UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM 10-K




(Mark One)





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





For
the fiscal year ended December 31, 2009





Or





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




For
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 incorporation or
                organization)
              
              (I.R.S.
      Employer 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)




Securities
registered pursuant to Section 12(b) of the Act: None




Securities
registered pursuant to Section 12(g) of the Act:




Common
Stock, $0.01 Par Value


(Title of
Class)





Indicate
by check mark if the Registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act of 1933. Yes  o     No  þ
 Indicate
by check mark if the Registrant is not required to file reports pursuant to
Section 13 or 15(d) of the Securities Exchange Act of 1934 (hereafter, the
“Exchange Act”). Yes   ̈     No  þ
 Indicate
by check mark whether the Registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Exchange Act 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  þ     No   ̈
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such
files). Yes   ̈     No   ̈
 Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant’s knowledge, in the definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or
any amendment to this Form 10-K.  þ
 Indicate
by check mark whether the Registrant is a large accelerated filer, an
accelerated filer, or 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 Exchange Act. (Check
one):
 Large
                      accelerated filer  ̈
                    
                    Accelerated filer  ̈
                    
                    Non-accelerated filer  ̈
                      (Do not check if a smaller reporting company)
                    
                    Smaller reporting
                      company þ
 Indicate
by check mark whether the Registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes   ̈     No  þ
 As of
June 30, 2009, which was the last business day of the Registrant’s most
recently completed second fiscal quarter, the aggregate market value of the the
Company’s common stock, par value $0.01 per share (“Common Stock”) held by
non-affiliates of the Registrant was $39,223,065.  Such aggregate
market value was computed by reference to the closing sale price of the
Registrant’s Common Stock as reported on the OTC Bulletin Board on such
date.
  As of
March 24, 2010, there were 338,627,636 shares of the Registrant’s
Common Stock outstanding.
  DOCUMENTS INCORPORATED BY
REFERENCE
 As stated
in Part III of this annual report on Form 10-K, portions of the
Registrant’s definitive proxy statement to be filed within 120 days after
the end of the fiscal year covered by this annual report on Form 10-K are
incorporated herein by reference.
  CERTAIN
DEFINITIONS
 Unless
the context indicates otherwise, the terms “WorldGate,” “the Company,”
“we,” “our” and “us” refer to WorldGate Communications, Inc. and, where
appropriate, one or more of its subsidiaries.  The term “Registrant” means
WorldGate Communications, Inc. Dollar
amounts contained in this Annual Report on Form 10-K are in thousands, except
per share and per unit amounts.







WORLDGATE
COMMUNICATIONS, INC.




ANNUAL
REPORT ON FORM 10-K




For
the Fiscal Year Ended December 31, 2009




TABLE
OF CONTENTS




PART
      ICautionary
      Note Regarding Forward-Looking Statements
                                
                                1Item
      1. Business
                                
                                4Item
      1A. Risk Factors.
                                
                                26Item
      2. Properties.
                                
                                45Item
      3. Legal Proceedings.
                                
                                46Item
      4. (Removed and Reserved).
                                
                                46PART
      IIItem
      5. Market for Registrant’s Common Equity, Related Stockholder Matters and
      Issuer Purchases of Equity Securities.
                                
                                46Item
      6. Selected Financial Data.
                                
                                47Item
      7. Management’s Discussion and Analysis of Financial Condition and Results
      of Operations.
                                
                                47Item
      7A.  Quantitative and Qualitative Disclosures About Market
      Risk.
                                
                                58Item
      8.  Financial Statements and Supplementary Data.
                                
                                58Item
      9. Changes in and Disagreements with Accountants on Accounting and
      Financial Disclosure.
                                
                                58Item
      9A (T). Controls and Procedures.
                                
                                58Item
      9B.  Other Information.
                                
                                59PART
      IIIItem
      10. Directors, Executive Officers and Corporate
Governance.
                                
                                60Item
      11. Executive Compensation.
                                
                                60Item
      12.  Security Ownership of Certain Beneficial Owners and
      Management and Related Stockholder Matters.
                                
                                60Item
      13. Certain Relationships and Related Transactions and Director
      Independence
                                
                                60Item
      14. Principal Accountant Fees and Services
                                
                                60PART
      IVItem
      15. Exhibits and Financial Statement Schedules.
                                
                                62











Cautionary
Note Regarding Forward-Looking Statements




From time
to time, we may provide information, whether orally or in writing, including
certain statements in this Annual Report on Form 10-K, which are deemed to be
“forward-looking” within the meaning of the Private Securities Litigation Reform
Act of 1995.  Any statements contained herein that are not statements
of historical fact may be deemed to be forward-looking
statements.  These forward-looking statements and other information
are based on our beliefs as well as assumptions made by us using information
currently available.




The
words  “if,” “will,” “predicts,” “may,” “should,” “believe,”
“anticipate,” “future,” “forward,” “potential,” “estimate,” “reinstate,”
“opportunity,” “goal,” “objective,” “continue,” “exchange,” “growth,” “outcome,”
“could,” “expect,” “intend,” “plan,” “strategy,” “provide,” “commitment,”
“result,” “seek,” “pursue,” “ongoing,” “include” or in the negative of such
terms or comparable terminology and similar expressions, as they relate to us,
are intended to identify forward-looking statements.  Forward-looking
statements include, without limitation, statements set forth in this document
and elsewhere regarding, among other things:




·
            expectations
      of future growth, creation of stockholder value, revenue and net income,
      as well as income from operations, margins, earnings per share, cash flow
      and cash sufficiency levels, working capital, network development,
      customer migration and related costs, spending on and success with our
      products, capital expenditures, selling, general and administrative
      expenses, tax expense, fixed asset and goodwill impairment charges,
      service introductions and cash
requirements;




·
            expectations
      of marketing and product launch efforts and initiatives of distributor or
      resellers;




·
            increased
      competitive pressures;




·
            financing,
      refinancing, debt extension, de-leveraging or restructuring plans or
      initiatives, and potential dilution of existing equity holders from such
      initiatives;




·
            liquidity
      and debt service forecast;




·
            timing,
      extent and effectiveness of cost reduction initiatives and management’s
      ability to moderate or control discretionary
  spending;




·
            management’s
      plans, goals, expectations, guidance, objectives, strategies, and timing
      for future operations, acquisitions, asset dispositions, product plans,
      performance and results; and




·
            management’s
      assessment of market factors and competitive developments, including
      pricing actions and regulatory
rulings.




In
accordance with the provisions of the Private Securities Litigation Reform Act
of 1995, we are making investors aware that such forward-looking statements,
because they relate to future events, are by their very nature subject to many
important factors that could cause actual results to differ materially from
those contemplated by the forward-looking statements contained in this Annual
Report on Form 10-K, any exhibits to this Form 10-K and other public statements
and disclosures we make.  Factors and risks that could cause actual
results to differ materially from those set forth or contemplated in forward
looking statements include, but are not limited to:




·
            changes
      in business conditions causing changes in the business direction and
      strategy by management;




·
            heightened
      competition, including competitive pricing and bundling pressures in the
      markets in which we operate;




·
            the
      ability to service indebtedness;




1




·
            the
      determination of distributors or resellers to reallocate resources away
      from selling, marketing or advertising our products and services or to
      delay the launch of selling our products and
  services;




·
            customer
      acceptance and demand for our voice over Internet protocol (“VoIP”)
      telephony products (including our video phone) and
    services;




·
            the
      reliability of our services, the prices for our products and services,
      customer renewal rates, and customer acquisition
  costs;




·
            difficulty
      in maintaining or increasing customer revenues and margins through our
      product and service initiatives;




·
            our
      history of net operating losses;




·
            our
      needs for and the availability of adequate working capital, including
      adequate financial resources to promote and to market product and service
      initiatives;




·
            the
      possible inability to raise additional capital when needed, on attractive
      terms, or at all;




·
            possible
      claims under our existing debt instruments which could impose constraints
      and limit our flexibility;




·
            the
      inability to service substantial indebtedness and to reduce, refinance,
      extend, exchange, tender for or restructure debt significantly, or in
      amounts sufficient to conduct regular ongoing
  operations;




·
            further
      changes in the telecommunications or Internet industry, including rapid
      technological changes, regulatory and pricing changes in our principal
      markets and the nature and degree of competitive pressure that we may
      face;




·
            adverse
      tax or regulatory rulings or actions affecting our operations, including
      the imposition of taxes and fees, the imposition of obligations upon VoIP
      providers to provide enhanced 911 (E-911) services and restricting access
      to broadband networks owned and operated by
  others;




·
            changes
      in the regulatory schemes or requirements and regulatory enforcement in
      the markets in which we operate;




·
            potential
      warranty claims and product
defects;




·
            our
      ability to innovate
technologically;




·
            enhanced  competition;




·
            changes
      in financial, capital market and economic
  conditions;




·
            changes
      in service offerings or business strategies, including the need to modify
      business models if performance is below
  expectations;




·
            difficulty
      in migrating or retaining customers associated with acquisitions of
      customer bases, or integrating other
assets;




·
            difficulty
      in selling new services in the
marketplace;




·
            difficulty
      in providing video phone and VoIP
services;




·
            restrictions
      on our ability to execute certain strategies or complete certain
      transactions as a result of our inexperience with new products, or
      limitations imposed by available cash resources, our capital structure or
      debt covenants;




·
            risks
      associated with our limited VoIP experience and expertise, including
      effectively utilizing new marketing
channels;




2




·
            entry
      into developing markets;




·
            the
      possible inability to hire and/or retain qualified executive management,
      sales, technical and other
personnel;




·
            the
      timely supply of products by our contract
  manufacturers;




·
            the
      availability of components necessary to manufacture our
      products;




·
            risks
      and costs associated with our effort to locate certain activities and
      functions off-shore;




·
            risks
      associated with international
operations;




·
            dependence
      on effective information and billing
systems;




·
            possible
      claims for patent infringement on products or processes employed in
      providing our services;




·
            other
      intellectual property and other litigation that may be brought against
      us;




·
            dependence
      on third parties for access to their networks to enable us to expand and
      manage our global network and operations and to offer digital voice and
      video phone services;




·
            our
      dependence on our customers’ existing broadband
    connections;




·
            the
      elimination or limitation of a substantial amount or all of our operating
      loss carryforwards, which carryforwards would otherwise be available to
      reduce future taxable income; and




·
            other
      factors that are set forth in the “Risk Factors” section, and other
      sections of this Annual Report on Form 10-K, as well as in our Quarterly
      Reports on Form 10-Q and Current Reports on Form
  8-K




Forward-looking
statements reflect our current views with respect to future events and are
subject to certain risks, uncertainties and assumptions.  Should one
or more of these risks or uncertainties materialize, or should underlying
assumptions prove incorrect, actual results may vary materially from such
forward looking statements or expectations.  Readers are also
cautioned not to place undue reliance on these forward looking statements which
speak only as of the date these statements were made.  Except as
required by law, we do not intend to update or revise any forward looking
statements, whether as a result of new information, future events or
otherwise.




3





PART
I




ITEM
1.  BUSINESS




Overview




We are a
leading provider of digital voice and video phone services and next generation
video phones.  We design and develop innovative digital video phones
featuring high quality, real-time, two-way video.  We also provide a
turn-key digital voice and video communication services platform supplying
complete back-end support services with a focus on best-in-class customer
service.  The unique combination of functional design, advanced
technology and use of IP broadband networks provides true-to-life video
communication.  As a result we are transforming how people connect,
communicate and collaborate by bringing family and friends closer together
through an immediate video connection allowing them to instantly hear and see
each other for a face-to-face conversation.




We are
transitioning from a business model focused primarily on one-time digital video
phone equipment sales to delivering an integrated audio and video telephony
solution.  Upon completion of the redevelopment of our video phone
platform, we will not only offer what we believe is an industry leading line of
consumer video phones but we will also provide a turnkey digital voice and video
phone service.  By building a service that is able to not only provide
video telephony, but also serve as a home’s primary telephone service, we enable
a recurring-revenue based business model that encourages service loyalty and one
where we are able to bundle in the cost of the video phone
itself.  The end result is a lower start-up cost to the consumer,
which we believe will drive faster market adoption of our video
phones.  Further, we believe WorldGate will be unique in the market in
that we will offer an end-to-end solution – digital video phones fully
integrated with a digital voice and video phone service – thus ensuring a
quick and trouble-free installation process.




Video
Phone.  Beginning in 2003, we initiated the engineering and
development of video phones that provide “true-to-life” audio and video
communications over broadband Internet connections.  We are in the
process of developing a new video phone platform, with customer availability of
this new video phone expected in the second quarter of 2010.




Digital Voice and Video
Phone Services.  Our digital voice and video phone service is
portable and we enable our customers to make and receive phone calls almost
anywhere a broadband Internet connection is available.  We transmit these
calls using VoIP technology, which converts voice signals into digital data
packets for transmission over the Internet.  Our calling plans provide
a number of basic features typically offered by traditional telephone service
providers, plus a wide range of enhanced features, including high quality,
real-time, two-way video, that we believe differentiate our service and offers
an attractive value proposition to our customers.




Business
Segments.  We have two reportable business segments: Consumer
Services and OEM Direct. The Consumer Services segment is aimed at the marketing
and distribution of products and related recurring services to end users. The
OEM Direct segment is focused on selling digital video phones and maintenance
services directly to telecommunications service providers who already have a
digital voice and video management and network infrastructure.




Distribution
Channels




Consumer Services
Segment. Distribution in the Consumer Services segment is aimed at the
following channels:





4




·
            Direct Retail
      Consumers.  Utilizing the internet and our corporate
      website we market our digital voice and video phone service directly to
      consumers.




·
            Sales Agents.
      Through independent sales agents and their network of sales
      representatives we distribute digital voice and video phone services to
      residential customers.  Sales agents receive commissions based
      on revenue generated by the agent.  We are able to provide
      agents partner-specific branding on all customer-specific touch points,
      including the digital video phone, the learn order and member center
      websites, customer communications, and customer service.  Agents
      that we target include direct selling companies, online marketing and
      online retail marketing companies, electronic and retail stores, and
      distribution companies with consumer service
  offerings.




·
            Wholesalers.  We
      expect to sell digital video phones and selected modules of our turn-key
      digital voice and video phone service offering, such as
      customer service, billing, network and supply chain distribution,
      depending on the specific customer requirements.  The focus of
      the wholesale distribution channel is on wholesale customer groups who
      already operate a portion of the service infrastructure, including
      telecommunication companies, VoIP service providers and select vertical
      providers in the education and health care services
    markets.




OEM Direct Segment.
This segment is focused on selling digital video phones and maintenance services
directly to telecommunications service providers who already have a complete
digital voice and video management and network infrastructure, such as incumbent
service providers, Competitive Local Exchange Carriers (“CLECs”),
international telecom service providers, cable service providers and select
vertical providers in the video relay service for deaf and hard-of-hearing and
education and healthcare services markets.




Revenues.  Our
primary sources of revenue are one-time sales of video phones and monthly
recurring subscription fees that we charge customers for our service
plans.  We also generate revenue from calls customers make that are
not included in their service plan, for additional features that customers add
to their service plans and through activation fees we charge customers to
activate their service.




Our
Strategy




Our
objective is to provide reliable, scalable, and profitable worldwide video and
voice communication services with unmatched quality by delivering innovative
technologies and services. We foster an environment that empowers our employees
to provide the best service to our customers and partners at every point of
interaction. We intend to bring the best possible voice and video products and
services, at an affordable price, to businesses and residential consumers and
enhance the ways in which these customers connect, communicate and collaborate
with each other and the world.




We
leverage the following factors in providing our products and
services:




·
            Attractive Value
      Proposition. We offer our customers an attractive value
      proposition: a portable land-line phone replacement with unique and
      compelling features including high quality, real-time, two-way video that
      differentiates our service from the competition at prices for domestic and
      international calling that are considerably lower than those of
      traditional telephone services.




·
            Innovative, Lower-Cost
      Technology Platform. We believe our innovative video phone
      technology platform not only provides us with a competitive cost advantage
      over many other video communication providers and phone manufacturers, but
      also allows us the flexibility to customize it based on individual
      customer requirements.




5




·
            Offer the best
      possible service and support to our customers.  We have
      an established call center and customer support group at our outsourced
      call center operation located in Toronto, Canada.  We also are
      investing in significant upgrades to our existing back office
      infrastructure to enhance the support we can provide to new and existing
      subscribers, as well as our distribution
  partners.




While we
will continue to build upon these strengths, we have identified the following
strategic imperatives that we believe will drive efficiencies and improve our
business performance through 2010 and beyond:




·
            Capitalize on our
      technological expertise to introduce new video communication products and
      features.  We introduced our first video phone in 2005
      and it quickly became known for its high-quality, real-time video
      capabilities.  In 2009, we started the development of our new,
      redesigned, reengineered next generation video phones with commercial
      availability planned in May 2010.




·
            Introduce a turn-key
      Digital Voice and Video Phone Services platform to enable the adoption and
      expansion of services while delivering recurring
      revenue.  We launched our new platform in February 2010,
      turning up our first Digital Voice and Video Phone Services customers
      along with our first distribution agents.  We offer a complete
      end-to-end service including local, long distance and international
      calling, a suite of calling features, including voice mail, caller ID and
      3-way calling, a global IP network optimized for Digital Voice and Video,
      and extensive back-office, support including online order entry, order
      provisioning, inventory management and fulfillment, billing, customer care
      and technical support.




·
            Organizational
      Capacity and Skills Enhancement.  We continue to improve
      our organization’s productivity through talent management, employee
      development and improved management
tools.




Operating
Highlights and Accomplishments in 2009 and Subsequent Events




2009 was
a transition year for us, including having a new investor obtain a majority
equity position in the Company; entering into a sales contract for 300,000 video
phones; entering into a manufacturing relationship with a new contract
manufacturer; settling past due obligations with certain parties; obtaining
services to launch our digital voice and video phone service; and financing our
ongoing operations.




Relationship with WGI and
ACN.




Securities Purchase
Agreement.  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, par value $0.01 per share (“Common Stock”), representing
approximately 63% of the total number of the then issued and outstanding shares
of Common Stock, as well as a warrant to purchase up to 140,009,750 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 we had previously issued to YA Global and the
outstanding warrants to purchase Common Stock then held by YA
Global.  WGI is a private investment fund whose ownership includes
owners of ACN, Inc. (“ACN”), a direct
seller of telecommunications services and a distributor of video
phones.




6





Anti-Dilution
Warrant.  The Anti-Dilution Warrant entitles WGI to purchase up
to 140,009,750 shares of Common Stock at an exercise price of $0.01 per share to
the extent we issue 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 us after April 6, 2009
(“Future Contingent
Equity”), or (iii) the ACN 2009 Warrant. The Anti-Dilution Warrant
is designed to ensure that WGI may maintain 63% of our issued and outstanding
shares of capital stock in the event that any of our capital stock is issued in
respect to the Existing Contingent Equity, the Future Contingent Equity or the
ACN 2009 Warrant (i.e., upon each issuance of a share pursuant to Existing
Contingent Equity, Future Contingent Equity or the ACN 2009 Warrant, the
Anti-Dilution Warrant may be exercised for 1.7027027 shares).  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
2009 Warrant.




The
following tables summarize, as of December 31, 2009, each contingent equity
category under the Anti-Dilution Warrant and the exercisability of the
Anti-Dilution Warrant.




Shares Under Contingent Equity CategoriesAs of December 31, 2009Contingent Equity
                        Categories
                      
                      Issuable as
                        of April 6,
                        2009
                      
                      
                      Terminated
                        or Expired
                        Shares
                      
                      
                      Shares Not
                        Exercisable
                      
                      
                      Shares
                        Exercisable
                      
                      
                      Total Shares
                        Issuable
                        (Exercisable and
                        Non-Exercisable)Existing
      Contingent Equity
                      
                      
                      24,318,869
                      
                      
                      
                      5,982,147
                      
                      
                      
                      5,953,236
                      
                      
                      
                      12,383,486
                      
                      
                      
                      18,336,722Future
      Contingent Equity
                      
                      
                      19,689,182
                      
                      
                      
                      98,639
                      
                      
                      
                      18,590,543
                      
                      
                      
                      1,000,000
                      
                      
                      
                      19,590,543ACN
      2009 Warrant
                      
                      
                      38,219,897
                      
                      
                      
                      0
                      
                      
                      
                      38,219,897
                      
                      
                      
                      0
                      
                      
                      
                      38,219,897Total
      Contingent Equity
                      
                      
                      82,227,948
                      
                      
                      
                      6,080,786
                      
                      
                      
                      62,763,676
                      
                      
                      
                      13,383,486
                      
                      
                      
                      76,147,162Anti-Dilution
      Warrant
                        (Total
      Contingent Equity * 1.7027027)
                      
                      
                      140,009,750
                      
                      
                      
                      10,353,771
                      
                      
                      
                      106,867,881
                      
                      
                      
                      22,788,098
                      
                      
                      
                      129,655,979




As of
March 24, 2010, the number of shares exercisable under the Existing Contingent
Equity category increased by 688,374 to an aggregate of 13,071,860 shares,
resulting in the Anti-Dilution Warrant being exercisable for an aggregate of
23,960,194 shares.




Registration Rights and
Governance.Concurrently with the closing on April 6, 2009 of
the transactions contemplated by the Securities Purchase Agreement, we entered
into a Registration Rights and Governance Agreement (the “Rights Agreement”)
with WGI and ACN Digital Phone Service, LLC (“ACN DPS”), a
subsidiary of ACN, granting them certain rights with respect to the shares
purchased pursuant to the Securities Purchase Agreement and the securities
underlying the Anti-Dilution Warrant and the ACN 2009 Warrant.  Under
the terms of the Rights Agreement, we agreed to file a registration statement on
Form S-3 covering the resale of any shares held by WGI and ACN DPS and to
maintain its effectiveness for a minimum period of time.  In addition,
WGI and ACN DPS have the right to require us to file additional registration
statements covering the resale of such securities to the extent they are not
covered by an effective registration statement and will be entitled to
“piggy-back” registration rights on all of our future registrations (with
certain limitations) and on any demand registrations of any other investors,
subject to customary underwriters’ cutbacks to reduce the number of shares to be
registered in view of market conditions.




7





Pursuant
to the terms of the Rights Agreement, we granted WGI and ACN DPS preemptive
rights to purchase a pro rata portion of any of Common Stock or other securities
convertible into Common Stock issued by us, except for shares issued under
board-approved employee benefit plans, conversions of Existing Contingent Equity
or upon exercise of the Anti-Dilution Warrant or the ACN 2009
Warrant.  The Rights Agreement also gives WGI the right to nominate a
total of four of the seven members of our board of directors.  This
nomination right will be reduced by one director for each reduction in WGI’s
beneficial ownership of Common Stock (including any warrants or other purchase
rights) below thresholds of 50%, 43%, 29% and 14% of our voting
stock.  To the extent that such nomination right decreases, the
corresponding number of WGI nominees will offer to tender their resignation for
acceptance by the board of directors.  To the extent the number of
members of the Board is changed, the number of directors WGI is entitled to
appoint will be increased or decreased (as applicable) to provide WGI with the
right to nominate no less than the same proportion of directors as otherwise
provided in the Rights Agreement.




Commercial Relationship with ACN
DPS.  Concurrently with the closing on April 6, 2009 of the
transactions contemplated by the Securities Purchase Agreement, we entered into
a commercial relationship with ACN DPS pursuant to which we agreed to design and
sell video phones to ACN DPS (the “Commercial
Relationship”).  As part of the Commercial Relationship, we
entered into two agreements with ACN DPS:  a Master Purchase Agreement
pursuant to which ACN DPS committed to purchase 300,000 videophones over a
two-year period (the “Master Purchase
Agreement”) and a Software Development and Integration and Manufacturing
Assistance Agreement pursuant to which ACN DPS committed to provide us with
$1,200 to fund associated software development costs.  In connection
with the Commercial Relationship, we granted ACN DPS a warrant to purchase up to
approximately 38.2 million shares of Common Stock at an exercise price of
$0.0425 per share (the “ACN 2009
Warrant”).  The ACN 2009 Warrant vests incrementally based on
ACN DPS’s purchases of video phones under the Commercial
Relationship.




On March
30, 2010, we entered into the First Amendment (the “MPA Amendment”) to
the Master Purchase Agreement with ACN DPS. Among other changes the MPA
Amendment amends the Master Purchase Agreement as follows:




·
            As
      soon as practicable after we  provide a demonstration to ACN DPS
      of the working video phone contemplated by the Master Purchase Agreement,
      ACN DPS will issue its first purchase order under the Master Purchase
      Agreement for 80,000 video phones.


·
            ACN
      DPS will pay us 50% of the purchase price for video phones pursuant to a
      purchase order upon the later of (a) acceptance of the purchase order by
      us and (b) five (5) weeks prior to the delivery of video phones to ACN DPS
      at our manufacturing facility.  ACN DPS will pay us the
      remaining 50% of the purchase price upon delivery of the video phones to
      ACN DPS at our manufacturing
facility.




In
connection with the MPA Amendment, we granted ACN DPS a warrant to purchase up
to 3 million shares of Common Stock at an exercise price of $0.0425 per share
(the “ACN 2010
Warrant”).  The ACN 2010 Warrant will vest incrementally based
on ACN DPS’s purchases of video phones under the Master Purchase Agreement, as
amended by the MPA Amendment. We refer
to the ACN 2009 Warrant and the ACN 2010 Warrant collectively as the “ACN
Warrants.”


8




Kenmec Manufacturing
Agreement.  On November 18, 2009, we entered into a Master
Manufacturing Agreement (the “Manufacturing
Agreement”) with Kenmec Mechanical Engineering Co., Ltd. (“Kenmec”), pursuant to
which Kenmec will provide us manufacturing services to produce a new line of
digital video phones for the consumer market.  The Manufacturing Agreement
has a term of 2 years, which is automatically extended for successive one year
terms unless a party delivers written notice to the other party of its intention
not to extend, not less than 120 days prior to the expiration of the then
current term.  Kenmec provided customary warranties regarding the products
to be produced under the Manufacturing Agreement.




Aequus Settlement
Agreement.On October 8, 2009, we entered into a letter agreement (the “Aequus Settlement
Agreement”) with Snap Telecommunications, Inc. and Aequus Technologies
Corp. (collectively, “Aequus”) to settle
all past due obligations owed by Aequus to us.  As of the date of
the Aequus Settlement Agreement, Aequus had committed to purchase from us but
had failed to pay for 2,284 video phones which we held in our
inventory.  Pursuant to the Aequus Settlement Agreement, all prior
agreements between us and Aequus have been terminated; neither we nor Aequus
have any further liabilities or obligations under such prior agreements and each
of us provided a mutual release of all prior claims between the parties; and
Aequus agreed to purchase and pay for 2,284 video phones, to the extent we have
available inventory of such video phones, on a periodic basis through February
2011 pursuant to the terms of a reseller agreement.  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 released under the
Aequus Settlement Agreement less any amounts paid by Aequus under the Aequus
Settlement Agreement.




Mototech
Agreement.On July 8, 2009, we
entered into a letter agreement with Mototech, Inc. (“Mototech”), to settle
all past due obligations owed by us to Mototech.  Mototech had
performed various services for us, 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.  Pursuant
to the letter agreement, all of our obligations to Mototech were terminated and
we were released from all liabilities or obligations to Mototech; we agreed to
pay $600 in cash to Mototech; we issued to Mototech 3,200,000 unregistered
shares of Common Stock, subject to the following conditions: (a) no shares can
be sold prior to April 8, 2010 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 we
issued to Mototech a 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) an expiration date
of the earlier of (i) July 8, 2014, (ii) a change of control of WorldGate or
(iii) the twentieth (20th) day following our delivery of notice to Mototech of
the occurrence of a period of ten consecutive trading days during which the
quoted bid price of the Common Stock has been greater than a price equal to 150%
of the exercise price of the warrant.  The Mototech warrant was
exercised on October 2, 2009.




Service
Agreement with deltathree, Inc.On October 9, 2009,
we entered into a Master Service Agreement (the “D3 Agreement”) with
deltathree, Inc. (“D3”).  Pursuant
to the D3 Agreement, D3 will provide us, and we will purchase from D3, wholesale
VoIP telephony and video services and operational support systems.  These
services provide us one of the tools necessary to provide our digital voice and
video phone services directly to end users.  We will pay D3 an activation
fee, usage charges and a monthly subscriber-based fee for each customer that
subscribes for the services provided to us under the D3 Agreement.  The
initial term of the D3 Agreement is for a period of five years from the date we
begin offering VoIP 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 we do not incur charges payable to D3 pursuant to the D3
Agreement of at least $300 during the six month period following the date that
our first customer is provided VoIP telephony and video services pursuant to the
D3 Agreement, we 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.  D3 is majority owned by D4 Holdings, LLC and we are
majority owned by WGI Investor LLC.  D4 Holdings, LLC and WGI Investor LLC
have common majority ownership and a common manager.





9




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




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




·
            Provisioning of VoIP
      Communication Devices.  ACN DPS has agreed to provide us the
      ability to purchase from time to time the Iris 3000 video phone.  The
      price to be paid by us for each video phone is the amount incurred by ACN
      DPS 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 related invoice, but we may delay payment of any invoice
      upon payment of a carrying cost of 1% per
month.




·
            Use of Equipment. ACN
      has agreed to provide us with use of an electromagnetic interference (EMI)
      test chamber owned by ACN for a fee of approximately $2 per month for 24
      months. At the end of the 24 month period, title to the EMI test chamber
      will transfer to us.




·
            Administrative and Travel
      Support.  ACN has agreed to provide to us administrative and
      travel support.  The cost for administrative support will 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
  us.




·
            Real Estate and Operations
      Services.  ACN has agreed to provide to us 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 us.  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
us.




Payment
of the fee for the EMI Test Chamber, the costs for administrative and travel
support, and the costs for real estate and operations services is not due until
the later of December 31, 2010 or the date we have sufficient cash generated
from operations to pay the outstanding amount of the deferred
payments.




Exercise of
Warrants.




2004 and 2005 Amended
Warrants. On June 23, 2009, we
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, representing rights to purchase, in the aggregate,
8,771,955 shares of Common Stock and that would have expired on June 23, 2009
(collectively, the “2004 Amended
Warrants”).  The exercise price of the 2004 Amended Warrants was
amended to $0.25 per share of Common Stock and the expiration date of the 2004
Amended Warrants was amended to August 7, 2009.  On June 23, 2009, we
also amended the exercise price and other provisions of certain Warrants to
Purchase Common Stock of WorldGate Communications, Inc. issued August 3, 2005,
representing rights to purchase, in the aggregate, 513,333 shares of Common
Stock that expire on August 3, 2010 (collectively, the “2005 Amended
Warrants”).  The exercise price of the 2005 Amended Warrants was
amended to $0.25 per share of Common Stock in return for the holder immediately
exercising the warrant.





10





All of
the 2004 Amended Warrants and the 2005 Amended Warrants were exercised during
2009 (including all of the 2004 Amended Warrants held by an affiliate of Antonio
Tomasello, who served on our board of directors until January 2009), resulting
in our receiving $2,321 in gross aggregate cash proceeds ($2,282 net
proceeds).  We incurred $39 of fees pursuant to the transfer of the 2004
Amended Warrants and 2005 Amended Warrants to new warrant holders from the
original warrant holders that were not interested in exercising the
warrants.  All Series B Warrants to Purchase Common Stock of WorldGate
Communications, Inc. issued June 23, 2004 that were not included in the 2004
Amended Warrants had expired unexercised during 2009.  As of December 31,
2009 and March 24, 2010, 879,359 of the Warrants to Purchase Common Stock of
WorldGate Communications, Inc. issued August 3, 2005, that expire on August 3,
2010 and which were not amended, remain outstanding.




2007 Warrants.  On July
15, 2009, we 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.  The 2007 Warrant was exercised
in full on September 8, 2009 resulting in the issuance of 2,564,102 shares of
Common Stock and our receipt of $641 in aggregate cash proceeds.




Mototech Warrants.  The
warrants issued pursuant to the July 8, 2009 letter agreement with Mototech
were exercised on October 2, 2009 resulting in the issuance of 1,000,000 shares
of Common Stock and our receipt of $350 in gross proceeds ($344 net
proceeds).




Revolving Loan and Security
Agreement with WGI.  On October 28, 2009, we entered into a
Revolving Loan and Security Agreement with WGI pursuant to which WGI provides us
a line of credit in a principal amount of $3,000.  On March 9, 2010 the
principal amount of the line of credit was increased to $5,000.  As of
December 31, 2009, we received aggregate advances under this Agreement of
$1,400, and during the period from January 1, 2010 through March 24, 2010, we
received an additional $2,400 in advances.  Pursuant to the amended
Revolving Loan and Security Agreement,




·
            as
      we may request from time to time, WGI agreed to lend amounts up to $5,000;
      interest shall accrue on any loan advances at the rate of 10% per annum;
      interest is payable beginning June 1, 2010 and monthly thereafter; any
      principal amounts repaid are available for re-borrowing; and all
      outstanding principal and interest outstanding are required to be repaid
      on October 28, 2014;




·
            we
      granted WGI a security interest in substantially all of our assets and we
      made customary representations and covenants to
  WGI;




·
            any
      loan advance requires the satisfaction of customary borrowing conditions;
      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, and may exercise its rights with
      respect to the security interest in substantially all of our assets and
      (2) all outstanding amounts under the Revolving Loan will bear interest at
      the rate of 15% per annum.




11




In
connection with amending the Revolving Loan, on March 9, 2010 we granted WGI a
warrant to purchase up to 6,000,000 shares of our Common Stock at an exercise
price of $0.574 per share (the “March 2010 WGI
Warrant”).  The March 2010 WGI Warrant was fully vested on
issuance, has a term of 10 years and was not deemed Future Contingent Equity
under the Anti-Dilution Warrant.




Office Space
Lease.  On March 24, 2010, WorldGate Service, Inc. (“WGAT Service”), a
subsidiary of the Company, entered into an Office Space Lease (the “Lease”), with Horizon
Office Development I, L.P., pursuant to which WGAT Service will lease
approximately 18,713 square feet of office space at Horizon II, 3800 Horizon
Boulevard, Bensalem, Pennsylvania, at the Horizon Corporate
Center.  The office space comprises part of the second floor of the
building, and will be used for engineering, corporate and administrative
operations and activities.  The new premises are expected to be available
for occupancy beginning in August 2010 following completion of leasehold
improvements.  The Lease has a term of 89 months from the commencement
date.  Following a full abatement of rent for the first 5 months of the
Lease term, the initial annual base rent is approximately $449.  The annual
base rent increases each year to certain fixed amounts over the course of the
term as set forth in the Lease and will be approximately $505 in the seventh
year.  In addition to the base rent, WGAT Service will also pay its
proportionate share of building operating expenses, insurance expenses, real
estate taxes and a management fee.  WGAT Service is required to pay a
security deposit of approximately $187 as security for its full and prompt
performance of the terms and covenants of the Lease.




In
addition, the Company provided a guaranty with respect to WGAT Service’s payment
obligations under the Lease.




Industry
Background




We employ
VoIP technology to deliver our digital voice and video phone services, which
enables communications over the Internet through the compression of voice, video
and/or other media into data packets that can be efficiently transmitted over
data networks and then converted back into the original media.  Data
networks, such as the Internet or local area networks, utilize packet-switched
technology to transmit information between two communicating
terminals.  IP is the most commonly used protocol for communicating on
these packet switched networks.  VoIP allows for the transmission of
voice and data over these same packet-switched networks, providing an
alternative to traditional telephone networks which use a fixed electrical path
to carry voice signals through a series of switches to a
destination.  VoIP has experienced significant growth in recent years
due to demand for lower cost telephone service; improved quality and reliability
of VoIP calls due to technological advances, increased network development and
greater bandwidth capacity; and new product innovations that allow VoIP
providers to offer services not currently offered by traditional telephone
companies.




The
traditional telephone networks maintained by many local and long distance
telephone companies, known as the public-switched telephone networks (the “PSTN”), were designed
to carry low-fidelity audio signals with a high level of
reliability.  Although these traditional telephone networks are very
reliable for voice communications, we believe these networks are not well-suited
to service the growth of digital communication applications for the following
reasons:





12




·
            They
      are expensive to build because each subscriber’s telephone must be
      individually connected to the central office switch, which is usually
      several miles away from a typical subscriber’s
  location;




·
            They
      transmit data at very low rates and resolutions, making them poorly suited
      for delivering high-fidelity audio, entertainment-quality video or other
      rich multimedia content;




·
            They
      use dedicated circuits for each telephone call, which inefficiently allots
      fixed bandwidth throughout the duration of each call whether or not voice
      is actually being transmitted; and




·
            They
      may experience difficulty in providing new or differentiated services or
      functions, such as video communications, that the network was not
      originally designed to accommodate.




Until
recently, traditional telephone companies have avoided the use of
packet-switched networks for transmitting voice calls due to the potential for
poor sound quality attributable to latency issues (delays) and lost packets
which can prevent real-time transmission.  Recent improvements in
packet-switching technology, compression and broadband access technologies, as
well as improved hardware and provisioning techniques, have significantly
improved the quality and usability of packet-switched voice calls.




Historically,
packet-switched networks were built mainly for carrying non real-time data,
although they are now fully capable of transmitting real time data. The
advantages of such networks are their efficiency, flexibility and scalability.
Bandwidth is only consumed when needed. Networks can be built in a variety of
configurations to suit the number of users, client/server application
requirements and desired availability of bandwidth, and many terminals can share
the same connection to the network. As a result, significantly more traffic can
be transmitted over a packet-switched network, such as a home network or the
Internet, than a circuit-switched telephony network. Packet-switching technology
allows service providers to converge their traditionally separate voice and data
networks and more efficiently utilize their networks by carrying voice, video,
facsimile and data traffic over the same network. The improved efficiency of
packet switching technology creates network cost savings that can be passed on
to the consumer in the form of lower telephony rates.




The
growth of the Internet in recent years has proven the scalability of these
underlying packet-switched networks.  As broadband connectivity,
including cable modem and digital subscriber line (“DSL”), has become
more available and less expensive, it is now possible for service providers like
us to offer voice and video services that run over these IP networks to
businesses and residential consumers. Providing such services has the potential
to both substantially lower the cost of telephone service and equipment to these
customers and increase the breadth of features available to our subscribers.
Services like full-motion, two-way video are now supported by the bandwidth
spectrum commonly available to broadband customers, whether business or
residential.




Product
and Service Offerings.




Product
Offerings.  We are in the process of redesigning, reengineering
and developing a new video phone hardware and software platform that will
support our video communications business for the next several
years.  Utilizing this new platform, the development of our first next
generation digital video phone is tracking to our previously announced schedule,
with commercial availability on-track and planned for May 2010.  Until
our new video phone platform is available, we are utilizing a video phone
provided by another company as part of our digital voice and video phone
service.




13




We are
developing a next generation digital video phone platform.  Leveraging
this new platform, we will be developing a full line of digital video phones to
support not only the requirements of the consumer market, but the small
office/home office business market as well.  We will also be
introducing new features and functionality, while opening the platform for third
party development and third party applications.  We strive to push
video quality higher while driving costs lower to provide the best value
possible to our partners and customers.  We are spending a significant
amount of time and energy to ensure that we are well differentiated and offer
advantages over our competitors, including as follows:




·
            “TV Like” or
      “True-to-Life” Video.  We expect that the video
      performance and quality of the new video phone platform will be “natural”,
      “TV Like”, and “True-to-Life” (meaning that images and sounds are
      synchronized, that there are minimum delays between the two ends of the
      communication, and that the quality of the image is similar to what is
      experienced with television) through technology that ensures precise
      audio/video synchronization, something our competitors have found
      difficult to achieve.




·
            Networks.  TV
      Like quality is expected to be maintained across all types of networks,
      including DSL, cable, carriers and internet service providers, including
      those that are bandwidth constrained.  We will do this by
      developing and deploying the latest improvements in compression technology
      and processing power to help enable and maintain high-quality end-to-end
      connections.




·
            Acoustics.  We
      have uniquely designed and developed how we handle the audio transmission
      acoustics to ensure the highest voice quality possible, making it seem
      like the person you are talking to is standing right beside
      you.




Video Phone Platform
Features.  In addition to providing what we believe to be the
highest quality consumer video available, our new video phone platform has many
new features, including a large, 7” High-Resolution LCD Screen; a new VGA
Resolution CMOS Camera, providing vivid color and clarity; the state-of-the-art
Texas Instruments DaVinci Chip Series; the ability to support multiple video and
audio codecs, to allow it to operate on, and interoperate within, most networks;
digital photo frame; the ability to connect to a large screen LCD/TV; video mail
(i.e., the ability to obtain messages via any computer, anywhere in the world);
and three-way video conferencing.




Manufacturer.  Our
video phones will be manufactured in Asia, to take advantage of lower labor,
tooling and components costs than would generally be available in the United
States. A formal relationship with Kenemc was established for the volume
manufacture of our video phones.  Kenmec’s responsibilities in this
role include product design finalization for manufacturing; component selection
and procurement; tool sourcing and management; coordination of video phone
manufacturing; implementation and monitoring of quality control; and video phone
cost reduction.  Although we have no obligation to purchase any
particular volume of products from Kenmec, Kenmec is generally required to
accept all purchase orders, subject to certain limits described in the
Manufacturing Agreement.  As part of our Manufacturing Agreement with
Kenmec, we retain formal sign-off control over any product, specification, or
component changes proposed by Kenmec.  We also maintain all rights to
the video phone technology and intellectual property, as well as the right to
second source our video phones.  The Manufacturing Agreement has a
term of 2 years, which is automatically extended for successive one year terms
unless a party delivers written notice to the other party of its intention not
to extend, not less than 120 days prior to the expiration of the then current
term.  Kenmec manages our third party component
suppliers.  Other than certain semiconductor circuit packages, the
components and raw materials used in our video phone product are generally
available from a multitude of vendors and are sourced based, among other
factors, on reliability, price and availability.  In certain
instances, our semiconductor circuit packages are provided by a single supplier,
resulting in reduced control over delivery schedules, quality assurance and
costs.  Additionally, our video phone may require specialized or
high-performance component parts that may not be available in quantities or in
time frames that meet our requirements.




14




Historical Offering of Products and
Services.  We had previously developed the Ojo video phone,
ergonomically designed specifically for in-home and business personal video
communication, which was our main product offering during the year ended
December 31, 2009.  We had identified several issues that have impeded
the commercial success and consumer acceptance of video phones and had sought to
address each of those issues within the Ojo video phone.  The Ojo
video phone was designed for use on the existing high speed data network
infrastructure, but required significant effort to assist partners to connect
the Ojo video phone to an analog phone line for interoperability with the voice
only communications offered by the existing PSTN and VoIP networks. The Ojo
video phone, therefore, was generally limited to private high speed data
networks without the ability to connect to existing public switched telephone
network and VoIP networks.  We are in the process of selling our
remaining inventory of Ojo video phones and do not have plans to manufacture any
additional Ojo video phone inventory.  In the future, we expect to
transition our customers that use the Ojo video phone on our private high speed
data network to our digital voice and video phone services and to subsequently
stop offering service on our private high speed data network.  Until
this transition occurs, our customers that use the Ojo video phone on our
private high speed data network will continue to be able to use this
service.  Revenue generated from the sale of video phone products and
associated services accounted for 100% of our revenue during the year ended
December 31, 2009, where the revenue generated from the sale of video phone
products accounted for 34% of such revenue and revenue generated from the sale
of all associated services accounted for 66% of such revenue.




Service
Offerings.  We offer our digital voice and video phone services
to customers through service plans with different pricing
structures.  In order to access our service, a customer need only
connect our video phone to a broadband Internet connection or a standard
telephone to a broadband Internet connection through our video phone or another
WorldGate-approved analog telephone adaptor.  After connecting the
device, our customers can use our video phone or their telephone to make and
receive calls.




Subject
to certain restrictions, our plans include unlimited local and long distance
calling anywhere in the U.S., Canada and Puerto Rico.  For a monthly
fee, our customers can choose to add an international calling plan where they
can make international calls at reduced per minute rates.  All of our
plans include a wide range of features at no additional charge to our customers,
such as (1) call waiting, caller ID, call forwarding, voicemail and videomail;
(2) selecting a non-local U.S. area code for their telephone number for use with
our service, regardless of physical location; (3) using their telephone number
to make and receive calls wherever a broadband Internet connection is available
by using their video phone or analog telephone adaptor; (4) viewing and managing
accounts online, including feature management, call forwarding options and call
activity logs; and (5) receiving e-mail notification of a voicemail or
videomail.




Customers




Consumer
Services.  Customers in the Consumer Services segment include
direct retail customers, agents, which include direct selling companies, online
marketing and online retail marketing companies, electronic and retail stores,
distribution companies with consumer service offerings, and wholesale customer
groups who already operate a portion of the service infrastructure, including
telecommunication companies, VoIP service providers and select vertical
providers in the education and healthcare services markets.





15




Our sales
strategy for the Consumer Services segment has targeted residential
customers.  We believe that such customers are attracted to our
service offerings because of the availability of the video phone and the
competitive pricing as compared to traditional carriers.  No wholesale
or end-user customer in our Consumer Services segment accounted for more than
10% of our revenue during the year ended December 31, 2009.  We also
compete for business agents and other resellers primarily on the basis of the
availability of the video phone, price, service quality and business support
systems.




OEM
Direct.  Customers in the OEM Direct segment include
telecommunications service providers who already have a complete digital voice
and video management and network infrastructure, such as incumbent service
providers, CLECs, international telecom service providers, cable service
providers and select vertical providers in the education and healthcare services
markets.




Our sales
strategy for the OEM Direct segment has targeted telecommunications carriers and
resellers.  Pursuant to the Master Purchase Agreement, ACN DPS has
agreed to purchase 300,000 videophones over a two-year period.  The
loss of ACN DPS as a customer would have a material adverse effect on our
expected future business and operating results.  WGI, our majority
stockholder, is a private investment fund whose ownership includes owners of
ACN.  During the year ended December 31, 2009, no sales of video phones
were made to ACN DPS.




We had
$550 of sales of our Ojo video phones to CSDVRS LLC, a provider of
telecommunications relay services, that accounted for approximately 90% of our
total product revenue during the year ended December 31, 2009.  In
addition, during the year ended December 31, 2009, we received payments of $178
for video phones from Aequus, another provider of telecommunications relay
services, that, at Aequus’s request, we had not shipped during 2009 and
therefore no revenue was recognized during 2009 with respect to such
payments.  During the first quarter of 2010, we shipped these products
and recognized the revenue with respect to such products.




Marketing




Our
marketing objective is to achieve subscriber line goals by cost-effectively
acquiring and retaining customers.  We employ an integrated
multi-channel approach to marketing.  Our customers have a variety of
vehicles to purchase our products and services, through sales agents, via the
Internet, by phone, or in a retail store.  We make use of marketing
research to gain consumer insights into brand, product and service
performance.  We also monitor brand strength among VoIP, broadband and
dial-up customers.  Market research is also leveraged in the areas of
testing, retention marketing and product marketing.  We believe
gaining insights into customer needs, wants and preferences is a key marketing
asset.  Through use of the WorldGate brand, we are in the process of
establishing relationships to market our services through external retailers,
manufacturers, affinity and preferred partnerships and programs.  We
believe these relationships will allow us to increase awareness of our services
among customers and reduce the cost of customer acquisition.  Through
our agents, we plan on using a variety of web-based tools, including banner ads
and pop-up windows to target Internet users for our digital voice and video
phone services.  As of December 31, 2009, we had sales offices in
Trevose, Pennsylvania, Rochester, New York and Concord, North
Carolina.




Operations




Management
Systems. 
We use a number of software systems that enable us to manage our network and
service offering more efficiently and effectively, including remote customer
provisioning, customer web access, fraud control, network security, call
routing, call monitoring, call reliability, detailed call records and robust
reporting.





16




Network.  The
global telecommunications network that we use to offer our digital voice and
video phone services is provided by D3 through the D3 Agreement and has been
optimized for digital voice and video.  In addition, D3 provides us
the ability to comply with various regulatory requirements, including providing
enhanced 911 service, compliance with the Communications Assistance for Law
Enforcement Act, and the ability to provide local number portability to our
customers.




Inventory
Management.  In coordination with Kenmec, our contract
manufacturer, we manage our inventory based on expected sales volumes and
manufacturing lead time.  Based on sales projections, we attempt to
maintain an adequate level of inventory of video phones to satisfy customer
orders and replacement of defective products.  To the extent necessary
to address customer demand, lead time for receiving manufactured products from
our contract manufacture can be shortened using expedited air delivery rather
than delivery by ship.  As part of our digital voice and video phone
services, we provide a limited warranty on the video phone provided to the
customer as to manufacturing defects for a period of one (1) year from the date
of purchase.




Customer
Service.  We offer our customers support 24 hours a day,
seven days a week through our online account management website and during
extended hours through our toll free customer support number. We believe that
many customers use our online account management website first when they have a
question or problem with their service and that many of them are able to
resolve their concerns online without needing to speak to a customer care
representative. Our customers can manage almost all aspects of their accounts
online. This capability empowers our customers through self-service and reduces
our customer service expenses.  Customers who cannot or do not wish to
resolve their questions through our website can contact a live customer care
representative through our toll free number.  We staff our customer
service hotline mainly through outsourced customer care
representatives.  All new customer care representatives are trained
through an established program developed by WorldGate.  We also have a
separate team for resolving customers’ complex issues that could not be handled
by our other representatives.  We monitor call quality and customer
complaints to determine additional training or coaching
requirements.




Management Information and
Billing Systems.All customer billing is
automated through our website.  We automatically collect all fees from
the customer’s credit card or debit card.  By collecting monthly
subscription fees in advance and certain other charges either in advance or
immediately after they are incurred, we are able to reduce the amount of
accounts receivable that we have outstanding, thus allowing us to have lower
working capital requirements.  Collecting in this manner also helps us
mitigate bad debt exposure.  If a customer’s credit card or debit card
is declined, we generally suspend calling involving usage charges, such as
directory assistance and international calling.  If the customer’s
credit card or debit card cannot be successfully processed for the monthly
recurring charge for any billing cycle, we generally convert the customer’s plan
to a per minute plan and if, at the beginning of the next monthly billing cycle,
the customer’s credit card or debit card cannot be successfully processed, the
customer’s account is cancelled and service is terminated.  We believe
that our financial reporting and billing systems are generally adequate to meet
our needs in the near term. As we grow, we may need to invest additional capital
to purchase hardware and software, license more specialized software and
increase our capacity.





17





Intellectual
Property




We rely
on patent, trade secret, trademark and copyright law to protect our intellectual
property. We
believe that our technological position depends primarily on the experience,
technical competence and the creative ability of our engineering
staff.  We review our technological developments with our engineering
staff to identify the features of our technology that provide us with a
technological or commercial advantage and file patent applications as necessary
to protect these features in the United States and
internationally.  Written agreements with each employee require our
employees to assign their intellectual property rights to us and to treat all
technology as our confidential information.  We have been awarded a
patent containing 39 claims issued in April 2007 related to a video phone system
and method and a patent for our distinctive design of our Ojo video phone design
issued in December 2006.  We also have other patents pending to
protect our technology.  Our patent position is subject to complex
factual and legal issues that may give rise to uncertainty as to the validity,
scope and enforceability of a particular patent. Accordingly, there can be no
assurance that additional patents will be issued pursuant to our current or
future patent applications or that patents issued pursuant to such applications
will not be invalidated, circumvented or challenged. Moreover, there can be no
assurance that the rights granted under any such patents will provide
competitive advantages to us or be adequate to safeguard and maintain our
proprietary rights. In addition, effective patent, trademark, copyright and
trade secret protection may be unavailable, limited or not applied for in
certain foreign countries.




We are
the owner of numerous trademarks and have applied for registration of our
trademarks in the United States and various foreign countries to establish and
protect our brand names as part of our intellectual property
strategy.  Some of our registered marks include “WorldGate®”,
“Ojo®” and
“Ojo Quality®”.  These
registered marks have a duration of five years from the date they are
registered.




We
endeavor to protect our internally developed systems and maintain our patents,
trade secrets, trademarks and copyrights. Typically, we enter into
confidentiality or license agreements with our employees, consultants, customers
and vendors in an effort to control access to and distribution of our
technology, software, documentation and other information.




Research
and Development




We have
made and continue to make substantial investments in the design and development
of new video phone products and services, as well as the development of
enhancements and features to our products and services.  Future
development is expected to focus on the use and interoperability of our products
and services with emerging audio and video telephony standards and protocols,
enhanced phone features, quality and performance enhancements, unified
communication service offerings, and wireless and mobile applications. We
believe that the development of new products and services and the enhancement of
existing products and services are essential to our success.  We
currently employ 24 individuals in research, development and engineering
activities in our facilities in Trevose, Pennsylvania.  The cost of
such work is not capitalized, but rather it is charged as an engineering and
development expense.  Our research and development expenses were
$2,693 and $1,807 in fiscal year 2009 and 2008, respectively.




Competition




We
compete in the digital telephony services and communications equipment markets
providing products and services enabling video communication and collaboration
across intranets, extranets and the Internet.  These markets are
characterized by rapid change and converging technologies, that represent both
an opportunity and competitive threat to us.  We compete with numerous
vendors and service providers in each area of our business.  The
number of competitors providing solutions may increase as the market evolves,
and as we continue to expand globally, we may see new competition in different
geographic regions.




Competition for Video
Phones.  Many of the current video phone manufacturers have
focused on two applications—business video phones and video
conferencing.  Business video phones are designed to be located on an
executive’s desk and used to personally communicate with colleagues, employees
and customers. Video conferencing units are designed for conference rooms where
multiple people on one end engage with multiple people on the other end. The
following is a brief description of the potential competitors and their impact
on the market.





18




·
            Business Phone
      Products.Most of these products are targeted for
      corporate use and are relatively high priced.  Generally, the
      ergonomic design of these units emulates that of a traditional office
      telephone with the addition of a camera and display.  The
      products use standard corporate gray or black material colors, familiar
      button shapes and designs, traditional style handsets for non-speakerphone
      conversation and often have business feature sets.  For
      connectivity these products use VoIP, PSTN or ISDN.  The main
      competitors in this sector include Cisco, Polycom, 8x8, Motion Media PLC,
      Grandstream and Leadtek Research.




·
            Video Conference
      Products.  These products are mainly TV-based video
      conferencing products that are targeted to consumers as a video phone and
      conferencing device. They use the home television as the display device
      and utilize either the TV’s speaker or connection to a standard analog
      phone for the audio portion of the call.  The main disadvantage
      of this product is that it requires a television to send and receive
      calls.  In many cases, this would obstruct the ability to watch
      television while a call is in progress thereby disrupting family
      television watching for the length of the call. Numerous video
      conferencing products also exist for the business
      market.  Typically these devices cost $2 or more and involve
      complex installations of one or more cameras, monitors, microphones and
      speakers within a conference room setting.  The videoconference
      nature of these products eliminates the ability to communicate on a
      private, one-on-one level.  The main competitors in this sector
      include Cisco, D-Link Systems, Sony, Sorenson Media and
      Polycom.




·
            Web Cam
      Products.  Web cams are different from other competitive
      products in that they did not arise from either business video phones or
      video conferencing.  Rather, the use of web cams began in the
      early days of the Internet when “techies” were expanding the capabilities
      of PC-based content and applications with low-cost computer
      attachments.  Currently, web cams are often used to display
      visual information as well as a means for personal
      communication.  Many popular web sites use web cams to show
      traffic, weather, personal activities and other visually interesting
      subjects.  Software such as Skype, Net Meeting, Instant
      Messenger, iChat and MSN Messenger, is being supported by web cams to
      provide a video chat option to these Internet-based services. Current web
      cams typically lack the quality of dedicated video phone
      devices.  They also require the utilization of separate personal
      computers which may not be co-located in the same areas where convenient
      video calls would occur.  Competitors in this category include
      Logitech, Intel, 3Com, Apple and Creative
  Technology.




Competition for
Services.  The telecommunications industry is highly
competitive and significantly affected by regulatory changes, marketing and
pricing decisions of the larger industry participants and the introduction of
new services made possible by technological advances.  In addition,
many of our competitors are significantly larger, have substantially greater
financial, technical and marketing resources, larger networks and more products
for bundling.  We face strong competition for our digital voice and
video phone services from incumbent telephone companies, cable companies,
alternative voice communication providers and wireless
companies.  Because most of our target customers are already
purchasing communications services from one or more of these providers, our
success is dependent upon our ability to attract these customers away from their
existing providers.  We believe that the principal competitive factors
affecting our ability to attract and retain customers are video phone
availability, sales channel strategy, customer service, price, call quality,
reliability and enhanced services and features.





19




·
            Incumbent Telephone
      Companies. The incumbent telephone companies have historically
      dominated their regional markets.  These competitors include
      AT&T, Qwest Communications and Verizon Communications as well as rural
      incumbents, such as CenturyLink and Frontier
      Communications.  These competitors are substantially larger and
      better capitalized than we are and have the advantage of a large existing
      customer base.  In addition, many users of traditional phone
      service who might otherwise switch to our service may believe that they
      cannot cancel their traditional phone service without also losing their
      broadband DSL service.  Other users may not be willing to
      install our video phone or another WorldGate-approved analog telephone
      adaptor, accept the limitations of VoIP emergency calling service or forgo
      service during power outages.  Before subscribing to our
      service, a substantial majority of our new customers must first decide to
      terminate their service from their incumbent telephone company or pay for
      our service in addition to their existing
  service.




In many
cases, we charge prices that are significantly lower than prices charged by the
incumbent phone companies. We believe that we currently compete successfully
with the incumbent phone companies on the basis of offering the ability to make
video calls, the features we offer that they do not (such as area code selection
and “virtual” phone numbers that will ring through to an existing subscriber
line) and features we offer at no extra charge.  However, the ability
of telephone companies to offer DSL last mile connections has significantly
enhanced their ability to compete with us on the basis of price and
features.  The incumbent phone companies own networks that include a
“last mile” connection to substantially all of our existing and potential
customers as well as the places our customers call.  As a result, the
vast majority of the calls placed by our customers are carried over the “last
mile” by an incumbent phone company, and we may be required to indirectly pay
access charges to these competitors for each of these calls.  In
contrast, traditional wireline providers do not pay us when their customers call
our customers.  Their “last mile” connections enable these competitors
to bundle phone service with Internet access and television at prices we may
find difficult to compete with.  The incumbent phone companies, as
well as the cable companies, have long-standing relationships with regulators,
legislators, lobbyists and the media.  This can be an advantage for
them because legislative, regulatory or judicial developments in our rapidly
evolving industry could have a negative impact on us.




·
            Cable
      Companies.  These competitors include companies such as
      Cablevision, Comcast Corporation, Cox Communications and Time Warner
      Cable.  Cable companies have significant financial resources and
      have made and are continuing to make substantial investments in delivering
      broadband Internet access and phone service to their
      customers.  Providing Internet access and cable television to
      many of our existing and potential customers allows them to engage in
      highly targeted, low-cost direct marketing and may enhance their image as
      trusted providers of services.  Similar to incumbent telephone
      companies, cable companies are also aggressively using their existing
      customer relationships to bundle services.  For example, they
      bundle Internet access, cable television and phone service with an implied
      price for the phone service that may be significantly below
      ours.  They are able to advertise on their local access channels
      with no significant out-of-pocket cost and through mailings in bills with
      little marginal cost.  They also receive advertising time as
      part of their relationships with television networks, and they are able to
      use this time to promote their telephone service
  offerings.




20





Many
cable companies send technicians to customers’ premises to initiate
service.  Although this is expensive, it also can be more attractive
to customers than installing our video phone or another WorldGate-approved
analog telephone adaptor.  In addition, these technicians may install
an independent source of power, which can give customers assurance that their
phone service will not be interrupted during power outages.  Cable
companies’ ownership of Internet connections to our customers could enable them
to detect and interfere with the completion of our customers’
calls.  While we are not aware of any occurrence, it is unclear
whether current regulations would permit these companies to degrade the
quality of, give low priority to or block entirely the information packets and
other data we transmit over their lines.  In addition, these companies
may attempt to charge their customers more for using our
services.  This could also apply to phone companies that connect our
customers to the Internet.  We believe our ability to successfully
compete with cable companies is enhanced by the availability of our video phone
and the features we offer that cable companies do not offer (such as portable
service and wide choice of area codes).




·
            Wireless Telephone
      Companies.  We also compete with wireless phone
      companies, such as AT&T, Sprint, T-Mobile and Verizon
      Wireless.  Some consumers use wireless phones, instead of VoIP
      phones, as a replacement for a wire line phone.  Also, wireless
      phone companies increasingly are providing wireless broadband Internet
      access to their customers.  As wireless providers offer more
      minutes at lower prices and other services that improve calling quality,
      their services have become more attractive to households as a competing
      replacement for wire line service.  Wireless telephone companies
      have a strong retail presence and have significant financial
      resources.




·
            Alternative Voice
      Communication Providers.  We also compete against
      established alternative voice communication providers, such as Skype,
      iChat, MagicJack, ooma, Google Voice and independent VoIP service
      providers.  Some of these service providers have chosen to
      sacrifice revenue in order to gain market share and have offered their
      services at lower prices or for free.  Google, Apple, Microsoft
      and Yahoo! also offer free instant messaging services that are voice
      enabled.  While not all of these competitors currently offer the
      ability to call or be called by anyone not using their service, line
      portability and customer service, in the future they may integrate such
      capabilities into their service offerings.  In addition, a
      continuing trend toward consolidation of telecommunications companies and
      the formation of strategic alliances within the telecommunications
      industry, as well as the development of new technologies, could give rise
      to significant new competition.




Government
Regulation




We are
subject to varying degrees of regulation in each of the jurisdictions in which
we operate. Local laws and regulations, and the interpretation of such laws and
regulations, differ among the jurisdictions in which we operate. There can be no
assurance that (1) future regulatory, judicial and legislative changes will
not have a material adverse effect on us; (2) domestic or international
regulators or third parties will not raise material issues with regard to our
compliance or noncompliance with applicable regulations; or (3) regulatory
activities will not have a material adverse effect on us.  Regulation
of the telecommunications industry has and continues to change rapidly both
domestically and globally.




Product
Regulation.  Our video phone is required to comply with various
laws and government regulations, including Parts 15 and 68 of the Federal
Communications Commission’s (“FCC”) regulations in
the United States, which relate to radio frequency devices and to terminal
equipment that is connected to the telephone network.  Our video phone
is also subject to requirements relating to the materials composition of our
products, including the restrictions on lead and certain other substances in
electronics that apply to specified electronics products put on the market in
the European Union as of July 1, 2006 (Restriction of Hazardous Substances in
Electrical and Electronic Equipment Directive (EU RoHS)) and relating to the
collection, labeling, recycling, treatment and disposal of past and future
covered products in certain jurisdictions, including the Waste Electrical and
Electronic Equipment Directive (WEEE) in the European Union.  The
legal and regulatory environment that pertains to video phones is uncertain and
changing rapidly and new legislation or regulations could substantially impact
our ability to distribute our video phone products.




21





Services
Regulation.  Our VoIP services are currently not subject to
substantial regulation by the FCC or state regulatory commissions to the extent
that they qualify as “enhanced” or “information” services. The FCC defines
enhanced services as services that (1) employ computer processing
applications that act on the format, content, code, protocol or similar aspects
of the subscriber’s transmitted information, (2) provide the subscriber
additional, different, or restructured information, or (3) involve
subscriber interaction with stored information. Our VoIP service can be
classified as an enhanced service because it uses broadband connections using
the public Internet and performs a net protocol conversion. Regulators are
trying to determine the appropriate regulatory treatment of VoIP services
because these services resemble both traditional telephony and information
services.  In the United States, our services are subject to the
provisions of the Communications Act of 1934, as amended, the FCC regulations,
and the applicable laws and regulations of the various states and state
regulatory commissions.




Classification of
VoIP.  In March 2004, the FCC released a comprehensive notice
of proposed rulemaking regarding IP-enabled services, including VoIP service.
The notice of proposed rulemaking addresses the regulatory classification
of, and jurisdiction over, VoIP and how to preserve key public policy. While the
FCC has yet to resolve comprehensively the regulatory classification of
IP-enabled services, and this proceeding remains open, the FCC has issued
several decisions that affect the regulatory treatment of VoIP services like
ours.  The FCC continues to examine the appropriate regulatory
treatment of VoIP.  Changes to, and further clarifications of, the
treatment of VoIP services could result in the imposition of burdensome
regulation and fees on some of our services and/or increase certain of our
operating costs.  For example, if the FCC were to determine that our
VoIP service is properly classified as a “telecommunications service,” this
could have a material adverse effect on our VoIP business and operating
results.




Preemption of State Entry
Regulations.  In November
2004, the FCC ruled that services provided by a particular VoIP provider are
interstate in nature, and not subject to entry regulations of the various state
Public Service Commissions. While the decision was specific to the VoIP offering
of a particular company, our VoIP service shares many of the same
characteristics.  The FCC ruling was appealed by several states and on
March 21, 2007, the United States Court of Appeals for the 8th Circuit
affirmed the FCC ruling.




CALEA.  In
August 2005, the FCC determined that VoIP services like ours must ensure that
their equipment can accommodate law enforcement wiretaps and that they assist
law enforcement agencies in conducting lawfully authorized electronic
surveillance under the Communications Assistance for Law Enforcement Act (“CALEA”).  We
believe that our VoIP products are capable of complying with these
requirements.  We cannot predict whether law enforcement or the FCC
will find our service in compliance with CALEA, nor can we predict whether we
may be subject to fines or penalties if we are found to be not in compliance
with CALEA.




E-911.  In
June 2005, the FCC adopted new rules requiring VoIP providers like us to provide
emergency 911 service in a manner similar to traditional telecommunications
carriers.  Through the D3 Agreement, a third-party provider provides
us with emergency 911 service solutions.  Our ability to expand our
VoIP services in the future may depend upon our ability to provide enhanced 911
(“E-911”)
access.  We currently only accept subscribers where E-911 services are
able to route emergency calls in a manner consistent with the FCC
rules.  Moreover, interconnected VoIP providers are required to
distribute stickers and labels warning customers of the limitations associated
with accessing emergency services through an interconnected VoIP service, as
well as notify and obtain affirmative acknowledgement from our customers that
they are aware of the differences between the emergency calling capabilities
offered by interconnected VoIP providers as compared to traditional, wireline
providers of telephone service.





22





On
June 1, 2007, the FCC released a notice of proposed rulemaking proceeding
to consider whether it should impose additional E-911 obligations on
interconnected VoIP providers, including consideration of a requirement that
interconnected VoIP providers automatically determine the physical location of
their customer rather than allowing customers to manually register their
location.  The notice of proposed rulemaking includes a tentative
conclusion that all interconnected VoIP service providers that allow customers
to use their service in more than one location must utilize automatic location
technology that meets the same accuracy standards applicable to mobile phone
service providers.  We cannot predict the outcome of this proceeding
nor its impact on us at this time.  On June 8, 2007, the FCC released
an order implementing various recommendations from its Independent Panel
Reviewing the Impact of Hurricane Katrina on Communications Networks Panel,
including a requirement that certain interconnected VoIP providers submit
reports regarding the reliability and resiliency of their 911
systems.  At this time, we are not subject to these reporting
requirements but may become subject in future years.




Universal Service Fund
Contribution.  In July 2006, the FCC adopted rules requiring
that certain VoIP services contribute to a Universal Service Fund (“USF”).  Certain
of our services are subject to USF obligations.  The U.S. Court of
Appeals for the District of Columbia ruled that the FCC was within its authority
when it required interconnected VoIP service providers to contribute to the
USF.  We plan on utilizing the FCC-established safe harbor percentage
of 64.9% of total VoIP service revenue with respect to our federal USF
contributions.




CPNI.  On
April 2, 2007, the FCC released an order extending the application of
customer proprietary network information (“CPNI”) rules to
interconnected VoIP providers.  CPNI includes information such as the
phone numbers called by a consumer, the frequency, duration, and timing of such
calls and any services/features purchased by the consumer, such as call waiting,
call forwarding, and caller ID, in addition to other information that may appear
on a consumer’s bill.  Under the FCC’s existing rules, carriers may
not use CPNI without customer approval except in narrow circumstances related to
their provision of existing services, and must comply with detailed customer
approval processes when using CPNI outside of these narrow
circumstances.  The new CPNI requirements are aimed at establishing
more stringent security measures for access to a customer’s CPNI data in the
form of required passwords for on-line access and call-in access to account
information as well as customer notification of account or password
changes.  Currently, we do not utilize our customer’s CPNI in a manner
which would require us to obtain consent from our customers, but in the event
that we do in the future, we will be required to adhere to specific CPNI rules
aimed at how such information is utilized.  We have implemented
internal processes in order to be compliant with the CPNI rules and we plan on
filing our annual certification of our compliance with CPNI rules with the FCC
as required.  We may be subject to enforcement actions including, but
not limited to, fines, cease and desist orders, or other penalties if we are not
able to comply with these CPNI obligations.




Disability Access
Requirements.  On June 15, 2007, the FCC expanded the
disability access requirements of Sections 225 and 255 of the Communications
Act, which applied to traditional phone services, to providers of interconnected
VoIP services and to manufacturers of specially designed equipment used to
provide those services.  Service providers must ensure that their
equipment and service is accessible to and usable by individuals with
disabilities, if readily achievable, including requiring service providers to
ensure that information and documentation provided in connection with equipment
or services be accessible to people with disabilities, where readily achievable,
and that employee training accounts for accessibility
requirements.  The FCC also found that interconnected VoIP providers
were subject to the requirements of Section 225, including contributing to
the Telecommunications Relay Services (“TRS”) fund and that
they must offer 711 abbreviated dialing for access to relay
services.  As part of the services provided under the D3 Agreement, D3
provides our customers the ability to access 711 abbreviated dialing for access
to relay services.





23




FCC Regulatory
Fees.  On August 6, 2007, the FCC released a Report and
Order concerning the collection of regulatory fees for Fiscal Year 2007, which
mandates the collection of such fees from interconnected VoIP service providers
like us based on reported interstate and international revenues.




Local Number
Portability.  On November 8, 2007, the FCC released a Report
and Order concerning Local Number Portability. The obligations require
interconnected VoIP providers to contribute to shared numbering administration
costs on a competitively neutral basis.  We rely on third parties to
comply with the required porting timeframes. We could be subject to fines,
forfeitures and other penalties by state public utilities commissions or the FCC
if we are not able to process ports in the required timeframes or we could face
legal liability in state or federal court from customers or
carriers.




On
May 13, 2009, the FCC adopted an order that reduced to one business day the
amount of time that a telecommunications provider has to port a telephone number
to another provider.  The North American Numbering Council proposed
processes to implement the one-day requirement on November 2,
2009.  Large telecommunication providers (greater than 2% of the
nation’s subscriber lines) have nine months to implement the process before the
one-day requirement becomes effective on August 2, 2010.  Smaller
telecommunication providers, like us, have fifteen months to implement the
process before the one-day requirement becomes effective on February 2,
2011.  If we, or third parties we rely upon for porting, have
difficulty complying with the new one-day porting requirement after the
effective date, we could be subject to FCC enforcement action.




Discontinuance
Rules.  On May 13, 2009, the FCC extended discontinuance rules
that apply to non-dominant common carriers to interconnected VoIP
providers.  The FCC’s rules require non-dominant domestic carriers to
provide notice to customers at least 30 days prior to discontinuing service to a
telephone exchange, toll stations serving a community in whole or in part, and
other similar activities that affect a community or part of a
community.  Additionally, carriers must inform certain state
authorities of the discontinuation, and obtain prior FCC approval before
undertaking the service disruption.  The FCC’s rules allow for
streamlined treatment for FCC discontinuance approvals and interconnected VoIP
providers will be able to take advantage of the same streamlined procedures
afforded to non-dominant carriers.




State Taxes Applicable to
VoIP Services.  In general, we collect or remit state or
municipal taxes (such as sales and use, excise, utility user, and ad valorem
taxes), fees or surcharges on the charges to our customers for the products and
services that they purchase.




State Fees Applicable to
VoIP Services.  Other state fees and charges may be applicable
to our VoIP offering. Some states require the filing of periodic reports, the
payment of various fees and surcharges, including 911, TRS and USF fees, and
compliance with certain consumer protection rules.  If we are subject
to state telecommunications-related fees and surcharges, to the extent permitted
by law, we generally pass such charges through to our customers.  The
impact of any resulting price increase on our customers or our inability to
recoup its costs or liabilities in remitting state telecommunications-related
fees and surcharges could have a material adverse effect on our financial
position, results of operations and cash flows.





24





Additional
Regulation.  The effect of any future laws, regulations and the
orders on our operations cannot be determined.  But as a general
matter, increased regulation and the imposition of additional funding
obligations increases product and service costs that may or may not be
recoverable from our customers, which could result in making our products and
services less competitive with traditional telecommunications services if we
increase our retail prices or decrease our profit margins if we attempt to
absorb such costs.




Geographic
Areas




Our
product and service offering is focused on the United States market, but we
expect to actively seek sales in various international markets in the
future.




Employees




As of
December 31, 2009, we had 40 total employees (39 full-time employees and one
part time employee).  We consider our employee relations to be
good.  None of our employees are represented by a labor union or are
subject to a collective bargaining agreement.




General
Company Information




WorldGate
Communications, Inc. was incorporated in Delaware in 1996 to succeed to the
business of our predecessor, WorldGate Communications, L.L.C., which commenced
operations in March 1995.  In April 1999, we completed our
initial public offering of shares of Common Stock. Our Common Stock is quoted on
the OTC Bulletin Board under the symbol “WGAT.OB.”  Our executive
offices are located at 3190 Tremont Avenue, Trevose, Pennsylvania
19053.




Available
Information




We
maintain a website with the address www.wgate.com. The information contained on
our website is not included as a part of, or incorporated by reference into,
this Annual Report on Form 10-K.  We make available free of charge
through our website our Annual Report on Form 10-K, Quarterly Reports on Form
10-Q and Current Reports on Form 8-K, and amendments to these reports, as soon
as reasonably practicable after we have electronically filed such material with,
or furnished such material to, the Securities and Exchange
Commission.  You can also read and copy any materials we file with the
SEC at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC
20549.  You can obtain additional information about the operation of
the Public Reference Room by calling the SEC at 1.800.SEC.0330.  In
addition, the SEC maintains a website (www.sec.gov) that contains reports, proxy
and information statements, and other information regarding issuers that file
electronically with the SEC, including WorldGate.




Executive
Officers of the Registrant


Our
current executive officers are:


Name
                        
                        Age
                        
                        PositionGeorge
      E. Daddis Jr.
                        
                        47
                        
                        Chief
      Executive Officer and PresidentJoel
      Boyarski
                        
                        63
                        
                        Senior
      Vice President, Finance and Administration, Chief Financial Officer and
      TreasurerAllan
      Van Buhler
                        
                        47
                        
                        Senior
      Vice President of Sales, Marketing and Business
  DevelopmentChristopher
      V. Vitale
                        
                        33
                        
                        Senior
      Vice President, Legal and Regulatory, General Counsel and
      Secretary




25




George E.
Daddis Jr. joined WorldGate on August 3, 2009 as our Chief Executive Officer and
President.  Prior to joining WorldGate, Mr. Daddis provided consulting
in entrepreneurial business strategy and product development from July 2008
through July 2009 for several high-tech firms in New York City and Rochester,
New York developing business plans, investor presentations, product roadmaps,
and channel development.  From October 2007 through July 2008, Mr.
Daddis was President of Allworx, Advanced Solutions Group of Allworx/PAETEC
Corp., a national telephone services company headquartered in Rochester, New
York.  From 2003 through October 2007, Mr. Daddis was Chief
Executive Officer and founder of Allworx Corp., a national provider of small
business voice-over-IP telephone systems




Joel
Boyarski joined WorldGate in October 1999, and was named Vice President and
Chief Financial Officer in September 2002 and Senior Vice President,
Finance and Administration, Chief Financial Officer and Treasurer in June
2009.  Prior to becoming Vice President and Chief Financial Officer of
WorldGate, Mr. Boyarski served in a variety of management positions at
TVGateway, LLC and at Joseph E. Seagram and Sons, Inc., including Vice
President of Finance and Business Planning for several of Seagram’s Domestic and
International divisions including North America, Asia Pacific and Global Duty
Free.




Allan Van
Buhler joined WorldGate in April 2009 as our Senior Vice President of Sales,
Marketing and Business Development responsible for driving WorldGate’s expansion
in both new and existing markets.  From March 2003 through April 2009, Mr.
Van Buhler served as ACN’s Chief Marketing Officer.  Prior to joining ACN,
Mr. Van Buhler held various executive management positions in Consumer and
Business Market Management, Product Management, Product Development, Marketing,
Finance and Network Operations, including as Vice President and General Manager
of Voice Services at Global Crossing.  Mr. Van Buhler is an equity holder
in WGI Investor, LLC.




Christopher
V. Vitale joined WorldGate in April 2009 as our General Counsel and Secretary
and was named Senior Vice President, Legal and Regulatory, General Counsel and
Secretary in June 2009.  From April 2006 through April 2009, Mr.
Vitale worked as an attorney in the Philadelphia office of the national law firm
of Morgan, Lewis & Bockius LLP.  From January 2005 through April
2006, Mr. Vitale was corporate counsel at Avaya Inc., and prior to Avaya began
his practice in the New York office of Sullivan & Cromwell LLP.




The
executive officers are elected or appointed by the Board of Directors of the
Company to serve until the election or appointment of their successors or their
earlier death, resignation or removal.  They may also hold positions
in subsidiaries of the Company.




ITEM
1A.  RISK FACTORS




You
should carefully consider the risks below, as well as all of the other
information contained in this Annual Report on Form 10-K and our financial
statements and the related notes included elsewhere in this Annual Report on
Form 10-K, in evaluating the Company and our business.  Any of these
risks could materially adversely affect our business, financial condition and
results of operations and the trading price of our Common
Stock.  Investing in our Common Stock involves a high degree of risk,
and you should be able to bear the complete loss of your
investment.  Additional risks and uncertainties not presently known to
us or that we currently deem immaterial also may impair our business, financial
condition and results of operations and the trading price of our Common
Stock.




26





Operational
Risks




The
growth of our Company is dependent on the growth and public acceptance of our
video communication services.




Our
future success depends on our ability to significantly increase revenues
generated from our video phone and digital voice and video phone
services.  In turn, the success of these products and services depends
upon, among other things, future demand for VoIP (digital phone service) and
video telephony systems and services.  Because the use of our products
and service requires that the user be a subscriber to an existing broadband
Internet service, usually provided through a cable, digital subscriber line,
fiber to the home or a wireless network, slow or limited adoption and
availability of broadband services could adversely affect the growth in our
sales of video phones, our subscriber base and revenues.  Although the
number of broadband subscribers worldwide has grown significantly over the last
five years, VoIP and video telephony has not yet been adopted by a majority of
consumers. To increase the deployment of broadband Internet services from
broadband Internet service providers, telephone companies and cable companies
must continue to invest in the deployment of high speed broadband networks to
residential and business customers, over which we have no control. In addition,
VoIP networks must improve quality of service for real-time communications,
managing effects such as packet jitter, packet loss, and unreliable bandwidth,
so that toll-quality service can be consistently provided. VoIP and video
telephony equipment and services must achieve a similar level of reliability
that users of the PSTN have come to expect from their telephone service, and the
cost and feature benefits of VoIP and video telephony must be sufficient to
cause customers to switch away from traditional telephony service
providers.  We will need to devote substantial resources to educate
customers and end users about the benefits of VoIP and video telephony
solutions, in general, and our products and services in
particular.  If any or all of these factors fail to occur, our
business may be affected adversely.




Certain
aspects of our digital voice and video phone service are not the same as
traditional telephone service, which may limit the acceptance of our digital
voice and video phone services by mainstream consumers and may limit our
potential for growth.




For
certain users, certain aspects of our service are not the same as traditional
telephone service. Our continued growth is dependent on the adoption of our
services by mainstream customers, so these differences are important. For
example:




·
            Both
      our E-911 and emergency calling services are different, in significant
      respects, from the 911 service associated with traditional wireline and
      wireless telephone providers and, in certain cases, with other VoIP
      providers.




·
            Our
      customers may experience lower call quality than they are used to from
      traditional wireline telephone companies, including static, echoes and
      delays in transmissions.




·
            Our
      customers may experience higher dropped-call rates than they are used to
      from traditional wireline telephone
companies.




·
            Customers
      who obtain new phone numbers from us do not appear in the phone book and
      their phone numbers are not available through directory assistance
      services offered by traditional telephone
  companies.




·
            Our
      customers cannot accept collect
calls.




·
            Our
      customers cannot call premium-rate telephone numbers such as 1-900 numbers
      and 976 numbers.




·
            In
      the event of a power loss or Internet access interruption experienced by a
      customer, our service is interrupted. Unlike some of our competitors, we
      have not installed batteries at customer premises to provide emergency
      power for our customers’ equipment if they lose power, although we do have
      backup power systems for our network equipment and service
      platform.




27




If
customers do not accept the differences between our digital voice and video
phone service and traditional telephone service, they may choose to remain with
their current telephone service provider or may choose to return to service
provided by traditional telephone companies.




Competition
related to our digital voice and video phone services is
substantial.




The
telecommunications industry is highly competitive.  We face intense
competition from traditional telephone companies, wireless companies, cable
companies and alternative voice communication providers. Our principal
competitors are the traditional telephone service providers, including AT&T,
Qwest Communications and Verizon Communications, and rural incumbents such as
CenturyLink and Frontier Communications, which provide telephone service based
on the public switched telephone network. Some of these traditional providers
also have added VoIP services to their existing telephone and broadband
offerings. We also face competition from cable companies, such as Cablevision,
Comcast Corporation, Cox Communications, and Time Warner Cable, which have added
VoIP services to their existing cable television, voice and broadband
offerings.  Further, as wireless providers, including AT&T,
Sprint, T-Mobile and Verizon Wireless, offer more minutes at lower prices and
companion landline alternative services, their services have become more
attractive to households as a replacement for wireline service.




Most
traditional wireline and wireless telephone service providers and cable
companies are substantially larger and better capitalized than we are and have
the advantage of a large existing customer base.  Because most of our
target customers are already purchasing communications services from one or more
of these providers, our success with our digital voice and video phone services
offering is dependent upon our ability to attract target customers away from
their existing providers. Our competitors’ financial resources may allow them to
offer services at prices below cost or even for free in order to maintain and
gain market share or otherwise improve their competitive positions. Our
competitors also could use their greater financial resources to offer VoIP
services with more attractive service packages that include on-site installation
and more robust customer service. In addition, because of the other services our
competitors provide, they may choose to offer VoIP services as part of a bundle
that includes other products, such as video, high speed Internet access and
wireless telephone service, which we do not offer. This bundle may enable our
competitors to offer VoIP service at prices with which we may not be able to
compete or to offer functionality that integrates VoIP service with their other
offerings, both of which may be more desirable to consumers. Any of these
competitive factors could make it more difficult for us to attract and retain
customers, cause us to lower our prices in order to compete and reduce our
market share and revenues.




We also
compete against alternative voice communication providers, such as Skype, iChat,
MagicJack, Google Voice and independent VoIP service providers. Some of these
service providers may choose to sacrifice revenue in order to gain market share
and have offered their services at lower prices or for free. Google, Apple,
Microsoft and Yahoo! also offer free instant messaging services that are voice
enabled. In order to compete with such service providers, we may have to reduce
our prices, which would delay or prevent our profitability.




We also
are subject to the risk of future disruptive technologies. If new technologies
develop that are able to deliver competing voice or video services at lower
prices, better or more conveniently, it could have a material adverse effect on
us.




28




Given
our limited experience in delivering VoIP services, we may not be able to
operate successfully or expand this part of our business.




During
the second half of 2009, we accelerated initiatives to become a provider of VoIP
services. Our experience in providing VoIP services is limited.  Our
primary competitors include incumbent telephone companies, cable companies,
alternative voice communication providers and wireless companies that have a
significant national or international presence.  Many of these
operators have substantially greater resources, capital and operational
experience than we do.  Therefore, future operations involving our
VoIP services may not succeed in the competitive environment, and we may not be
able to expand successfully; we may experience margin pressure; we may face
quarterly revenue and operating results variability; we may have limited
resources to develop and to market the new services; and we have heightened
difficulty in establishing future revenues or results.  As a result,
there can be no assurance that we will maintain or increase revenues or be able
to generate sufficient income from operations or net income in the future or on
any predictable or timely basis.




Our
success also depends on third parties in our distribution channels.




We
currently sell our products and services through our direct, agency, wholesale
and OEM direct distribution channels.  Agreements with distribution
partners generally provide for one-time or recurring commissions, and generally
do not require minimum purchases.  In addition, distributors and
resellers may not dedicate sufficient resources or give sufficient priority to
selling our products and services. Our failure to develop new distribution
channels, the loss of a distribution relationship or a decline in the efforts of
a material reseller or distributor could have a material adverse effect on our
business, financial condition or operating results.




The
extent and timing of revenues from our digital voice and video phone service and
next generation video phone is not certain.




While we
expect revenues related to our new product and service offerings to begin in the
second quarter of 2010, the extent and timing of revenues for our digital voice
and video phone services and next generation video phones depends on several
factors, including the rate of market acceptance of our products and services,
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 digital voice and video phone services and
next generation video phones will produce revenues, or when, or if, we will
reach profitability.




Current
economic conditions may adversely affect our industry, business and results of
operations.




The
United States economy is currently undergoing a period of slowdown and very high
volatility and the future economic environment may continue to be less favorable
than that of recent years.  A substantial portion of our digital voice
and video phone services revenues comes from residential and small office and
home office customers whose spending patterns may be affected by prevailing
economic conditions.  If the weakening economy continues to
deteriorate, the growth of our business and results of operations may be more
impacted.  Economic conditions may cause more households to rely
solely on a mobile phone for home telecommunications and eliminate landline
connections.  In addition, reduced consumer spending may drive us and
our competitors to offer certain services at promotional prices, which could
have a material adverse effect on our business, financial condition or results
of operations.





29





A
high rate of customer terminations would negatively affect our business by
reducing our revenue or requiring us to spend more money to grow our customer
base.




Our rate
of customer terminations, or average monthly customer turnover, could increase
in the future if customers are not satisfied with the quality and reliability of
our network, products and core operational platforms and our customer
service.  Other factors, including increased competition from other
providers, disruptive technologies, general economic conditions and our ability
to properly activate and register new customers on the network, also influence
our customer turnover rate.




Because
of customer turnover, we have to acquire new customers on an ongoing basis just
to maintain our existing level of customers and revenues. As a result, marketing
expense is an ongoing requirement of our business. If our customer turnover rate
increases, we will have to acquire even more new customers in order to maintain
our existing revenues. We incur significant costs to acquire new customers, and
those costs are an important factor in determining our net losses and achieving
future profitability. Therefore, if we are unsuccessful in retaining customers
or are required to spend significant amounts to acquire new customers beyond
those budgeted, our revenue could decrease and our operating results could be
negatively impacted.




Flaws
in our technology and systems could cause delays or interruptions of digital
voice and video phone services, damage our reputation, cause us to lose
customers and limit our growth.




Our
service may be disrupted by problems with our technology and systems, such as
malfunctions in our or our partners’ software or other facilities and
overloading of our partners’ network.  Our customers and potential
customers subscribing to our digital voice and video phone services may
experience interruptions as a result of these types of
problems.  Interruptions may cause us to lose customers or potential
customers and offer substantial customer credits, which could adversely affect
our revenue and profitability.  In addition, because our systems and
our customers’ ability to use our services are Internet-dependent, our services
may be subject to “hacker attacks” from the Internet, which could have a
significant impact on our systems and services. If service interruptions
adversely affect the perceived reliability of our digital voice and video phone
services, we may have difficulty attracting and retaining customers and our
brand reputation and growth may suffer.




Our
business may be harmed if we are unable to maintain data security and meet
Payment Card Industry data security standards.




We are
dependent upon automated information technology processes.  Any
failure to maintain the security of our data and our employees’ and customers’
confidential information, including via the penetration of our network security
and the misappropriation of confidential information, could result in financial
obligations to third parties, fines, penalties, regulatory proceedings and
private litigation with potentially large costs. Any such failure also could put
us at a competitive disadvantage and result in deterioration in our employees’
and customers’ confidence in us, which may have a material adverse impact on our
business, financial condition and results of operations.




Our
network, systems and procedures are required to meet Payment Card Industry
(“PCI”) data
security standards, which requires periodic audits by independent third parties
to assess compliance.  PCI data security standards are a comprehensive
set of requirements for enhancing payment account data security that was
developed by the PCI Security Standards Council including American Express,
Discover Financial Services, JCB International, MasterCard Worldwide and VISA,
to help facilitate the broad adoption of consistent data security
measures.  Failure to comply with the security requirements or rectify
a security issue may result in fines.  Restrictions on accepting
payment cards, including a complete restriction, may be imposed on companies
that are not compliant.





30




Our
credit card processors have the ability to take significant holdbacks or propose
reserves in certain circumstances.  The initiation of such holdbacks
or reserves likely would have a material adverse effect on our
liquidity.




Our
credit card processors may establish reserves to cover any exposure that they
may have as we collect revenue in advance of providing services to our
customers, which is a customary credit card processor practice with respect to
companies that bill their customers in advance of providing
services.  Under our credit card processing agreements with our
Visa/MasterCard, American Express and Discover credit card processors, the
credit card processor has the right, in certain circumstances, including adverse
events affecting our business, to impose a holdback of our advanced payments
purchased using a Visa/MasterCard, American Express or Discover credit card, as
applicable, or demand reserves or other security.  If our processors
initiate a holdback or impose reserves, the negative impact on our liquidity
likely would be significant.  In addition, each of our credit card
processing agreements may be terminated by the credit card processor at its
discretion.  If the credit card processor does not assist in
transitioning our business to another credit card processor, the negative impact
on our liquidity likely would be significant.




Our
success also depends on our ability to handle a large number of simultaneous
calls, which our network may not be able to accommodate.




We expect
the volume of simultaneous calls, including video calls, to increase
significantly as our subscriber base grows.  The network hardware and
software provided by D3 may not be able to accommodate this additional
volume.  If we fail to maintain an appropriate level of operating
performance, or if our service is disrupted, our reputation could be hurt and we
could lose customers, which could have a material adverse effect on our
business, financial condition or operating results.




Our
ability to provide our digital voice and video phone services is dependent upon
third-party facilities and equipment, the failure of which could cause delays or
interruptions of our service, damage our reputation, cause us to lose customers
and limit our growth.




Our
success depends on our ability to provide quality and reliable digital voice and
video phone service, which is in part dependent upon the proper functioning of
facilities and equipment owned and operated by third parties and is, therefore,
beyond our control.  Unlike traditional wireline telephone service or
wireless service, our service requires our customers to have an operative
broadband Internet connection and an electrical power supply, which are provided
by the customer’s Internet service provider and electric utility company,
respectively, and not by us.  The quality of some broadband Internet
connections may be too poor for customers to use our services
properly.  In addition, if there is any interruption to a customer’s
broadband Internet service or electrical power supply, that customer will be
unable to make or receive calls, including emergency calls, using our
service.




We also
outsource our network functions to D3.  If D3 fails to maintain its
network properly, or fails to respond quickly to problems, our customers may
experience service interruptions.  Interruptions in our service caused
by third-party facilities may cause us to lose customers, or cause us to offer
substantial customer credits, which could adversely affect our revenue and
profitability. If interruptions adversely affect the actual or perceived
reliability of our service, we may have difficulty attracting new customers and
our brand, reputation and growth will be negatively impacted.  If D3
ceases providing the services that we depend on, the delay in switching our
technology to another network service provider, if available, and qualifying
this new service could have a material adverse effect on our business, financial
condition or operating results.  While we believe that relations with
D3 are good and we have contracts in place, there can be no assurance that D3
will be able or willing to supply cost-effective services to us in the future or
that we will be successful in arranging for alternative or additional
providers.  While we believe that we could replace D3, if necessary,
our ability to provide service to our subscribers could be impacted during this
timeframe, and this could have a material adverse effect on our business,
financial condition or results of operations.




31




We
rely on third parties to provide our customer service representatives, provide
inventory logistics, initiate local number portability for our customers and
provide aspects of our E-911 service. If these third parties do not provide our
customers with reliable, high-quality service, our reputation will be harmed and
we may lose customers.




We offer
our customers support 24 hours a day, seven days a week through our online
account management website and during extended hours through our toll free
customer support number.  We rely on a third party in Toronto, Canada
to provide customer service representatives that respond to customer
inquiries.  This third-party provider generally represents us without
identifying themselves as an independent party.  The ability of this
third party provider to provide these representatives may be disrupted by
factors not within our control, such as financial viability of the third party,
strikes, natural disasters and other adverse events.




Through
the D3 Agreement, D3 provides us access to an E-911 provider to assist us in
routing emergency calls directly to an emergency service dispatcher at the
public safety answering point (“PSAP”) in the area of
the customer’s registered location.  Interruptions in service from
these vendors could cause failures in our customers’ access to E-911 services
and expose us to liability and damage our reputation.  Through the D3
Agreement, D3 also provides us access to a third-party provider that initiates
our local number portability, which allows new customers to retain their
existing telephone numbers when subscribing to our digital voice and video phone
services.  In addition, we utilize a third party to provide logistics
support for our inventory of video phones and analog telephone
adaptors.




If any of
these third parties do not provide reliable, high-quality service, our
reputation and our business will be harmed. In addition, industry consolidation
among providers of services to us may impact our ability to obtain these
services or increase our expense for these services.




We
depend on Kenmec, our contract manufacturer, to manufacture substantially all of
our video phone products, and any delay or interruption in manufacturing by
Kenmec or shortage or lack of availability of components would result in delayed
or reduced shipments to our customers and may harm our business.




We do not
have long-term purchase agreements with Kenmec and we depend on Kenmec to
manufacture our video phone products.  There can be no assurance that
Kenmec will be able or willing to reliably manufacture our video phone products,
in volumes, on a cost-effective basis or in a timely manner.  If we
cannot compete effectively for the business of Kenmec, or if Kenmec experiences
financial or other difficulties in their business, our revenue and our business
could be adversely affected.  In particular, if Kenmec becomes subject
to bankruptcy proceedings, we may not be able to obtain any of our products held
by Kenmec.




We also
rely on third party component suppliers to provide semiconductor circuit
packages for our video phone products.  In some instances, these
components are provided by a single supplier.  Our reliance on these
suppliers involves a number of risks, including reduced control over delivery
schedules, quality assurance and costs.  Kenmec manages our third
party component suppliers.  We currently do not have long-term supply
contracts with any of these component vendors.  As a result, most of
these third party vendors are not obligated to provide products or perform
services to us for any specific period, in any specific quantities or at any
specific price, except as may be provided in a particular purchase
order.  The inability of these third party vendors to deliver
components of acceptable quality and in a timely manner, particularly the sole
source vendors, could adversely affect our operating results or cause them to
fluctuate more than anticipated.  Additionally, some of our products
may require specialized or high-performance component parts that may not be
available in quantities or in time frames that meet our
requirements.




32




The
success of our business partly relies on customers’ continued and unimpeded
access to broadband service.  Providers of broadband services may be
able to block our products or services or charge their customers more for also
using our products or services, which could adversely affect our revenue and
growth.




Our
customers must have broadband access to the Internet in order to use our digital
voice and video phone services and video phones. Some providers of broadband
access may take measures that affect their customers’ ability to use our
products and services, such as degrading the quality of the data packets we
transmit over their lines, giving those packets low priority, giving other
packets higher priority than ours, blocking our packets entirely or attempting
to charge their customers more for also using our products or
services.




It is not
clear whether suppliers of broadband Internet access have a legal obligation to
allow their customers to access and use our products and services without
interference.  Providers of broadband services are subject to
relatively light regulation by the FCC.  Consequently, federal and
state regulators might not prohibit broadband providers from limiting their
customers’ access to using video phones or VoIP or otherwise discriminating
against video phone or VoIP providers.  Interference with our products
or services or higher charges for also using our products or services could
cause us to lose existing customers, impair our ability to attract new customers
and could have a material adverse effect on our business, financial condition or
results of operations.  These problems could also arise in
international markets.




Because
much of our potential success and value lies in our use of internally developed
systems and software, if we fail to protect them, it could negatively affect
us.




Our
ability to compete effectively is dependent in large part upon the maintenance
and protection of systems and software that we have developed
internally.  While we have two issued patents and one pending patent
application that were developed internally, we cannot patent much of the
technology that is important to our business.  To date, we have relied
on copyright, trademark and trade secret laws, as well as confidentiality
procedures and licensing arrangements, to establish and protect our rights to
this technology. We typically enter into confidentiality or license agreements
with our employees, consultants, customers and vendors in an effort to control
access to and distribution of technology, software, documentation and other
information.  Despite these precautions, it may be possible for a
third party to copy or otherwise obtain and use this technology without
authorization.  Policing unauthorized use of this technology is
difficult.  The steps we take may not prevent misappropriation of the
technology we rely on.  In addition, effective protection may be
unavailable or limited in some jurisdictions outside the United
States.  Litigation may be necessary in the future to enforce or
protect our rights or to determine the validity and scope of the rights of
others.  That litigation could cause us to incur substantial costs and
divert resources away from our daily business, which in turn could have a
material adverse effect on our business, financial condition or results of
operations.




33





The
telecommunications industry is rapidly changing, and if we are not able to
adjust our strategy and resources effectively in the future to meet changing
market conditions, we may not be able to compete effectively.




The
telecommunications industry is changing rapidly due to deregulation,
privatization, consolidation, technological improvements, availability of
alternative services such as wireless, broadband, DSL, Internet, VOIP and
wireless DSL through use of the fixed wireless spectrum, and the globalization
of the world’s economies.  If we do not adjust to meet changing market
conditions, including if we do not have adequate resources to do so, we may not
be able to compete effectively.  The telecommunications industry is
marked by the introduction of new product and service offerings and
technological improvements.  Achieving successful financial results
will depend on our ability to anticipate, assess and adapt to rapid
technological changes, and offer, on a timely and cost-effective basis, services
that meet evolving industry standards.  If we do not anticipate,
assess or adapt to such technological changes at a competitive price, maintain
competitive services or obtain new technologies on a timely basis or on
satisfactory terms, our business, financial condition or results of operations
may be materially and adversely affected.




We
need to retain key personnel to support our products and ongoing
operations.




The
development and marketing of our products and services will continue to place a
significant strain on our limited personnel, management, and other
resources.  Our future success depends upon the continued services of
our executive officers and other key employees, including our key engineering
personnel who have critical industry experience and relationships that we rely
on to implement our business plan.  None of our officers or key
employees are bound by employment agreements for any specific
term.  The loss of the services of any of our officers or key
employees could delay the development and introduction of, and negatively impact
our ability to sell, our products and services which could have a material
adverse effect on our business, financial condition or results of
operations.  We currently do not maintain key person life insurance
policies on any of our employees.




We
may not be able to manage our inventory levels effectively, which may lead to
inventory obsolescence that would force us to incur inventory
write-downs.




Our video
phone products have lead times of up to several months and are built to
forecasts that are necessarily imprecise.  Because of our practice of
building our products to necessarily imprecise forecasts, it is likely that from
time to time we will have either excess or insufficient product
inventory.  In addition, because we rely on third party vendors for
the supply of components and contract manufacturers to assemble our products,
our inventory levels are subject to the conditions regarding the timing of
purchase orders and delivery dates that are not within our
control.  Excess inventory levels would subject us to the risk of
inventory obsolescence, while insufficient levels of inventory may negatively
affect relations with customers.  Our customers rely upon our ability
to meet committed delivery dates, and any disruption in the supply of our
products could result in legal action from our customers, loss of customers or
harm to our ability to attract new customers.  In addition, we are
managing the remaining inventory of our original video phone and a third-party
developed video phone currently used in our digital voice and video phone
service in anticipation of the availability of our next generation video
phone.  Failure to sell these video phones could result in inventory
obsolescence and substantial write-offs by the Company.  Any of these
factors could have a material adverse effect on our business, financial
condition or operating results.





34





We
may not be able to meet our product development objectives or market
expectations.




Our video
phone products are complex and use “state of the art”
technology.  Accordingly, our development efforts are inherently
difficult to manage and keep on schedule and there can be no assurance that
we will be able to meet our development objectives or market
expectations.  In addition to development delays, we may experience
substantial cost overruns in completing development of our
product.  The technological feasibility for some aspects of the
products that we envision is not completely established.  Our products
may contain undetected flaws.  There can be no assurance that, despite
testing by us and by potential customers, flaws will not be found in the
product, resulting in loss of or delay in market acceptance.  We may
be unable, for technological or other reasons, to develop and introduce products
in a timely manner in response to changing customer
requirements.  Further, there can be no assurance that a competitor
will not introduce a similar product.  The introduction by a
competitor of either a similar product or a superior alternative to our product,
may diminish our technological advantage, render our product and technologies
partially or wholly obsolete, or require substantial re-engineering of our
product in order to become commercially acceptable.  Our failure to
maintain our product development schedules, avoid cost overruns and undetected
errors or introduce a product that is superior to competing products would have
a materially adverse effect on our business, financial condition and results of
operations.




We
identified a material weakness in our internal control over financial reporting
which was remediated as of September 30, 2009 and we may identify additional
material weaknesses in the future that may cause us to fail to meet our
reporting obligations or result in material misstatements of our financial
statements.




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting.  Internal control over financial
reporting is a process designed to provide reasonable assurance regarding the
reliability of financial reporting and the preparation of financial statements
in accordance with accounting principles generally accepted in the United
States.  A material weakness is a deficiency, or a combination of
deficiencies, in internal control over financial reporting, such that there is a
reasonable possibility that a material misstatement of the company’s annual or
interim financial statements will not be prevented or detected on a timely
basis.




Our
management determined as of December 31, 2008 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
resources of the Company as well as the Company’s focus and efforts toward
keeping the Company solvent contributed to the material weakness.  As a
result, our management 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, we undertook a number of actions to eliminate the
material weakness.  Based on the remedial actions taken, the Company
concluded that as of September 30, 2009 and December 31, 2009 it had 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.




If we
fail to maintain the adequacy of our internal controls, we may not be able to
conclude in the future that we have effective internal control over financial
reporting in accordance with the Sarbanes-Oxley Act. Moreover, effective
internal controls are necessary for us to produce reliable financial reports and
are important to help prevent fraud. As a result, our failure to maintain
effective internal controls could result in the loss of investor confidence in
the reliability of our financial statements, which in turn could harm the market
value of our Common Stock. Any failure to maintain effective internal controls
also could impair our ability to manage our business and harm our financial
results.





35





Litigation and Regulatory
Risks




We
may be subject to damaging and disruptive intellectual property litigation that
could materially and adversely affect our business, results of operations and
financial condition, as well as the continued viability of our
company.




Given the
rapid technological change in our industry and our continual development of new
products and services, we may be subject to intellectual property infringement
claims in the future. Third parties have asserted, and may in the future assert,
that the technologies we use infringe their intellectual property
rights.  We may be unaware of filed patent applications and issued
patents that could include claims covering our products and
services.




Parties
making claims of infringement may be able to obtain injunctive or other
equitable relief that could effectively block our ability to provide our
products and services and could cause us to pay substantial royalties, licensing
fees or damages.  The defense of any lawsuit could divert management’s
efforts and attention from the ordinary business operations and result in
time-consuming and expensive litigation, regardless of the merits of such
claims.  If we are forced to defend against any third-party
infringement claims, we could face expensive and time-consuming litigation and
be required to pay monetary damages, which could include treble damages and
attorneys’ fees for any infringement that is found to be willful, and either be
enjoined or required to pay ongoing royalties with respect to any conduct or
technologies that are found to be infringing.  Further, as a result of
infringement claims either against us or against those who license technology to
us, we may be required, or deem it advisable, to develop non-infringing
technology, which could be costly and time-consuming, or enter into costly
royalty or licensing agreements.




Litigation
may be necessary in the future to enforce our intellectual property rights, to
protect our trade secrets or to determine the validity and scope of the
proprietary rights of others.  Any litigation, regardless of outcome
or merit, could result in substantial costs and diversion of management and
technical resources, which could materially harm our business.




These
outcomes may:




·
            result
      in the loss of a substantial number of existing customers or prohibit the
      acquisition of new customers;




·
            lead
      to an event of default under the terms of our Revolving Loan with WGI,
      which could permit WGI to declare due and payable immediately all amounts
      due under the Revolving Loan, including principal and accrued interest and
      take action to foreclose upon the collateral securing the
      indebtedness;




·
            cause
      existing or new vendors to require prepayments or letters of
      credit;




·
            cause
      our credit card processors to demand additional reserves or letters of
      credit or make holdbacks;




·
            result
      in substantial employee layoffs;




·
            materially
      and adversely affect our brand in the market place and cause a substantial
      loss of goodwill;




·
            cause
      our stock price to decline significantly or otherwise cause us to fail to
      meet the continued listing requirements of any exchange on which our
      securities may be traded, which could distract management and result in
      the delisting of our Common Stock from the
  exchange;




·
            materially
      and adversely affect our liquidity, including our ability to pay debts and
      other obligations as they become due;
and




36




·
            lead
      to our bankruptcy or liquidation.




Compliance
with current and future environmental regulations and worker health and safety
laws may be costly and noncompliance with these laws could have a material
adverse effect on our results of operations, expenses and financial
condition.




Some of
our operations use substances regulated under various federal, state, local and
international laws governing the environment and worker health and safety,
including those governing the discharge of pollutants into the ground, air and
water, the management and disposal of hazardous substances and wastes, and the
cleanup of contaminated sites.  Some of our products are subject to
various federal, state, local and international laws governing chemical
substances in electronic products. We could be subject to increased costs,
fines, civil or criminal sanctions, third-party property damage or personal
injury claims if we violate or become liable under environmental and/or worker
health and safety laws.




We may be
subject to environmental and other regulations due to our production and
marketing of products in certain states and countries. We also face increasing
complexity in our product design and procurement operations as we adjust to new
and upcoming requirements relating to the materials composition of our products,
including the restrictions on lead and certain other substances in electronics
that apply to specified electronics products put on the market in the European
Union as of July 1, 2006 (Restriction of Hazardous Substances in Electrical and
Electronic Equipment Directive (EU RoHS)).  The European Union has
also finalized the Waste Electrical and Electronic Equipment Directive (WEEE),
which makes producers of electrical goods financially responsible for specified
collection, labeling, recycling, treatment and disposal of past and future
covered products.  The deadline for enacting and implementing this
directive by individual European Union governments was August 13, 2004 (WEEE
Legislation), although extensions were granted in some
countries.  Producers became financially responsible under the WEEE
Legislation beginning in August 2005.  Other countries, such as the
United States, China and Japan, have enacted or may enact laws or regulations
similar to the EU RoHS or WEEE Legislation.  These and other
environmental regulations may require us to reengineer certain of our existing
products and develop new strategies for the design of new products to utilize
components which are more environmentally compatible.  Such
reengineering and component substitution may result in delays in product design
and manufacture and could cause us to incur additional costs.  We
cannot assure you that the costs to comply with these laws, or with current and
future environmental and worker health and safety laws will not have a material
adverse effect on our results of operation, expenses and financial
condition.




Our
use of open source software could impose limitations on our ability to
commercialize our products.




We
incorporate open source software into our products.  Although we
monitor our use of open source closely, the terms of many open source licenses
have not been interpreted by U.S. courts, and there is a risk that such licenses
could be construed in a manner that could impose unanticipated conditions or
restrictions on our ability to commercialize our products.  In such
event, we could be required to seek licenses from third parties in order to
continue offering our products, to re-engineer our products or to discontinue
the sale of our products in the event re-engineering cannot be accomplished on a
timely basis, any of which could adversely affect our business, operating
results and financial condition.





37





We
are subject to governmental export and import controls that could subject us to
liability or impair our ability to compete in international
markets.




Because
we incorporate encryption technology into our products, our products are subject
to U.S. export controls and may be exported outside the United States only with
the required level of export license or through an export license
exception.  In addition, various countries regulate the import of
certain encryption technology and radio frequency transmission equipment and
have enacted laws that could limit our ability to distribute our products or
could limit our customers’ ability to implement our products in those
countries.  Changes in our products or changes in export and import
regulations may create delays in the introduction of our products in
international markets, prevent our customers with international operations from
deploying our products throughout their global systems or, in some cases,
prevent the export or import of our products to certain countries
altogether.  Any change in export or import regulations or related
legislation, shift in approach to the enforcement or scope of existing
regulations, or change in the countries, persons or technologies targeted by
such regulations, could result in decreased use of our products by, or in our
decreased ability to export or sell our products to, existing or potential
customers with international operations.




Regulation
of VoIP services is developing and therefore uncertain, and future legislative,
regulatory or judicial actions could adversely affect our business and expose us
to liability.




The
United States and other countries have begun to assert regulatory authority over
VoIP and are continuing to evaluate how VoIP will be regulated in the
future.  Both the application of existing rules to us and our
competitors and the effects of future regulatory developments are
uncertain.  Future legislative, judicial or other regulatory actions
could have a negative effect on our business.  If we become subject to
the rules and regulations applicable to telecommunications providers in
individual states, we may incur significant litigation and compliance costs, and
we may have to restructure our digital voice and video phone service offerings,
exit certain markets or raise the price of our digital voice and video phone
services, any of which could cause our digital voice and video phone services to
be less attractive to customers. In addition, future regulatory developments
could increase our cost of doing business and limit our growth.  In
addition, because customers can use our services almost anywhere that a
broadband Internet connection is available, including countries where providing
VoIP services is illegal, the governments of those countries may attempt to
assert jurisdiction over us, which could expose us to significant liability and
regulation.




If
we are unable to improve our process for local number portability provisioning,
our growth may be negatively affected.




We
support local number portability (“LNP”) for our
customers, which allows our customers to retain their existing telephone numbers
when subscribing to our services.  We have engaged D3 to handle the
manual process of transferring numbers, which, in the past, has taken D3 from
two to four weeks or longer, although D3 has taken steps to automate this
process to reduce the delay.  A new customer of our services must
maintain both our digital voice and video phone service and the customer’s
existing telephone service during the number transfer process.  By
comparison, transferring wireless telephone numbers among wireless service
providers generally takes several hours, and transferring wireline telephone
numbers among traditional wireline service providers generally takes a few
days.  The additional delay that D3 experiences is due to its reliance
on third party carriers to transfer the numbers, as well as the delay the
existing telephone service provider may contribute to the
process.  Local number portability is considered an important feature
by many potential customers and, if we fail to reduce related delays, we may
experience increased difficulty in acquiring new customers or retaining existing
customers.  Moreover, the FCC now requires interconnected VoIP
providers, like us, to comply with industry standard timeframes and a new FCC
order shortens the timeframe for certain types of ports
considerably.  If we are unable to process ports within the requisite
timeframes, we could be subject to fines and/or penalties.





38




Our
emergency and E-911 calling services may expose us to significant
liability.




The FCC
rules for the provision of 911 service by interconnected VoIP providers, such as
the digital voice and video phone service we provide, require that for all
geographic areas covered by the traditional wireline E-911 network,
interconnected VoIP providers must provide E-911 service as defined by the FCC’s
rules.  Under the FCC’s rules, E-911 service means that interconnected
VoIP providers must transmit the caller’s telephone number and registered
location information to the PSAP for the caller’s registered
location.  We only accept subscribers to which we can provide E-911
service.




There are
a variety of reasons that potential subscribers may not have access to E-911
service, including refusal by PSAPs to accept VoIP 911 calls, the inability of
PSAPs to receive the registered location data from us, and the failure by third
party companies with whom we contract to provide the necessary access or
complete implementation of the necessary interfaces to the traditional wireline
E-911 infrastructure. In addition, it is a subscriber’s responsibility to notify
us of any change in the location where they use the service.  Without
such notice, if a subscriber uses our digital voice and video phone services at
locations other than their registered E-911 location, any 911 calls made by the
subscriber will not be routed to the proper PSAP.




Delays
our customers may encounter when making emergency services calls and any
inability of a PSAP to automatically recognize the caller’s location or
telephone number can have negative consequences.  Customers may
attempt to hold us responsible for any loss, damage, personal injury or death
suffered as a result.  In July 2008, the New and Emerging Technologies
911 Improvement Act of 2008 became law and provided that interconnected VoIP
providers have the same protections from liability for the operation of 911
service as traditional wireline and wireless providers.  Limitations
on liability for the provision of 911 service are normally governed by state law
and these limitations typically are not absolute.  Thus, for example,
we could be subject to liability for a problem with our 911 service where our
failures are greater than mere negligence.




There
may be risks associated with our ability to comply with the requirements of
federal and other regulations related to Customer Proprietary Network
Information (“CPNI”).




As an
interconnected VOIP provider, we are subject to the CPNI rules.  CPNI
includes information that appears on customers’ bills such as called telephone
numbers, the frequency, duration, time and length of calls; and any services or
features purchased by the consumer, like caller ID.  Pursuant to the
CPNI rules, interconnected VOIP providers may not use CPNI without obtaining
customer consent except in limited circumstances.  Moreover,
interconnected VOIP providers are required to adhere to particular customer
approval processes when using CPNI outside of pre-defined limits.  The
CPNI requirements are also aimed at establishing more stringent security
measures for access to a customer’s CPNI data in the form of required passwords
for on-line access and call-in access to account information as well as customer
notification of account or password changes.  At the present time, we
do not utilize our customer’s CPNI in a manner which would require us to obtain
consent from our customers but, in the event that we do in the future, we will
be required to adhere to specific CPNI rules aimed at marketing such services.
Accordingly, we have implemented internal processes in order to comply with the
FCC’s CPNI rules.  Our failure to achieve compliance with any future
CPNI orders, rules, filings or standards, or any enforcement action initiated by
the FCC or other agency, state or task force against us could have a material
adverse effect on our business, financial condition or operating
results.




39





We
may be exposed to liability resulting from FCC orders regarding access for
people with disabilities.




On
June 15, 2007, the FCC applied the disability access requirements of
Sections 225 and 255 of the Communications Act to providers of interconnected
VOIP services, like us, and to equipment manufacturers that make equipment to
use with those services.  Section 255 of the Communications Act
requires, if readily achievable, service providers to ensure that its equipment
and service is accessible to and usable by individuals with
disabilities.  Where readily achievable, the relevant regulations also
require service providers to ensure that information and documentation provided
in connection with equipment or services be accessible to people with
disabilities and that employee training account for accessibility
requirements.  In addition, the FCC said that interconnected VOIP
providers were subject to the requirements of Section 225, including
contributing to the Telecommunications Relay Services fund and that they must
offer 711 abbreviated dialing for access to relay services.  We may be
subject to enforcement actions including, but not limited to, fines, cease and
desist orders, or other penalties for failure to comply with these rules, any of
which could have a material adverse effect on our business, financial condition
or operating results.




There
may be risks associated with our ability to comply with the requirements of
federal law enforcement agencies.




As an
interconnected VoIP provider, we are required to comply with the Communications
Assistance for Law Enforcement Act (“CALEA”).  The
FCC allowed VoIP providers to comply with CALEA through the use of a solution
provided by a trusted third party with the ability to extract call content and
call-identifying information from a VoIP provider’s network.  While
the FCC permits carriers to use such a trusted third party, the interconnected
VoIP provider remains ultimately responsible for ensuring the timely delivery of
call content and call-identifying information to law enforcement, and for
protecting subscriber privacy, as required by CALEA.  Given their
access to the network, we use D3 as our trusted third party to facilitate
compliance with CALEA.  However, we could be subject to an enforcement
action by the FCC or law enforcement agencies for failure by D3, on our behalf,
to comply with any current or future CALEA obligations.




Our
results of operations may be adversely affected or our retail prices may rise
due to increased regulation or the imposition of additional taxes, fees and
surcharges.




The FCC
mandated the collection of regulatory fees from interconnected VOIP service
providers like us based on reported interstate and international
revenues.  We cannot predict the impact of any future laws,
regulations and orders adopted either domestically or abroad on our operations
and services.  But increased regulation and the imposition of
additional taxes, fees and surcharges increases the costs associated with
providing our service and such taxes, fees and surcharges may or may not be
recoverable from our customers.  If we choose to absorb such costs,
our profit margins would likely decrease.  Moreover, even if such
costs are recoverable or if we choose to maintain profitability, we may need to
increase the retail price of our service that could result in making our service
less competitive both with other providers of interconnected VOIP service
providers and traditional providers of telecommunications
services.  The net effect could reduce the number of our subscribers,
our revenue and our profit margin, any of which could have a material adverse
effect on our business, financial condition or operating results.





40





Decreasing
telecommunications rates and increasing regulatory charges may diminish or
eliminate our competitive pricing advantage.




Decreasing
telecommunications rates may diminish or eliminate the competitive pricing
advantage of our services.  Increased regulation and the imposition of
additional regulatory funding obligations at the federal, state and local level
could require us to either increase the retail price for our services, thus
making us less competitive, or absorb such costs, thus decreasing our profit
margins.  We pass Universal Service and E-911 fees and taxes and
sales, use and communications taxes onto our customers.  Users who
select our services to take advantage of the current pricing differential
between traditional telecommunications rates and our rates may switch to
traditional telecommunications carriers if pricing differentials diminish or
disappear, and we will be unable to use pricing differentials to attract new
customers in the future.  Continued rate decreases would require us to
lower our rates to remain competitive and would reduce or possibly eliminate any
gross profit from our services or result in the loss of subscribers for our
services, any of which could have a material adverse effect on our business,
financial condition or operating results.




We
may incur significant costs and harm to our reputation from lawsuits and
regulatory inquiries related to our business practices, which may also divert
the attention of our management from other aspects of our business.




Class
action litigation and regulatory inquiries are often expensive and time
consuming and their outcome may be uncertain.  Any such claims or
regulatory inquiries, whether successful or not, could require us to devote
significant amounts of monetary or human resources to defend ourselves and could
harm our reputation. We may need to spend significant amounts on our legal
defense, senior management may be required to divert their attention from other
portions of our business, new product launches may be deferred or canceled as a
result of any proceedings, and we may be required to make changes to our present
and planned products or services. If, as a result of any proceedings, a judgment
is rendered or a decree is entered against us, it may materially and adversely
affect our business, financial condition and results of operations and harm our
reputation.




Technology
that we license from third parties may not provide us with the benefits we
expect and loss of the ability to license certain technologies may result in
delays in product development and sales.




We rely
upon certain technology, including hardware and software, licensed from third
parties.  There can be no assurance that the technology licensed by us
will continue to provide competitive features and functionality or that licenses
for technology currently utilized by us or other technology which we may seek to
license in the future will be available to us on commercially reasonable terms
or at all.  The loss of, or inability to maintain, existing licenses
could result in shipment delays or reductions until equivalent technology or
suitable alternative products could be developed, identified, licensed and
integrated, and could harm our business.  These licenses are on
standard commercial terms made generally available by the companies providing
the licenses. To date, the cost and terms of these licenses individually has not
been material to our business.




Financing and Capital
Risks




We
may need to raise additional capital to support our future
operations.




As of
December 31, 2009, we had cash and cash equivalents and investments of
approximately $578.  Based on management’s internal forecasts and
assumptions regarding our short term cash requirements, the increase in and full
utilization of the expanded credit line of the Revolving Loan (See Note 9 and
Note 16 of the accompanying consolidated financial statements), the planned
completion of the development of our new voice and video phone and the
commencement of delivery of these new video phones expected in May 2010, the
expected placement of purchase orders for the purchase of units by ACN DPS in
accordance with the ACN Master Purchase Agreement as amended by the MPA
Agreement (See Note 3 and Note 16 of the accompanying consolidated financial
statements), and our current forecast for other sales of product and services,
we currently believe that we will have sufficient working capital to support our
current operating plans through at least December 31, 2010 (See Note 2 of the
accompanying consolidated financial statements).  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 support our current operating plans, provide us with sufficient
capital or that sales will be sustainable over the short and long term so as to
obviate the need for additional funding.




41




If we do
need to raise additional capital, we may not be able to obtain such additional
financing as needed on acceptable terms, or at all, which may require us to
reduce our operating costs and other expenditures, including reductions of
personnel and capital expenditures.  Because of our significant losses
to date and our limited tangible assets, we do not fit traditional credit
lending criteria, which, in particular, could make it difficult for us to obtain
loans or to access the capital markets.  In addition, the credit
documentation for our Revolving Loan and Security Agreement with WGI contains
affirmative and negative covenants that affect, and in many respects may
significantly limit or prohibit, among other things, our and our subsidiaries’
ability to incur, prepay, refinance or modify indebtedness and create
liens.  If we issue additional equity or convertible debt securities
to raise funds, the ownership percentage of our existing stockholders would be
reduced and they may experience significant dilution.  New investors
may demand rights, preferences or privileges senior to those of existing holders
of our Common Stock.  If we are not successful in these actions, we
may be forced to reduce the size of our organization which could have a material
adverse effect on our business.




We
have incurred yearly losses since our inception, and we may continue to incur
losses in the future.




We have
incurred losses since our inception, and we may continue to incur losses in the
future. For the period from our inception through December 31, 2009, our
accumulated deficit was approximately $275,745.  For the year ended
December 31, 2009, our net loss was $6,336. Our net losses were driven primarily
by minimal sales volume and substantialproduct development costs.  We ultimately may not be successful
in achieving profitability at any point in the future.




Our
common stockholders may suffer dilution in the future upon exercise of the
Anti-Dilution Warrant by WGI and the ACN 2009 and 2010 Warrants.




In
connection with the closing on April 6, 2009 of the transactions contemplated by
the Securities Purchase Agreement with WGI, we issued the Anti-Dilution Warrant
to WGI, which entitles WGI to purchase up to 129,655,979 shares of Common Stock
at an exercise price of $0.01 per share to the extent we issue any capital stock
upon the exercise or conversion of any Existing Contingent Equity, Future
Contingent Equity, or the ACN 2009 Warrant.  On March 9, 2010, we also
issued WGI a warrant to purchase 6,000,000 shares of Common Stock in connection
with the amendment of the Revolving Loan Agreement.  The Anti-Dilution
Warrant is designed to ensure that WGI may maintain 63% of our issued and
outstanding shares of capital stock in the event that any of our capital stock
is issued in respect to the Existing Contingent Equity, the Future Contingent
Equity or the ACN 2009 Warrant (i.e., upon each issuance of a share pursuant to
Existing Contingent Equity, Future Contingent Equity or the ACN 2009 Warrant,
the Anti-Dilution Warrant may be exercised for 1.7027027 shares).  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 2009 Warrant.




In
addition, in connection with the closing on April 6, 2009 of the transactions
contemplated by the Securities Purchase Agreement with WGI, we granted ACN DPS a
warrant to purchase up to approximately 38,219,897 shares of Common Stock at an
exercise price of $0.0425 per share.





42




On March
30, 2010, in connection with the MPA Amendment, we granted to ACN DPS a
warrant to purchase up to 3 million shares of Common Stock at an exercise price
of $0.0425 per share.  The
warrants granted to ACN DPS will vest incrementally based on ACN DPS’s purchases
of video phones under the Master Purchase Agreement.




If the
warrants held by WGI or ACN DPS are exercised, our stockholders may experience
significant and immediate dilution.




WGI,
as our majority stockholder, has the ability to exert a controlling influence
over us.




As of
December 31, 2009, WGI owned a majority of our outstanding Common
Stock.  As a result, WGI is able to exert a controlling influence over
all matters presented to our stockholders for approval, including composition of
our board of directors and, through it, our direction and policies, including
the appointment and removal of our officers; potential mergers, acquisitions,
sales of assets and other significant corporate transactions; future issuances
of capital stock or other securities by us; incurrence of debt by us;
amendments, waivers and modifications to any agreements between us and WGI;
payment of dividends on our capital stock; and approval of our business plans
and general business development.




In
addition, this concentration of ownership may discourage, delay or prevent a
change in control of our Company, which could deprive our stockholders of an
opportunity to receive a premium for their Common Stock as part of a sale of our
Company or result in strategic decisions that could negatively impact the value
and liquidity of our outstanding stock.  WGI also has sufficient
voting power to amend our organizational documents.  Furthermore,
conflicts of interest could arise in the future between us and WGI concerning,
among other things, potential competitive business activities or business
opportunities.  WGI is not restricted from competitive activities or
investments.  We cannot provide assurance that the interests of WGI
will coincide with the interests of other holders of Common
Stock.  Also, four of our seven directors are affiliated with
WGI.  As a result, the ability of any of our other stockholders to
influence the management of our company is limited, which could have could have
a material adverse effect on the market price of our stock.




The
ownership of WGI includes owners of ACN, and we have engaged, and may in the
future further engage, in commercial transactions with ACN and its affiliated
entities.




WGI is a
private investment fund whose ownership includes owners of ACN. Several of the
members of our board of directors currently serve as officers and/or directors
of ACN.  Because ACN is a direct seller of telecommunications
services, we may seek to engage in commercial transactions to provide services
to ACN and its subsidiaries in the future, as demonstrated by the Master
Purchase Agreement for 300,000 video phones.  Although we expect that
the terms of any such transactions will be established based upon negotiations
between employees of ACN and us and, when appropriate, subject to the approval
of the Audit
Committeeon our board of directors, there can be no assurance the terms
of any such transactions will be as favorable to us as might otherwise be
obtained in arm’s length negotiations.





43





We
will be required under applicable accounting guidelines to report significant
reductions in the revenue we recognize from sales of our products to ACN and its
subsidiaries.




Current
accounting principles require that revenue generated as result of the commercial
relationship with ACN DPS entered into in April 2009 be reduced to reflect the
extent that the ACN Warrants are determined to be consideration given by a
vendor to a customer for which an otherwise identifiable benefit has not been
received.  The Company will record a charge for the fair value of the
portion of the ACN Warrants earned from the point in time when shipments of
units are initiated to ACN DPS through the vesting date.  Final
determination of fair value of the ACN Warrants will occur upon actual
vesting.  Applicable accounting guidance requires that the fair value
of the ACN Warrants be recorded as a reduction of revenue to the extent of
probable cumulative revenue recorded from ACN DPS.  As a result,
investors may not see the revenue expected from our business and this could have
a material adverse effect on our stock price.




We
may be unable to fully realize the benefits of our net operating loss (“NOL”)
carryforwards.




Our
ability to utilize our net operating loss carryforwards and credit carryforwards
may 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 (“Section
382”).  It is more likely than not that we experienced the
following changes of control resulting in the limitations in net operating loss
carryforwards:  (1) 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 and (2) during
April 2009, as a result of the private placement pursuant to which WGI acquired
shares of Common Stock representing 63% of our outstanding Common
Stock.




The NOL
carryforward limitations under Section 382 would impose an annual limit on the
amount of the future taxable income that may be offset by our NOL generated
prior to the change in ownership.  If a change in ownership was
determined to have occurred, we may be unable to use a significant portion of
our NOL to offset future taxable income.  In general, a change in
ownership occurs when, as of any testing date, there has been a cumulative
change in the stock ownership of the corporation held by 5% stockholders of more
than 50 percentage points over an applicable three-year period.  For
these purposes, a 5% stockholder is generally any person or group of persons
that at any time during an applicable three-year period has owned 5% or more of
our outstanding Common Stock.  In addition, persons who own less than
5% of the outstanding Common Stock are grouped together as one or more “public
group” 5% stockholders.  Under Section 382, stock ownership would be
determined under complex attribution rules and generally includes shares held
directly, indirectly (though intervening entities) and constructively (by
certain related parties and certain unrelated parties acting as a
group).




Our
future operating results may vary substantially from period to period and may be
difficult to predict.




Our
historical operating results have fluctuated significantly and will likely
continue to fluctuate in the future, and a decline in our operating results
could cause our stock price to fall.  On an annual and a quarterly
basis, there are a number of factors that may affect our operating results, many
of which are outside our control.  These include, but are not limited
to, changes in market demand; the timing of customer orders; customer
cancellations; competitive market conditions; lengthy sales cycles; new product
introductions by us or our competitors; market acceptance of new or existing
products; the cost and availability of components; the mix of our customer base
and sales channels; the mix of products sold; the management of inventory;
continued compliance with industry standards and regulatory requirements; the
impact of any financing we may obtain; and general economic
conditions.




Due to
these and other factors, we believe that period-to-period comparisons of our
results of operations are not meaningful and should not be relied upon as
indicators of our future performance. It is possible that in some future periods
our results of operations may be below the expectations of public market
analysts and investors. If this were to occur, the price of our Common Stock
would likely decline significantly.




44




The
market price of our Common Stock has been and may continue to be volatile, and
purchasers of our Common Stock could incur substantial losses.




Securities
markets experience significant price and volume fluctuations.  This
market volatility, as well as general economic conditions, could cause the
market price of our Common Stock to fluctuate substantially.  The
trading price of our Common Stock has been, and is likely to continue to be,
volatile.  Many factors that are beyond our control may significantly
affect the market price of our shares.  These factors include
judgments in our litigation, changes in our earnings or variations in operating
results, any shortfall in revenue or increase in losses from levels expected by
securities analysts, changes in regulatory policies or tax law, operating
performance of companies comparable to us; and general economic trends and other
external factors.  If any of these factors causes the price of our
Common Stock to fall, investors may not be able to sell their Common Stock at or
above their respective purchase prices.




Our
Common Stock is quoted on the OTC Bulletin Board, which may increase the
volatility of our stock and make it harder to sell shares of our
stock.




On
October 4, 2007, our Common Stock was delisted from the NASDAQ Capital Market
and on October 10, 2007, it commenced being quoted on the OTC Bulletin Board,
which tends to be a highly illiquid market.  There is a greater chance
of market volatility for securities that trade on the OTC Bulletin Board (as
opposed to a national exchange or quotation system), as a result of which
stockholders may experience wide fluctuations in the market price of our
securities. Thus, stockholders may be required to either sell our securities at
a market price which is lower than their purchase price or to hold our
securities for a longer period of time than they planned.  Because our
Common Stock falls under the definition of “penny stock,” trading in our Common
Stock may be limited because broker-dealers are required to provide their
customers with disclosure documents prior to allowing them to participate in
transactions involving our Common Stock. These rules impose additional sales
practice requirements on broker-dealers that sell low-priced securities to
persons other than established customers and institutional accredited investors;
and require the delivery of a disclosure schedule explaining the nature and
risks of the penny stock market. As a result, the ability or willingness of
broker-dealers to sell or make a market in our Common Stock might decline, and
stockholders could find it more difficult to sell their stock.




Our
board of directors’ right to authorize additional shares of preferred stock
could adversely impact the rights of holders of our Common Stock.




Our board
of directors currently has the right to designate and authorize the issuance of
one or more series of our preferred stock with such voting, dividend and other
rights as our directors may determine.  The board of directors can
designate new series of preferred stock without the approval of the holders of
our Common Stock.  The rights of holders of our Common Stock may be
adversely affected by the rights of any holders of shares of preferred stock
that may be issued in the future, including, without limitation, dilution of the
equity ownership percentage of our holders of Common Stock and their voting
power if we issue preferred stock with voting rights.  Additionally,
the issuance of preferred stock could make it more difficult for a third party
to acquire a majority of our outstanding voting stock.




ITEM
2. PROPERTIES




Our
corporate headquarters is located in Trevose, Pennsylvania in a leased facility
consisting of approximately 17,000 square feet.  The lease is
cancelable by either party at any time with ninety (90) days prior notice with
no termination cost.  Additionally, we lease administrative, sales and
customer operations office space from a related party in Rochester, New York and
Concord, North Carolina.  Each of our office locations supports each
of our business segments.




45




On March
24, 2010, we entered into a lease agreement for approximately 18,713 square feet
of space in Bensalem, Pennsylvania for engineering, corporate and administrative
operations and activities.




ITEM
3. LEGAL PROCEEDINGS




We are
not party or subject to any material pending legal
proceedings.  However, from time to time, we become involved in
various legal proceedings, claims, investigations and proceedings that arise in
the normal course of our operations. While the results of such claims and
litigation cannot be predicted with certainty, we are not currently aware of any
such matters that we believe would have a material adverse effect on our
financial position, results of operations or cash flows.




ITEM
4. (REMOVED AND RESERVED)




PART
II




ITEM
5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS
AND ISSUER PURCHASES OF EQUITY SECURITIES




Our
common stock, par value $0.01 per share (“Common Stock”), is quoted on the OTC
Bulletin Board under the symbol “WGAT.OB.”  The following table shows
the high and low inter-dealer bid quotation price as reported by the OTC
Bulletin Board, for each quarter of 2008 and 2009, but does not include retail
mark-up, mark-down or commission and may not necessarily represent actual
transactions.




High
                    
                    
                    LowYear
      Ended December 31, 2008First
      Quarter
                    
                    $
                    $0.20
                    
                    
                    $
                    0.02Second
      Quarter
                    
                    
                    0.26
                    
                    
                    
                    0.07Third
      Quarter
                    
                    
                    0.18
                    
                    
                    
                    0.02Fourth
      Quarter
                    
                    
                    0.40
                    
                    
                    
                    0.01Year
      Ended December 31, 2009First
      Quarter
                    
                    $
                    0.49
                    
                    
                    $
                    0.20Second
      Quarter
                    
                    
                    0.35
                    
                    
                    
                    0.20Third
      Quarter
                    
                    
                    1.55
                    
                    
                    
                    0.29Fourth
      Quarter
                    
                    
                    1.04
                    
                    
                    
                    0.61





On
March 24, 2010, the closing price of our Common Stock was
$0.52.  As of March 24, 2010, we had 343 holders of record of our
Common Stock.




We have
never paid or declared any cash dividends on our Common Stock. We do not
anticipate paying any cash dividends in the foreseeable future.  We
currently expect to retain future earnings, if any, to finance the growth and
development of our business.  Any future determination to pay cash
dividends will be at the discretion of our board of directors and will be
dependent on our results of operations, financial condition, contractual
restrictions and other factors that our board of directors considers
relevant.




Information
regarding compensation plans under which our equity securities may be issued is
included in Item 12 of Part III of this Annual Report on Form 10-K.




46




ITEM
6.  SELECTED FINANCIAL DATA




Not
required.




ITEM
7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS(Dollar amounts
contained in this Item 7 are in thousands, except per share
amounts)




You
should carefully read the cautionary note on page 1 regarding important
information on forward looking statements made in this Annual Report on Form
10-K including this Item 7.




Results of
Operations




General




We
are a leading provider of digital voice and video phone services and next
generation video phones.  We design and develop innovative digital
video phones featuring high quality, real-time, two-way video.  We
also provide a turn-key digital voice and video communication services platform
supplying complete back-end support services with a focus on best-in-class
customer service.  The unique combination of functional design,
advanced technology and use of IP broadband networks provides true-to-life video
communication.  As a result, we bring family and friends closer
together through an immediate video connection allowing them to instantly hear
and see each other for a face-to-face conversation.




We are
transitioning from a business model focused primarily on one-time digital video
phone equipment sales to delivering an integrated audio and video telephony
solution.  Upon completion of the redevelopment of our video phone
platform, we will not only offer what we believe is an industry leading line of
consumer video phones but we will also provide a turnkey digital voice and video
phone service.  By building a service that is able to not only provide
video telephony, but also serve as a home’s primary telephone service, we enable
a recurring-revenue based business model that encourages service loyalty and one
where we are able to bundle in the cost of the video phone
itself.  The end result is a lower start-up cost to the consumer
driving faster market adoption of our video phones.  Further, we
believe WorldGate will be unique in the market in that we will offer an
end-to-end solution – digital video phones fully integrated with a digital voice
and video phone service – thus ensuring a quick and trouble-free
installation process.




We have
two reportable business segments: Consumer Services and OEM Direct. The Consumer
Services segment is aimed at the marketing and distribution of products and
related recurring services to end users. In the Consumer Services segment, we
market to three principal groups: (i) directly to retail consumers through the
Internet and our corporate website, (ii) through commissioned independent sales
agents, and (iii) on a wholesale basis through established telecommunication
providers who will offer our video phone bundle as a product extension to their
existing customer base. The OEM Direct segment is focused on selling digital
video phones and maintenance services directly to telecommunications service
providers who already have a digital voice and video management and network
infrastructure, such as incumbent service providers, CELCs, international
telecom service providers and cable service providers.




Critical
Accounting Policies and Estimates




Our 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.




47




Our significant accounting policies are
described in Note 3 to the accompanying consolidated financial statements for
the year ended December 31, 2009.  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, accounts receivable,
inventory valuation, revenue incentive asset, 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.




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 its equipment customers’ and service
customers’ accounts for collectibility at the date of sale and on an ongoing
basis.  Revenues are also offset by a reserve for any price refunds
consistent with ASC Topic 605-50.




Video Phone Sales. During the
year ended December 31, 2009, the Company did not ship any product to customers
with a right of return.  During the year ended December 31, 2008, the
Company shipped 9 units with a sales value of $2 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.  The Company also deferred
revenue in accordance with the guidance related to “bill and hold arrangements”
wherein customers were billed for units purchased but shipments had not been
made.




Pursuant
to the ACN Master Purchase Agreement, ACN DPS has committed to purchase three
hundred thousand videophones over a two-year period.  Current
accounting principles require that revenue generated be reduced to reflect the
extent that ACN Warrants
are determined to be consideration given by a vendor to a customer for which an
otherwise identifiable benefit has not been received.  The Company will
record a charge for the fair value of the portion of the ACN Warrants earned from the
point in time when shipments of units are initiated to ACN DPS through the
vesting date.  Final determination of fair value of the ACN Warrants will occur upon
actual vesting.  Applicable accounting guidance requires that the fair
value of the ACN Warrants
be recorded as a reduction of revenue to the extent of probable cumulative
revenue recorded from ACN DPS.




ACN DPS Development
Revenues.  On April 6, 2009, the Company entered into a
Software Development and Integration and Manufacturing Assistance Agreement
pursuant to which ACN DPS provided the Company with $1,200 to fund certain
software development costs during the quarter ended June 30,
2009.  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 of the
video phone in accordance with guidance for accounting for performance of
construction and production type contracts.  The Company did not
recognize any revenue related to this agreement during the year ended December
31, 2009.





48




Accounts
Receivable.  We record accounts receivable at the invoiced
amount.  Management reviews the receivable balances on a monthly
basis.  Management analyzes collection trends, payment patterns and
general credit worthiness when evaluating collectibility and may require letters
of credit whenever deemed necessary.  Additionally, we have
established an allowance for doubtful accounts based upon factors surrounding
the credit risk of specific customers, historical trends related to past losses
and other relevant information.  Account balances would be charged off
against the allowance after all means of collection have been exhausted and the
potential for recovery is considered remote.  As of December 31, 2009
and 2008, we established an allowance for doubtful accounts of $42 and $0,
respectively.  The Company did not have any off-balance sheet credit
exposure related to our customers.  At December 31, 2009 the Company
did not have accounts receivable concentrated with one customer.  At
December 31, 2008 approximately 96% of accounts receivable was concentrated with
one customer.  Trade accounts receivable at December 31, 2009 and 2008
were $24 and $1,019, respectively.  For the years ended December 31,
2009 and 2008 we recorded bad debt expense of $42 and $0,
respectively.





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. We reflect inventory at the lower of cost or
market and reduced our inventory balance by $30 and $0, respectively, for the
years ended December 31, 2009 and 2008 to reflect such valuation.  To
motivate trials and sales of its products, and to motivate customers to become a
subscriber for our digital voice and video phone services, 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 December 31, 2009 and December 31,
2008, the Company’s inventory balance was $763 and $1,176, respectively (net of
a reserve of $757 and $0, respectively, for excess and obsolete inventory that
is not expected to be utilized in the continued development of the video
phone).  Included in the inventory balance reported as of December 31,
2009 and 2008 are costs of units purchased by Aequus in a “Bill and Hold”
arrangement of $178 and $745, respectively (See Note 3 of the accompanying
consolidated financial statements).





Long-Lived
Assets.  Our long-lived assets consist of property and equipment.
These long-lived assets are recorded at cost and are depreciated or amortized
using the straight-line method over their estimated useful lives. The carrying
value of a long-lived asset is considered impaired when the anticipated
undiscounted cash flows from such assets are separately identifiable and are
less than the carrying value. In that event, a loss is recognized based on the
amount by which the carrying value exceeds the fair market value of the
long-lived asset. Fair market value is determined by using the anticipated cash
flows discounted at a rate commensurate with the risk involved. If useful life
estimates or anticipated cash flows change in the future, we may be required to
record an impairment charge.




Accounting for Income
Taxes.  As part of the process of preparing our consolidated
financial statements we are required to estimate our income taxes in each of the
jurisdictions in which we operate. This process involves us estimating our
actual current tax exposure together with assessing temporary differences
resulting from differing treatment of items, such as depreciation of property
and equipment and valuation of inventories, for tax and accounting purposes.
These differences result in deferred tax assets and liabilities. We must then
assess the likelihood that our deferred tax assets will be recovered from future
taxable income and, to the extent we believe that it is more likely than not
that we will not recover the deferred tax asset, we must establish valuation
allowances. To the extent we establish valuation allowances or increase the
allowances in a period, we must include an expense within the tax provision in
the statement of operations.





49




We have a
full valuation allowance against the net deferred tax asset as of
December 31, 2009 and 2008 of $7,784 and $6,357, respectively, due to our
lack of earnings history and the uncertainty as to the realizability of the
asset. In the future, if sufficient evidence of our ability to generate
sufficient future taxable income becomes apparent, we would be required to
reduce our valuation allowance, resulting in a benefit from income tax in the
consolidated statements of operations.
   The
Company completed  an analyses under Section 382 of the Internal
Revenue Code.  Generally Section 382 limits the utilization of an
entity’s net operating loss carry forward upon a change in
control.  Based on our review, it is more likely than not that the
Company experienced a change of ownership in October 2008, as defined under
Section 382. Upon the closing of the Private Placement in April 2009, and WGI
acquiring 63% of the post transaction shares of the Company, the Company once
again experienced an ownership change and concluded that the ability to utilize
its remaining net operating loss carryforwards and credit carryforwards will be
subject to further annual limitations as a result of current tax law as defined
under Section 382 (See Note 8 of the accompanying consolidated financial
statements). Prior to the October 2008 change of control, the Company had a net
operating loss carryforward (NOL) of approximately $237,440.  Due to
annual limitations imposed by Section 382, the Company believes it will be
unable to utilize approximately $234,951 of the NOL and the remaining amount of
approximately $2,489 may be subject to an annual limitation of $124 for 20
years.


As a
result of the second change of ownership in April 2009, the Company believes it
is more likely than not that the limitation attributable to the first change of
ownership of approximately $124 annually may remain in place limiting
approximately $2,489 of NOL.  Further as a result of the April 2009
change of ownership, the Company believes it is more likely than not that the
loss attributable to the post October 2008 change in ownership and to the April
2009 change of ownership of approximately $2,921 would be able to be utilized
with no limitations.  Any losses incurred after the April 2009 change
of ownership (approximately $3,965) would not be limited assuming that the
Company does not experience any additional changes of ownership.




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&E), which provides tax credit
for certain R&E efforts, will also be subject to an annual
limitation.  Due to the limitation pursuant to Section 383, all but
approximately $25 of the credit was lost effective October 2008.  The
federal credits remaining subsequent to the change of ownership will expire in
2028 and 2029.  All state research and experimentation credit
carryovers have been refunded and no state credit remains.




Stock-Based
Compensation.  We account for stock based compensation using the
fair value recognition method, which requires that all stock based compensation
be recognized as an expense in the financial statements measured at the fair
value of the award.  Under this method, in addition to reflecting
compensation for new share-based awards, expense is also recognized to reflect
the remaining service period of awards that had been included in pro-forma
disclosure in prior periods.  This guidance also requires that excess
tax benefits related to stock option exercises be reflected as financing cash
inflows instead of operating inflows.   As a result, the
Company’s net loss before taxes for the year ended December 31, 2009 and 2008
included approximately $1,012 and $632, of stock based compensation. The stock
based compensation expense is included in general and administrative expense in
the accompanying consolidated statements of operations (See Note 10 of the
accompanying consolidated financial statements).





50





Accounting
for Secured Convertible Debentures and Related Warrants.  The
Company initially accounted for conversion options embedded in the convertible
debentures by bifurcating conversion options embedded in the 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.




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 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.   Interest was 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 (See
Note 3 of the accompanying consolidated financial statements).




As of
December 31, 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(See Note 3
of the accompanying consolidated financial statements).




Results
of Operations For the Years Ended December 31, 2009 and 2008.




Revenues.




For the Year ended December 312009
                        
                        
                        2008
                        
                        
                        2009versus2008$
                        
                        
                        %Consumer
      Services
                        
                        $
                        385
                        
                        
                        $
                        408
                        
                        
                        $
                        (23
                        )
                        
                        
                        (6
                        )%OEM
      Direct
                        
                        $
                        1,393
                        
                        
                        $
                        2,561
                        
                        
                        $
                        (1,168
                        )
                        
                        
                        (46
                        )%Total
      net revenues
                        
                        $
                        1,778
                        
                        
                        $
                        2,969
                        
                        
                        $
                        (1,191
                        )
                        
                        
                        (40
                        )%




Revenues.  Consumer
service revenues consist of shipments of products and related recurring services
to end users.  For the year ended December 31, 2009 compared with
the year ended December 31, 2008, the decrease of $23 in consumer service
revenues primarily reflects the reduction of video phone shipments to end user
customers.  Direct OEM revenues consist of digital video phones and
maintenance services sold directly to telecommunications service providers who
already have a digital voice and video management and network
infrastructure.  For the year ended December 31, 2009 compared
with the year ended December 31, 2008, the decrease in OEM Direct revenue
of $1,168 primarily reflects reduced shipments of product to Aequus of
approximately $1,740, partially offset by $552 of product shipments to another
customer and increased non-recurring engineering services of $112 realized
during the year ended December 31, 2009 (See Note 3 of the accompanying
consolidated financial statements. Two customers, (one representing 47% and the
other 31%) accounted for 78% of our total revenue for the year ended December
31, 2009.


51




Cost of Revenues and Gross
Profit.




For the Year ended December 312009
                            
                            
                            2008
                            
                            
                            2009 versus 2008$
                            
                            
                            %Cost
      of revenues:Consumer
      Services
                            
                            $
                            41
                            
                            
                            $
                            67
                            
                            
                            $
                            (26
                            )
                            
                            
                            (39
                            )%OEM
      Direct
                            
                            $
                            1,373
                            
                            
                            $
                            1,832
                            
                            
                            $
                            (459
                            )
                            
                            
                            (25
                            )%Total
      cost of revenues
                            
                            $
                            1,414
                            
                            
                            $
                            1,899
                            
                            
                            $
                            (485
                            )
                            
                            
                            (26
                            )%Gross
      profit:Consumer
      Services
                            
                            $
                            344
                            
                            
                            $
                            341
                            
                            
                            $
                            3
                            
                            
                            
                            1
                            %Direct
      OEM
                            
                            $
                            20
                            
                            
                            $
                            729
                            
                            
                            $
                            (709
                            )
                            
                            
                            (97
                            )%Total
      gross profit
                            
                            $
                            364
                            
                            
                            $
                            1,070
                            
                            
                            $
                            (706
                            )
                            
                            
                            (66
                            )%




Cost of
Revenues.  The consumer services cost of revenues consists of
direct costs related to product and delivery costs relating to the deliveries of
video phones to end user customers.  The OEM Direct cost of revenues
consists of direct costs related to product and delivery costs related to
deliveries of video phones primarily to resellers and costs related to
non-recurring engineering services revenues.  For the year ended
December 31, 2009 compared with the year ended December 31, 2008, the
decrease in consumer services cost of revenues of $26 primarily reflects
decreased costs related to lower consumer services product shipments of
$42.  For the year ended December 31, 2009 compared with the year
ended December 31, 2008, the Direct OEM cost of revenues decrease of $459
primarily reflects the lower costs of $341 resulting from reduced shipments of
video phones of $1,280, primarily to resellers, and reduced non-recurring
engineering costs of $275.




Gross
Profit.  For the year ended December 31, 2009 compared
with the year ended December 31, 2008, the decrease in Consumer services
gross margin of $3 primarily reflects the increase $9 of subscriber service
revenues.  For the year ended December 31, 2009 compared with the
year ended December 31, 2008, the decrease in OEM Direct gross margin of
$709 includes the establishment in 2009 of a reserve of $757 relating to certain
excess and obsolete inventory and a lower of cost or market adjustment of
$30.  There was no reserve established or lower of cost or market
adjustment recorded in 2008.   Partially offsetting these
decreases in OEM Direct gross margin were decreased costs of non-recurring
engineering, training and service center usage revenues recognized from our
agreement with Aequus of $275 that had been previously incurred and recorded in
2008. In addition, lower video phone shipments and lower selling prices during
the year ended December 31, 2009, compared to the same period in 2008, also
contributed to reduced margins in 2009.




52





Expenses
From Operations.




For the Year ended December 312009
                    
                    
                    2008
                    
                    
                    2009 Versus 2008$
                    
                    
                    %Engineering
      and development
                    
                    $
                    2,693
                    
                    
                    $
                    1,807
                    
                    
                    $
                    886
                    
                    
                    
                    49
                    %Operations
                    
                    $
                    675
                    
                    
                    $
                    647
                    
                    
                    $
                    28
                    
                    
                    
                    4
                    %Sales
      and marketing
                    
                    $
                    638
                    
                    
                    $
                    363
                    
                    
                    $
                    275
                    
                    
                    
                    76
                    %General
      and administrative
                    
                    $
                    4,215
                    
                    
                    $
                    3,526
                    
                    
                    $
                    689
                    
                    
                    
                    20
                    %Depreciation
      and amortization
                    
                    $
                    302
                    
                    
                    $
                    266
                    
                    
                    $
                    36
                    
                    
                    
                    14
                    %Total
      Expenses from Operations
                    
                    $
                    8,523
                    
                    
                    $
                    6,609
                    
                    
                    $
                    1,914
                    
                    
                    
                    29
                    %




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 year
ended December 31, 2009 compared with the year ended December 31,
2008, the increase of $886 in engineering and development expenses primarily
reflects increased staffing of $554, and an increase in development costs of
$374, primarily related to the increased development effort on the next
generation video phone.




Operations.  Operations
expenses consist primarily of the indirect cost of providing the software
systems that enable us to manage our network and service offering and the
resources necessary to deliver these services, including our
network  systems, customer portal, our customer service center,
billing expenses, and logistics and inventory management,  For the
year ended December 31, 2009 compared with the year ended December 31,
2008, the increase of $28 in operations expenses primarily reflects increased
staffing of $71, and the establishment of reserves of $30 and $12 against
certain service and product receivables, partially offset by a reduction of $73
in customer service expenses.




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 products and services.  For the year ended
December 31, 2009 compared with the year ended December 31, 2008, the increase
of $275 in sales and marketing expenses is primarily the result of increased
staffing of $299, primarily related to the new business service model, partially
offset by a reduction of $49 in certain marketing promotional
expenses.




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 year ended December 31, 2009 compared
with the year ended December 31, 2008, the $689 increase in general and
administrative expenses is primarily the result of an increase in non-cash
compensation expense of $380 and the accrual of $626 in compensation and
severance expenses related to officers that resigned, partially offset by
reductions in certain administrative expenses of $237.  The
compensation expense related to officers that have resigned will cease on April
7, 2010.  In addition, the year ended December 31, 2009, included a
bad debt reserve of $42 primarily related to certain service
customers.





53




Other
Income and Expense




For the Year ended December 312009
                        
                        
                        2008
                        
                        
                        2009 Versus 2008$
                        
                        
                        %Interest
      and other income
                        
                        $
                        228
                        
                        
                        $
                        51
                        
                        
                        $
                        177
                        
                        
                        
                        347
                        %Change
      in fair value of derivative warrants and conversion
options
                        
                        $
                        4,252
                        
                        
                        $
                        (4,124
                        )
                        
                        $
                        8,376
                        
                        
                        NMF
                        *Income
      from service fee contract termination
                        
                        $
                        395
                        
                        
                        $
                        3,165
                        
                        
                        $
                        (2,770
                        )
                        
                        
                        (88
                        )%Amortization
      of debt discount
                        
                        $
                        (2,918
                        )
                        
                        $
                        (2,212
                        )
                        
                        $
                        (706
                        )
                        
                        
                        32
                        %Loss
      on equipment disposal
                        
                        $
                        (12
                        )
                        
                        $
                        (295
                        )
                        
                        $
                        283
                        
                        
                        
                        96
                        %Interest
      and other expense
                        
                        $
                        (122
                        )
                        
                        $
                        (328
                        )
                        
                        $
                        206
                        
                        
                        
                        63
                        %Total
      other (expense)
                        
                        $
                        1,823
                        
                        
                        $
                        (3,743
                        )
                        
                        $
                        5,566
                        
                        
                        NMF
                        *


*Not
meaningful


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 years
ended December 31, 2009 and 2008, we earned interest on an average cash balance
of approximately $799 and $559, respectively, and recorded the negotiated
cancellation of certain obligations of $227 and $0, respectively.




Change in fair value of
derivative warrants and conversion options.  The fair value
adjustments of our derivative warrants and conversion options issued in our June
2004 private placement of our Series A Convertible Preferred Stock and Warrants
and our August 11, 2006 and October 13, 2006 private placements of secured
convertible debentures and warrants are primarily a result of changes in our
Common Stock price during
each reporting period and anti-dilution provisions that increased the number of
outstanding warrants and reduced the warrant exercise price as of December 31,
2008 (See Note 3 of the accompanying consolidated financial statements). As of
December 31, 2009 there were no remaining derivative warrants or conversion
options from our June 2004 private placement, and as a result there will be no
further changes to the fair value recognized in our financial statements related
to these derivative instruments.




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 and we realized $395 for the year ended December 31,
2009 of other income from the elimination of these
obligations.  Income from service fee contract termination for the
year ended December 31, 2008 of $3,165 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 3 of the accompanying
consolidated 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 of $706 for the year ended December 31, 2009, when compared to
the year ended December 31, 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 9 of the accompanying consolidated 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 year ended December 31, 2008, certain
equipment, furniture and fixtures were sold and disposed of during our move to
smaller facilities.  The net loss realized during the year ended
December 31, 2008 was $295.  There was a $12 loss realized during the
year ended December 31, 2009.





54





Interest and Other
Expense.  The decrease of $206 in interest expense for the year
ended December 31, 2009, when compared to the year ended December 31, 2008,
primarily consisted of a reduction 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 9 of the accompanying consolidated financial statements
for).





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 December 31, 2009, our primary sources of
liquidity consisted of proceeds from notes issued, the sale of Common Stock, the
exercise of warrants and options, funds the Company received as a result of the
closing on April 6, 2009 of the transactions contemplated by the Securities
Purchase Agreement, the Commercial Relationship with ACN DPS, borrowings from
WGI under the Revolving Loan Agreement, 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
December 31, 2009, we had cash and cash equivalents of $578.





Cash Used in
Operations.  We utilized cash from operations of $5,525 and
$655, respectively, during the year ended December 31, 2009 and
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 year
ended December 31, 2009 was primarily a result of capital expenditures of $536
for investments in equipment and software for new product
development.  For the year ended December 31, 2008, cash provided from
investment activities was $2.




Cash Provided by Financing
Activities.  Cash provided by financing activities during the
year ended December 31, 2009 and 2008 was $6,198 and $1,
respectively.  During the year ended December 31, 2009, we received
cash of $750 from stock issuances, $1,400 of advances from a revolving loan
facility, and $3,276 from the exercise of warrants and options (See Note 10 of
the accompanying consolidated financial statements).





Operations and
Liquidity. We have incurred recurring net losses and have an accumulated
deficit of $275,745, stockholders’ deficiency of $2,035 and a working capital
deficiency of $1,374 as of December 31, 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 with WGI pursuant to which WGI agreed to provide to
the Company, a line of credit in a principal amount of $3,000. On March 9, 2010,
the principal amount of the line of credit was increased to $5,000 (See Note 9
and 16 of the accompanying consolidated financial statements).  As of
December 31, 2009, the Company had received aggregate advances under this
Agreement of $1,400, and during the period January 1, 2010 and through March 24,
2010, the Company received an additional $2,400 in advances against the
increased credit line.





55




As of
December 31, 2009, we had $4,435 of liabilities and substantially all of our
assets are pledged pursuant to the Revolving Loan.  These liabilities
primarily include $1,422 of notes payable, $1,206 of accounts payable and
accrued expenses, $1,460 of deferred revenues and income, $100 of accrued
compensation and benefits and accrued officer’s compensation and severance of
$232.




Our
ability to generate cash is dependent upon the sale of our product and services,
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 voice and 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 impact on our ability to raise additional
financing.




Based on
management’s internal forecasts and assumptions regarding its short term cash
requirements, the increase in and full utilization of the expanded credit line
of the Revolving Loan (See Note 9 and Note 16 of the accompanying consolidated
financial statements), the planned completion of the development of our new
voice and video phone and the commencement of delivery of  these new
video phones expected in May of 2010, the expected placement of purchase orders
for the  purchase of units by ACN DPS in accordance with the ACN
Master Purchase Agreement and the accelerated terms under which we receive
payment from ACN DPS for such order (See Note 3 of the accompanying consolidated
financial statements), and our current forecast for sales of other products and
services, we currently believe that we will have sufficient working capital to
support our current operating plans through  at least December 31,
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 or that sales will be sustainable over the short and long term so as to
obviate the need for additional funding.




If these
assumptions do not materialize, or do not materialize in the timeframe we
project we will need to obtain additional funding through the private or public
issuance of debt or equity securities.  Given that our voice and 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 to achieve our plan. The lack of success of our sales efforts could
also have an adverse ability to raise additional financing.




We
continue to evaluate possibilities to obtain additional financing through public
or private equity or debt offerings, asset securitizations, or from other
sources to address the risks inherent in our plans and to help insure that we
have the adequate financial resources in the event the realization of our plan
requires additional time or is faced by additional marketplace
challenges.




We
continue to focus on the business elements we believe are important for our
sustainability. We continue to explore additional service and distribution sales
opportunities. We believe that growing the Consumer Services segment of our
business, which includes a recurring revenue stream, is an essential element in
the long term sustainability our operations.  In addition, we are
focused on reducing the cost of our voice and video phone which we believe
facilitates the growth of our product and services. Further, we believe that it
is essential maintain our video technology leadership in order to support the
growth of the combined voice and video market sector.




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 additional funds,
and our plans are not achieved in the planned time frame we may be required to
reduce the size of the organization which could have a material adverse impact
on our business.





56





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 generally accepted accounting principles
(“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 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 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.   Upon adoption of this guidance
on January 1, 2009, the Company 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
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 3 of the
accompanying consolidated financial statements).




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
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 and
results of operations.




57




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.




ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK




Not
required.




ITEM
8.  FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA




The
consolidated financial statements of the Company and its subsidiaries, together
with the report of our independent registered public accounting firm, appear at
pages F-2 through F-38 of this Annual Report on Form 10-K.




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





None.





Item
9A (T). Controls and Procedures





(a)
            Disclosure
      Controls and Procedures.





The
Company maintains disclosure controls and procedures (as defined in Exchange Act
Rule 13a-15(e) and 15d-15(e))  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.





The
Company carried out an evaluation, under the supervision and with the
participation of management, including its 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, 2009.  The
Company’s Chief Executive Officer and Chief Financial Officer concluded that as
of December 31, 2009, its disclosure controls and procedures were designed
properly and were effective in ensuring that the information required to be
disclosed by the Company in the reports that we file and submit under the
Exchange Act is recorded, processed, summarized and reported within the time
periods specified in the 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 required disclosure.




58


There is
no assurance that the necessary resources required under the new business model
are available going forward to ensure that our reporting systems will continue
to be  appropriately designed or effective, or that a future material
weakness will not be found in our internal controls over financial reporting or
disclosure controls and procedures, which could result in a material
misstatement in future financial statements.




(b)  Management’s
Annual Report on Internal Control Over Financial Reporting.




Management
is responsible for establishing and maintaining adequate internal control over
financial reporting as defined in Rules 13a-15(f) or 15d-15(f) under the
Securities Exchange Act of 1934. Our internal control over financial reporting
is designed to provide reasonable assurance regarding the reliability of
financial reporting and preparation of financial statements for external
purposes in accordance with generally accepted accounting
principles.




Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Therefore, even those systems determined to be
effective can provide only reasonable assurance with respect to financial
statement preparation and presentation.




Management
assessed the effectiveness of our internal control over financial reporting as
of December 31, 2009. In making this assessment, management used the criteria
set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (“COSO”) in Internal
Control - Integrated Framework.




Based on
management’s assessment, management concluded that internal controls over
financial reporting were effective, as of December 31, 2009. This annual report
does not include an attestation report of the Company’s independent registered
public accounting firm, regarding internal control over financial reporting.
Management’s report was not subject to attestation by the Company’s independent
registered public accounting firm pursuant to temporary rules of the Securities
and Exchange Commission that permit the Company to provide only managements
report in this annual report.





(c) Changes in internal
control over financial reporting.





During
the quarter ended December 31, 2009 the Company enhanced its procedures and
controls over financial reporting.  Enhancements included improved month-end
closing and SEC filing procedures and hiring additional experienced staffing. We
believe these changes have materially enhanced the Company’s internal control
over financial reporting.




Item
9B.  Other Information.




None


59


PART
III




ITEM
10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE




Identification of
Directors.  Information with respect to our board of directors
called for by Item 10 of Form 10-K will be set forth under the caption
“Election of Directors” in our definitive proxy statement, to be filed within
120 days after the end of the fiscal year covered by this annual report on
Form 10-K, and is incorporated herein by reference.




Section 16(a) Beneficial
Ownership Compliance.  Information with respect to Section
16(a) compliance of our directors and executive officers called for by
Item 10 of Form 10-K will be set forth under the caption
“Section 16(a) Beneficial Ownership Reporting Compliance” in our definitive
proxy statement, to be filed within 120 days after the end of the fiscal
year covered by this annual report on Form 10-K, and is incorporated herein
by reference.




Corporate
Governance.  Information with respect to our Corporate
Governance called for by Item 10 of Form 10-K will be set forth under
the caption “Board of Directors and Committees of the Board” and “Code of
Conduct” in our definitive proxy statement, to be filed within 120 days
after the end of the fiscal year covered by this annual report on
Form 10-K, and is incorporated herein by reference.




The
required information as to executive officers is set forth in Part I hereof and
is incorporated herein by reference.




ITEM
11. EXECUTIVE COMPENSATION




The
information called for by Item 11 of Form 10-K will be set forth under
the caption “Executive Compensation and Other Information” in our definitive
proxy statement, to be filed within 120 days after the end of the fiscal
year covered by this annual report on Form 10-K, and is incorporated herein
by reference.




ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS




The
information called for by Item 12 of Form 10-K will be set forth under
the caption “Security Ownership of Certain Beneficial Owners and Management” and
“Executive Compensation and Other Information – Equity Compensation Plan
Information” in our definitive proxy statement, to be filed within 120 days
after the end of the fiscal year covered by this annual report on
Form 10-K, and is incorporated herein by reference.




ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE




The
information called for by Item 13 of Form 10-K will be set forth under
the captions “Certain Relationships and Related Transactions” and “Board of
Directors and Committees of the Board – Director Independence” in our definitive
proxy statement, to be filed within 120 days after the end of the fiscal
year covered by this annual report on Form 10-K, and is incorporated herein
by reference.




ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES




The
information called for by Item 14 of Form 10-K will be set forth under
the caption “Ratification of the Appointment of the Company’s Independent
Registered Public Accounting Firm of the year ending December 31, 2010” in our
definitive proxy statement, to be filed within 120 days after the end of
the fiscal year covered by this annual report on Form 10-K, and is
incorporated herein by reference.




60


PART
IV




ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES




(a)           1.
Financial
Statements.  The following consolidated financial statements
are filed as part of this annual report on Form 10-K:


PageReport
      of Marcum LLP, Independent Registered Public Accounting
    Firm
                F-2Consolidated
      Balance Sheets as of December 31, 2009 and 2008
                F-3Consolidated
      Statements of Operations for the years ended December 31, 2009 and
      2008
                F-4Consolidated
      Statements of Stockholders’ Deficiency for the years ended
      December 31, 2009 and 2008
                F-5Consolidated
      Statements of Cash Flows for the years ended December 31, 2009 and
      2008
                F-6Notes
      to Consolidated Financial Statements
                F-7





2. Financial Statement
Schedules.  Not applicable.





3. Exhibits.  The following is
a list of exhibits filed as part of this annual report on Form 10-K. Where
so indicated, exhibits which were previously filed are incorporated by
reference. For exhibits incorporated by reference, the location of the exhibit
in the previous filing is indicated in parentheses.





Exhibit
                    Number
                  
                  Description3.1
                  
                  Restated
      Certificate of Incorporation reflecting all amendments through March 31,
      2009 (Incorporated by reference to Exhibit 3.1 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended March 31, 2009,
      filed with the SEC on May 15, 2009)3.2
                  
                  Amended
      and Restated Bylaws (Incorporated by reference to Exhibit 3.2 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended
      March 31, 1999, filed with the SEC on May 28,
1999)3.3
                  
                  Certificate
      of Designations, Preferences and Rights of the Series A Convertible
      Preferred Stock of the Company dated June 24, 2004 (Incorporated by
      reference to Exhibit 3.2 of our Quarterly Report on Form 10-Q
      for the fiscal quarter ended September 30, 2004, filed with the SEC
      on November 17, 2004)4.1
                  
                  Form
      of Warrant issued by the Company pursuant to the Amended and Restated
      Securities Purchase Agreement dated as of December 4, 2003 (Incorporated
      by reference to Exhibit 4.1 to our Current Report on Form 8-K filed
      with the SEC on December 2, 2003)4.2
                  
                  Form
      of Additional Investment Right issued by the Company pursuant to the
      Amended and Restated Securities Purchase Agreement dated as of December 4,
      2003 (Incorporated by reference to Exhibit 4.2 to our Current Report on
      Form 8-K filed with the SEC on December 2, 2003)4.3
                  
                  Form
      of Warrant issued by the Company pursuant to the Securities Purchase
      Agreement dated as of January 20, 2004 (Incorporated by reference to
      Exhibit 4.1 to our Current Report on Form 8-K filed with the SEC on
      January 21, 2004)4.4
                  
                  Form
      of Additional Investment Right dated issued by the Company pursuant to the
      Securities Purchase Agreement dated as of January 20, 2004 (Incorporated
      by reference to Exhibit 4.2 to our Current Report on Form 8-K filed
      with the SEC on January 21, 2004)4.5
                  
                  Form
      of Series A Warrant issued by the Company pursuant to the Securities
      Purchase Agreement dated as of June 24, 2004 (Incorporated by reference to
      Exhibit 4.1 to our Current Report on Form 8-K filed with the SEC on
      June 25, 2004)




61




4.6
                
                Form
      of Series B Warrant issued by the Company pursuant to the Securities
      Purchase Agreement dated as of June 24, 2004 (Incorporated by reference to
      Exhibit 4.2 to our Current Report on Form 8-K filed with the SEC on
      June 25, 2004)4.7
                
                Form
      of Series C Warrant issued by the Company pursuant to the Securities
      Purchase Agreement dated as of June 24, 2004 (Incorporated by reference to
      Exhibit 4.3 to our Current Report on Form 8-K filed with the SEC on
      June 25, 2004)4.8
                
                Form
      of Warrant issued by the Company to Mr. K. Y. Cho (Incorporated by
      reference to Exhibit 4.9 to our Registration Statement on Form SB-2 filed
      with the SEC on May 24, 2005)4.9
                
                Form
      of Warrant dated August 3, 2005 issued by the Company pursuant to the
      Stock Purchase Agreement dated August 3, 2005 (Incorporated by reference
      to Exhibit 4.1 to our Current Report on Form 8-K filed with the SEC
      on August 8, 2005)4.10
                
                Form
      of Warrant dated August 3, 2005 issued by the Company pursuant to the
      Stock Purchase Agreement dated August 3, 2005 (Incorporated by reference
      to Exhibit 4.2 to our Current Report on Form 8-K filed with the SEC
      on August 8, 2005)4.11
                
                Registration
      Rights Agreement, August 3, 2005, by and among the Company and
      certain investors, pursuant to the Stock Purchase Agreement dated August
      3, 2005 (Incorporated by reference to Exhibit 4.3 to our Current Report on
      Form 8-K filed with the SEC on August 8, 2005)4.12
                
                Investor
      Registration Rights Agreement, dated August 11, 2006, by and among the
      Company and Cornell Capital Partners, LP (Incorporated by reference to
      Exhibit 4.2 of our Quarterly Report on Form 10-Q for the fiscal
      quarter ended June 30, 2006, filed with the SEC on August 14,
      2006)4.13
                
                Form
      of Amended and Restated Secured Convertible Debenture, originally issued
      August 11, 2006, dated as of May 17, 2007, issued by the Company to
      Cornell Capital Partners, LP (Incorporated by reference to Exhibit 99.2 to
      our Current Report on Form 8-K filed with the SEC on May 24,
      2007)4.14
                
                Form
      of amended and restated Secured Convertible Debenture originally issued
      October 2006, dated may17, 2007, issued by the Company to Cornell Capital
      Partners, LP (Incorporated by reference to Exhibit 99.3to our Current
      Report on Form 8-K filed with the SEC on May 24,
  2007)4.15
                
                Warrant,
      dated April 6, 2009, issued to ACN Digital Phone Service, LLC
      (Incorporated by reference to Exhibit 4.1 of our Quarterly Report on
      Form 10-Q for the fiscal quarter ended June 30, 2009, filed with the
      SEC on August 14, 2009)4.16
                
                Warrant,
      dated April 6, 2009, issued to WGI Investor LLC (Incorporated by reference
      to Exhibit 4.2 of our Quarterly Report on Form 10-Q for the
      fiscal quarter ended June 30, 2009, filed with the SEC on August 14,
      2009)4.17
                
                Form
      of Amendment No. 1 to Warrant and Exercise Agreement with respect to the
      2004 Amended Warrants (Incorporated by reference to Exhibit 10.1 to our
      Current Report on Form 8-K filed with the SEC on June 26,
      2009)4.18
                
                Form
      of Amendment No. 1 to Warrant with respect to the 2004 Amended Warrants
      (Incorporated by reference to Exhibit 10.2 to our Current Report on Form
      8-K filed with the SEC on June 26, 2009)4.19
                
                Form
      of Amendment No. 1 to Warrant and Exercise Agreement with respect to the
      2005 Amended Warrants (Incorporated by reference to Exhibit 10.3 to our
      Current Report on Form 8-K filed with the SEC on June 26,
      2009)4.20
                
                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 with the SEC on July 10, 2009)4.21
                
                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 with the SEC on July 20, 2009)4.22
                
                Revolving
      Promissory Note, dated October 28, 2009, by WorldGate Communications,
      Inc., WorldGate Service, Inc., WorldGate Finance, Inc., Ojo Service LLC,
      and Ojo Video Phones LLC  in favor of WGI Investor LLC in a
      principal amount of $3,000 (Incorporated by reference to Exhibit 4.1 to
      our Current Report on Form 8-K filed with the SEC on October 30,
      2009)




62




4.23
              
              Promissory
      Note, dated February 4, 2009, in the amount of $550, issued to WGI
      Investor LLC (Incorporated by reference to Exhibit 10.1 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,
      2009, filed with the SEC on May 15, 2009)4.24
              
              Promissory
      Note, dated March 24, 2009, in the amount of $200, issued to WGI Investor
      LLC (Incorporated by reference to Exhibit 10.2 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended March 31, 2009,
      filed with the SEC on May 15, 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 with the SEC on July 10, 2009)10.2
              
              Manufacturing
      Agreement, dated September 9, 2003, between the Company and Mototech Inc.
      (Incorporated by reference to Exhibit 10.2 to our Registration Statement
      on Form SB-2 filed with the SEC on December 24, 2003 (Registration No.
      333-111571))10.3
              
              Letter
      Agreement, dated October 8, 2009, by and among Snap Telecommunications,
      Inc., Aequus Technologies Corp., WorldGate Communications, Inc. and OJO
      Service LLC (Incorporated by reference to Exhibit 10.1 to our Current
      Report on Form 8-K filed with the SEC on October 15,
      2009)10.4
              
              License,
      Maintenance and Update Services Agreement, dated March 31, 2008, between
      the Company and Aequus Technologies Corp. (Incorporated by reference to
      Exhibit 10.13 of our Annual Report on Form 10-K for the fiscal
      year ended December 31, 2007, filed with the SEC on April 17,
      2008)10.5
              
              Revised
      and Restated Amendment and Master Contract, dated March 31, 2008, between
      the Company and Aequus Technologies Corp. (Incorporated by reference to
      Exhibit 10.14 of our Annual Report on Form 10-K for the fiscal
      year ended December 31, 2007, filed with the SEC on April 17,
      2008)10.6
              
              Master
      Agreement, dated March 31, 2008, between the Company and Aequus
      Technologies Corp. (Incorporated by reference to Exhibit 10.15 of our
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2007, filed with the SEC on April 17, 2008)10.7
              
              Master
      Manufacturing Agreement, dated November 18, 2009, between Kenmec
      Mechanical Engineering Co., Ltd. and Ojo Video Phones LLC* [Certain information in this
      exhibit has been omitted and has been filed separately with the SEC
      pursuant to a confidential treatment request under Rule 24b-2 of the
      Securities Exchange Act of 1934, as amended]10.8
              
              ACN
      Consumer Communications Equipment Master Purchase Agreement, dated as of
      April 6, 2009, between ACN Digital Phone Service, LLC and Ojo Video Phones
      LLC (Incorporated by reference to Exhibit 10.8 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended June 30, 2009, filed
      with the SEC on August 14, 2009)10.9
              
              Software
      Development and Integration and Manufacturing Assistance Agreement, dated
      as of April 6, 2009, between ACN Digital Phone Service, LLC and Ojo Video
      Phones LLC (Incorporated by reference to Exhibit 10.9 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
      2009, filed with the SEC on August 14, 2009)10.10
              
              Securities
      Purchase Agreement, dated December 12, 2008, by and between the Company
      and WGI Investor LLC (Incorporated by reference to Annex A of our Proxy
      Statement dated February 13, 2009, filed with the SEC on February 13,
      2009)10.11
              
              Registration
      Rights and Governance Agreement, dated as of April 6, 2009, by and among
      WorldGate Communications, Inc., WGI Investor LLC, and ACN Digital Phone
      Service, LLC (Incorporated by reference to Exhibit 10.10 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
      2009, filed with the SEC on August 14, 2009)10.12
              
              Revolving
      Loan and Security Agreement, dated October 28, 2009, by and among WGI
      Investor LLC, WorldGate Communications, Inc., WorldGate Service, Inc.,
      WorldGate Finance, Inc., Ojo Service LLC, and Ojo Video Phones LLC
      (Incorporated by reference to Exhibit 10.1 to our Current Report on
      Form 8-K filed with the SEC on October 30,
  2009)




63




10.13
              
              Services
      Agreement, dated October 12, 2009, between ACN, Inc. and WorldGate
      Communications, Inc. (Incorporated by reference to Exhibit 10.2 to our
      Current Report on Form 8-K filed with the SEC on October 16,
      2009)10.14
              
              Master
      Service Agreement, dated October 9, 2009, between Ojo Service LLC and
      deltathree, Inc. (Incorporated by reference to Exhibit 10.1 to our Current
      Report on Form 8-K filed with the SEC on October 16,
      2009)10.15
              
              Lease
      Amendment, dated April 2, 2009, between WorldGate Service, Inc. and 3190
      Tremont LLC (Incorporated by reference to Exhibit 10.14 of our Quarterly
      Report on Form 10-Q/A for the fiscal quarter ended June 30, 2009, filed
      with the SEC on March 31, 2010)10.16
              
              1996
      Stock Option Plan, as amended and restated effective February 15, 2001
      (Incorporated by reference to Exhibit 10.10 of our Annual Report on
      Form 10-K/A for the fiscal year ended December 31, 2000, filed with
      the SEC on August 17, 2001) †10.17
              
              2003
      Equity Incentive Plan (Incorporated by reference to Exhibit D of our
      Proxy Statement dated September 1, 2004, filed with the SEC on September
      3. 2004) †10.18
              
              Amendment
      No.1 to the WorldGate Communications, Inc. 2003 Equity Incentive Plan
      (Incorporated by reference to Exhibit 10.1 to our Current Report on Form
      8-K filed with the SEC on May 28, 2009) †10.19
              
              Form
      A of the Non-Qualified Stock Option Grant (Incorporated by reference to
      Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on May
      28, 2009) †10.20
              
              Form
      B of the Non-Qualified Stock Option Grant (Incorporated by reference to
      Exhibit 10.3 to our Current Report on Form 8-K filed with the SEC on May
      28, 2009) †10.21
              
              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 with the
      SEC on August 4, 2009) †10.22
              
              Offer
      Letter, dated June 23, 2009, to Allan Van Buhler* †10.23
              
              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and Joel
      Boyarski (Incorporated by reference to Exhibit 10.1 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended June 30, 2009, filed
      with the SEC on August 14, 2009) †10.24
              
              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and Harold
      Krisbergh (Incorporated by reference to Exhibit 10.2 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended June 30, 2009, filed
      with the SEC on August 14, 2009) †10.25
              
              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and
      Randall J. Gort (Incorporated by reference to Exhibit 10.3 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
      2009, filed with the SEC on August 14, 2009) †10.26
              
              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and James
      McLoughlin (Incorporated by reference to Exhibit 10.4 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
      2009, filed with the SEC on August 14, 2009) †10.27
              
              Resignation
      Letter, dated as of April 8, 2009, from Harold Krisbergh to WorldGate
      Communications, Inc. (Incorporated by reference to Exhibit 10.5 of
      our Quarterly Report on Form 10-Q for the fiscal quarter ended June
      30, 2009, filed with the SEC on August 14, 2009) †10.28
              
              Resignation
      Letter, dated as of April 8, 2009, from Randall J. Gort to WorldGate
      Communications, Inc. (Incorporated by reference to Exhibit 10.6 of
      our Quarterly Report on Form 10-Q for the fiscal quarter ended June
      30, 2009, filed with the SEC on August 14, 2009) †10.29
              
              Resignation
      Letter, dated as of May 15, 2009, from James McLoughlin to WorldGate
      Communications, Inc. (Incorporated by reference to Exhibit 10.7 of
      our Quarterly Report on Form 10-Q for the fiscal quarter ended June
      30, 2009, filed with the SEC on August 14, 2009) †10.30
              
              Subscription
      Agreement, dated September 24, 2007, between the Company and Antonio
      Tomasello (Incorporated by reference to Exhibit 10.16 of our Annual
      Report on Form 10-K for the fiscal year ended December 31, 2007,
      filed with the SEC on April 17,
2008)




64




10.31
              
              Amended
      and Restated Securities Purchase Agreement, dated as of December 4, 2003,
      among the Company and the Purchasers (as defined therein) (Incorporated by
      reference to Exhibit 99.1 to our Current Report on Form 8-K filed
      with the SEC on December 4, 2003)10.32
              
              Securities
      Purchase Agreement, dated as of January 20, 2004, among the Company and
      the Purchasers (as defined therein) (Incorporated by reference to Exhibit
      99.1 to our Current Report on Form 8-K filed with the SEC on January
      21, 2004)10.33
              
              Securities
      Purchase Agreement, dated as of June 24, 2004, by and between the Company
      and the Investors (as defined therein) (Incorporated by reference to
      Exhibit 99.1 to our Current Report on Form 8-K filed with the SEC on
      June 25, 2004)10.34
              
              Securities
      Purchase Agreement, dated as of August 11, 2006, by and among the Company
      and Cornell Capital Partners, LP (Incorporated by reference to
      Exhibit 4.1 of our Quarterly Report on Form 10-Q for the fiscal
      quarter ended June 30, 2006, filed with the SEC on August 14,
      2006)10.35
              
              Securities
      Purchase Agreement, dated as of August 3, 2005, among the Company and the
      Investors (as defined therein) (Incorporated by reference to Exhibit 99.1
      to our Current Report on Form 8-K filed with the SEC on August 8,
      2005)10.36
              
              Voting
      Agreement among the Company, Antonio Tomasello and David Tomasello
      (Incorporated by reference to Exhibit 99.5 to our Current Report on
      Form 8-K filed with the SEC on May 24, 2007)21
              
              Subsidiaries*23.1
              
              Consent
      of Marcum  LLP*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





†Management
contract or compensatory plan or arrangement required to be filed or
incorporated as an exhibit.


65


FINANCIAL
STATEMENTS





WORLDGATE
COMMUNICATIONS, INC.





Report
      of Marcum LLP, Independent Registered Public Accounting
    Firm
                  F-2Consolidated
      Balance Sheets as of December 31, 2009 and 2008
                  F-3Consolidated
      Statements of Operations for the years ended December 31,
      2009,  and 2008
                  F-4Consolidated
      Statements of Stockholders’ Deficiency for the years ended
      December 31, 2009  and 2008
                  F-5Consolidated
      Statements of Cash Flows for the years ended December 31, 2009 and
      2008
                  F-6Notes
      to Consolidated Financial Statements
                  F-7




F-1




Report of Independent Registered
Public Accounting Firm




To the Audit Committee of the
Board of Directors and Stockholders


WorldGate
Communications, Inc.




We have
audited the accompanying consolidated balance sheets of WorldGate
Communications, Inc. and Subsidiaries (the “Company”) as of December 31,
2009 and 2008, and the related consolidated statements of operations,
stockholders’ deficiency and cash flows for the years then
ended.  These consolidated financial statements are the responsibility
of the Company’s management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.




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




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of WorldGate
Communications, Inc. and its subsidiaries as of December 31, 2009 and 2008
and the consolidated results of its operations and its cash flows for the years
then ended, in conformity with accounting principles generally accepted in the
United States of America.
  As
discussed in Note 3 to the consolidated financial statements the Company changed
its method of accounting for warrants in accordance with Financial Accounting
Standards Board’s Accounting Standards Codification Sub Topic 815-40 “Contracts
in Entity’s Own Stock” effective January 1, 2009.


/s/
Marcum LLP


Marcum
LLP


Melville,
New York


March 31,
2010




F-2


WORLDGATE
COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


(DOLLARS
IN THOUSANDS, EXCEPT SHARE AMOUNTS)




As of December 31,2009
                        
                        
                        2008ASSETSCurrent
      assets:Cash
      and cash equivalents
                        
                        $
                        578
                        
                        
                        $
                        429Trade
      accounts receivable less allowance for doubtful accounts of $42 at
      December 31, 2009 and $0 at December 31, 2008
                        
                        
                        24
                        
                        
                        
                        1,019Inventory,  net
                        
                        
                        763
                        
                        
                        
                        1,176Prepaid
      and other current assets
                        
                        
                        296
                        
                        
                        
                        161Total
      current assets
                        
                        
                        1,661
                        
                        
                        
                        2,785Property
      and equipment, net
                        
                        
                        739
                        
                        
                        
                        234Deposits
      and other assets
                        
                        
                        —
                        
                        
                        
                        66Total
      assets
                        
                        $
                        2,400
                        
                        
                        $
                        3,085LIABILITIES
      AND STOCKHOLDERS’ DEFICIENCYCurrent
      liabilities:Accounts
      payable
                        
                        $
                        535
                        
                        
                        $
                        1,750Due
      to related parties
                        
                        
                        262
                        
                        
                        
                        0Accrued
      expenses
                        
                        
                        409
                        
                        
                        
                        1,420Accrued
      compensation and benefits
                        
                        
                        100
                        
                        
                        
                        173Accrued
      severance
                        
                        
                        232
                        
                        
                        
                        0Detachable
      warrants
                        
                        
                        —
                        
                        
                        
                        4,360Warranty
      reserve
                        
                        
                        15
                        
                        
                        
                        17Deferred
      revenues and income
                        
                        
                        1,460
                        
                        
                        
                        1,762Note
      payable
                        
                        
                        22
                        
                        
                        
                        —Convertible
      debenture payable (net of unamortized discount of $0 and
      $2,287,  at December 31, 2009 and 2008
    respectively)
                        
                        
                        -
                        
                        
                        
                        1,793Total
      current liabilities
                        
                        
                        3,035
                        
                        
                        
                        11,275Long
      term liabilities:Revolving
      Loan, with related party
                        
                        
                        1,400
                        
                        
                        
                        -Total  liabilities
                        
                        
                        4,435
                        
                        
                        
                        11,275Commitments
      and contingenciesStockholders’
      deficiency:Preferred
      Stock, $.01 par value, 13,500,000 shares authorized, and 0 shares issued
      December 31, 2009 and 2008
                        
                        
                        -
                        
                        
                        
                        -Common
      Stock, $.01 par value; 700,000,000 and 200,000,000 shares authorized at
      December 31, 2009 and  2008, respectively; and 337,947,088 and
      118,906,345 shares issued and outstanding at December 31,
      2009  and  2008, respectively
                        
                        
                        3,380
                        
                        
                        
                        1,189Additional
      paid-in capital
                        
                        
                        270,330
                        
                        
                        
                        261,478Accumulated
      deficit
                        
                        
                        (275,745
                        )
                        
                        
                        (270,857
                        )Total
      stockholders’ deficiency
                        
                        
                        (2,035
                        )
                        
                        
                        (8,190
                        )Total
      liabilities and stockholders’ deficiency
                        
                        $
                        2,400
                        
                        
                        $
                        3,085





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


F-3


WORLDGATE
COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(DOLLARS
IN THOUSANDS,  EXCEPT PER SHARE AMOUNTS)




Year EndedDecember 31,2009
                    
                    
                    Year EndedDecember 31,2008Net
      revenues
                    
                    $
                    1,778
                    
                    
                    $
                    2,969Cost
      of revenues
                    
                    
                    1,414
                    
                    
                    
                    1,899Gross
      profit
                    
                    
                    364
                    
                    
                    
                    1,070Expenses
      from operations:Engineering
      and development (excluding depreciation and amortization amounts of $186,
      and $58, respectively)
                    
                    
                    2,693
                    
                    
                    
                    1,807Operations(excluding
      depreciation and amortization amounts of $92 and $126,
      respectively)
                    
                    
                    675
                    
                    
                    
                    647Sales
      and marketing (excluding depreciation and amortization amounts of $1 and
      $11, respectively)
                    
                    
                    638
                    
                    
                    
                    363General
      and administrative (excluding depreciation and amortization amounts of $23
      and $71, respectively)
                    
                    
                    4,215
                    
                    
                    
                    3,526Depreciation
      and amortization
                    
                    
                    302
                    
                    
                    
                    266Total
      expenses from operations
                    
                    
                    8,523
                    
                    
                    
                    6,609Loss
      from operations
                    
                    
                    (8,159
                    )
                    
                    
                    (5,539
                    )Other
      income (expense):Interest
      and other income
                    
                    
                    228
                    
                    
                    
                    51Change
      in fair value of derivative warrants and conversion
options
                    
                    
                    4,252
                    
                    
                    
                    (4,124
                    )Income
      from service fee contract termination
                    
                    
                    395
                    
                    
                    
                    3,165Amortization
      of debt discount
                    
                    
                    (2,918
                    )
                    
                    
                    (2,212
                    )Loss
      on equipment disposal
                    
                    
                    (12
                    )
                    
                    
                    (295
                    )Interest
      and other expense (includes interest expense of $14 and $0, respectively,
      with a related party for the years ended December 31, 2009 and
      2008)
                    
                    
                    (122
                    )
                    
                    
                    (328
                    )Total
      other income (expense)
                    
                    
                    1,823
                    
                    
                    
                    (3,743
                    )Net
      loss
                    
                    
                    (6,336
                    )
                    
                    
                    (9,282
                    )Net
      loss per common share (Basic and Diluted)
                    
                    $
                    (0.02
                    )
                    
                    $
                    (0.13
                    )Weighted
      average common shares outstanding (Basic and Diluted)
                    
                    
                    285,035,357
                    
                    
                    
                    71,175,379





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


F-4


WORLDGATE COMMUNICATIONS, INC.AND SUBSIDIARIES




CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ DEFICIENCY


(DOLLARS
AND SHARES IN THOUSANDS)





Common
      Stock
                      
                      
                      Additional
      Paid-
                      
                      
                      Accumulated
                      
                      
                      Total
      Stock
                        holders’Shares
                      
                      
                      Amount
                      
                      
                      In
      Capital
                      
                      
                      Deficit
                      
                      
                      DeficiencyBalance
      at January 1, 2008
                      
                      
                      56,940
                      
                      
                      $
                      569
                      
                      
                      $
                      259,544
                      
                      
                      $
                      (261,575
                      )
                      
                      $
                      (1,462
                      )Issuance
      of Common Stock pursuant to employee stock purchase plan
                      
                      
                      8
                      
                      
                      
                      -
                      
                      
                      
                      1
                      
                      
                      
                      -
                      
                      
                      
                      1Issuance
      of Common Stock upon conversion of convertible debenture
                      
                      
                      61,958
                      
                      
                      
                      620
                      
                      
                      
                      1,301
                      
                      
                      
                      -
                      
                      
                      
                      1,921Non-cash
      stock based compensation
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      632
                      
                      
                      
                      -
                      
                      
                      
                      632Net
      Loss
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (9,282
                      )
                      
                      
                      (9,282
                      )Balance
      at December 31, 2008
                      
                      
                      118,906
                      
                      
                      
                      1,189
                      
                      
                      
                      261,478
                      
                      
                      
                      (270,857
                      )
                      
                      
                      (8,190
                      )Cumulative
      effect of a change in Accounting principle (See Note 3)
                      
                      
                      —
                      
                      
                      
                      -
                      
                      
                      
                      (1,751
                      )
                      
                      
                      1,448
                      
                      
                      
                      (303
                      )Balance
      at January 1, 2009
                      
                      
                      118,906
                      
                      
                      
                      1,189
                      
                      
                      
                      259,727
                      
                      
                      
                      (269,409
                      )
                      
                      
                      (8,493
                      )Issuance
      of Common Stock upon exercise of stock options
                      
                      
                      534
                      
                      
                      
                      5
                      
                      
                      
                      54
                      
                      
                      
                      -
                      
                      
                      
                      59Issuance
      of Common Stock upon cancellation of obligation to a
vendor
                      
                      
                      3,200
                      
                      
                      
                      32
                      
                      
                      
                      807
                      
                      
                      
                      -
                      
                      
                      
                      839Issuance
      of Common Stock upon exercise of warrants
                      
                      
                      12,850
                      
                      
                      
                      129
                      
                      
                      
                      3,139
                      
                      
                      
                      -
                      
                      
                      
                      3,268Issuance
      of Common Stock in the WGI transaction
                      
                      
                      202,462
                      
                      
                      
                      2,025
                      
                      
                      
                      (1,325
                      )
                      
                      
                      -
                      
                      
                      
                      700Cancellation
      of convertible debt and Accrued Interest as consideration exchanged in the
      WGI transaction
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      5,923
                      
                      
                      
                      -
                      
                      
                      
                      5,923Cancellation
      of the derivative warrant as consideration exchanged in the WGI
      transaction
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      623
                      
                      
                      
                      -
                      
                      
                      
                      623Reclassification
      of the derivative warrant upon exercise
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      370
                      
                      
                      
                      -
                      
                      
                      
                      370Non-cash
      stock based compensation
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      
                      1,012
                      
                      
                      
                      
                      
                      
                      
                      1,012Adjustment
      for roundings
                      
                      
                      (5
                      )
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -Net
      Loss
                      
                      
                      —
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (6,336
                      )
                      
                      
                      (6,336
                      )Balance
      at December 31, 2009
                      
                      
                      337,947
                      
                      
                      $
                      3,380
                      
                      
                      $
                      270,330
                      
                      
                      $
                      (275,745
                      )
                      
                      $
                      (2,035
                      )





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


F-5


WORLDGATE
COMMUNICATIONS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(DOLLARS
IN THOUSANDS)





YearEnded December31,
                  2009
                
                
                YearEnded December31,
                  2008Cash
      flows from operating activities:Net
      loss
                
                $
                (6,336
                )
                
                $
                (9,282
                )Adjustments
      to reconcile net loss to cash used in operating
activities:Depreciation
      and amortization
                
                
                302
                
                
                
                266Amortization
      of debt discount
                
                
                2,918
                
                
                
                2,212Change
      in fair value of derivative warrants and conversion
options
                
                
                (4,252
                )
                
                
                4,124Loss
      on disposal of fixed assets
                
                
                12
                
                
                
                295Inventory
      reserve
                
                
                787
                
                
                
                -Non-cash
      stock based compensation
                
                
                1,012
                
                
                
                632Bad
      debt expense
                
                
                42
                
                
                
                -Changes
      in operating assets and liabilities:Trade
      accounts receivable
                
                
                114
                
                
                
                (853
                )Other
      receivables
                
                
                (14
                )
                
                
                5Inventory
                
                
                (374
                )
                
                
                (119
                )Prepaid
      and other current assets
                
                
                (121
                )
                
                
                26Deposits
      and other assets
                
                
                66
                
                
                
                55Accounts
      payable
                
                
                (671
                )
                
                
                1,003Due
      to a related party
                
                
                262
                
                
                
                0Accrued
      expenses and other current liabilities
                
                
                35
                
                
                
                (596
                )Accrued
      severance
                
                
                232
                
                
                
                -Accrued
      compensation and benefits
                
                
                (73
                )
                
                
                99Warranty
      reserve
                
                
                (2
                )
                
                
                (32
                )Deferred
      revenue and income
                
                
                536
                
                
                
                1,510Net
      cash used in operating activities
                
                
                (5,525
                )
                
                
                (655
                )Cash
      flows from investing activities:Capital
      expenditures
                
                
                (536
                )
                
                
                (2
                )Proceeds
      from the sale of property and equipment
                
                
                12
                
                
                
                4Net
      cash (used in) provided by investing activities
                
                
                (524
                )
                
                
                2Cash
      flows from financing activities:Proceeds
      from issuance of common stock
                
                
                4,026
                
                
                
                1Proceeds
      from the issuance of notes
                
                
                836
                
                
                
                -Proceeds
      from revolving loan with related party
                
                
                1,400
                
                
                
                0Repayments
      of notes
                
                
                (64
                )
                
                
                -Net
      cash provided by financing activities
                
                
                6,198
                
                
                
                1Net
      increase (decrease) in cash and cash equivalents
                
                
                149
                
                
                
                (652
                )Cash
      and cash equivalents, beginning of year
                
                
                429
                
                
                
                1,081Cash
      and cash equivalents, end of year
                
                $
                578
                
                
                $
                429




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


F-6


WORLDGATE
COMMUNICATIONS, INC.


NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS


(Dollars
in thousands except per share and per unit amounts)




1. 
Basis of Presentation




The
consolidated financial statements of WorldGate Communications, Inc. (“WorldGate” or the
“Company”)
presented herein have been prepared by the Company pursuant to the rules and
regulations of the Securities and Exchange Commission (“SEC”) for annual
reports on Form 10-K. WorldGate was incorporated in Delaware in 1996 to succeed
to the business of the predecessor company, WorldGate Communications, L.L.C.,
which commenced operations in March 1995.




The
consolidated financial statements of the Company include the accounts of
WorldGate Communications, Inc. and its wholly owned subsidiaries WorldGate
Service, Inc., WorldGate Finance, Inc., Ojo Services LLC, Ojo Video Phone LLC
and WorldGate Acquisition Corp. All significant intercompany accounts and
transactions have been eliminated in consolidation.




The
Company is a provider of digital voice and video phone services and next
generation video phones. The Company designs and develops digital video phones
featuring real-time, two-way video. It also provides a turn-key digital voice
and video communication services platform supplying complete back-end support
services.




The
Company is transitioning from a business model focused primarily on one-time
digital video phone equipment sales to delivering an integrated audio and video
telephony solution. Upon completion of the redevelopment of its video phone
platform, the Company will not only offer a line of consumer video phones but
the Company will also provide a turnkey digital voice and video phone service.




The
Company markets its video phone equipment, communications and support services
through two segments.




Through
its Consumer Services segment, the Company markets its video phone equipment,
bundled with digital voice and video phone service and support, principally to
end user consumers. In the Consumer Services segment, the Company markets to
three principal groups (i) directly to retail consumers through the Internet and
the corporate website (“Direct Retail”), (ii)
through commissioned independent sales agents (“Agency”) and (iii) on
a wholesale basis through established telecommunication providers who will offer
the Company’s video phone bundle as a product extension to their existing
customer base (See Note 13).




Through
its Original Equipment Manufacturer (the “OEM Direct”) segment
the Company distributes its digital video phones directly to telecommunications
service providers who already have a complete digital voice and video management
and network infrastructure, such as incumbent service providers, competitive
local exchange carriers, international telecom service providers and cable
service providers (See Note 13).




2.
Liquidity Considerations




Key Events. During the year
ended December 31, 2009, the Company completed a number of activities that were
significant in providing resources and capital that enabled the Company to
resume pursuit of its business plan.




F-7


On April
6, 2009, the Company 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 the Company and WGI, involving the receipt
of cash, the issuance of warrants, the cancellation of convertible debt and
derivative warrants and resulting in WGI owning approximately 63% of the Company
(See Note 3).




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 Digital Phone Service, LLC (“ACN DPS”), a
subsidiary of ACN, Inc. (“ACN”), pursuant to
which the Company agreed to design and sell video phones to ACN DPS (the “Commercial
Relationship”). As part of the Commercial Relationship, the Company
entered into two agreements with ACN DPS: a Master Purchase Agreement pursuant
to which ACN DPS committed to purchase 300,000 videophones over a two-year
period (the “Master
Purchase Agreement”) and a Software Development and Integration and
Manufacturing Assistance Agreement pursuant to which ACN DPS committed to
provide the Company with $1.2 million to fund associated software development
costs. In connection with the Commercial Relationship, the Company granted ACN
DPS a warrant to purchase up to approximately 38.2 million shares of the
Company’s common stock, par value $0.01 per share (“Common Stock”) at an
exercise price of $0.0425 per share (the “ACN 2009 Warrant”).
The ACN 2009 Warrant vests incrementally based on ACN DPS’s purchases of video
phones under the Commercial Relationship.




On
October 28, 2009, the Company and WGI entered into a Revolving Loan agreement
(See Note 9 and Note 16), which after being amended on March 9, 2010 provides
for borrowings of up to $5,000.




Cash and Cash Flow. As of
December 31, 2009, the Company had cash and cash equivalents of $578. The
Company’s cash used in operations for the year ended December 31, 2009 was
$5,525. 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, (b) the Commercial Relationship with ACN DPS (See Note 3),
(c) the net proceeds from the exercise of certain warrants totaling $3,268 and
(d) $1,400 of funds received under the Revolving Loan contributed to the
generation of funds during the year ended December 31, 2009 and have provided
financing for the on-going operations of the Company.




Liabilities.The Company had
$4,435 of liabilities at December 31, 2009. These liabilities primarily include
$1,422 of the Revolving Loan and notes payable, $1,206 of accounts payable and
accrued expenses, $1,460 of deferred revenues and income, $100 of accrued
compensation and benefits and accrued officer’s compensation and severance of
$232. Substantially all of the Company’s assets were pledged as collateral as of
December 31, 2009 pursuant to the Revolving Loan.




Increase in Executive Compensation.As of December 31, 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 remaining
severance payments to Messrs. Krisbergh, Gort, and McLoughlin, pursuant to their
resignation. The accrued severance compensation for Messrs. Krisbergh, Gort, and
McLoughlin is scheduled to be paid in full by April 7, 2010. As of December 31,
2009, the Company accrued $232 in officer’s compensation and
severance.




Net Losses and Impact on Operations.The Company has incurred recurring net losses and has an accumulated
deficit of $275,745, stockholders’ deficiency of $2,035 and a working capital
deficiency of $1,374.




F-8




Liquidity Plan. The Company’s
ability to generate cash is dependent upon the sale of its product and services,
its 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 the Company’s voice and 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 the Company’s
sales efforts could also have an adverse impact on the Company’s ability to
raise additional financing.




Based on
management’s internal forecasts and assumptions regarding its short term cash
requirements, the increase in and full utilization of the expanded credit line
of the Revolving Loan (See Note 9 and Note 16), the planned completion of the
development of the Company’s new voice and video phone the commencement of
delivery of these new video phones expected in May 2010, the expected placement
of purchase orders for the purchase of units by ACN DPS in accordance with the
ACN Master Purchase Agreement and the accelerated timing for the receipt of
funds from ACN DPS for the purchase of video phones (See Note 3), and the
Company’s current forecast for sales for other products and services, as of
March 2010, the Company believes that it will have sufficient working capital to
support its current operating plans through at least December 31,
2010.




If these
assumptions do not materialize, or do not materialize in the projected timeframe
the Company will need to obtain additional funding through the private or public
issuance of debt or equity securities. The Company continues to evaluate
possibilities to obtain additional financing through public or private equity or
debt offerings, asset securitizations, or from other sources to address the
risks inherent in its plans and to help insure that the Company has the adequate
financial resources in the event the realization of its plan requires additional
time or is faced by additional marketplace challenges.




The
Company continues to focus on the business elements that it believes are
important for its sustainability. The Company continues to explore additional
service and distribution sales opportunities. The Company believes that growing
the Consumer Services segment of its business, which includes a recurring
revenue stream, is an essential element in the long term sustainability of its
operations. In addition, the Company is focused on reducing the cost of its
voice and video phone which it believes facilitates the growth of the Company’s
product and services.




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 additional funds, and its
plans are not achieved in the planned time frame the Company may be required to
reduce the size of the organization which could have a material adverse impact
on its business.




3.
Summary of Significant Accounting Policies




Use
of Estimates




The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities, at the date of
the financial statements and the reported amount of revenues and expenses during
the reporting period. Significant estimates relate to revenue recognition,
accounts receivable, inventory valuation, deferred tax valuation allowances,
deferred revenues, valuation of derivative liabilities and related warrants, and
stock based compensation. Actual results could differ from those
estimates.




F-9


Cash
and Cash Equivalents




The
Company considers all highly liquid investments with original maturities of
three months or less to be cash equivalents.




Accounts
Receivable




The Company records accounts receivable
at the invoiced amount. Management reviews the receivable balances on a monthly
basis. Management analyzes collection trends, payment patterns and general
credit worthiness when evaluating collectability and may require letters of
credit whenever deemed necessary. Additionally, the Company has an allowance for
doubtful accounts based upon factors surrounding the credit risk of specific
customers, historical trends related to past losses and other relevant
information. Account balances are charged off against the allowance after all
means of collection have been exhausted and the potential for recovery is
considered remote. As of December 31, 2009 and 2008, the Company had total trade
receivables of $66, and $1,019, respectively, and an allowance for doubtful
accounts of $42 and $0, respectively. Bad debt expense recorded for the years
ended December 31, 2009 and 2008 was $42 and $0, respectively, and is recorded
in general and administrative expenses.




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 December 31, 2009 and 2008, the Company’s inventory balance was $763
and $1,176, respectively (net of a reserve of $757 and $0, respectively, for
excess and obsolete inventory that is not expected to be utilized in the
continued development of the video phone) and a $30 and $0, respectively, lower
of cost or market adjustment (See Note 4).




Property
and Equipment




Property
and equipment is carried at original cost. Depreciation is recorded on a
straight-line basis over the estimated useful lives of the related assets. The
Company depreciates furniture and fixtures over seven years; office equipment
over five years; and computer equipment and trade show exhibits over three
years. Leasehold improvements are capitalized and amortized on a straight-line
basis over the shorter of their useful life or the term of the lease.
Maintenance and repairs are expensed as incurred. When the property or equipment
is retired or otherwise disposed of, related costs and accumulated depreciation
are removed from the accounts and any resulting gain or loss is included in the
consolidated statement of operations.




Long-lived
Assets




The
Company periodically evaluates the carrying value of long-lived assets when
events and circumstances warrant such review. The carrying value of a long-lived
asset is considered impaired when the anticipated undiscounted cash flows from
such assets are separately identifiable and are less than the carrying value. In
that event, a loss is recognized based on the amount by which the carrying value
exceeds the fair market value of the long-lived asset. Fair market value is
determined by using the anticipated cash flows discounted at a rate commensurate
with the risk involved. Measurement of the impairment, if any, will be based
upon the difference between carrying value and the fair value of the
asset.




F-10


Accounting
for Secured Convertible Debentures and Related Warrants.




General Terms of Convertible
Debentures. On August 11, 2006 and October 13, 2006, the Company issued
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 from
the date of issuance, 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 was payable at maturity, and the Company had the
option 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. The Company recorded interest and accrued
interest expense of $64 and $328 for the years ended December 31, 2009 and 2008,
respectively.




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 terms of the convertible debentures were amended 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 convertible debenture could not be converted 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 would be waived
by the Company unless it elected to pay the holder in cash the difference in
value between 840,000 shares and the number of shares the holder wished 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
convertible debenture could be converted at $1.75 per share without restriction.




In no
case, however, could 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 could 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 that were issuable upon conversion, exercise of the warrants
(described below), payment for commitment shares (described below), and payment
of liquidated damages (described below) was 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.




F-11


The
convertible debentures provided that the Company had the right to redeem all or
any portion of the principal amount of the debentures in cash at any time upon
not less than four business days notice if the closing price of its stock is
less than $1.75 per share. Such early redemption would require the Company to
pay a 10% prepayment premium. In addition, without any prepayment premium, the
Company had the right to force the holder to convert a maximum of $500 of the
aggregate principal amount of the debentures in any thirty day period if for
five consecutive trading days the VWAP of its Common Stock is above $1.925 per
share but less than $3.50 per share and provided the daily trading volume
exceeded 200,000 shares for these five days, and certain other conditions were
met. If the VWAP of Common Stock was greater than $3.50 per share for 30
consecutive trading days, the daily trading volume exceeds 250,000 shares for
five days prior, and if certain other conditions are met, the Company could have
also forced the holder to convert all or any portion of the outstanding
principal and interest into shares of Common Stock without any prepayment
premium.




In
December 2008, WGI acquired all of the outstanding convertible debentures and
the August and October 2006 warrants owned by the initial holder of the
debentures. On December 12, 2008, the Company entered into the Securities
Purchase Agreement with WGI pursuant to which the Company agreed to issue to WGI
an aggregate of 202,462,155 shares of Common Stock and the Anti-Dilution Warrant
(See Note 10) 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 the August and October 2006 warrants held by WGI which closed on
April 6, 2009.




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.




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
year ended December 31, 2009 there were no issuances of Common Stock related to
the debentures. During the year ended December 31, 2008, $1,921 in face value of
the convertible debentures was converted, resulting in the issuance of
61,956,168 shares of Common Stock. The Company waived the 840,000 monthly shares
limitation with respect to these conversions. As a result of the amortization,
$2,918 of the discount on the convertible debenture has been charged to
amortization of debt discount for the year ended December 31, 2009, which
includes the effects of the closing on April 6, 2009 of the transactions
contemplated by the Securities Purchase Agreement. During the year ended
December 31, 2008, $2,212 of the discount on the convertible debenture was
charged to discount amortization. At December 31, 2008, the balances of the
convertible debentures and the offsetting related discount were $4,080 and
$2,287, respectively. As of December 31, 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.




F-12


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




Accounting for Derivative
Instruments.




The
Company accounted 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 in operations. 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.
On June 23, 2009, the Company amended the exercise price and other provisions of
certain Series A warrants to purchase Common Stock of the Company issued June
23, 2004 and certain Series B warrants to purchase Common Stock issued June 23,
2004 (collectively the “2004 Amended
Warrants”) representing rights to purchase 8,771,955 shares of Common
Stock and that would have expired on June 23, 2009. The exercise price of the
2004 Amended Warrants was amended to $0.25 per share of Common Stock and the
expiration date of the 2004 Amended Warrants was amended to August 7, 2009. All
of the 2004 Amended Warrants were exercised as of December 31, 2009. All Series
B Warrants to Purchase Common Stock of the Company issued June 23, 2004 that
were not included in the 2004 Amended Warrants had expired unexercised during
2009.The Company
recognized a total non-cash gain of $4,252 for the year ended December 31, 2009
and a non-cash charge of $4,124 for the year ended December 31, 2008, for these
derivative warrants, based on the following criteria, each of which impact on
the fair value of the derivative, using the Black-Scholes valuation
model.




F-13




June 2004 Private Placement
      WarrantsCriteria
                            
                            December 31, 2009*
                            
                            December 31, 2008Common
      Stock price per share
                            
                            $0.30
      - $0.35
                            
                            $0.38Applicable
      volatility rates
                            
                            68%
      -58%
                            
                            451%Risk-free
      interest rates
                            
                            0.17%
      - 19%
                            
                            0.27%Contractual
      life of instrument
                            
                            0.101
      - 0.063 years
                            
                            0.5
      years





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





The
following table summarizes the derivative instruments (warrants) liability for
the year ended December 31, 2009:




June
      2004 Private
                  Placement
                
                
                August
      & October
                  2006
      Private
                  Placement
                
                
                TotalOutstanding
      liability, December 31, 2008
                
                $
                4,360
                
                
                
                -
                
                
                $
                4,360Cumulative
      effect of the change in accounting principal, January 1,
    2009
                
                
                -
                
                
                $
                885
                
                
                
                885Net
      non-cash gain in fair value
                
                
                (3,990
                )
                
                
                (262
                )
                
                
                (4,252
                )Cancellation
      of warrants April 6, 2009
                
                
                -
                
                
                
                (623
                )
                
                
                (623
                )Reclassification
      to equity upon exercise of warrants during the year ended December 31,
      2009
                
                
                (370
                )
                
                
                -
                
                
                
                (370
                )Outstanding,
      December 31, 2009
                
                $
                0
                
                
                $
                0
                
                
                $
                0




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.




Accounting
for the WGI / ACN DPS transaction




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 received 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, the Company issued to WGI (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 fair value of the
securities issued to WGI was equivalent to the consideration received by the
Company, as value for these elements were the most relevant to the transaction
and clearly determinable compared  to a valuation of the securities
issued by the Company based principally upon the closing price of the Company’s
Common Stock.The
Company has determined that while WGI and ACN share common ownership the WGI
transaction none the less should be reflected as a stand alone equity
transaction valued at approximately $7,199.




F-14


In
addition, in connection with the Commercial Relationship entered into with ACN
DPS on April 6, 2009, the Company granted ACN DPS the ACN 2009 Warrant to
purchase up to approximately 38.2 million shares of Common Stock at an exercise
price of $0.0425 per share.  The ACN 2009 Warrant will vest
incrementally based on ACN DPS’s purchases of videophones under the Commercial
Relationship.  The Company will record a charge for the fair value of the
portion of the ACN 2009 Warrant earned from the point in time when shipments of
units are initiated to ACN DPS through the vesting date. Final determination of
fair value of the ACN 2009 Warrant will occur upon actual vesting. Applicable
accounting guidance requires that the fair value of the ACN 2009 Warrant be
recorded as a reduction of revenue to the extent of cumulative revenue recorded
from ACN DPS.




Revenue
Recognition.





Revenue
is recognized when persuasive evidence of an arrangement exists, the price is
fixed or determinable, the collectability 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
collectability of customer accounts requires significant judgment. The Company
continually evaluates its equipment customers and service customers’ accounts
for collectability at the date of sale and on an ongoing
basis.





The
Company’s revenue is net of any collections of state or municipal taxes, fees or
surcharges on the charges to customers for the products and services that they
purchase (such as sales and use, excise, utility user, and ad valorem taxes),
and net of other applicable charges related to the Company’s voice over Internet
protocol (“VoIP”) offering
(including 911, Telecommunications Relay Services (“TRS”) and Universal
Service Fund (“USF”)
fees).  If the Company is subject to the above taxes, fees and
surcharges, to the extent permitted by law, the Company generally passes such
charges through to its customers.




Revenues
are also offset by a reserve for any price refunds and consumer rebates
consistent with ASC Topic 605-50.




Video Phone Sales.
During the year ended December 31, 2009, the Company did not ship any products
to customers with a right of return.  During the year ended December
31, 2008, the Company shipped 9 units with a sales value of $2 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 products 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 in the OEM Direct segment upon confirmation from Aequus of
the fees earned by the Company.




F-15


On March
31, 2008, the Company entered into a new agreement with Aequus and Snap
Telecommunications Inc. (“Snap!VRS”). This new
agreement provided 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 March 31, 2008
      Agreement are related to multiple deliverables to Aequus that have
      standalone value with objective and reliable evidence of fair value, and
      included 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 were 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 years ended December 31, 2009 and 2008 such
      revenue was $796 and $491, respectively.   The revenue of
      $796 in the year ended December 31, 2009 included $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 year ended December 31, 2009 and 2008, other
      income was recorded for the contract termination fee of $395 and $3,165,
      respectively.  The Company has 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 year ended December 31,
      2009).




·
            Purchase of
      Units.Units purchased per the March 31, 2008 agreement
      with Aequus were 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 Accounting Standards
      Codification (“Codification”
      or “ASC”) 
      Topic 605-10 regarding Bill and Hold Arrangements.  Revenue for
      the units held is recognized as and when the units are shipped to the
      Aequus customers.  For the year ended December 31, 2008, the
      Company shipped $1,740 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 and as a result the Company has no obligation
      to hold any units for Aequus. As of December 31, 2009, Aequus paid for 550
      video phones under the October 8, 2009 Aequus Agreement, and additionally
      purchased 50 more video phones between January 1, 2010 and March 31, 2010.
      The Company is holding these Ojo units purchased by Aequus pending
      shipment to Aequus’ ultimate customers.  The Company is also
      deferring revenue on these units in accordance with ASC Topic 605-10 until
      shipment to the ultimate Aequus customer and at thattime will be included in OEM
      Direct segment revenue.




F-16




ACN DPS Development
Revenues.  On April 6, 2009, the Company entered into a
Software Development and Integration and Manufacturing Assistance Agreement
pursuant to which ACN DPS 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 DPS.  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 in the OEM Direct segment upon completion of the
development in accordance with guidance for accounting for performance of
construction and production type contracts. The Company deferred the revenue
related to this agreement during the year ended December 31,
2009.




Cost of Revenues





Cost of revenues for 2008 and 2009
reflects primarily the cost of products, maintenance and consumer services
relating to the deliveries of product and services to end user customers. The
components and raw materials used in the Company’s Ojo video phone product are
generally available from a multitude of vendors and are sourced based, among
other factors, on reliability, price and availability.





Engineering
and Development Costs





Engineering
and development costs are expensed as incurred. Engineering and development were
$2,693 and $1,807 for the years ended December 31, 2009 and 2008,
respectively.





Advertising
Costs





Advertising
costs, included in sales and marketing expense, are expensed in the period
incurred. Advertising costs were $22 and $79 for the years ended
December 31, 2009 and 2008, respectively.





Income
Taxes




Provision
for income taxes is determined based on the asset and liability method. The
asset and liability method provides that deferred tax balances are recorded
based on the difference between the tax basis of assets and liabilities and
their carrying amounts for financial reporting purposes. Deferred tax
liabilities or assets at the end of each period are determined using the tax
rate enacted under the current tax law. The measurement of net deferred tax
assets is reduced by the amount of any tax benefits that, based on available
evidence, are not expected to be realized, and a corresponding valuation
allowance is established.  The Company has recorded a full valuation
allowance against its net deferred tax assets at December 31, 2009 and 2008 due
to the uncertainty regarding whether the deferred tax asset will be
realized.





The
Company follows 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.




F-17


The
Company has identified its federal tax return and its state tax return in
Pennsylvania as “major” tax jurisdictions, as defined in ASC Topic
740-10.  Based on the Company’s evaluation, it concluded that there
are no significant uncertain tax positions requiring recognition in the
Company’s financial statements as of December 31, 2009 and 2008.  The
Company’s evaluation was performed for tax years ended 2006 through 2009, the
only periods subject to examination.  The Company believes that it is
more likely than not 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 year ended December 31, 2009 and
2008.  The Company does not expect its unrecognized tax benefit
position to change during the next year.  Management is currently
unaware of any issues under review that could result in significant payments,
accruals or material deviations from its position.





The
Company completed its analysis under Section 382 of the Internal Revenue Code
with respect to the limitations on the Company’s net operating loss
carryforwards (“NOL”).  Generally,
Section 382 limits the utilization of an entity’s net operating loss and other
carry forward attributes upon a change of ownership.  Upon completion
of this analysis, it was concluded that it was more likely than not that during
October 2008, the Company experienced a change of ownership and its NOLs are
subject to annual limitation, as defined under Section 382, and as more fully
described in Note 8.  Upon the closing of the transaction with WGI on
April 6, 2009, and WGI acquiring 63% of the post transaction shares of the
Company, the Company concluded that it was more likely than not that the ability
to utilize its remaining net operating loss carryforwards and credit
carryforwards were subject to further annual limitations as a result of current
tax law as defined under Section 382.





Stock-Based
Compensation




The
Company accounts for stock-based compensation utilizing the fair value
recognition method, which requires that all stock based compensation be
recognized as an expense in the financial statements and that such cost be
measured at the fair value of the award.  Under this method, in
addition to reflecting compensation for new share-based awards, expense is also
recognized to reflect the remaining service period of awards that had been
included in pro-forma disclosure in prior periods.  This guidance also
requires that excess tax benefits related to stock option exercises be reflected
as financing cash inflows instead of operating inflows.  As a result,
the Company’s net loss before taxes for the years ended December 31, 2009 and
2008 included approximately $1,012 and $632, of stock based compensation. The
stock based compensation expense is included in general and administrative
expense in the 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.




F-18


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 stockholders by the weighted average number of common shares outstanding
for the period.  Basic weighted average shares outstanding include
22,788,098 WGI Anti-Dilution Warrants that are exercisable at a nominal amount
($0.01 per share).  Diluted EPS includes under the “treasury stock”
and “if converted” methods 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.




Potential
common shares excluded from net loss per share computation were 167,917,015 and
27,237,092 for the years ended December 31, 2009 and 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.




Fair
Value of Financial Instruments




The Company’s financial instruments
consist primarily of cash and cash equivalents, embedded and free standing
derivatives, accounts receivable and accounts payable. The book value of cash
and cash equivalents, accounts receivable, and accounts payable is considered to
be representative of their fair value because of their short term
maturities.   The carrying value of the Convertible Debentures
Payable on the balance sheet as of December 31, 2008 approximates fair value as
terms approximate those currently available for similar
instruments.  Free standing warrant derivative liabilities on the
balance sheet at December 31, 2008 are measured at fair value using the
Black Scholes
model.





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:




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;
 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 did not have any assets or liabilities categorized as Level 1 or Level 2
as of December 31, 2009.





The
following is a reconciliation of the beginning and ending balances for the
Company’s liabilities measured at fair value on a recurring basis using
significant unobservable inputs (Level 3) during the years ended December 31,
2009 and 2008:




F-19


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





Description
                      
                      DerivativesLiabilities:Balance,
      January 1, 2008
                      
                      $
                      236Total
      change in fair value included in operations
                      
                      
                      4,124Balance,
      December 31, 2008
                      
                      
                      4,360Cumulative
      effect of the change in accounting Principal, January 1,
    2009
                      
                      
                      885Cancelation
      of warrants April 6, 2009
                      
                      
                      (623
                      )Exercise
      of warrants during the year ended December 31, 2009
                      
                      
                      (370
                      )Total
      gain in fair value included in operations
                      
                      
                      (4,252
                      )Balance,
      December 31, 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 statements of operations




Concentration
of Credit and Business Risk




Financial
instruments that potentially subject the Company to a concentration of credit
risk principally consist of cash and cash equivalents and accounts
receivable.  As part of its cash management process, the Company
performs periodic evaluation of the relative credit standing of these
institutions.  At times, the Company’s cash and cash equivalents may
be uninsured or in deposit accounts that exceed the Federal Deposit Insurance
Corporation insurance limit.  At December 31, 2009, all of the Company’s
cash was held at one financial institution.





In 2009
and 2008, accounts receivable primarily consisted of receivables from the sales
of its video phone service, and from the sale of video phones to retailers,
distributors, service providers and from its web site.  As a result of
the creditworthiness and payment history related to these sales, there was an
allowance for potential credit losses of $42 and $0 respectively, as of December
31, 2009 and 2008.





Sales to
major customers, in excess of 10% of total revenues and accounts receivable,
were as follows for each of the years ended and as of
December 31:




Customer
                      
                      
                      Sales
                      
                      
                      Accounts Receivable2009
                      
                      
                      2008
                      
                      
                      2009
                      
                      
                      2008A
                      
                      
                      
                      47
                      %
                      
                      
                      82
                      %
                      
                      
                      0
                      %
                      
                      
                      96
                      %B
                      
                      
                      
                      31
                      %
                      
                      
                      0
                      %
                      
                      
                      0
                      %
                      
                      
                      0
                      %




As of
December 31, 2009, Kenmec is the sole direct volume manufacturer of video phones
to the Company.  A formal relationship was established with Kenmec in
November 2009.  Kenmec is a Taiwanese manufacturer and distributor of high
performance, high speed data and computer networking products. The
components and raw materials used in the Company’s video phone product are
generally available from a multitude of vendors and are sourced based, among
other factors, on reliability, price and availability.





In
addition, ACN has agreed to provide to the Company the ability to purchase from
time to time the Iris 3000 video phone.  As of December 31, 2009, the
Company purchased $143 of Iris video phones from ACN.




At
December 31, 2009 the Company had long-lived assets, with a net book value
total of $707, located in the United States, and $32 located in Taiwan,
R.O.C.  At December 31, 2008, the Company had long-lived assets, with
a net book value total of $152, located in the United States, and $82 located in
Taiwan, R.O.C.




F-20




Recent
Accounting Pronouncements





The
Financial Accounting Standards Board (“FASB”), in June 2009,
issued new accounting guidance that established the FASB ASC as the single
source of authoritative GAAP to be applied by nongovernmental entities,
except for the rules and interpretive releases of the SEC under authority
of federal securities laws, which are sources of authoritative 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 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.  Upon adoption of this guidance on
January 1, 2009, the Company 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 recorded the fair
value of these instruments and the resulting cumulative effect of this change in
accounting method, as of January 1, 2009.





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
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 and
results of operations.


F-21





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.





4.   Inventory





The
Company reflects inventory at the lower of cost or market and reduced its
inventory by $30 and $0, respectively, for the years ended December 31, 2009 and
2008 to reflect such valuation.  Included in the inventory balance
reported on the balance sheet as of December 31, 2009 and 2008 is $178 and $745,
respectively, for units purchased in a “Bill and Hold” arrangement by
Aequus.  As of December 31, 2009 and 2008, the Company’s inventory
balance was net of a reserve of $757 and $0, respectively, for excess and
obsolete inventory that is not expected to be utilized in the continued
development of the video phone.





5.  Property
and Equipment





Property
and equipment consist of the following at December 31, 2009 and
2008:





2009
                    
                    
                    2008Computer
      equipment and system packages
                    
                    $
                    792
                    
                    
                    $
                    778Furniture
      and fixtures
                    
                    
                    426
                    
                    
                    
                    495Hardware,
      software and tooling
                    
                    
                    1,983
                    
                    
                    
                    1,188Leasehold
      improvements
                    
                    
                    40
                    
                    
                    
                    45Sub-Total
                    
                    
                    3,241
                    
                    
                    
                    2,506Accumulated
      depreciation and amortization
                    
                    
                    (2,502
                    )
                    
                    
                    (2,272
                    )Property
      and equipment, net
                    
                    $
                    739
                    
                    
                    $
                    234





Depreciation
and amortization on property and equipment in the amount of $302 and $266 was
recorded for the years ended December 31, 2009 and 2008,
respectively.





During the year ended December 31,
2008, certain equipment, furniture and fixtures were sold and disposed of during
the Company’s move to a smaller facility. The net loss realized during the years
ended December 31, 2009 and 2008 was $12 and $295, respectively.





6.   Accrued
Expenses





The
Company’s accrued expenses consisted of the following as of December 31, 2009
and 2008:


F-22




2009
                      
                      
                      2008Interest
      on Notes
                      
                      $
                      10
                      
                      
                      $
                      0Interest
      on Convertible Debt
                      
                      
                      0
                      
                      
                      
                      978Contingent
      penalties
                      
                      
                      157
                      
                      
                      
                      157Board
      fees
                      
                      
                      94
                      
                      
                      
                      94Taxes
                      
                      
                      33
                      
                      
                      
                      0Other
                      
                      
                      115
                      
                      
                      
                      191Total
                      
                      $
                      409
                      
                      
                      $
                      1,420




7. 
Warranty Reserve




The
Company provides a warranty covering defects arising from the sales of its video
phone product. This warranty is limited to a specific time period. As of
December 31, 2009 and 2008, the Company had a reserve of $15 and $17,
respectively, based on expected and historical loss rates as a percentage of
product sales.  Warranty costs are charged to cost of revenues when
they are probable and reasonably estimable. While the Company believes its
estimate at December 31, 2009 is reasonable and adequate, it is subject to
change based on its future sales and experience, which may require an increase
or decrease in its reserve.





During
the years ended December 31, 2009 and 2008, the Company reduced its warranty
reserve by $2 and $32, respectively.  The adjustment in 2009 and 2008
reflects warranty claims of $0 and $5, respectively, increases of $15 and $32,
respectively, for additional warranty costs from increased product sales and $17
and $49, respectively, for expired warranties based on the term of warranty
issued.





8.  Income
Taxes


The
significant components of the net deferred tax assets and liabilities as of
December 31, 2009 and 2008 are as follows:





2009
                
                
                2008Current
      Deferred Tax AssetsOfficer
      compensation accrued expense and other
                
                $
                2,538
                
                
                $
                1,938Inventory
                
                
                550
                
                
                
                449Total
      current deferred tax assets
                
                
                3,088
                
                
                
                2,387Valuation
      allowance
                
                
                (3,088
                )
                
                
                (2,387
                )Net
      current deferred tax assets
                
                $
                0
                
                
                $
                0Non
      Current Tax AssetsFederal
      tax loss carryforward
                
                $
                3,188
                
                
                $
                2,434State
      tax loss carryforward
                
                
                609
                
                
                
                715Property
      and equipment
                
                
                724
                
                
                
                677Research
      and experimentation credits
                
                
                175
                
                
                
                144Total
      deferred tax assets
                
                
                4,696
                
                
                
                3,970Valuation
      allowance
                
                
                (4,696
                )
                
                
                (3,970
                )Net
      non current deferred tax assets
                
                $
                0
                
                
                $
                0Net
      Deferred Tax Asset
                
                $
                0
                
                
                $
                0





F-23


The change in the valuation allowance
for deferred tax assets are summarized as follows:





2009
                      
                      
                      2008Beginning
      balance
                      
                      $
                      6,357
                      
                      
                      $
                      90,890Change
      in allowance
                      
                      
                      1,427
                      
                      
                      
                      (84,533
                      )Ending
      balance
                      
                      $
                      7,784
                      
                      
                      $
                      6,357





The
change in the valuation allowance for the year end 2008 is primarily
attributable to the Section 382 change in control and net operating loss and
credits unavailable subsequent to the change.





The
following table is a reconciliation of the provision to loss on continuing
operations computed at the U.S. Federal statutory tax rate:





2009
                
                
                2008Tax
      provision at federal statutory rate
                
                
                (34.00
                )%
                
                
                (34.00
                )%Change
      in valuation allowance for deferred tax
                
                
                40.95
                %
                
                
                11.00
                %Change
      in fair value of derivative warrants
                
                
                (22.83
                )%
                
                
                15.10
                %Debt
      discount
                
                
                15.67
                %
                
                
                8.10
                %Other
                
                
                0.21
                %
                
                
                (0.20
                )%Total
                
                
                0.00
                %
                
                
                0.00
                %





October 2008 Change of
Ownership.  Upon completing an initial analysis as required by
the Internal Revenue Code (“IRC”) Section 382, it
was concluded 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
$237,440.  Due to the annual limitations imposed by Section 382, the
Company will be unable to utilize approximately $234,951 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
Ownership.  Upon completing an initial analysis as required by
IRC Section 382, it was preliminarily concluded 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 has
experienced a second change of ownership as defined in Section
382.  As a result of the 2009 change, the limitation preliminarily
attributable to the 2008 change of ownership of approximately $124 annually may
remain in place limiting approximately $2,489 of NOL.  Further, as a
result of the April 2009 change of ownership the loss attributable to operations
after the October 2008 change of ownership and prior to April 2009 change of
ownership of approximately $2,921 may be fully available without
limitation.





Post April
2009.  Any losses incurred after the April 2009 change of
ownership would not be limited assuming that the Company does not experience any
additional changes of ownership.




The state
net operating loss that may be lost due to IRC Section 382 limitations is
approximately $187,356 resulting in approximately $2,489 remaining to be carried
forward.  The state net operating losses may also be limited by state
law and subject to maximum utilization limits.


F-24


The
federal research and experimentation credit (R&E), which provides tax
credits for certain R&E efforts, may also be subject to an annual limitation
as a result of the change of ownership.  Due to the limitation
pursuant to Section 383, all but approximately $25 of the R&E credit was
lost in October 2008.  The remaining federal R&E credits will
expire in 2028 and 2029.  All state research and experimentation
credit carryovers have been refunded and no state credit remains.





Preliminary
results of the Company’s net operating loss and R&D credit carryforwards
related to changes of ownership noted above are expressed within the table
below:





NetOperatingLoss
                  Carryforward
                
                
                R&D
                  CreditFederal
                
                
                State
                
                
                FederalNOL
      and credit prior to October 2008 change of ownership
                
                $
                237,440
                
                
                $
                189,846
                
                
                $
                4,112Unavailable
      losses/credit as a result of the October 2008 change of
      ownership
                
                
                (234,951
                )
                
                
                (187,357
                )
                
                
                (4,112
                )Loss/credit
      Available after October 2008 change of ownership
                
                
                2,489
                
                
                
                2,489
                
                
                
                -NOL/Credit
      attributable to period post the October 2008 change of ownership
      and  prior to the change of ownership in April
      2009
                
                
                2,921
                
                
                
                2,921
                
                
                
                25NOL/credit
      attributable to period post April 2009 change of ownership and prior to
      December 31, 2009
                
                
                3,965
                
                
                
                3,965
                
                
                
                150Total  NOL/credits
      as of December 31, 2009
                
                $
                9,375
                
                
                $
                9,375
                
                
                $
                175




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.




The
remaining carryforwards may be applied as a reduction to future taxable income
of the Company, if any, subject to annual limitations to the pre-change
losses.  The state net operating losses are also limited by state law
to a maximum utilization of $2,000 per year per entity for losses generated
prior to and during 2006 and $3,000 per entity for losses generated during or
after 2007.





9.
Debt





Revolving Loan and Security Agreement
with WGI.  On October 28, 2009, the Company entered into the
Revolving Loan and Security Agreement (the “Revolving Loan”) with
WGI, pursuant to which WGI provided the Company a line of credit in a principal
amount of $3,000.   Pursuant to the Revolving Loan and the
Revolving Promissory Note, WGI agreed to lend from time to time, as requested by
the Company amounts up to $3,000.  Interest accrues on any loan
advances at the rate of 10% per annum.  Interest is payable beginning
June 1, 2010 and monthly thereafter and any principal amount 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 substantially
all the assets of the Company and the Company made customary representations and
covenants to WGI.   Any loan advance requires the satisfaction of
customary borrowing conditions.  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.  As of
December 31, 2009, the Company received aggregate advances under the Revolving
Loan of $1,400.  See Note 16 for information regarding an amendment to
the Revolving Loan entered into by the Company in 2010.


F-25





10. 
Stockholders’ Equity





Common
Stock




On
March 20, 2009, the Company received stockholder approval to increase the
authorized common shares from 200,000,000 to 700,000,000.




Preferred
Stock




The
Company has the authority to issue from time to time up to an aggregate of
13,500,000 shares of preferred stock in one or more classes or series and to
determine the designation and the number of shares of any class or series as
well as the voting rights, preferences, limitations and special rights, if any,
of the shares of any class or series.  At December 31, 2009 and
2008 there was no preferred stock outstanding.




Warrants


.


June 2004 Private
Placement.  In connection with the June 2004 private
placement, the Company issued warrants to purchase up to 803,190 shares of
Common Stock at an exercise price of $2.69 per share and warrants to purchase up
to 803,190 shares of Common Stock at an exercise price of $3.14 per share. Each
of these warrants had an expiration date of June 23, 2009.  The
investors also received an additional investment right, for a limited period of
time, to purchase 1,606,383 additional shares of Common Stock at $3.14 per
share. This exercise price of the warrants was subject to adjustment if, at any
time after the date the warrants were issued, the Company issued or sold, or was
deemed to have issued or sold, any shares of Common Stock for per share
consideration less than the exercise price of the warrants on the date of such
issuance or sale.   As of December 31, 2006, 125,000 warrants
exercisable at $2.69 had been exercised and 51,915 warrants exercisable at $3.14
had been exercised.  All of the additional investment rights had been
exercised as of December 31, 2006.  Pursuant to anti-dilution
provisions triggered by the issuance of convertible debentures and warrants in
August 2006 and October 2006 and as a result of the conversion price related to
those issuances, (1) the $2.69 warrants were modified to an exercise price of
$0.31 as of December 31, 2008 and the number of outstanding warrants were
increased by 5,227,287 to an aggregate of 5,905,477 and (2) the $3.14 warrants
were also modified to an exercise price of $0.33 as of December 31, 2008 and the
number of outstanding warrants were increased by 6,164,765 to an aggregate of
6,916,040.  On June 23, 2009, the Company amended the exercise price
and other provisions of the 2004 Amended Warrants (See Note 3) 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
Amended Warrants was amended to $0.25 per share of Common Stock and the
expiration date of the 2004 Amended Warrants was amended to August 7,
2009.  All of the 2004 Amended Warrants were exercised as of December
31, 2009.  All Series B Warrants to Purchase Common Stock issued June
23, 2004 that were not included in the 2004 Amended Warrants expired unexercised
during 2009.


F-26





August 2005 Private Transaction.In connection with the August 2005 private placement, the Company
issued five-year warrants to purchase a total of 1,671,947 shares of Common
Stock, consisting of (1) 1,633,333 shares to the investors at an exercise price
of $5.00 per share, and (2) 38,614 shares to the placement agent at an exercise
price of $4.53 per share.  On June 23, 2009, the Company amended the
exercise price and other provisions of certain these warrants (collectively, the
“2005 Amended
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 Amended Warrants was amended to $0.25 per share of Common
Stock in return for the holder immediately exercising the warrant.  As
of December 31, 2009 all of the 2005 Amended Warrants had been
exercised.  As of December 31, 2009, 879,359 of the August 2005
warrants that were not amended remained outstanding.





August and October 2006 Private
Placement.On August 11, 2006, the Company completed a private
placement of a convertible debenture in the aggregate principal amount of
$11,000.  As part of this private placement, the Company issued
five-year warrants to purchase a total of 2,595,000 shares of  Common
Stock, with 1,145,000 of the warrants having an exercise price of $1.85 per
share, 1,100,000 of the shares having an exercise price of $2.35 per share and
350,000 warrants having an exercise price of $2.60 per share (with 190,909 of
these warrants issued at the initial closing and 159,091 warrants issued at the
closing of the second tranche of funding on October 13, 2006).  These
warrants were cancelled as part of the transaction completed with WGI on April
6, 2009.





September 2007 Private
Placement.On September 24, 2007, the Company completed a
private placement of Common Stock in the principal amount of $1,000.  As
part of the private placement, the Company issued 2,564,102 shares of Common
Stock and warrants to purchase a total of 2,564,102 shares of Common Stock, with
an exercise price of $0.485 per share. The exercise price of these warrants
were amended 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 these 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
cash proceeds.




April 2009 WGI and ACN DPS
Transaction. On April 6, 2009, the Company completed a private placement
of securities to WGI pursuant to the terms of the Securities Purchase Agreement
(See Note 3).  In connection with the transaction, the Company issued
to WGI a warrant to purchase up to approximately 140.0 million shares of Common
Stock in certain circumstances (the “Anti-Dilution
Warrant”).  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 2009 Warrant (See Note 3).  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 of the Existing
Contingent Equity, the Future Contingent Equity or the ACN 2009
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 2009 Warrant.




The
following table summarizes, as of December 31, 2009, each contingent equity
category under the Anti-Dilution Warrant and the exercisability of the
Anti-Dilution Warrant.


F-27




Shares Under Contingent Equity CategoriesAs of December 31, 2009Contingent Equity
                          Categories
                        
                        Issuable as
                          of April 6,
                          2009
                        
                        
                        Terminated
                          or Expired
                          Shares
                        
                        
                        Shares Not
                          Exercisable
                        
                        
                        Shares
                          Exercisable
                        
                        
                        Total Shares
                          Issuable
                          (Exercisable and
                          Non-Exercisable)Existing
      Contingent Equity
                        
                        
                        24,318,869
                        
                        
                        
                        5,982,147
                        
                        
                        
                        5,953,236
                        
                        
                        
                        12,383,486
                        
                        
                        
                        18,336,722Future
      Contingent Equity
                        
                        
                        19,689,182
                        
                        
                        
                        98,639
                        
                        
                        
                        18,590,543
                        
                        
                        
                        1,000,000
                        
                        
                        
                        19,590,543ACN
      2009 Warrant
                        
                        
                        38,219,897
                        
                        
                        
                        0
                        
                        
                        
                        38,219,897
                        
                        
                        
                        0
                        
                        
                        
                        38,219,897Total
      Contingent Equity
                        
                        
                        82,227,948
                        
                        
                        
                        6,080,786
                        
                        
                        
                        62,763,676
                        
                        
                        
                        13,383,486
                        
                        
                        
                        76,147,162Anti-Dilution
      Warrant
                          (Total
      Contingent Equity * 1.7027027)
                        
                        
                        140,009,750
                        
                        
                        
                        10,353,771
                        
                        
                        
                        106,867,881
                        
                        
                        
                        22,788,098
                        
                        
                        
                        129,655,979




Concurrently
with the closing on April 6, 2009 of the transactions contemplated by the
Securities Purchase Agreement, the Company entered into the Commercial
Relationship with ACN DPS pursuant to which the Company granted ACN DPS the ACN
2009 Warrant (see Note 3).




July 2009 Mototech
Transaction.Warrants issued under the July 8, 2009 Mototech
Agreement 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 cash
proceeds).




A summary
of the Company warrant activity for the year ended December 31, 2009, is as
follows:





Warrants
                    
                    
                    Weighted Average
                      Exercise Price
                    
                    
                    Weighted Average
                      Remaining Contract
                      LifeOutstanding,
      January 1, 2009
                    
                    
                    20,146,311
                    
                    
                    $
                    0.96
                    
                    
                    
                    1.26Granted
                    
                    
                    179,229,647
                    
                    
                    
                    0.02Exercised
                    
                    
                    (12,849,389
                    )
                    
                    
                    (0.26
                    )Cancelled
      / Forfeited/ Expired
                    
                    
                    (17,771,334
                    )
                    
                    
                    (0.47
                    )Outstanding,
      December 31, 2009
                    
                    
                    168,755,235
                    
                    
                    $
                    0.04
                    
                    
                    
                    9.22Exercisable,
      December 31, 2009
                    
                    
                    23,667,547





Stock
Option Plan




In
December 1996, the Company adopted the 1996 Stock Option Plan (“1996 Plan”). This
plan provided for the grant of stock options to officers, directors, employees
and consultants. Grants under this plan may consist of options intended to
qualify as incentive stock options (“ISOs”) or
nonqualified stock options that are not intended to so qualify (“NQSOs”). The 1996
Plan originally authorized a maximum of 933,333 shares of Common Stock which was
increased through a series of amendments to 3,200,000 shares in 2000 and
automatic annual increase of shares reserved under the 1996 Plan in an amount
equal to the lesser of 4% of the then outstanding shares of Common Stock or
1,000,000 shares.


F-28




In
May 1999 and May 2000, the Board increased the total number of shares
of Common Stock available under the 1996 Plan to 1,600,000 and 3,200,000 shares,
respectively.  In October 2000, the Company’s stockholders
approved these increases. In February 2001, the Board approved an automatic
annual increase of shares reserved under the 1996 Plan in an amount equal to the
lesser of 4% of the then outstanding shares of Common Stock or 1,000,000 shares.
In October 2001, the Company’s stockholders approved this
increase.





In
October 2004, the Company’s stockholders approved the 2003 Equity Incentive
Plan (“2003
Plan”). This plan replaced the 1996 Plan for new grants. No additional
shares were reserved for the new plan but rather all available shares under the
1996 Plan were made available for the new plan. As with the 1996 Plan, the 2003
Plan includes the same automatic annual increase in the number of shares
reserved for use with the plan equal to the lesser of 4% of the then outstanding
shares of Common Stock or 1,000,000 shares. In addition to ISOs and NQSOs, the
2003 Plan also provides for performance based awards and restricted
stock.





On May
26, 2009, the Company’s Board of Directors approved the terms of Amendment No. 1
(the “Amendment”) to the
2003 Plan.  The Amendment, among other things, increased the maximum
number of shares of Common Stock that may be issued or transferred under the
2003 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 2003 Plan underlying
an option award to 2,000,000 shares.




Both the
1996 Plan and its successor, the 2003 Plan are administered by a committee of
the Board of Directors. The committee determines the term of each award,
provided, however, that the exercise period may not exceed ten years from the
date of grant, and for ISOs, in certain instances, may not exceed five
years.  As of December 31, 2009, there were 2,952,142 shares available
for grant under the 2003 Plan and 21,890,798 options and restricted shares
outstanding.  As of December 31, 2008 there were 2,939,482 shares
available for grant under the 2003 Plan and 6,913,364 options and restricted
shares outstanding.




On July 29, 2008, the
Company’s Board of Directors approved a re-pricing of 3,756,132 stock options,
which represented all outstanding stock options that had been issued to
employees of the Company prior to January 1, 2008.  The new exercise price
was established as the closing price of the Company’s stock on that date, which
was $0.108.   All other terms of the stock options remained the
same.  This re-pricing resulted in the Company recording additional
compensation expense of $133 on July 29, 2008.




Between
May 26, 2009 and December 31, 2009 grants of non-qualified stock options to
purchase an aggregate of 17,018,250 shares of Common Stock were made 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 on the
date of the grants (which was between $0.28 and $0.80 per share based on the
closing price on the OTC Bulletin Board between May 26, 2009 and December 31,
2009), vest in four equal annual installments commencing on the first
anniversary of the date of grant and have a ten year term.





The
weighted-average fair values of the options granted were $0.33 and $0.08 per
option during the years ended December 31, 2009 and 2008, respectively. The
fair value of each option grant is estimated on the date of grant using the
Black-Scholes fair value option valuation model. The following weighted-average
assumptions were used for grants in 2009 and 2008, respectively: expected
volatility of 191.9% and 119.2%; average risk-free interest rates of 2.53% and
3.01%; dividend yield of 0%; and expected lives of 6.3 and 6.2
years.


F-29





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
year ended December 31, 2009 and 2008 included approximately $1,012 and $632,
respectively, of stock based compensation. The stock based compensation expense
is included in general and administrative expense in the 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.




A summary
of the Company’s stock plans is presented below:




Stock Options
                                    
                                    
                                    Weighted-Average
                                      Exercise Price
                                    
                                    
                                    Aggregate Intrinsic
                                      ValueOutstanding,
      January 1, 2009
                                    
                                    
                                    6,080,364
                                    
                                    
                                    $
                                    0.27Granted
                                    
                                    
                                    17,018,250
                                    
                                    
                                    $
                                    0.
      33Exercised
                                    
                                    
                                    (534,096
                                    )
                                    
                                    $
                                    (0.11
                                    )Cancelled/forfeited
                                    
                                    
                                    (922,640
                                    )
                                    
                                    $
                                    (1.73
                                    )Outstanding,
      December 31, 2009
                                    
                                    
                                    21,641,878
                                    
                                    
                                    $
                                    0.26
                                    
                                    
                                    $
                                    8,596,906Exercisable,
      December 31, 2009
                                    
                                    
                                    3,290,288
                                    
                                    
                                    $
                                    0.14
                                    
                                    
                                    $
                                    661,709




As of
December 31, 2009, there was $4,943 of total 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
December 31, 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
                          
                          
                          4,566,386
                          
                          
                          
                          5.89
                          
                          
                          $
                          0.11
                          
                          
                          
                          3,100,671
                          
                          
                          $
                          0.11$0.13
      - $0.39
                          
                          
                          15,340,500
                          
                          
                          
                          9.43
                          
                          
                          
                          0.29
                          
                          
                          
                          125
                          
                          
                          
                          0.23$0.40
      - $0.59
                          
                          
                          185,492
                          
                          
                          
                          3.70
                          
                          
                          
                          0.59
                          
                          
                          
                          185,492
                          
                          
                          
                          0.58$0.60
      - $0.89
                          
                          
                          1,549,500
                          
                          
                          
                          9.80
                          
                          
                          
                          0.73
                          
                          
                          
                          4,000
                          
                          
                          
                          0.59Total
                          
                          
                          21,641,878
                          
                          
                          
                          8.67
                          
                          
                          $
                          0.26
                          
                          
                          
                          3,290,288
                          
                          
                          $
                          0.14





Restricted
Stock Grants





The 2003
Plan provides for performance share grants of restricted shares of Common Stock,
which are bookkeeping entries representing a right to receive a payment in cash,
shares of Common Stock, or a combination thereof as determined by the
Compensation and Stock Option Committee equal to the value of the shares of
Common Stock on achievement of performance criteria.  These awards vest
pursuant to the following performance criteria: (a) 10% of the shares vest upon
achieving each of a 10%, 20%, 30% 40% and 50% increase in our total gross
revenue in a quarter over its third quarter 2007 total gross revenue shown on
its statement of operations as reported in its SEC filings, (b) 25% of the
shares vest upon the Company’s achievement of 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” in
the financial statements filed with SEC) and (c) 25% of the shares vest upon the
Company’s achievement of 10% net income as a percent of
revenue.


F-30





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.




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 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 2009, 525,000 restricted shares
were forfeited by executives whose employment with the Company
ended.  As of December 31, 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 $24 for these grants for the year ended
December 31, 2009.




The
following table is the summary of the Company’s restricted shares as of December
31, 2009.




Restricted SharesNonvested
      as of January 1, 2009
                  
                  
                  833,000Granted
                  
                  
                  0Vested
                  
                  
                  0Cancelled/forfeited
                  
                  
                  (525,000
                  )Nonvested
      as of December 31, 2009
                  
                  
                  308,000





Employee
Stock Purchase Plan




In
October 2001, the Company’s stockholders approved the WorldGate 2001
Employee Stock Purchase Plan that provides eligible participants with the
opportunity to periodically acquire shares of Common Stock through payroll
deductions. Eligible participants may contribute up to fifteen percent of their
compensation towards the purchase of Common Stock. At the end of each calendar
quarter, the contributions of the participants are used to purchase shares of
Common Sock at the lower of eighty-five percent of the market price of its
common stock: (i) at the beginning of each calendar quarter or (ii) at
the end of each calendar quarter. A maximum of 750,000 shares of Common Stock
(plus an annual increase of 375,000 shares) may be purchased in the aggregate by
participants in the Stock Purchase Plan.





In 2008,
the Company suspended the Employee Stock Purchase Plan. The Company has no plans
to reinstitute the Employee Stock Purchase Plan.  During 2009 and
2008, the Company sold 0 and 8,251 shares of Common Stock under the Stock
Purchase Plan for proceeds of $0 and $1, respectively.


F-31


11. 
Commitments and Contingencies




Leases




The
Company was party to a five year lease dated September 1, 2005 and covering
42,500 square feet at an annual rate of $11.40 per square foot with a 3% annual
increase, cancelable by either party with eight months notice, with a
termination by tenant which included a six month termination fee.  In
April 2009, the parties entered into 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 is cancelable by either party
upon 90 days notice with no termination costs. Total rent expense for the year
ended December 31, 2009 and 2008 was approximately $182 and $250,
respectively.  See Note 16 for information regarding a new office
lease entered into by the Company in 2010.




In
December 2008, the Company entered into a new 60 month lease for office
equipment.  As of December 31, 2009 there remains a total of $34 to be
paid over the remaining period of this lease.





Disclosure
of Contractual Obligations





The future minimum contractual rental
commitments under non-cancelable leases for each of the fiscal years ending
December 31, including the new office lease executed March 24, 2010 (See Note
16), are as follows:





2010
                        
                        $
                        112011
                        
                        $
                        4602012
                        
                        
                        4702013
                        
                        
                        4682014
                        
                        
                        477Thereafter
                        
                        
                        1,487Total
                        
                        $
                        3,374




Legal
Proceedings




From time
to time, the Company becomes involved in various legal proceedings, claims,
investigations and proceedings that arise in the normal course of operations.
While the results of such claims and litigation cannot be predicted with
certainty, the Company is not currently aware of any such matters that it
believes would have a material adverse effect on its financial position, results
of operations or cash flows.   In accordance with generally
accepted accounting principles, the Company makes a provision for a liability
when it is both probable that a liability has been incurred and the amount of
the loss or range of loss can be reasonably estimated.  These
provisions are reviewed at least quarterly and adjusted to reflect the impacts
of negotiations, settlements, rulings, advice of legal counsel, and other
information and events pertaining to a particular case.




12. 
Other Significant Agreements and Related Party Transactions





Robert
Stevanovski, Anthony Cassara, Gregory Provenzano and David Stevanovski were each
appointed to serve on the Company’s Board pursuant to the terms of the
Securities Purchase Agreement.  Each of these directors is a principal
of WGI, has an ownership interest in ACN and has a director, officer and/or
advisory position with ACN.  Robert Stevanovski also serves as manager
of Praescient, LLC, the sole manager of WGI.  As a result of their
relationship with WGI and ACN, each of these individuals may be deemed to have a
direct or indirect interest in the transactions involving WGI, ACN and their
respective affiliates.  WGI beneficially owns an aggregate of 63.1% of
the Company’s Common Stock (which includes 202,462,155 shares of Common Stock,
23,960,194 shares of Common Stock issuable under the Anti-Dilution Warrant as of
March 24, 2010 and 6,000,000 shares of Common Stock issuable under the March
2010 WGI Warrant (see Note 10 and Note 16)).
  F-32





During
the year ended December 31, 2009, the Company engaged in the following related
party transactions described elsewhere in these footnotes: the Securities
Purchase Agreement (See Note 3), the Anti-Dilution Warrant (See Note 10), the
Commercial Relationship (See Note 3) the ACN 2009 Warrant (See Note 10) and the
Revolving Loan (See Note 9).  The Company believes that the Revolving
Loan was made on terms no less favorable than the Company could have received in
a negotiated transaction with an unrelated third party.





Registration Rights and
Governance.Concurrently with the closing on April 6, 2009 of
the transactions contemplated by the Securities Purchase Agreement, the Company
entered into the Registration Rights and Governance Agreement with WGI and ACN
DPS (the “Rights
Agreement”) granting them certain rights with respect to the shares
purchased pursuant to the Securities Purchase Agreement and the securities
underlying the Anti-Dilution Warrant and the ACN 2009 Warrant.  Under
the terms of the Rights Agreement, the Company agreed to file a registration
statement on Form S-3 covering the resale of any shares held by WGI and ACN DPS
and to maintain its effectiveness for a minimum period of time.  In
addition, WGI and ACN DPS have the right to require the Company to file
additional registration statements covering the resale of such securities to the
extent they are not covered by an effective registration statement and will be
entitled to “piggy-back” registration rights on all of the Company’s future
registrations (with certain limitations) and on any demand registrations of any
other investors, subject to customary underwriters’ cutbacks to reduce the
number of shares to be registered in view of market conditions.




Pursuant
to the terms of the Rights Agreement, the Company granted WGI and ACN DPS
preemptive rights to purchase a pro rata portion of any of its Common Stock or
other securities convertible into the Company Common Stock issued by the
Company, except for shares issued under board-approved employee benefit plans,
conversions of Existing Contingent Equity or upon exercise of the Anti-Dilution
Warrant or the ACN 2009 Warrant.  The Rights Agreement also gives WGI
the right to nominate a total of four of the seven members of the Company’s
Board.  This nomination right will be reduced by one director for each
reduction in WGI’s beneficial ownership of our Common Stock (including any
warrants or other purchase rights) below thresholds of 50%, 43%, 29% and 14% of
the Company’s voting stock.  To the extent that such nomination right
decreases, the corresponding number of WGI nominees will offer to tender their
resignation for acceptance by the Board.  To the extent the number of
members of the Board is changed, the number of directors WGI is entitled to
appoint will be increased or decreased (as applicable) to provide WGI with the
right to nominate no less than the same proportion of directors as otherwise
provided in the Rights Agreement.


Service Agreement with deltathree,
Inc. (“D3”).On October 9,
2009, the Company entered into a Master Service Agreement (the “D3 Agreement”) with
D3.  Pursuant to the D3 Agreement, D3 will provide the Company, and
the Company will purchase from D3, wholesale VoIP telephony and video services
and operational support systems.  These services provide the Company one of
the tools necessary to provide our digital voice and video phone services
directly to end users.  The Company will pay D3 an activation fee, usage
charges and a monthly subscriber-based fee for each customer that subscribes for
the services provided to us 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 VoIP 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 Company’s first customer is provided VoIP telephony and video
services pursuant to the D3 Agreement (which occurred in February, 2010), it
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.  D3 is majority owned by D4 Holdings, LLC and the
Company is are majority owned by WGI.  D4 Holdings, LLC and WGI have common
majority ownership and a common manager.  The Company believes that
this related party transaction was made on terms comparable to terms it could
have received in a negotiated transaction with an unrelated third
party.




F-33




Service Agreement with
ACN.  On October 12, 2009, the Company entered into a Service
Agreement (the “ACN
Service Agreement”) with ACN, pursuant to which ACN agreed to provide the
Company, and the Company agreed to 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 to the Company
by ACN:




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




·
            Provisioning of VoIP
      Communication Devices.  ACN DPS has agreed to provide 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 DPS 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 related invoice relating to such
      video phone, but the Company may delay payment of any invoice upon payment
      of a carrying cost of 1% per month.




·
            Use of Equipment. ACN
      has agreed to provide the Company with use of an electromagnetic
      interference (“EMI”) test
      chamber owned by ACN for a fee of approximately $2 per month for 24
      months.  At the end of the 24 month period, title to the EMI test
      chamber will transfer to the
Company.




·
            Administrative and Travel
      Support.  ACN has agreed to provide to the Company
      administrative and travel support.  The cost for administrative
      support will 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.




·
            Real Estate and Operations
      Services.  ACN has agreed to provide to 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 fee for the EMI Test Chamber, the costs for administrative and travel
support, and the costs for real estate and operations services 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. The Company believes that this related party transaction was made on
terms more favorable than the Company could have received in a negotiated
transaction with an unrelated third party.


F-34


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.  Pursuant to the letter agreement, all of the Company’s
obligations to Mototech were terminated and the Company was released from all
liabilities or obligations to Mototech; the Company agreed to pay $600 in cash
to Mototech; the Company issued to Mototech 3,200,000 shares of Common Stock,
subject to the following conditions: (a) no shares can be sold prior to April 8,
2010 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 a
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) an expiration date of the earlier of (i)
July 8, 2014, (ii) a change of control of WorldGate or (iii) the twentieth
(20th) day following the Company’s delivery of notice to Mototech of the
occurrence of a period of ten consecutive trading days during which the quoted
bid price of the Common Stock has been greater than a price equal to 150% of the
exercise price of the warrant.  The Mototech Warrant qualified as
Future Contingent Equity under the Anti-Dilution Warrant.  The
Mototech Warrant was exercised in the quarter ended December 31,
2009.




As of
December 31, 2009, the Company reported $262 of related party liabilities,
consisting of $252 of accounts payable to ACN for purchases of inventory and
services and $10 of accrued interest to WGI on loan advances pursuant to the
Revolving Loan.  The Company leases administrative, sales and customer
operations office space from related parties in Rochester, New York and Concord,
North Carolina, with combined annual lease costs not material to the
Company.




See Note
16 for information regarding an amendment to the Revolving Loan, the issuance of
an additional warrant to WGI, a new office lease entered into by the Company,
the amendment to the ACN Master Purchase Agreement, and the issuance of
additional warrants to ACN DPS in 2010.


13.   Client and
Segment Data





The
Company’s reportable operating segments consist of the following two
business segments principally based upon the sale and distribution channels of
the Company’s products and services: Consumer Services and OEM Direct.  The
reporting for the Consumer Services segment includes the revenue and cost of
revenues for products and related recurring services to end users. The reporting
for the OEM Direct segment includes the revenue and cost of revenues for digital
video phones and maintenance services directly to telecommunications service
providers who already have a digital voice and video management and network
infrastructure.




These
product and service channels are provided to different customer groups, and are
managed under a consolidated operations management.




The
Consumer Services segment is aimed at the marketing and distribution of products
and related recurring services to end users as follows:




·
            Direct Retail
      Consumers.  Utilizing the internet and the Company’s
      website the Company markets its digital voice and video phone service
      directly to consumers.


·
              Sales Agents.
      Through independent sales agents and their network of sales
      representatives the Company distributes digital voice and video phone
      services to residential customers.  Sales agents receive
      commissions based on revenue generated by the
      agent.


F-35


·
            Wholesalers.The Company expects to sell digital video phones and selected
      modules of its turn-key digital voice and video phone service offering,
      such as customer service, billing, network and supply chain
      distribution, depending on the specific customer
      requirements.




The OEM
Direct segment is focused on selling digital video phones and maintenance
services directly to telecommunications service providers who already have a
complete digital voice and video management and network infrastructure, such as
incumbent service providers, Competitive Local Exchange Carriers, international
telecom service providers, cable service providers and select vertical providers
in the video relay service for deaf and hard-of-hearing and education and
healthcare services markets.




The
Company’s reportable segments have changed from the prior year to accommodate
the refinement of selling and distribution of the Company’s products and
services into these two channel groups.




Total
revenues by segment include revenues to unaffiliated customers. The Company
evaluates performance based on revenue and gross margin.  Gross margin
is net revenues less costs of goods sold.




The
following tables summarize financial information about the Company’s business
segments for the years ended December 31, 2009 and 2008.




For the Year Ended December
31, 2009





Consumer
                    Services
                  
                  
                  OEM Direct
                  
                  
                  ConsolidatedRevenues
                  
                  $
                  385
                  
                  
                  $
                  1,393
                  
                  
                  $
                  1,778Gross
      Profit
                  
                  $
                  344
                  
                  
                  $
                  20
                  
                  
                  $
                  364Identifiable
      Assets
                  
                  $
                  165
                  
                  
                  $
                  622
                  
                  
                  $
                  787




For the Year Ended December
31, 2008





Consumer
                    Services
                  
                  
                  OEM Direct
                  
                  
                  ConsolidatedRevenues
                  
                  $
                  408
                  
                  
                  $
                  2,561
                  
                  
                  $
                  2,969Gross
      Profit
                  
                  $
                  341
                  
                  
                  $
                  729
                  
                  
                  $
                  1,070Identifiable
      Assets
                  
                  $
                  55
                  
                  
                  $
                  2,140
                  
                  
                  $
                  2,195


F-36




The
identifiable assets noted above include inventory, account receivables, as
applicable to each segment.




14. 
Employee Benefit Plan




The
Company maintains a Retirement Savings Plan that is funded by the participant’s
salary reduction contributions. All employees of the Company are eligible to
participate in the plan upon joining the Company. The plan is intended to permit
any eligible employee who wishes to participate to contribute up to $16.5 of the
employee’s compensation on a before-tax basis under Section 401(k) of the
Internal Revenue Code for employees under 50 years of age and up to $22 for
employees 50 years of age or older. The plan provides for discretionary Company
matching contributions and discretionary Company profit-sharing contributions.
Contributions are invested in such proportions as the employee may elect in a
variety of mutual investment funds. During the years ended December 31, 2009 and
2008, the Company made no matching or discretionary profit-sharing contributions
to the plan.





15.  Supplemental disclosure of cash flow
information




Year Ended December 312009
                  
                  
                  2008Cash
      paid for interest
                  
                  $
                  9
                  
                  
                  $
                  9Non-cash
      investing and financing activities:Cumulative
      effect on a change in accounting principle on (See
      Note  3):Detachable
      Warrants
                  
                  
                  885
                  
                  
                  
                  0Additional
      paid in capital
                  
                  
                  (1,751
                  )
                  
                  
                  0Accumulated
      deficit
                  
                  
                  1,449
                  
                  
                  
                  0Purchase
      of engineering software in accounts payable
                  
                  
                  300
                  
                  
                  
                  0Conversion
      of convertible debenture to common stock
                  
                  
                  0
                  
                  
                  
                  1,921Common
      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





16.  Subsequent
Events.




Increase of WGI Credit
Line.  As described in Note 9, on October 28, 2009, the Company
entered into the Revolving Loan pursuant to which WGI provided to the Company a
line of credit in a principal amount of $3,000.




On March
9, 2010, the Company entered into the First Amendment to the Revolving Loan with
WGI (the Revolving Loan as amended by the First Amendment, the “Amended Revolving
Loan”), pursuant to which the maximum principal amount of the line of
credit was increased to $5,000.  All other terms of the Amended
Revolving Loan remained unchanged by the increase in the maximum principal
amount of the line of credit.  As of March 24, 2010, the Company had
drawn down an additional $2,400 in principal amount under the Amended Revolving
Loan.


F-37


Issuance of Warrant to
WGI.  In connection with the Amended Revolving Loan, on March
9, 2010, the Company granted WGI a warrant to purchase up to 6,000,000 shares of
Common Stock at an exercise price of $0.574 per share (the “March 2010 WGI
Warrant”).  The March 2010 WGI Warrant was fully vested on
issuance and has a term of 10 years.  The March 2010 WGI Warrant has a
value of $3,330 utilizing the Black-Scholes option pricing model with the
following assumptions used: term of 10 years, volatility of 162%, dividends
of $0 and a risk free interest rate of 3.71%.




The
Company believes that the Amended Revolving Loan and March 2010 WGI Warrant were
made on terms no less favorable than the Company could have received in a
negotiated transaction with an unrelated third party.




Office Space
Lease.  On March 24, 2010, WorldGate Service, Inc. (“WGAT Service”), a
subsidiary of the Company, entered into an Office Space Lease (the “Lease”), with Horizon
Office Development I, L.P., pursuant to which WGAT Service will lease
approximately 18,713 square feet of office space at Horizon II, 3800 Horizon
Boulevard, Bensalem, Pennsylvania, at the Horizon Corporate
Center.  The office space comprises part of the second floor of the
building, and will be used for engineering, corporate and administrative
operations and activities.  The new premises are expected to be available
for occupancy beginning in August 2010 following completion of leasehold
improvements.  The Lease has a term of 89 months from the commencement
date.  Following a full abatement of rent for the first 5 months of the
Lease term, the initial annual base rent is approximately $449.  The annual
base rent increases each year to certain fixed amounts over the course of the
term as set forth in the Lease and will be approximately $505 in the seventh
year.  In addition to the base rent, WGAT Service will also pay its
proportionate share of building operating expenses, insurance expenses, real
estate taxes and a management fee.  WGAT Service is required to pay a
security deposit of approximately $187 as security for its full and prompt
performance of the terms and covenants of the Lease.




WGAT
Service has two options to extend the Lease for a period of 60 months
each.  Each option to extend will be at 95% of the then market rent
rate.  WGAT Service is permitted to terminate the Lease as of the 65th
month of the Lease term upon at least 6 months prior notice, compliance with
certain other conditions and the payment of a termination fee equal to the
amount of unamortized broker commissions paid by landlord plus the unamortized
amount of tenant improvement costs and expenses expended by landlord WGAT
Service has the right of first offer during the Lease term, subject to certain
conditions, to lease additional space on the second and third floors of the
building.  In addition, the Company provided a guaranty with respect
to WGAT Service’s payment obligations under the Lease.




Amendment to Master Purchase
Agreement.
  As described in Note 3, on April 6, 2009 the Company entered into a
commercial relationship with ACN DPS pursuant to which the Company agreed to
design and sell video phones to ACN DPS under the Commercial
Relationship.  As part of the Commercial Relationship, the
Company entered into a Master Purchase Agreement pursuant to which ACN DPS
committed to purchase 300,000 videophones over a two-year period.




On March
30, 2010, the Company entered into the First Amendment (the “MPA Amendment”) to
the Master Purchase Agreement with ACN DPS. Among other changes the MPA
Amendment amends the Master Purchase Agreement as follows:




·
            As
      soon as practicable after the Company provides a demonstration to ACN DPS
      of the working video phone contemplated by the Master Purchase Agreement,
      ACN DPS will issue its first purchase order under the Master Purchase
      Agreement for 80,000 video phones.




F-38


·
            ACN
      DPS will pay the Company 50% of the purchase price for video phones
      pursuant to a purchase order upon the later of (a) acceptance of the
      purchase order by the Company and (b) five (5) weeks prior to the delivery
      of video phones to ACN DPS at the Company’s manufacturing
      facility.  ACN DPS will pay the Company the remaining 50% of the
      purchase price upon delivery of the video phones to ACN DPS at the
      Company’s manufacturing facility.




In
connection with the MPA Amendment, on March 30, 2010 the Company granted ACN DPS
a warrant to purchase up to 3 million shares of Common Stock at an exercise
price of $0.0425 per share (the “ACN 2010
Warrant”).  The ACN 2010 Warrant will vest incrementally based
on ACN DPS’s purchases of video phones under the Master Purchase Agreement, as
amended by the MPA Amendment.




The
Company has evaluated events that occurred subsequent to December 31, 2009 and
through the date that the financial statements were issued, and except as
disclosed above, management concluded that no other events required disclosure
in these financial statements.


F-39


SIGNATURES




Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the Registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.




WORLDGATE
      COMMUNICATIONS, INC.Date:
      March 31, 2010
                  
                  By
                  /s/
      George E. Daddis Jr.Name:
      George E. Daddis Jr.Title:
      Chief Executive
Officer




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




Signature
                                      
                                      Title
                                      
                                      Date/s/
      Geoffrey M. Boyd
                                      
                                      Director
                                      
                                      March
      31, 2010Geoffrey
      M. Boyd/s/
      Anthony
      Cassara
                                      
                                      Director
                                      
                                      March
      31, 2010Anthony
      Cassara/s/
      Brian Fink
                                      
                                      Director
                                      
                                      March
      31, 2010Brian
      Fink/s/
      Richard P. Nespola
                                      
                                      Director
                                      
                                      March
      31, 2010Richard
      P. Nespola/s/
      Gregory
      Provenzano
                                      
                                      Director
                                      
                                      March
      31, 2010Gregory
      Provenzano/s/
      David Stevanovski
                                      
                                      Director
                                      
                                      March
      31, 2010David
      Stevanovski/s/
      Robert
      Stevanovski
                                      
                                      Chairman
                                      
                                      March
      31, 2010Robert
      Stevanovski/s/
      George E. Daddis Jr.
                                      
                                      Chief
      Executive Officer
                                      
                                      March
      31, 2010George
      E. Daddis Jr.
                                      
                                      (principal
      executive officer)/s/
      Joel
      Boyarski
                                      
                                      Senior
      Vice President and
                                      
                                      March
      31, 2010Joel
      Boyarski
                                      
                                      Chief
      Financial Officer (principal financial and accounting
    officer)









EXHIBIT INDEX




Exhibit
                Number
              
              Description3.1
              
              Restated
      Certificate of Incorporation reflecting all amendments through March 31,
      2009 (Incorporated by reference to Exhibit 3.1 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended March 31, 2009,
      filed with the SEC on May 15, 2009)3.2
              
              Amended
      and Restated Bylaws (Incorporated by reference to Exhibit 3.2 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended
      March 31, 1999, filed with the SEC on May 28,
1999)3.3
              
              Certificate
      of Designations, Preferences and Rights of the Series A Convertible
      Preferred Stock of the Company dated June 24, 2004 (Incorporated by
      reference to Exhibit 3.2 of our Quarterly Report on Form 10-Q
      for the fiscal quarter ended September 30, 2004, filed with the SEC
      on November 17, 2004)4.1
              
              Form
      of Warrant issued by the Company pursuant to the Amended and Restated
      Securities Purchase Agreement dated as of December 4, 2003 (Incorporated
      by reference to Exhibit 4.1 to our Current Report on Form 8-K filed
      with the SEC on December 2, 2003)4.2
              
              Form
      of Additional Investment Right issued by the Company pursuant to the
      Amended and Restated Securities Purchase Agreement dated as of December 4,
      2003 (Incorporated by reference to Exhibit 4.2 to our Current Report on
      Form 8-K filed with the SEC on December 2, 2003)4.3
              
              Form
      of Warrant issued by the Company pursuant to the Securities Purchase
      Agreement dated as of January 20, 2004 (Incorporated by reference to
      Exhibit 4.1 to our Current Report on Form 8-K filed with the SEC on
      January 21, 2004)4.4
              
              Form
      of Additional Investment Right dated issued by the Company pursuant to the
      Securities Purchase Agreement dated as of January 20, 2004 (Incorporated
      by reference to Exhibit 4.2 to our Current Report on Form 8-K filed
      with the SEC on January 21, 2004)4.5
              
              Form
      of Series A Warrant issued by the Company pursuant to the Securities
      Purchase Agreement dated as of June 24, 2004 (Incorporated by reference to
      Exhibit 4.1 to our Current Report on Form 8-K filed with the SEC on
      June 25, 2004)4.6
              
              Form
      of Series B Warrant issued by the Company pursuant to the Securities
      Purchase Agreement dated as of June 24, 2004 (Incorporated by reference to
      Exhibit 4.2 to our Current Report on Form 8-K filed with the SEC on
      June 25, 2004)4.7
              
              Form
      of Series C Warrant issued by the Company pursuant to the Securities
      Purchase Agreement dated as of June 24, 2004 (Incorporated by reference to
      Exhibit 4.3 to our Current Report on Form 8-K filed with the SEC on
      June 25, 2004)4.8
              
              Form
      of Warrant issued by the Company to Mr. K. Y. Cho (Incorporated by
      reference to Exhibit 4.9 to our Registration Statement on Form SB-2 filed
      with the SEC on May 24, 2005)4.9
              
              Form
      of Warrant dated August 3, 2005 issued by the Company pursuant to the
      Stock Purchase Agreement dated August 3, 2005 (Incorporated by reference
      to Exhibit 4.1 to our Current Report on Form 8-K filed with the SEC
      on August 8, 2005)4.10
              
              Form
      of Warrant dated August 3, 2005 issued by the Company pursuant to the
      Stock Purchase Agreement dated August 3, 2005 (Incorporated by reference
      to Exhibit 4.2 to our Current Report on Form 8-K filed with the SEC
      on August 8, 2005)







Exhibit
                Number
              
              Description4.11
              
              Registration
      Rights Agreement, August 3, 2005, by and among the Company and
      certain investors, pursuant to the Stock Purchase Agreement dated August
      3, 2005 (Incorporated by reference to Exhibit 4.3 to our Current Report on
      Form 8-K filed with the SEC on August 8, 2005)4.12
              
              Investor
      Registration Rights Agreement, dated August 11, 2006, by and among the
      Company and Cornell Capital Partners, LP (Incorporated by reference to
      Exhibit 4.2 of our Quarterly Report on Form 10-Q for the fiscal
      quarter ended June 30, 2006, filed with the SEC on August 14,
      2006)4.13
              
              Form
      of Amended and Restated Secured Convertible Debenture, originally issued
      August 11, 2006 dated as of May 17, 2007, issued by the Company to Cornell
      Capital Partners, LP (Incorporated by reference to Exhibit 99.2 to our
      Current Report on Form 8-K filed with the SEC on May 24,
      2007)4.14
              
              Form
      of amended and restated Secured Convertible Debenture originally issued
      October 2006, dated may17, 2007, issued by the Company to Cornell Capital
      Partners, LP (Incorporated by reference to Exhibit 99.3to our Current
      Report on Form 8-K filed with the SEC on May 24,
  2007)4.15
              
              Warrant,
      dated April 6, 2009, issued to ACN Digital Phone Service, LLC
      (Incorporated by reference to Exhibit 4.1 of our Quarterly Report on
      Form 10-Q for the fiscal quarter ended June 30, 2009, filed with the
      SEC on August 14, 2009)4.16
              
              Warrant,
      dated April 6, 2009, issued to WGI Investor LLC (Incorporated by reference
      to Exhibit 4.2 of our Quarterly Report on Form 10-Q for the
      fiscal quarter ended June 30, 2009, filed with the SEC on August 14,
      2009)4.17
              
              Form
      of Amendment No. 1 to Warrant and Exercise Agreement with respect to the
      2004 Amended Warrants (Incorporated by reference to Exhibit 10.1 to our
      Current Report on Form 8-K filed with the SEC on June 26,
      2009)4.18
              
              Form
      of Amendment No. 1 to Warrant with respect to the 2004 Amended Warrants
      (Incorporated by reference to Exhibit 10.2 to our Current Report on Form
      8-K filed with the SEC on June 26, 2009)4.19
              
              Form
      of Amendment No. 1 to Warrant and Exercise Agreement with respect to the
      2005 Amended Warrants (Incorporated by reference to Exhibit 10.3 to our
      Current Report on Form 8-K filed with the SEC on June 26,
      2009)4.20
              
              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 with the SEC on July 10, 2009)4.21
              
              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 with the SEC on July 20, 2009)4.22
              
              Revolving
      Promissory Note, dated October 28, 2009, by WorldGate Communications,
      Inc., WorldGate Service, Inc., WorldGate Finance, Inc., Ojo Service LLC,
      and Ojo Video Phones LLC  in favor of WGI Investor LLC in a
      principal amount of $3,000,000 (Incorporated by reference to Exhibit 4.1
      to our Current Report on Form 8-K filed with the SEC on October 30,
      2009)4.23
              
              Promissory
      Note, dated February 4, 2009, in the amount of $550, issued to WGI
      Investor LLC (Incorporated by reference to Exhibit 10.1 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended March 31,
      2009, filed with the SEC on May 15, 2009)4.24
              
              Promissory
      Note, dated March 24, 2009, in the amount of $200, issued to WGI Investor
      LLC (Incorporated by reference to Exhibit 10.2 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended March 31, 2009,
      filed with the SEC on May 15,
2009)







Exhibit
                Number
              
              Description10.1
              
              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 with the SEC on July 10, 2009)10.2
              
              Manufacturing
      Agreement, dated September 9, 2003, between the Company and Mototech Inc.
      (Incorporated by reference to Exhibit 10.2 to our Registration Statement
      on Form SB-2 filed with the SEC on December 24, 2003 (Registration No.
      333-111571))10.3
              
              Letter
      Agreement, dated October 8, 2009, by and among Snap Telecommunications,
      Inc., Aequus Technologies Corp., WorldGate Communications, Inc. and OJO
      Service LLC (Incorporated by reference to Exhibit 10.1 to our Current
      Report on Form 8-K filed with the SEC on October 15,
      2009)10.4
              
              License,
      Maintenance and Update Services Agreement, dated March 31, 2008, between
      the Company and Aequus Technologies Corp. (Incorporated by reference to
      Exhibit 10.13 of our Annual Report on Form 10-K for the fiscal
      year ended December 31, 2007, filed with the SEC on April 17,
      2008)10.5
              
              Revised
      and Restated Amendment and Master Contract, dated March 31, 2008, between
      the Company and Aequus Technologies Corp. (Incorporated by reference to
      Exhibit 10.14 of our Annual Report on Form 10-K for the fiscal
      year ended December 31, 2007, filed with the SEC on April 17,
      2008)10.6
              
              Master
      Agreement, dated March 31, 2008, between the Company and Aequus
      Technologies Corp. (Incorporated by reference to Exhibit 10.15 of our
      Annual Report on Form 10-K for the fiscal year ended December 31,
      2007, filed with the SEC on April 17, 2008)10.7
              
              Master
      Manufacturing Agreement, dated November 18, 2009, between Kenmec
      Mechanical Engineering Co., Ltd. and Ojo Video Phones LLC* [Certain information in this
      exhibit has been omitted and has been filed separately with the SEC
      pursuant to a confidential treatment request under Rule 24b-2 of the
      Securities Exchange Act of 1934, as amended]10.8
              
              ACN
      Consumer Communications Equipment Master Purchase Agreement, dated as of
      April 6, 2009, between ACN Digital Phone Service, LLC and Ojo Video Phones
      LLC (Incorporated by reference to Exhibit 10.8 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended June 30, 2009, filed
      with the SEC on August 14, 2009)10.9
              
              Software
      Development and Integration and Manufacturing Assistance Agreement, dated
      as of April 6, 2009, between ACN Digital Phone Service, LLC and Ojo Video
      Phones LLC (Incorporated by reference to Exhibit 10.9 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
      2009, filed with the SEC on August 14, 2009)10.10
              
              Securities
      Purchase Agreement, dated December 12, 2008, by and between the Company
      and WGI Investor LLC (Incorporated by reference to Annex A of our Proxy
      Statement dated February 13, 2009, filed with the SEC on February 13,
      2009)10.11
              
              Registration
      Rights and Governance Agreement, dated as of April 6, 2009, by and among
      WorldGate Communications, Inc., WGI Investor LLC, and ACN Digital Phone
      Service, LLC (Incorporated by reference to Exhibit 10.10 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
      2009, filed with the SEC on August 14, 2009)10.12
              
              Revolving
      Loan and Security Agreement, dated October 28, 2009, by and among WGI
      Investor LLC, WorldGate Communications, Inc., WorldGate Service, Inc.,
      WorldGate Finance, Inc., Ojo Service LLC, and Ojo Video Phones LLC
      (Incorporated by reference to Exhibit 10.1 to our Current Report on
      Form 8-K filed with the SEC on October 30,
  2009)







Exhibit
                Number
              
              Description10.13
              
              Services
      Agreement, dated October 12, 2009, between ACN, Inc. and WorldGate
      Communications, Inc. (Incorporated by reference to Exhibit 10.2 to our
      Current Report on Form 8-K filed with the SEC on October 16,
      2009)10.14
              
              Master
      Service Agreement, dated October 9, 2009, between Ojo Service LLC and
      deltathree, Inc. (Incorporated by reference to Exhibit 10.1 to our Current
      Report on Form 8-K filed with the SEC on October 16,
      2009)10.15
              
              Lease
      Amendment, dated April 2, 2009, between WorldGate Service, Inc. and 3190
      Tremont LLC (Incorporated by reference to Exhibit 10.14 of our Quarterly
      Report on Form 10-Q/A for the fiscal quarter ended June 30, 2009, filed
      with the SEC on March 31, 2010)10.16
              
              1996
      Stock Option Plan, as amended and restated effective February 15, 2001
      (Incorporated by reference to Exhibit 10.10 of our Annual Report on
      Form 10-K/A for the fiscal year ended December 31, 2000, filed with
      the SEC on August 17, 2001) †10.17
              
              2003
      Equity Incentive Plan (Incorporated by reference to Exhibit D of our
      Proxy Statement dated September 1, 2004, filed with the SEC on September
      3. 2004) †10.18
              
              Amendment
      No.1 to the WorldGate Communications, Inc. 2003 Equity Incentive Plan
      (Incorporated by reference to Exhibit 10.1 to our Current Report on Form
      8-K filed with the SEC on May 28, 2009) †10.19
              
              Form
      A of the Non-Qualified Stock Option Grant (Incorporated by reference to
      Exhibit 10.2 to our Current Report on Form 8-K filed with the SEC on May
      28, 2009) †10.20
              
              Form
      B of the Non-Qualified Stock Option Grant (Incorporated by reference to
      Exhibit 10.3 to our Current Report on Form 8-K filed with the SEC on May
      28, 2009) †10.21
              
              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 with the
      SEC on August 4, 2009) †10.22
              
              Offer
      Letter, dated June 23, 2009, to Allan Van Buhler* †10.23
              
              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and Joel
      Boyarski (Incorporated by reference to Exhibit 10.1 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended June 30, 2009, filed
      with the SEC on August 14, 2009) †10.24
              
              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and Harold
      Krisbergh (Incorporated by reference to Exhibit 10.2 of our Quarterly
      Report on Form 10-Q for the fiscal quarter ended June 30, 2009, filed
      with the SEC on August 14, 2009) †10.25
              
              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and
      Randall J. Gort (Incorporated by reference to Exhibit 10.3 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
      2009, filed with the SEC on August 14, 2009) †10.26
              
              Employment
      Agreement, dated April 6, 2009, between WorldGate Service, Inc. and James
      McLoughlin (Incorporated by reference to Exhibit 10.4 of our
      Quarterly Report on Form 10-Q for the fiscal quarter ended June 30,
      2009, filed with the SEC on August 14, 2009) †10.27
              
              Resignation
      Letter, dated as of April 8, 2009, from Harold Krisbergh to WorldGate
      Communications, Inc. (Incorporated by reference to Exhibit 10.5 of
      our Quarterly Report on Form 10-Q for the fiscal quarter ended June
      30, 2009, filed with the SEC on August 14, 2009) †10.28
              
              Resignation
      Letter, dated as of April 8, 2009, from Randall J. Gort to WorldGate
      Communications, Inc. (Incorporated by reference to Exhibit 10.6 of
      our Quarterly Report on Form 10-Q for the fiscal quarter ended June
      30, 2009, filed with the SEC on August 14, 2009)
  †







Exhibit
                Number
              
              Description10.29
              
              Resignation
      Letter, dated as of May 15, 2009, from James McLoughlin to WorldGate
      Communications, Inc. (Incorporated by reference to Exhibit 10.7 of
      our Quarterly Report on Form 10-Q for the fiscal quarter ended June
      30, 2009, filed with the SEC on August 14, 2009) †10.30
              
              Subscription
      Agreement, dated September 24, 2007, between the Company and Antonio
      Tomasello (Incorporated by reference to Exhibit 10.16 of our Annual
      Report on Form 10-K for the fiscal year ended December 31, 2007,
      filed with the SEC on April 17, 2008)10.31
              
              Amended
      and Restated Securities Purchase Agreement, dated as of December 4, 2003,
      among the Company and the Purchasers (as defined therein) (Incorporated by
      reference to Exhibit 99.1 to our Current Report on Form 8-K filed
      with the SEC on December 4, 2003)10.32
              
              Securities
      Purchase Agreement, dated as of January 20, 2004, among the Company and
      the Purchasers (as defined therein) (Incorporated by reference to Exhibit
      99.1 to our Current Report on Form 8-K filed with the SEC on January
      21, 2004)10.33
              
              Securities
      Purchase Agreement, dated as of June 24, 2004, by and between the Company
      and the Investors (as defined therein) (Incorporated by reference to
      Exhibit 99.1 to our Current Report on Form 8-K filed with the SEC on
      June 25, 2004)10.34
              
              Securities
      Purchase Agreement, dated as of August 11, 2006, by and among the Company
      and Cornell Capital Partners, LP (Incorporated by reference to
      Exhibit 4.1 of our Quarterly Report on Form 10-Q for the fiscal
      quarter ended June 30, 2006, filed with the SEC on August 14,
      2006)10.35
              
              Securities
      Purchase Agreement, dated as of August 3, 2005, among the Company and the
      Investors (as defined therein) (Incorporated by reference to Exhibit 99.1
      to our Current Report on Form 8-K filed with the SEC on August 8,
      2005)10.36
              
              Voting
      Agreement among the Company, Antonio Tomasello and David Tomasello
      (Incorporated by reference to Exhibit 99.5 to our Current Report on
      Form 8-K filed with the SEC on May 24, 2007)21
              
              Subsidiaries*23.1
              
              Consent
      of Marcum LLP*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




†Management
contract or compensatory plan or arrangement required to be filed or
incorporated as an exhibit.