockholders’ equity (deficiency)
                    
                    
                    59,609
                    
                    
                    
                    (391
                    )Total
      liabilities and stockholders equity
                    
                    
                    63,228
                    
                    
                    
                    3,228




For the nine months ended September 30, 2009Consolidated Statement of Operations
                      
                      As previously reported
                      
                      
                      As restatedExcess
      fair value transferred to WGI
                      
                      
                      14,463
                      
                      
                      
                      0Total
      expenses from operations
                      
                      
                      20.684
                      )
                      
                      
                      6,221
                      )Net
      loss from operations
                      
                      
                      (20,139
                      )
                      
                      
                      (5,676
                      )Net
      loss
                      
                      
                      (18,474
                      )
                      
                      
                      (4,011
                      )Net
      loss per common share:Basic
      and diluted
                      
                      
                      (0.07
                      )
                      
                      
                      (0.02
                      )




3. Significant
Transactions.




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 maintained in
its possession most of the units sold to Aequus.  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). On October 8, 2009, the Company entered into a letter agreement
(the “Aequus Settlement Agreement”) with Aequus to settle all past due
obligations owed by Aequus to the Company (see Note 19).





WGI and ACN
Transactions.  On April 6, 2009, the Company completed a private
placement of securities to WGIInvestor LLC
(“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, (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 has used the proceeds from the closing on April 6, 2009 of the
transactions primarily for working capital purposes.





The
Anti-Dilution Warrant entitled 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.





8


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 paid the Company $1,200 to fund certain
software development costs.  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.




WGI Warrant.    As a
result of the termination of a total of 6,048,907 of the Company’s previously
issued options, warrants and performance shares, 10,299,492 shares of the
Anti-Dilution Warrant have been terminated resulting in WGI having a remaining
balance of 129,710,258 shares underlying the Anti-Dilution Warrant.  As of
September 30, 2009, in connection with (i) the exercise of 11,849,390 shares of
common stock under the previously issued warrants, and (ii) 225,575 shares of
Common Stock issued in connection with the exercise of employee options, WGI has
the right pursuant to the terms of the Anti-Dilution Warrant to purchase an
aggregate of 20,560,075 of Common Stock at a price of $0.01 per share. 
Subsequent to September 30, 2009, and through November 13, 2009, 1,000,000
Mototech Warrants were exercised and 61,457 employee stock options were
exercised, resulting in WGI receiving the right to purchase 1,807,346 additional
shares of common stock at an exercise price of $0.01 per share under the
Anti-Dilution Warrant.  In total, WGI has the right to purchase an
aggregate of 22,367,421 shares of Common Stock at a price of $0.01 per
share.




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 was paid on
      August 28, 2009; (c) $150 was paid on September 30, 2009; and (d) $300 was
      paid on 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. As of
September 30, 2009, $300 of the $600 accrued expense had been paid and as of
October 30, 2009 the remaining $300 of the $600 accrued expense was
paid.




Exercise of Warrants.





2004 and 2005 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.





9




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 that expire on
August 3, 2010.  The exercise price of the 2005 Warrants was amended to
$0.25 per share of Common Stock in return for the holder immediately exercising
the warrant.




As of
September 30, 2009, all of the 2004 Warrants and the 2005 Warrants were
exercised (including all of the 2004 Warrants held by an affiliate of Antonio
Tomasello), resulting in the Company receiving $2,321 in gross aggregate cash
proceeds ($2,282 net 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 September 30, 2009, all 2004 Warrants had either expired or been
exercised.  As of September 30, 2009, 879,359 of the warrants issued August
3, 2005 that were not amended remain outstanding.




2007 Warrants.  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,
representing rights to purchase 2,564,102 shares of Common Stock, held by
Antonio Tomasello and that expired on September 23, 2012.




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 warrant was exercised in full prior to
September 15, 2009, (b) $0.31 per share of Common Stock if the warrant was
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 Warrant was exercised in full on
or after November 15, 2009 or is exercised in part at any time. All of the
warrants were exercised on September 8, 2009 resulting in the issuance of
2,564,102 shares of Common Stock and the Company receiving $641 in aggregate
cash proceeds.





Mototech Warrants.  The
warrants issued under the  July 8, 2009 Mototech Agreement were assigned to
Mr. K.Y. Chou and were exercised on October 2, 2009 resulting in the Company
issuing 1,000,000 shares and the Company receiving $350 in gross proceeds ($344
net proceeds).




4. Liquidity
and Going Concern Considerations.




Cash and Cash Flow.  As
of September 30, 2009, the Company had cash and cash equivalents of $1,043.
  The Company’s cash used in operations was $1,918 and $3,309,
respectively, during the three and nine months ended September 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; (b) the Commercial Relationship with
ACN Digital Phone Service, LLC (“ACN”) described below, including $1,200 of
payments received for development efforts,and (c) the net proceeds
from the exercise of certain warrants totaling $2,923, contributed to the
generation of funds during the nine months ended September 30, 2009 and have
provided financing for the on-going operations of the Company.




Liabilities.  The Company
had $3,619 of liabilities and none of its assets are pledged as collateral as of
September 30, 2009.  These liabilities primarily include $1,609 of accounts
payable and accrued expenses, $453 of accrued severance, $1,291 of deferred
revenues and income, $203 of accrued compensation and benefits and accrued
officer’s compensation and severance of $453




See Note
19 for information on a revolving loan entered into after September 30, 2009
pursuant to which the Company pledged all of its assets as
collateral.




Short Term Cash
Requirements.  At September 30, 2009, the Company’s short term cash
requirements and obligations include payments for finished, excess and obsolete
inventory, accounts payable from continuing operations and operating
expenses.




Net Losses and Impact on
Operations.  The Company has incurred recurring net losses and has
an accumulated deficit of $273,419, stockholders’ deficiency of $391 and working
capital deficit of $1,237 as of September 30, 2009.  These factors as well
as the uncertainty in raising additional funding raise substantial doubt about
the Company’s ability to continue as a going concern as of September 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.




10




Increase in Executive
Compensation.As of September 30, 2009, the Company increased its
annual compensation obligations for officers and senior executives of the
Company by $825 as a result of hiring additional members of senior management
and the termination and severance payments of Messrs. Krisbergh, Gort, and
McLoughlin. The accrued severance compensation for Messrs. Krisbergh, Gort, and
McLoughlin will be paid out in full by April 7, 2010.  As of September 30,
2009, the Company accrued $453 in officer’s compensation and
severance.




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 and service 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 adversely impact the
Company’s ability to raise additional financing. In addition, WGI holds 63% of
the Common Stock of the Company and holds certain anti-dilution warrants which
could also impact the Company’s ability to raise financing (see Note
3).




On
October 28, 2009, the Company entered into a Revolving Loan and Security
Agreement (the “Revolving Loan”) with WGI pursuant to which WGI will provide to
the Company, a line of credit in a principal amount of $3,000 (See Note
19).





Based on
management’s internal forecasts and assumptions regarding its short term cash
requirements including the payments pursuant to the July 8, 2009 Mototech
agreement (see Note 3), and the establishment of the Revolving Loan, the Company
currently believes that it will have sufficient cash on hand to meet its
obligations into the first quarter of 2010.  However, there can be no
assurance given that these assumptions are correct or that the revenue
projections associated with sales of products and services 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.




5.
            Recent
      Accounting Pronouncements.




The
Financial Accounting Standards Board (“FASB”), in June 2009, issued new
accounting guidance that established the FASB Accounting Standards
Codification,  ("Codification" or “ASC”) as the single source of
authoritative GAAP to be applied by nongovernmental entities, except for
the rules and interpretive releases of the Securities and Exchange
Commission (“SEC”) under authority of federal securities laws, which
are sources of authoritative Generally Accepted Accounting Principles
(“GAAP”) for SEC registrants.  The FASB will no longer issue new standards
in the form of Statements, FASB Staff Positions, or Emerging Issues Task Force
Abstracts; instead the FASB will issue Accounting Standards Updates. Accounting
Standards Updates will not be authoritative in their own right as they will only
serve to update the Codification. These changes and the Codification itself do
not change GAAP. This new guidance became effective for interim and annual
periods ending after September 15, 2009.  Other than the manner in which
new accounting guidance is referenced, the adoption of these changes did not
have a material effect on the Company’s consolidated financial
statements.





In
December 2007, the FASB issued new accounting guidance, under ASC Topic 805 on
business combinations, which 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. This guidance also requires acquisition-related transaction
expenses and restructuring costs to be expensed as incurred rather than
capitalized as a component of the business combination.  This guidance is
effective for business combinations with an acquisition date on or after the
beginning of the first annual reporting period beginning on or after December
15, 2008. The adoption of this guidance will have an impact on accounting for
businesses acquired after the effective date of this pronouncement.




In
December 2007, the FASB issued new accounting guidance, under ASC Topic 805 on
business combinations, which establishes accounting and reporting standards for
the noncontrolling interest in a subsidiary (previously referred to as minority
interests).  This guidance also requires that a retained noncontrolling
interest upon the deconsolidation of a subsidiary be initially measured at its
fair value. Upon the adoption of this guidance, 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. This guidance is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after January 1, 2009.  The
implementation of this guidance would require retroactive adoption of the
presentation and disclosure requirements for existing minority interests, with
all other requirements of this guidance to be applied prospectively. As the
Company does not have noncontrolling interests in any subsidiary, the adoption
of this guidance did not have any impact upon the Company’s consolidated
financial position or results of operations.




11




In March
2008, the FASB issued new accounting guidance, under ASC Topic 815 on
derivatives and hedging,   which amends and expands existing
disclosure requirements 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 guidance
is effective beginning January 1, 2009. The adoption of this guidance did
not have a material impact upon the Company’s consolidated financial position or
results of operations.




In June
2008, the FASB issued new accounting guidance, under ASC Topic 815 on
derivatives and hedging, as to how an entity should determine whether an
instrument (or an embedded feature) is indexed to an entity’s own
stock. This guidance 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.  This guidance is effective for
financial statements issued for fiscal years beginning after December 15,
2008.  Upon adoption of this guidance 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 8).




In
April 2009, the FASB issued new accounting guidance, under ASC Topic 820 on
fair value measurements and disclosures, which established the requirements for
estimating fair value when market activity has decreased and on identifying
transactions that are not orderly.  Under this guidance, entities are
required to disclose in interim and annual periods the inputs and valuation
techniques used to measure fair value. This guidance is effective for
interim and annual periods ending after June 15, 2009. The adoption of this
guidance did not have a material impact on the Company’s consolidated financial
position or results of operations.





In
May 2009, the FASB issued new accounting guidance, under ASC Topic 855 on
subsequent events, which sets forth 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.  This
guidance is effective for interim and annual periods ending after June 15,
2009. The adoption of this guidance did not have a material impact on the
Company’s consolidated financial position or results of operations.





In
June 2009, the FASB issued new accounting guidance, under SFAS No. 167
“Amendments to FASB Interpretation No. 46(R)”, which modify how a company
determines when an entity that is insufficiently capitalized or is not
controlled through voting (or similar rights) should be consolidated. This
guidance clarified that the determination of whether a company is required to
consolidate an entity is based on, among other things, an entity’s purpose and
design and a company’s ability to direct the activities of the entity that most
significantly impact the entity’s economic performance. An ongoing reassessment
is required of whether a company is the primary beneficiary of a variable
interest entity. Additional disclosures are also required about a company’s
involvement in variable interest entities and any significant changes in risk
exposure due to that involvement. This guidance 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
this guidance is not expected to have a material effect on the Company’s
consolidated financial position or results of operations. This guidance has not
yet been integrated into the FASB Accounting Standards
Codification.





In
October 2009, the FASB issued new accounting guidance, under ASC Topic 605
on revenue recognition, which amends revenue recognition policies for
arrangements with multiple deliverables. This guidance eliminates the residual
method of revenue recognition and allows the use of management’s best estimate
of selling price for individual elements of an arrangement when vendor specific
objective evidence (VSOE), vendor objective evidence (VOE) or third-party
evidence (TPE) is unavailable. This guidance is effective for all new or
materially modified arrangements entered into on or after January 1, 2011
with earlier application permitted as of the beginning of a fiscal year. Full
retrospective application of the new guidance is optional.  The Company has
not completed its assessment of this new guidance on its financial condition,
results of operations.





In
October 2009, the FASB issued new accounting guidance, under ASC Topic 985
on software, which amends the scope of existing software revenue recognition
accounting. Tangible products containing software components and non-software
components that function together to deliver the product’s essential
functionality would be scoped out of the accounting guidance on software and
accounted for based on other appropriate revenue recognition guidance. 
This guidance is effective for all new or materially modified arrangements
entered into on or after January 1, 2011 with earlier application permitted
as of the beginning of a fiscal year. Full retrospective application of this new
guidance is optional. This guidance must be adopted in the same period that the
company adopts the amended accounting for arrangements with multiple
deliverables described in the preceding paragraph. The Company has not completed
its assessment of this new guidance on its financial position or results of
operations.




12




6.
            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 its products  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 September 30,
2009 and December 31, 2008, the Company’s inventory balance was $1,087 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).




7.
            Stock
      Based Compensation.




The
Company accounts for all stock based compensation as an expense in the financial
statements and associated costs are measured at the fair value of the
award.  The Company also recognizes the excess tax benefits related to
stock option exercises as financing cash inflows instead of operating
inflows.  As a result, the Company’s net loss before taxes for the three
and nine months ended September 30, 2009 included approximately $425 and $714,
respectively, of stock based compensation. The three and nine months ended
September 30, 2008 included approximately $264 and $515, respectively, of
stock based compensation.  The stock based compensation expense is included
in general and administrative expense in the condensed consolidated statements
of operations. The Company has selected a “with-and-without” approach regarding
the accounting for the tax effects of share-based compensation
awards.




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.




Between
May 26, 2009 and September 30, 2009, 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 15,913,500 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 between $0.28 and $0.80 per share based on the closing
price on the Over the Counter Bulletin Board between May 26, 2009 and September
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 $0.30 per share determined using
the Black Scholes fair value option model.  Options granted during the nine
months ended September 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 $0.30. 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 2.51%; dividend yield of 0%; and
expected life of 6.25 years.




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
                  
                  
                  $
                  0.27Granted
                  
                  
                  15,913,500
                  
                  
                  $
                  0.30Exercised
                  
                  
                  (225,575
                  )
                  
                  
                  1.32Cancelled/forfeited
                  
                  
                  (841,511
                  )
                  
                  $
                  1.35Outstanding,
      September 30, 2009
                  
                  
                  20,926,778
                  
                  
                  $
                  0.53
                  
                  
                  $
                  8,633,083Exercisable,
      September 30, 2009
                  
                  
                  3,398,496
                  
                  
                  $
                  1.71
                  
                  
                  $
                  653,708





As of
September 30, 2009, there was a total of $4,691 of unrecognized
compensation arrangements granted under the Plan.  The cost is expected to
be recognized through 2013.




The
following table summarizes information about stock options outstanding at
September 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
      - $0.12
                                        
                                        4,960,278
                                        
                                        5.91
                                        
                                        $
                                        0.11
                                        
                                        3,348,371
                                        
                                        $
                                        0.11$0.13
      - $0.39
                                        
                                        15,366,500
                                        
                                        9.68
                                        
                                        0.29
                                        
                                        125
                                        
                                        0.23$0.40
      - $0.59
                                        
                                        0
                                        
                                        0.00
                                        
                                        0.00
                                        
                                        0
                                        
                                        0.00$0.60
      - $0.89
                                        
                                        600,000
                                        
                                        9.61
                                        
                                        0.77
                                        
                                        50,000
                                        
                                        0.63Total
                                        
                                        20,926,778
                                        
                                        8.79
                                        
                                        $
                                        0.53
                                        
                                        3,398,496
                                        
                                        $
                                        1.71





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 as of their dates of grant. 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 nine month period ended September 30, 2009,
525,000 additional restricted shares were forfeited by executives whose
employment with the Company ended.  As of September 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 is amortizing the fair value of these shares over the expected
period that they will vest and recorded compensation expense of $8 and $16 for
these grants for the three and nine months ended September 30,
2009.




14




The
following table is the summary of the Company’s nonvested restricted shares as
of September 30, 2009.




Restricted
                    SharesNonvested
      as of January 1, 2009
                  
                  
                  833,000Granted
                  
                  
                  0Vested
                  
                  
                  0Cancelled/forfeited
                  
                  
                  (525,000
                  )Nonvested
      as of September 30, 2009
                  
                  
                  308,000




8. 
          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 by bifurcating conversion options
embedded in convertible debentures from their host instruments and accounting
for them as free standing derivative financial instruments.   The
applicable accounting guidance 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 and measured at
fair value on the balance sheet.





15




Effective
January 1, 2007, the Company adopted accounting guidance which states that, 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.  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, allowing the instrument to be classified as stockholders’
equity. Under this accounting guidance, when an embedded conversion option
previously accounted for as a derivative no longer meets the bifurcation
criteria, an issuer shall disclose a description of the principal changes
causing the embedded conversion option to no longer require bifurcation 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 nine months ended September 30, 2009 there were no issuances of Common
Stock related to the debentures.  During the three and nine months ended
September 30, 2008, $762 and $1,409, respectively in face value of the
convertible debentures was converted, resulting in the issuance of 19,846,180
and 25,962,761 shares of Common Stock, respectively.  The Company waived
the 840,000 monthly shares limitation with respect to these conversions. 
As a result of the amortization, $0 and $2,918, respectively, of the discount on
the convertible debenture has been charged to discount amortization for the
three and nine months ended September 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 nine months ended September 30,
2008, $706 and $1,632, respectively, of the discount on the convertible
debenture has been charged to discount amortization.As of September 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.




Determination that Warrants Were Not
Indexed to the Company’s Common Stock.   On January 1, 2009, in
connection with the adoption of newly issued accounting guidance, 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.




16




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





9. 
         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). On June 23, 2009, the Company amended the exercise price and other
provisions of the 2004 Warrants representing rights to purchase shares of Common
Stock in the Company 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.  As of September 30, 2009, all of the 2004 Warrants were
exercised  The Company recognized a total non-cash gain of $43 and $4,252,
respectively, for the three and nine months ended September 30, 2009 and a
non-cash gain of $843 and $157, respectively, for the three and nine months
ended September 30, 2008, for these derivative warrants, based on the following
criteria, each of which impacton the fair
value of the derivative, using the Black-Scholes valuation model.  The
assumptions used in these fair value calculations were as follows:




June 2004 Private Placement WarrantsCriteria
                            
                            September 30, 2009*
                            
                            September 30, 2008Common
      Stock price per share
                            
                            $0.30
      - $0.35
                            
                            $
                            0.025Applicable
      volatility rates
                            
                            68%
      -58%
                            
                            
                            273
                            %Risk-free
      interest rates
                            
                            0.17%
      - 19%
                            
                            
                            1.55
                            %Contractual
      life of instrument
                            
                            0.101
      -0.063 years
                            
                            0.75
      years





*
Reflects a range of assumptions underlying the exercises during the quarter
ended September 30, 2009





17




The
following table summarizes the derivative instruments (warrants) liability for
the three and nine months ended September 30, 2009 (See Note 8):




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
      8)
                                    
                                    
                                    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
                                    )Three
      months ended September 30, 2009
                                    
                                    
                                    (43
                                    )
                                    
                                    
                                    0
                                    
                                    
                                    
                                    (43
                                    )Total
      nine months ended September 30, 2009
                                    
                                    
                                    (3,990
                                    )
                                    
                                    
                                    (262
                                    )
                                    
                                    
                                    (4,252
                                    )Cancellation
      of warrants April 6, 2009
                                    
                                    
                                    
                                    
                                    
                                    
                                    (623
                                    )
                                    
                                    
                                    (623
                                    )Reclassification
      to equity upon exercise of warrants during the three months ended
      September 30, 2009
                                    
                                    
                                    (370
                                    )
                                    
                                    
                                    
                                    
                                    
                                    
                                    (370
                                    )Outstanding,
      September 30, 2009
                                    
                                    $
                                    0
                                    
                                    
                                    $
                                    0
                                    )
                                    
                                    $
                                    0




10. 
         Accounting for the WGI / ACN
transaction




The
Company accounts for common stock and warrants issued to third parties,
including customers, by amortizing the value of the instrument, determined as of
the vesting date,  over the related service period.





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.  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. Applicable accounting
guidance 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.




11. 
          Fair Value of Financial
Instruments.




Applicable
accounting guidance 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.  This guidance applies to all assets
and liabilities that are measured and reported on a fair value
basis.





The fair
value guidance establishes a three-tier fair value hierarchy which prioritizes
the inputs used in measuring fair value as follows:





18




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 1 or Level 2  as
of September 30, 2009.




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 nine months ended September
30, 2009:





Fair Value Measurements
Using Significant Unobservable Inputs (Level 3):





Description
                      
                      DerivativesLiabilities:Balance,
      January 1, 2009
                      
                      $
                      4,360Cumulative
      effect of the change in accountingPrincipal,
      January 1, 2009 (See Note 8)
                      
                      
                      885Cancelation
      of warrants April 6, 2009
                      
                      
                      (623
                      )Exercise
      of warrants during the three months endedSeptember
      30,  2009
                      
                      
                      (370
                      )Total
      gain in fair value included in operations
                      
                      
                      (4,252
                      )Balance,
      September 30, 2009
                      
                      $
                      0





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.





12. 
         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 nine
months ended September 30, 2009 amounted to approximately $47 and $135,
respectively, and for the three and nine months ended September 30, 2008
amounted to approximately $43 and $207, respectively.




In
December 2008, the Company entered into a 60 month lease for office
equipment. As of September 30, 2009, there remains an aggregate of $36 to be
paid over the remaining period of the term of the lease.




The future minimum contractual rental
commitments under non-cancelable leases for each of the fiscal years ending
December 31 are as follows:




2009
      (October 1 to December 31, 2009)
                        
                        $
                        32010
                        
                        
                        112011
                        
                        
                        112012
                        
                        
                        11Total
                        
                        $
                        36




13.       
   Net Loss per Share (Basic and Diluted).




The Company displays dual presentation
of earnings per share as both 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” 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) income per share for the three
and six months ended September 30, 2009 and 2008:




19




For the three months ended September 30,2009
                        
                        
                        2008Numerator
      for diluted EPS calculation:Net(loss)
      income
                        
                        $
                        (1,937
                        )
                        
                        $
                        23Denominator
      for diluted EPS calculation:Basic
      and Fully Diluted weighted average common sharesOutstanding
                        
                        
                        348,971,268
                        
                        
                        
                        69,445,002Basic
      and Fully Diluted EPS*
                        
                        $
                        (0.01
                        )
                        
                        $
                        0.00For
      the nine months ended September 30,2009
      Restated
                        
                        
                        2008Numerator
      for diluted EPS calculation:Net
      loss
                        
                        $
                        (4,011
                        )
                        
                        $
                        (4,001
                        )Denominator
      for diluted EPS calculation:Basic
      and Fully Dilutive weighted average common sharesOutstanding
                        
                        
                        259,730,073
                        
                        
                        
                        61,739,560Basic
      and Fully Dilutive EPS*
                        
                        $
                        (0.02
                        )
                        
                        $
                        (0.06
                        )





* The
Company had net losses during the three and nine month periods ended September
30, 2009 and for the nine months ended September 30, 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).  The Company had net income for the three months ended
September 30, 2008.  For the calculation of fully dilutive earnings per
share the potential common shares comprise shares of common stock issuable upon
the exercise of stock options, and warrants, and upon the conversion of
convertible debentures.  Potential common shares of 44,651,904 were
excluded from net income per share for the three months ended September 30, 2008
because their effect would be anti-dilutive following the “if converted” method
of adjusting income and outstanding shares in the calculation.





Potential
common shares excluded from net loss per share for the three and nine months
ended September 30, 2009, were 169,546,717 and 44,651,904 for the three and nine
months ended September 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.





14. 
         Warrants.





A summary
of the Company’s warrant activity for the nine months ended September 30, 2009
is as follows:





Warrants
                                  
                                  
                                  Weighted Average
                                    Exercise Price
                                  
                                  
                                  Weighted
                                    Average
                                    Remaining
                                    Contract
                                    LifeOutstanding,
      January 1, 2009
                                  
                                  
                                  20,146,311
                                  
                                  
                                  $
                                  0.96
                                  
                                  
                                  
                                  1.26Granted
                                  
                                  
                                  178,229,647
                                  
                                  
                                  
                                  0.02Expired/cancelled
                                  
                                  
                                  (17,654,555
                                  )
                                  
                                  
                                  (0.46
                                  )Exercised
                                  
                                  
                                  (11,849,389
                                  )
                                  
                                  
                                  (0.25
                                  )Outstanding,
      September 30, 2009
                                  
                                  
                                  168,872,014
                                  
                                  
                                  $
                                  0.04
                                  
                                  
                                  
                                  9.47Exercisable,
      September 30, 2009
                                  
                                  
                                  21,501,934




20




15. 
         Stockholders’ Deficiency
Restated.
  The following summarizes the
transactions in stockholders’ deficiency from January 1, 2009 through September
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 (see Footnote
    10)
                
                
                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
                
                
                
                
                
                
                714
                
                
                
                
                
                
                
                714Issuance
      of Common Stock upon exercise of warrants
                
                
                118
                
                
                
                2,800
                
                
                
                
                
                
                
                2,918Issuance
      of Common Stock upon exercise of options
                
                
                2
                
                
                
                23
                
                
                
                
                
                
                
                25April
      6, 2009 Issuance of Common Stock and Anti-Dilution Warrant in the WGI
      transaction
                
                
                2,025
                
                
                
                (1,325
                )
                
                
                
                
                
                
                700April
      6, 2009 Cancellation of convertible debt and accrued interest as
      consideration exchanged in the WGI transaction
                
                
                
                
                
                
                5,923
                
                
                
                
                
                
                
                5,923July
      8, 2009 Cancellation of obligation to a vendor
                
                
                32
                
                
                
                807
                
                
                
                
                
                
                
                839April
      6, 2009 Cancellation of the derivative warrants as consideration exchanged
      in the WGI transaction
                
                
                
                
                
                
                623
                
                
                
                
                
                
                
                623August
      2009 Reclassification  of the derivative warrants upon
      exercise
                
                
                
                
                
                
                370
                
                
                
                
                
                
                
                370Net
      loss for the nine months endedSeptember
      30, 2009
                
                
                
                
                
                
                
                
                
                
                (4,011
                )
                
                
                (4,011
                )Balance
      as of September 30, 2009
                
                $
                3,366
                
                
                $
                269,662
                
                
                $
                (273,419
                )
                
                $
                (391
                )




16. 
         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.




21




Revenues
are also offset by a reserve for any price refunds and consumer
rebates.




Video Phone Sales.
During the three and nine months ended September 30, 2009, the Company did not
ship any product to customers with a right of return.  During the three and
nine months ended September 30, 2008, the Company shipped 0 and 9 units,
respectively, with a sales value of $0 and $2, respectively, to customers with a
right of return.  The Company deferred revenues and costs for the sale of
units where customers may exercise their right of return only if they do not
sell the units to their respective customers.




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 recognized this service fee revenue upon confirmation from
Aequus of the fees earned by the Company.




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.




·
            $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 connection with 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 nine months ended September 30,
      2009 such revenue was $0 and $796, respectively. For the three and nine
      months ended September 30, 2008, revenue of $133 and $412, respectively,
      was recognized for NRE and training and support.  The revenue of $796
      in the nine months ended  September 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 September 30, 2009 and 2008, other income was
      recorded for the contract termination fee of $0 and $1,064,
      respectively.  For the nine months ended September 30, 2009 and 2008,
      other income was recorded for the contract termination fee of $348 and
      $2,121, 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 September 30, 2008 the Company
      shipped $844 worth of products to Aequus customers. For the nine months
      ended September 30,  2008, the Company shipped $1,637 worth of
      products to Aequus customers.  On October 8, 2009, the Company
      entered into a letter agreement with Aequus to settle all past due
      obligations owed by Aequus to the Company (see Note 19) and as a
      result the Company has no obligation to hold any units for Aequus.




22




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 guidance for accounting for
performance of construction and production type contracts.




17. 
         Accounting for the Uncertainty in Income
Taxes.




The
Company has adopted the applicable accounting guidance which clarifies the
accounting for uncertainty in income taxes recognized in an enterprise’s
financial statements 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.  The Company also applies
accounting guidance for the topics of 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 nine months ended September 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 believes it is
more likely than not  it 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.




April 2009 Change of
Control. 
Upon completing an analysis as required by IRC 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 Company believes it is
more likely than not that the limitation attributable to the first change of
approximately $124 annually will remain in place limiting approximately $2,489
of NOL. Further, as a result of the April 2009 change in control the Company
believes it is more likely than not that the loss attributiable to the post
October 2008 change of control and to April 2009 of approximately $2,921 would
be able to be fully utilized with no likely limitations.




Post April 2009.   Any losses incurred post the April 2009 change in control
would not be limited assuming that the Company does not experience any
additional changes in control.




The state
net operating loss projected to be lost due to IRC Section 382 limitations is
approximately $187,356 resulting in approximately $2,489 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
                
                
                
                4,111Unavailable
      losses/credit as a result of the October 2008 change in
      control
                
                
                234,952
                
                
                
                187,356
                
                
                
                4,111Loss/credit
      Available after October 2008 change subject to annual
      limitations
                
                
                2,489
                
                
                
                2,489
                
                
                noneNOL/Credit
      attributable to period post the October 2008 change in control and 
      to the control change in April 2009
                
                
                2,921
                
                
                
                2,921
                
                
                
                25Total 
      NOL and credits subject to limitation
                
                
                5,410
                
                
                
                5,410
                
                
                
                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




Aequus Agreement.On
October 8, 2009, the Company entered into a letter agreement (the “Aequus Settlement
Agreement”) with Aequus to settle all past due obligations owed by
Aequus to to the Company.




As of the
date of the Aequus Settlement Agreement, Aequus had committed to purchase from
the Company but had failed to pay for 2,284 video phones which are held by the
Company.




Pursuant
to the Aequus Settlement Agreement,





·
            all
      prior agreements between Aequus and any of its subsidiaries and the
      Company, have been terminated;




·
            none
      of Aequus or the Company have any further liabilities or obligations under
      such prior agreements and each of Aequus and the Company provided a mutual
      release of all prior claims between the
parties;




·
            Aequus
      agreed to purchase and pay for 2,284 video phones , to the extent the
      Company has available inventory of such video phones, on a periodic basis
      through February 2011 pursuant to the terms of a reseller agreement with
      the Company.any default by Aequus of its obligations under the Aequus
      Settlement Agreement will result in Aequus being required to pay all of
      its financial obligations being released under the Aequus Settlement
      Agreement less any amounts paid by Aequus under the Aequus Settlement
      Agreement.




Service Agreement with deltathree,
Inc.  On October 9, 2009, the Company entered into a master service
agreement (the “D3
Agreement”) with deltathree, Inc. (“D3”).




Pursuant
to the D3 Agreement, D3 will provide the Company, and the Company will purchase
from D3, wholesale voice over internet protocol telephony and video services,
including providing D3’s operational support systems to OJO Service in the
United States.  These services will provide the Company one of the tools
necessary to provide “turn-key” digital video phone services (meaning a
complete, ready-to-use digital video phone services solution) directly to end
using customers.  The Company will pay D3 an activation fee and a monthly
subscriber-based fee for each customer of the Company that subscribes for the
services provided to the Company under the D3 Agreement.  The initial term
of the D3 Agreement is for a period of five years from the date the Company
begins offering voice over internet protocol telephony and video services to
customers.  The term will renew automatically for successive terms of one
year each unless either party provides the other party written notice of
termination at least 180 days prior to the expiration of the then-current
term.  The D3 Agreement can be terminated by either party for cause or upon
180 days notice for convenience.  If the Company does not incur charges
payable to D3 pursuant to the D3 Agreement of at least $300 during the six month
period following the date that the first customer of  the Company is
provided voice over internet protocol telephony and video services pursuant to
the D3 Agreement, the Company will be obligated to pay D3 an amount equal to
33.0% multiplied by the difference between $300 and the actual amount of such
charges during such six month period.





24




D3 is
majority owned by D4 Holdings, LLC and the Company is majority owned by WGI
Investor LLC.  D4 Holdings, LLC and WGI Investor LLC have common majority
ownership and a common manager.





Services Agreement with ACN,
Inc. 
On October 12, 2009, the Company entered into a Service Agreement (the “ACN Service
Agreement”) with ACN, Inc., pursuant to which ACN will provide to the
Company, and the Company will provide to ACN, certain services.  No
services are currently contemplated to be provided by the Company to ACN. 
The following services are currently contemplated to be provided by ACN to the
Company:





·
            Secondment
      Services.  ACN has agreed to second mutually agreed employees
      of ACN to the Company on customary
terms.





·
            Use
      of Equipment. ACN has agreed to provide the Company with use of an
      EMI test chamber owned by ACN.  The Company has agreed to pay ACN a
      fee of approximately $2 per month for 24 months for use of the EMI test
      chamber.  At the end of the 24 month period, title to the EMI test
      chamber will transfer to the Company.  Payment of the fee for the EMI
      Test Chamber is not due until the later of December 31, 2010 or the date
      the Company has sufficient cash generated from operations to pay the
      outstanding amount of the deferred
payments.





·
            Administrative
      and Travel Support.  ACN has agreed to provide to the Company
      as requested by the Company, administrative and travel support.  The
      cost for administrative support shall be mutually agreed by the parties as
      such services are requested.  The cost for travel support is the
      actual out-of-pocket costs paid by ACN to third parties for travel
      services requested by the Company.  Payment of the costs for
      administrative and travel support are not due until the later of December
      31, 2010 or the date the Company has sufficient cash generated from
      operations to pay the outstanding amount of the deferred
      payments.





·
            Real
      Estate and Operations Services.  ACN has agreed to provide to
      the Company, as requested by the Company, office space, telecommunications
      and electronic communications services, computer support, recruiting
      services, tax and regulatory advice, force management and other requested
      services relating to a telecommunications customer operation center. 
      The cost for the use of real estate services is the incremental
      out-of-pocket costs incurred by ACN in order to provide office space to
      the Company.  The cost for the use of operations services is the
      incremental out-of-pocket costs incurred by ACN in order to provide the
      operations services to the Company.  Payment of the costs for real
      estate and operations services are not due until the later of December 31,
      2010 or the date the Company has sufficient cash generated from operations
      to pay the outstanding amount of the deferred
  payments.





·
            Provisioning
      of VOIP Communication Devices.  ACN has agreed,to provide to
      the Company, the ability to purchase from time to time the Iris 3000 video
      phone.  The price to be paid by the Company for each video phone is
      the amount incurred by ACN to manufacture the phone without any markup,
      plus the costs and expenses for shipping and handling.  The purchase
      price for each video phone is due and payable thirty (30) days after the
      date of the receipt of the invoice relating to such video phone. 
      Notwithstanding the foregoing, if the Company has paid ACN all outstanding
      carrying costs contemplated by the next sentence when due, the Company
      shall not be in default if the Company fails to pay ACN  the purchase
      price for each video phone as contemplated by the prior sentence;
      provided, however, that the Company must pay outstanding invoices, to the
      extent commercially reasonable, upon the Company having sufficient cash
      generated from operations to pay such outstanding invoiced amounts. 
      The Company will pay ACN a carrying cost of 1% per month applied to the
      total value in a given month of video phones received by the Company and
      for which the Company has not made payment; provided that, the carrying
      cost will not be applied to video phones within the first 30 days after
      receipt of the invoice relating to delivery of such video phone, but will
      apply monthly thereafter until the Company has made full payment with
      respect to such video phone.  ACN  will have a purchase money
      security interest in all video phones received by the Company for which
      the Company has not made full payment to ACN.





Revolving Loan and Security Agreement
with WGI.  On October 28, 2009, the Company entered into a Revolving
Loan and Security Agreement with WGI pursuant to which WGI will provide to the
Company, a line of credit in a principal amount of $3,000.  In addition, on
October 28, 2009, pursuant to the Revolving Loan the Company issued a Revolving
Promissory Note, in a principal amount of $3,000, to WGI.





Pursuant
to the Revolving Loan and the Revolving Promissory Note,





·
            WGI
      agrees to lend from time to time, as requested by the Company amounts up
      to $3,000;




25




·
            interest
      shall accrue on any loan advances at the rate of 10% per
      annum;





·
            the
      initial payment of accrued interest shall be paid on June 1, 2010 and
      monthly thereafter;





·
            principal
      amounts repaid by the Company is available for
    re-borrowing;





·
            all
      outstanding principal and interest outstanding are required to be repaid
      on October 28, 2014;





·
            the
      Company granted WGI a security interest in all assets of the
      Company;





·
            the
      Company made customary representations and covenants to
    WGI;





·
            any
      loan advance requires the satisfaction of the following conditions:
      receipt by WGI of an executed notice of borrowing; the representations and
      warranties of the Company shall be true in all material respects on the
      date of the notice of borrowing and the loan date; no event of default
      shall have occurred and be continuing or result from such loan advance;
      and there shall not have occurred, in WGI’s sole discretion, any material
      adverse change; and





·
            upon
      the occurrence of an event of default, (1) WGI may require repayment of
      all outstanding amounts under the Revolving Loan, may terminate its
      commitment to make additional loans to the Company, and may exercise its
      rights with respect to the security interest in all of the assets of the
      Company and (2) all outstanding amounts under the Revolving Loan will bear
      interest at the rate of 15% per
annum.





The Company has evaluated events that
occurred subsequent to September 30, 2009 through November 16, 2009, the date of
which the financial statements for the period ended September 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, (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 and voice 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 service. Customer
availability of the new video phone is expected in the second quarter of
2010.





26




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 early 2010, 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 ability 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 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 us and WGI.  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 the then 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,
(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.




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.   ACN has committed to purchase
three hundred thousand videophones from us over a two-year period.  In
connection with this 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 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.





27




Results
of Operations:




Three and Nine Months Ended September
30, 2009 and September 30, 2008.





Revenues.





For the three months ended September 30,
                
                
                For the nine months ended September 30,2009
                
                
                2008
                
                
                Change
                
                
                2009
                
                
                2008
                
                
                ChangeProduct
      revenues
                
                $
                8
                
                
                $
                938
                
                
                $
                (930
                )
                
                
                (99
                )%
                
                $
                373
                
                
                $
                1,769
                
                
                $
                (1,396
                )
                
                
                (79
                )%Service
      revenues
                
                $
                89
                
                
                $
                176
                
                
                $
                (87
                )
                
                
                (49
                )%
                
                $
                271
                
                
                $
                435
                
                
                $
                (164
                )
                
                
                (38
                )%Other
      revenues
                
                $
                0
                
                
                $
                133
                
                
                $
                (133
                )
                
                
                (100
                )%
                
                $
                833
                
                
                $
                412
                
                
                $
                421
                
                
                
                102
                %Total
      net revenues
                
                $
                97
                
                
                $
                1,247
                
                
                $
                (1,150
                )
                
                
                (92
                )%
                
                $
                1,477
                
                
                $
                2,616
                
                
                $
                (1,139
                )
                
                
                (44
                )%





Product
Revenue.  Product revenue consists of the sale of Ojo video
phones.  For the three months ended September 30, 2009 compared with
the three months ended September 30, 2008, the decrease in product revenue
primarily reflects reduced shipments of product to Aequus.  For the nine
months ended September 30, 2009 compared with the nine months ended
September 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 nine months ended September 30,
2009.





Service
Revenue.  Service revenue consists of subscription service revenues
and service provided to service operators. For the three and nine months ended
September 30, 2009 compared with the three and nine months ended
September 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 September 30, 2009 compared with
the three months ended September 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 nine months
ended September 30, 2009 compared with the nine months ended
September 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 our $900 obligation to provide NRE to Aequus and that was credited to
NRE services provided under the March 31, 2008 agreement with
Aequus.




Cost of Revenues and Gross
Margin.




For the three months ended September 30,
                
                
                For the nine months ended September 30,2009
                
                
                2008
                
                
                Change
                
                
                2009
                
                
                2008
                
                
                ChangeTotal
      net revenues
                
                $
                97
                
                
                $
                1,247
                
                
                $
                (1,150
                )
                
                
                (92
                )%
                
                $
                1,477
                
                
                $
                2,616
                
                
                $
                (1,139
                )
                
                
                (44
                )%Cost
      of product revenues
                
                $
                14
                
                
                $
                716
                
                
                $
                (702
                )
                
                
                (98
                )%
                
                $
                932
                
                
                $
                1,432
                
                
                $
                (500
                )
                
                
                (35
                )%Cost
      of other revenues
                
                $
                0
                
                
                $
                95
                
                
                $
                (95
                )
                
                
                (100
                )%
                
                $
                0
                
                
                $
                254
                
                
                $
                (254
                )
                
                
                (100
                )%Total
      cost of revenues
                
                $
                14
                
                
                $
                811
                
                
                $
                (797
                )
                
                
                (98
                )%
                
                $
                932
                
                
                $
                1,686
                
                
                $
                (754
                )
                
                
                (45
                )%Gross
      margin
                
                $
                83
                
                
                $
                436
                
                
                $
                (353
                )
                
                
                (81
                )%
                
                $
                545
                
                
                $
                930
                
                
                $
                (385
                )
                
                
                (41
                )%





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
September 30, 2009 compared with the three months ended September 30,
2008, the decrease in cost of revenues primarily reflects decreased costs
related to reduced product shipments of $702, and decreased other revenue
engineering services costs of $95.  For the nine months ended
September 30, 2009 compared with the nine months ended September 30,
2008, the decrease in cost of revenues primarily reflects the reduced product
shipments and other revenue engineering services in 2009 compared to
2008.





Gross Margin. 
For the three months ended September 30, 2009 compared with the three
months ended September 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 nine months ended
September 30, 2009 compared with the nine months ended September 30,
2008, gross margin was reduced by $600 relating to the establishment of an
inventory reserve for certain excess and obsolete inventory.    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 16 of the accompanying financial statements), and increased selling prices
and lower unit costs of the product shipped during the nine months ended
September 30, 2009 compared to the same period in 2008.





28


Expenses From Operations.





For the three months ended September 30,
                
                
                For the nine months ended September 30,2009
                
                
                2008
                
                
                Change
                
                
                2009
                  Restated
                
                
                2008
                
                
                ChangeEngineering
      and development
                
                $
                938
                
                
                $
                631
                
                
                $
                307
                
                
                
                49
                %
                
                $
                2,343
                
                
                $
                1,707
                
                
                $
                636
                
                
                
                37
                %Sales
      and marketing
                
                $
                249
                
                
                $
                73
                
                
                $
                176
                
                
                
                241
                %
                
                $
                355
                
                
                $
                431
                
                
                $
                (76
                )
                
                
                (18
                )%General
      and administrative
                
                $
                870
                
                
                $
                797
                
                
                $
                73
                
                
                
                9
                %
                
                $
                3,311
                
                
                $
                2,674
                
                
                $
                637
                
                
                
                24
                %Depreciation
      and amortization
                
                $
                93
                
                
                $
                43
                
                
                $
                50
                
                
                
                116
                %
                
                $
                212
                
                
                $
                224
                
                
                $
                (12
                )
                
                
                (5
                )%





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 nine months ended
September 30, 2009 compared with the three and nine months ended
September 30, 2008, the increase in engineering and development expenses
primarily reflects increased staffing of $223 and $408, respectively, primarily
related to the increased development effort on the next generation video
phone.  In addition, for the three and nine months ended September 30, 2008
certain direct engineering development costs, including staffing costs of $95
and $254, respectively, was related to revenues reported for NRE services
performed for Aequus and charged to cost of revenues.





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 related to the continued
sales of our video phone product   For the three months ended
September 30, 2009 compared with the three months ended September 30, 2008, the
increase in sales and marketing expenses is primarily the result of increased
staffing of $123, primarily related to the new business service model, and the
establishment of a $30 reserve against certain service receivables.  For
the nine months ended September 30, 2009 compared with the nine months
ended September 30, 2008, the decrease in sales and marketing expenses is
primarily the result of reduced marketing, customer service and promotional
expenditures of $221, partially offset by the increase in staffing and the
establishment of the service receivable reserve.





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 months ended September 30, 2009
compared with the three months ended September 30, 2008, the increase in general
and administrative expenses is primarily the result of increased non-cash
compensation expense of $153 related to the issuance of employee stock options,
partially offset by reduced staffing costs of $80.  For the nine months
ended September 30, 2009 compared with the nine months ended
September 30, 2008, the increase in general and administrative expenses is
primarily the result of the increase in non-cash compensation expense of $192
and the accrual of $626 in compensation and severance expenses related to
officers that were terminated, partially offset by reductions in other
administrative expenses of $195.  The terminated officer’s compensation
will cease on April 7, 2010.  In addition the nine months ended September
30, 2009, included a bad debt reserve of $46 primarily related to certain
service customers.




Other Income and Expenses.





For the three months ended September30,
                
                
                For the nine months ended September 30,2009
                
                
                2008
                
                
                Change
                
                
                2009
                
                
                2008
                
                
                ChangeInterest
      and other income
                
                $
                41
                
                
                $
                6
                
                
                $
                35
                
                
                
                583
                %
                
                $
                50
                
                
                $
                16
                
                
                $
                34
                
                
                
                213
                %Change
      in fair value of derivative warrants and conversion
options
                
                $
                43
                
                
                $
                843
                
                
                $
                800
                
                
                
                95
                %
                
                $
                4,252
                
                
                $
                157
                
                
                $
                4,095
                
                
                
                2,608
                %Income
      from service fee contract termination
                
                $
                47
                
                
                $
                1,064
                
                
                $
                (1,017
                )
                
                
                (96
                )%
                
                $
                395
                
                
                $
                2,121
                
                
                $
                (1,726
                )
                
                
                (81
                )%Amortization
      of debt discount
                
                $
                0
                
                
                $
                (706
                )
                
                $
                (706
                )
                
                
                (100
                )%
                
                $
                (2,918
                )
                
                $
                (1,632
                )
                
                $
                1,286
                
                
                
                79
                %Loss
      on equipment disposal
                
                $
                0
                
                
                $
                0
                
                
                $
                0
                
                
                
                N/A
                
                
                $
                0
                
                
                $
                (295
                )
                
                $
                (295
                )
                
                
                (100
                )%Interest
      and other expense
                
                
                (1
                )
                
                
                (76
                )
                
                $
                (75
                )
                
                
                (99
                )%
                
                
                (114
                )
                
                
                (262
                )
                
                $
                (148
                )
                
                
                (56
                )%





Interest and Other
Income.  Interest and other income consisted of interest earned on
cash and cash equivalents and reductions in our accounts payable obligations
through negotiated settlements with certain vendors.  During the three and
nine months ended September 30, 2009, we earned interest on an average cash
balance of approximately $1,369 and $830, respectively, and recorded the
negotiated cancellation  of certain obligations of $41 and $49,
respectively.  During the three and nine months ended September 30, 2008,
we earned interest on an average cash balance of approximately $557 and $573,
respectively.





29




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 September 30, 2008 (See Note 9 of the accompanying
financial statements).





Income from Service Fee
Contract Termination  On October 8, 2009, we entered into a letter
agreement with Aequus to settle all past due obligations owed by Aequus to
the Company (see Note 19 of the accompanying financial statements) and we
realized $47 for the three and nine months ended September 30, 2009 of other
income from the elimination of these obligations.  Income from service fee
contract termination for the three and nine months ended September 30, 2008 of
$1,064 and $2,121, respectively, 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 16 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 nine months ended September 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 8 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.





Loss on Equipment
Disposal.  During the nine months ended September 30, 2008, certain
equipment, furniture and fixtures were sold and disposed of during our move to
smaller facilities.  The net loss realized during the nine months ended
September 30, 2008 was $295.  There was no loss or gain realized during the
three and nine months ended September 30, 2009.





Interest and Other
Expense. 
The decrease in interest expense for the three and nine months ended September
30, 2009, when compared to the same periods in 2008, primarily consisted of a
reduction of $76 and $262, respectively, of interest expense resulting from the
elimination in 2009 of interest 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 September 30, 2009, our primary sources of
liquidity consisted of proceeds from notes issued, the sale of Common Stock, the
exercise of warrants and options, the sale of Ojo video phones and engineering
development services.  Cash and cash equivalents are invested in
investments that are highly liquid, are high quality investment grade and have
original maturities of less than three months.  As of September 30, 2009,
we had cash and cash equivalents of $1,043.





Cash Used in
Operations.  We utilized cash from operations of $1,918 and $3,309,
respectively, during the three and nine months ended September 30, 2009 and
generated cash from operations during the three months ended September 30, 2008
of $30 and utilized cash of  $624 during the nine months ended September
30, 2008.  Our short term cash requirements and obligations included
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
nine months ended September 30, 2009 was primarily a result of capital
expenditures of $269 and $525, respectively, for investments in equipment for
new product development.  Cash used in investing activities for the three
months ended September 30, 2008 was primarily a result of capital expenditures
of $2 and for the nine months ended September 30, 2008, cash of $2 was
provided.





Cash Provided by Financing
Activities.  Cash provided by financing activities during the three
and nine months ended September 30, 2009 was $2,021 and $4,448,
respectively.  Cash provided by financing activities during the three and
nine months ended September 30, 2008 was $0 and $1, respectively. 
 During the three  and nine months ended September 30, 2009, we
received cash of $0 and $1,450, respectively, from stock issuances and $2,036
and $2,917, respectively from the exercise of warrants (See Note 3 of the
accompanying financial statements).





30


Operations and Liquidity.




We have
incurred recurring net losses and have an accumulated deficit of $273,419,
stockholder’s deficiency of $391 and a working capital deficit of $1,237 as of
September 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.On October
28, 2009, we entered into a Revolving Loan and Security Agreement (the
“Revolving Loan”) with WGI pursuant to which WGI will provide to the Company, a
line of credit in a principal amount of $3,000 (See Note 19 of the accompanying
financial statements).  Based on management’s internal forecasts and
assumptions regarding its short term cash requirements, and the establishment of
a revolving credit facility, we currently believe that we will have sufficient
cash on hand to meet our obligations into the first quarter of 2010. 
However, there can be no assurance given that these assumptions are correct or
that the revenue projections associated with sales of products and services will
materialize to a level that will provide us with sufficient capital to operate
our business.  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
$3,619 of liabilities and none of our assets are pledged as collateral as of
September 30, 2009.  These liabilities primarily include $1,609 of accounts
payable and accrued expenses, $453 of accrued severance, $1,291 of deferred
revenues and income, and $203 of accrued compensation and benefits.





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 as
of April 6, 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.





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, and the establishment on October 28, 2009 of a $3,000
Revolving Loan facility we currently believe that we will have sufficient cash
on hand to meet our obligations into the first quarter of 2010. However, there
can be no assurance given that these assumptions are correct or that the revenue
projections associated with product sales and services to customers 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, we continue 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.




31




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.





In an effort
to remediate the reported material weakness related to the lack of internal GAAP
expertise to assist with the accounting and reporting of complex financial
transactions, the Company undertook the following actions:




·
            Contracted with outside
      consulting experts to evaluate the nature of the weakness and provide
      training and detailed recommendations so that the Company had a defined
      process and the capacity and capability to determine accounting treatment
      on complex financial transactions and for changes in the nature of
      transactions the Company is engaged in. The process included the review by
      financial management of all transactions to ensure that the proper
      application of generally accepted accounting principles in recording
      complex transactions were identified and whether these transactions
      required additional
expertise.





·
            Engaged ongoing services of a
      consulting firm with demonstrated expertise in advising clients on GAAP
      issues to assist with the identification and proper application of
      generally accepted accounting principles in recording complex
      transactions.





·
            Established a Disclosure
      Committee consisting of executive management across all functional
      disciplines to review the effectiveness of the Company’s disclosure
      controls and procedures and identify any significant deficiencies in the
      design or operation of the Company’s internal controls and ensure that all
      relevant transactions are being recorded.  The Disclosure Committee
      helps identify that all transactions and commitments have been accounted
      for and ensures that new developments that could have complex accounting
      treatment implications are identified and analyzed on a timely
      basis.





·
            Independent testing was performed
      to validate that the new internal controls were effective, including
      testing to ascertain that the new processes for identifying and analyzing
      complex transactions were in
effect.




Based on
testing performed, the Company concluded that it now has effective controls
through the adoption of new processes and procedures to ensure timely and
thorough research and evaluation of accounting and reporting of complex
financial transactions





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 September 30, 2009.  As a result of the evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that, as of
September 30, 2009, its disclosure controls and procedures were effective as the
material weakness identified at December 31, 2008 was remediated.





Change in Internal Control
over Financial Reporting.





As
described in our evaluation of disclosure controls and procedures, the Company
implemented new controls to add GAAP expertise and adopt new processes and
procedures to ensure timely and thorough research and evaluation of accounting
treatment for all complex transactions.  Part of the new processes and
controls includes establishing a Disclosure Committee to help identify changes
in the business or other activities that could impact accounting treatment and
the engagement of consulting expertise to establish process and support proper
application of generally accepted accounting principles in recording complex
transactions.





32





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.





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).





On
October 8, 2009, the Company entered into a letter agreement (the “Aequus
Settlement Agreement”) with Aequus to settle all past due obligations owed by
Aequus to to the Company.





Pursuant
to the Aequus Settlement Agreement,





·
            all
      prior agreements between Aequus and any of its subsidiaries and the
      Company, have been terminated, including the License, Maintenance and
      Update Service Agreement, dated March 31, 2008, the Revised and Restated
      Amendment and Master Contract, dated March 31, 2008, and the Master
      Agreement, dated March 31, 2008;





·
            none
      of Aequus or the Company have any further liabilities or obligations under
      such prior agreements and each of Aequus and the Company provided a mutual
      release of all prior claims between the
parties;





·
            the
      Company provided Aequus a license to use certain of its intellectual
      property to support and operate video relay services and video remote
      interpreting services in the United States, Canada and Mexico solely with
      respect to video phones sold by the Company to Aequus and paid for in full
      by Aequus;





·
            Aequus
      agreed to purchase and pay for 2,284 video phones, to the extent the
      Company has available inventory of such video phones, on a periodic basis
      through February 2011 pursuant to the terms of a reseller agreement with
      the Company, which restricts the reselling by Aequus of video phones to
      end users in the United States, Canada and Mexico that have speech and/or
      hearing impairment and whose ability to engage in telephonic communication
      requires access to and use of video relay services and video remote
      interpreting services; and





·
            any
      default by Aequus of its obligations under the Aequus Settlement Agreement
      will result in Aequus being required to pay all of its financial
      obligations being released under the Aequus Settlement Agreement less any
      amounts paid by Aequus under the Aequus Settlement
    Agreement.





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, 8,771,954 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.




33




As of
September 30, 2009, all of the 2004 Warrants and the 2005 Warrants were
exercised (including a significant number of 2004 Warrants held by an affiliate
of Antonio Tomasello), resulting in the Company receiving $2,321 in gross
aggregate cash proceeds ($2,282 net proceeds).  During the quarter ended
September 30, 2009 the remaining outstanding 2004 Warrants were exercised
resulting in the Company issuing 5,605,287 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 September 30, 2009, all 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 had either expired or been exercised.  As of September
30, 2009, 879,359 of the Warrants to Purchase Common Stock of WorldGate
Communications, Inc. issued August 3, 2005 remain outstanding.




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 expire on September 23,
2012.




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. All of the
2007 Warrant was exercised on September 8, 2009 resulting in the issuance of
2,564,102 and the Company receiving $641 in gross aggregate cash
proceeds.


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.  Among other things, pursuant to
the letter agreement,




·
            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.  These warrants were
      assigned to Mr. K.Y. Chou and were exercised on October 2, 2009 resulting
      in the Company issuing 1,000,000 shares and the Company receiving $350 in
      gross proceeds ($344 net
proceeds.




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.




34




4.1
                              
                              Form
      of Warrant, issued July 8, 2009, by the Company to Mototech, Inc.
      (Incorporated by reference to Exhibit 10.2 to our Current Report on
      Form 8-K filed July 10, 2009)4.2
                              
                              Form
      of Amendment No. 1 to Warrant Agreement with respect to the 2007 Warrant
      (Incorporated by reference to Exhibit 4.1 to our Current Report on
      Form 8-K filed July 20, 2009)10.1
                              
                              Letter
      Agreement, dated July 8, 2009, between the Company and Mototech, Inc.
      (Incorporated by reference to Exhibit 10.1 to our Current Report on
      Form 8-K filed July 10, 2009)10.2
                              
                              Offer
      Letter, dated July 31, 2009, to George E. Daddis Jr. (Incorporated by
      reference to Exhibit 10.1 to our Current Report on Form 8-K filed
      August 4, 2009)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




35




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
      BoyarskiSenior
      Vice President and Chief Financial Officer(Principal
      Financial and Accounting Officer)




36