UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

or

Commission File Number 001-32887

VONAGE HOLDINGS CORP.

(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (732) 528-2600

(Former name, former address and former fiscal year, if changed since last report): Not Applicable

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

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

VONAGE HOLDINGS CORP.

INDEX

Financial Information Presentation

For the financial information discussed in this Quarterly Report on Form 10-Q, other than per share and per line amounts, dollar amounts are presented in thousands, except where noted.

Explanatory Note

In March 2008, our Quarterly Report on Form 10-Q for the three and six months ended June 30, 2007 was restated to reflect a correction of the amount of share-based compensation expense recorded by us for the three and six months ended June 30, 2007. The consolidated financial statements, Note 1 in Item 1 of Part I and Management’s Discussion and Analysis of Financial Condition and Results of Operations in Item 2 of Part I were amended and restated to reflect the correct amount of share-based compensation for the three and six months ended June 30, 2007. For further discussion regarding the restatement, see Note 1 to our unaudited consolidated financial statements as of and for the period ended June 30, 2008.

Part I—Financial Information

Item 1.    Financial Statements

VONAGE HOLDINGS CORP.

CONSOLIDATED BALANCE SHEETS

(In thousands, except par value)

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

VONAGE HOLDINGS CORP.

CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except per share amounts)

(Unaudited)

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

VONAGE HOLDINGS CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)

(Unaudited)

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

VONAGE HOLDINGS CORP.

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)

(In thousands)

(Unaudited)

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

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Note 1.    Basis of Presentation and Significant Accounting Policies

Nature of Operations

Vonage Holdings Corp. (“Vonage”, “Company”, “we,“we”, “our”, “us”) is incorporated as a Delaware corporation. The original Certificate of Incorporation was filed in May 2000 as MIN-X.COM, INC., our original name, which was changed in February 2001 to Vonage Holdings Corp. We are a provider of broadband Voice over Internet Protocol (“VoIP”) services to residential and small business and home office customers. We launched service in the United States in October 2002, in Canada in November 2004 and in the United Kingdom in May 2005.

For the six months ended June 30, 2008, we generated positive cash flows from operations of $24,094. However, weWe have incurred operating losses since our inception and have an accumulated deficit at JuneSeptember 30, 2008 of $1,004,128.$1,011,945. For the nine months ended September 30, 2008, we had cash flows from operating activities of $6,171. Our primary source of funds to date has been through the issuance of equity and debt securities, including net proceeds from our initial public offering (“IPO”) in May 2006.

Going Concern

Our consolidated financial statements as of JuneSeptember 30, 2008 and December 31, 2007 have been prepared under the assumption that we will continue as a going concern for the twelve months ending December 31, 2008. Our independent registered public accounting firm’s report dated March 17, 2008 on our 2007 financial statements included an explanatory paragraph referring to our $217,000 working capital deficit caused primarily by $253,460 of convertible notes (“Notes”) due December 1, 2010 classified as a current liability since they can becould have been put to us on December 16, 2008 and expressing substantial doubt as to our ability to continue as a going concern without refinancing them or obtaining additional debt or equity capital.

As of JuneSeptember 30, 2008, we had a working capital deficit of $239,679$248,117 caused primarily by $253,460 of Notes being classified as a current liability since they can becould have been put by the holders on December 16, 2008. On July 22,October 19, 2008, we entered into definitive agreements for a commitment letterfinancing consisting of (i) a $130,300 senior secured first lien credit facility (the “Commitment Letter”“First Lien Senior Facility”), including an original issuance discount of $7,200, (ii) a $72,000 senior secured second lien credit facility (the “Second Lien Senior Facility”) with Silver Point Finance, LLC (“Silver Point”) establishingand (iii) the terms and conditionssale of a $185,000 initial private debt financing (the “Initial Financing”). Silver Point has also agreed, subject to certain conditions, to use commercially reasonable efforts to assemble a syndicate of other lenders to provide up to $30,000 of incremental private debt financing (the “Incremental Financing”).

The closing for the Initial Financing is expected to occur in the third quarter of 2008. Silver Point has committed to be allocated $125,000$18,000 of the InitialCompany’s 20% senior secured third lien notes due 2015 (the “Convertible Notes” and, together with the First Lien Senior Facility and the Second Lien Senior Facility, the “Financing”). The Financing and it is a condition to closing ofwas consummated on November 3, 2008. We used the Initial Financing that we obtain commitments from a permitted group for the remaining amounts of the Initial Financing. Silver Point may syndicate a portion of its commitment.

We intend to use thenet proceeds of the Initial Financing, less estimated fees and expenses of approximately $21,000 to $24,000, of which approximately $3,000 has been paid as of June 30, 2008, plus cash on hand, to repurchase our existing$253,460 of Notes in a tender offer (“Offer”), which we commenced on July 31, 2008. Assuming all holders tender all of their Notes and such Notes are accepted pursuant to the Offer on the expiration date, the aggregate cost to us of such repurchases, for principal, accrued and unpaid interest and all fees and expenses, will be approximately $257,600.

There can be no assurance that we will be successful in completing this or any other refinancing transaction, which raises substantial doubt as to our ability to continue as a going concern. The unaudited consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.offer.

Unaudited Interim Financial Information

The accompanying unaudited interim consolidated financial statements and information have been prepared in accordance with accounting principles generally accepted in the United States and in accordance with the instructions for Form 10-Q. Accordingly, they do not include all of the information and disclosures required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, these financial statements contain all normal and recurring adjustments considered necessary to present fairly the financial position, results of operations, cash flows and statement of stockholders’ equity (deficit) for the periods presented. The results for the three and sixnine month periods ended JuneSeptember 30, 2008 are not necessarily indicative of the results to be expected for the full year.

These unaudited interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and related notes included in our 2007 Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 17, 2008.

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Restatement of Prior Period Consolidated Financial Statements

Due to the departure of our former chief executive officer, certain senior executives and other personnel primarily as a result of the reduction in force during the second and third quarters of 2007, there was a corresponding forfeiture of a large number of stock awards. We determined that actual forfeitures as a result of these actions exceeded previous estimates. As a result, non-cash stock compensation expense should have been reduced concurrent with the resignation of these employees and a reduction of stock-based compensation as required by Statement of Financial Accounting Standards No. 123(R) should have been recorded at that time. Therefore, our management, after consultation with our audit committee of the board of directors and our independent public accounting firm, determined that it was necessary to restate our previously issued consolidated financial statements for the three and six months ended June 30, 2007 in order to correct the amount of share-based compensation expense recorded by us for those periods.

The restatement was accounted for in accordance with Statement of Financial Accounting Standards No. 154,“Accounting Changes and Error Corrections–a replacement of APB Opinion No. 20 and FASB Statement No. 3,”as a revision of previously issued financial statements to reflect the correction of an error.

This restatement did not result in a change in our previously reported revenues, cash flow from operations or total cash and cash equivalents shown in the consolidated financial statements for or as of the three and six months ended June 30, 2007. Instead, the resulting decrease in non-cash share-based compensation expense resulted in a reduction of $10,400 in our net loss for the three and six months ended June 30, 2007. In addition, because the amount of decrease in non-cash share-based compensation expense had an effect of decreasing by the same amount both our accumulated deficit and additional paid-in capital, there was no effect on our consolidated stockholders’ equity at June 30, 2007. Further, the restatement had no impact on our operating results for any periods prior to the quarter ended June 30, 2007.

Significant Accounting Policies

Basis of Consolidation

The consolidated financial statements include the accounts of Vonage and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Use of Estimates

Our consolidated financial statements are prepared in conformity with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the amounts reported and disclosed in the consolidated financial statements and the accompanying notes. Actual results could differ materially from these estimates.

On an ongoing basis, we evaluate our estimates, including the following:

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

We base our estimates on historical experience, available market information, appropriate valuation methodologies, and on various other assumptions that we believed to be reasonable, the results of which form the basis for making judgments about the carrying values of assets and liabilities.

Restricted Cash and Letters of Credit

Our credit card processors have established 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 practice for companies that bill their customers in advance of providing services. As such, we provided our credit card processors with cash reserves of $22,335$22,237 and a cash collateralized letter of credit for $10,413 as of JuneSeptember 30, 2008. In addition, weWe also had a cash collateralized letter of credit for $7,000 as of JuneSeptember 30, 2008 and December 31, 2007 related to lease deposits for our offices and a cash collateralized letter of credit for $2,185 issued in March 2008 for our appeal of state taxes due.offices. The total amount of collateralized letters of credit was $19,857$17,562 and $17,254 at JuneSeptember 30, 2008 and December 31, 2007, respectively. In the aggregate, cash reserves and collateralized letters of credit of $42,192$39,799 and $38,928 were recorded as long-term restricted cash at JuneSeptember 30, 2008 and December 31, 2007, respectively.

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)addition, we had outstanding a cash collateralized letter of credit for $2,185 for our appeal of state taxes due which was classified as short-term restricted cash at September 30, 2008 as it was released in October 2008.

Software Costs

We capitalize certain costs, such as purchased software and internally developed software that we use for customer acquisition and customer care automation tools, in accordance with Statement of Position 98-1,Accounting for Costs of Computer Software Development or Obtained for Internal Use.These costs are classified as “Other Assets” in the consolidated balance sheet.sheets. Computer software is stated at cost less accumulated amortization and the estimated useful life is three years. Total computer software was $33,373$51,650 and $29,277 at JuneSeptember 30, 2008 and $20,129 at December 31, 2007, substantially all of which were external costs.costs respectively. Accumulated amortization was $15,514 and $7,678 at September 30, 2008 and December 31, 2007. Amortization expense was $2,733$4,322 and $887$1,023 for the three months ended JuneSeptember 30, 2008 and 2007, respectively, and $4,730$9,052 and $1,524$2,547 for the sixnine months ended JuneSeptember 30, 2008 and 2007, respectively.

Long-Lived Assets

We review the carrying values of our property and equipment for possible impairment whenever circumstances indicate the carrying amount of an asset may not be recoverable. An impairment loss is recognized to the extent the sum of the undiscounted estimated future cash flow expected to result from the use of the asset is less than the carrying value. For the three and nine months ended September 30, 2008, we incurred an impairment loss of $1,447 and $1,847, respectively, for certain network equipment, computer hardware costs and capitalized software that no longer had future benefit. This impairment loss was recorded in the statement of operations as part of depreciation expense.

Intangible Assets

Intangible assets acquired in the settlement of litigation or by direct purchase are accounted for based upon the fair value of assets received.

Patents

In June 2006, we purchased three patents related to the compression of packetized digital signals commonly used in VoIPVoice over Internet Protocol (“VoIP”) technology at a cost of $5,268. In July 2006, we began amortizing the cost of these patents over their estimated useful lives of 2.7 years. Amortization expense was $484 for the three months ended JuneSeptember 30, 2008 and 2007, and $969$1,453 for the sixnine months ended JuneSeptember 30, 2008 and 2007.2007, respectively. Annual amortization will be approximately $1,940.

In October 2007, in connection with the settlement of our patent litigation with Sprint, we acquired a license to use Sprint’s portfolio of “Voice over Packet” patents. The fair value assigned to these patents was $5,500. We began amortizing the cost of these patents in October 2007 over their patent lives of 6.6 years. Amortization expense was $206 and $413$619 for the three and sixnine months ended JuneSeptember 30, 2008, respectively. Annual amortization will be approximately $825.

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Trademark

In April 2008, in connection with the settlement of a trademark dispute, we acquired the right to use the trademark in question. The fair value assigned to the trademark was $560. This trademark is being amortized over its remaining life of 8 years. Amortization expense was $17 and $35 for the three and nine months ended JuneSeptember 30, 2008. Annual amortization will be approximately $70.

Fair Value

Statement of Financial Accounting Standards No. 157 (“SFAS No. 157”), “Fair Value Measurements” defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. This standard is now the single source in United States Generally Accepted Accounting Principles (“GAAP”) for the definition of fair value, except for the fair value of leased property as defined in Statement of Financial Accounting Standards No. 13 “Accounting for Leases”. SFAS No. 157 establishes a fair value hierarchy that distinguishes between (1) market participant assumptions developed based on market data obtained from independent sources (observable inputs) and (2) an entity’s own assumptions about market participant assumptions developed based on the best information available in the circumstances (unobservable inputs). The fair value hierarchy consists of three broad levels, which gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1) and the lowest priority to unobservable inputs (Level 3). The three levels of the fair value hierarchy under SFAS 157 are described below:

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

The following table presents the assets that are measured and recognized at fair value on a recurring basis classified under the appropriate level of the fair value hierarchy as of June 30, 2008:

1) Included in marketable securities on our consolidated balance sheet.

Convertible Notes

As of JuneSeptember 30, 2008, the estimatedcarrying amount of our convertible notes approximate fair value of our Notessince a tender offer was approximately $220,510 based onoutstanding to purchase the average price from private transactions during the second quarter of 2008 as there is no public market for the Notes.convertible notes at par value. The fair value amount is not necessarily indicative of the amount that we would pay since the Notes can be put to us by the holdersconvertible notes were repurchased at facepar value on December 16,November 3, 2008.

Reclassifications

Certain reclassifications have been made to prior years’ financial statements in order to conform to the current year’s presentation. The reclassifications had no impact on net earnings previously reported.

Loss per Share

Basic and diluted loss per common share is calculated by dividing loss to common stockholders by the weighted average number of common shares outstanding during the period. The effects of potentially dilutive common shares, including shares issued under outstanding warrants and for restricted stock units and stock options issued under our 2001 Stock Incentive Plan and 2006 Incentive Plan using the treasury stock method, have been excluded from the calculation of diluted loss per common share because of their anti-dilutive effects.

The following were excluded from the calculation of diluted earnings per common share because of their anti-dilutive effects:

Recent Accounting Pronouncements

In MayMarch 2008, the Financial Accounting Standards Board (“FASB”), affirmed the consensus of FASB Staff Position (FSP) Accounting Principles Board Opinion No. 14-1 (APB 14-1),Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement), which applies to all convertible debt instruments that have a net settlement feature; which means that such convertible debt instruments, by their terms, may be settled either wholly or partially in cash upon conversion. FSP APB 14-1 requires issuers of convertible debt instruments that may be settled wholly or partially in cash upon conversion to separately account for the liability and equity components in a manner reflective of the issuer’s nonconvertible debt borrowing rate. Previous guidance provided for accounting for this type of convertible debt instrument entirely as debt. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those fiscal years. We are evaluating if the adoption of FSP APB 14-1 will have a material impact on our financial statements.

In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162 (“SFAS No. 162”), “The Hierarchy of Generally Accepted Accounting Principles.” SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements that are presented in conformity with generally accepted accounting principles. SFAS No. 162 becomes effective 60 days following the Securities and Exchange Commission’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411,“The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” We do not expect that the adoption of SFAS No. 162 will have a material impact on our consolidated financial statements.

In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159 (“SFAS No. 159”), “The Fair Value Option for Financial Assets and Financial Liabilities.” Under SFAS No. 159, companies may elect to measure certain financial instruments and certain other items at fair value. The standard requires that unrealized gains and losses on items for which the fair value option has been elected be reported in earnings. SFAS No. 159 was effective for us beginning in the first quarter of 2008. We currently do not have any instruments eligible for election of the fair value option. Therefore, the adoption of SFAS No. 159 in the first quarter of 2008 did not impact our consolidated financial position, results of operations or cash flows.

In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157 (“SFAS No. 157,157”), “Fair Value Measurements”, which defines fair value, establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather eliminates inconsistencies in guidance found in various prior accounting pronouncements and is effective for fiscal years beginning after November 15, 2007. In February 2008, the

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

FASB issued FASB FSP 157-2, which delays the effective date of SFAS No. 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually), until fiscal years beginning after November 15, 2008, and interim periods within those fiscal years.

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

These nonfinancial items include assets and liabilities such as reporting units measured at fair value in a goodwill impairment test and nonfinancial assets acquired and liabilities assumed in a business combination. Effective January 1, 2008, we adopted SFAS No. 157 for financial assets and liabilities recognized at fair value on a recurring basis. The partial adoption of SFAS No. 157 for financial assets and liabilities did not have a material impact on our consolidated financial position, results of operations or cash flows.

Note 2.    Commitments and Contingencies

Litigation

State Attorney General Proceedings.

On June 19, 2008, Vonage learned that a group of approximately twenty-six states’ attorney generals had begun an investigation into certain of our business practices. By August 10,October 15, 2008, we received six19 document requests, and expect to receive additional requests, from most, if not all, of the participating states. The requests seek information that Vonage previously produced to the Wisconsin Attorney General as part of an investigation commenced in November 2007, which consisted of, among other things, sales and retention marketing scripting, advertising disclosures, and information related to our money back guarantee. The most recent requests also seek information related to marketing and billing practices, as well as early termination fees. To date, none of the attorney generals have filed a complaint against us or taken other formal action. We are unable to predict whether a formal action will be filed against us. We intend to fully cooperate in the investigation.

Patent Litigation.

Web Telephony, LLC.    On March 14, 2007, Web Telephony, LLC filed suit in the United States District Court for the Eastern District of Texas against us and several other defendants. Web Telephony alleged that we were infringing two telecommunications patents held by Web Telephony and sought injunctive relief, compensatory and treble damages and attorneys’ fees. On May 14, 2008, the parties settled the lawsuit. The agreement resolves all past alleged infringement and grants Vonage patent licenses. The settlement of $3,000 has been recorded as selling, general and administrative expense in the consolidated statement of operations with $2,250 and $3,000 recorded in the three and the six months ended June 30, 2008, respectively.

IPO Litigation.    During June and July 2006, Vonage, several of our officers and directors, and the firms who served as the underwriters in our IPO were named as defendants in several purported class action lawsuits arising out of our IPO. On January 9, 2007, the Judicial Panel on Multidistrict Litigation transferred all complaints to the District of New Jersey. On September 7, 2007, the Court appointed Zyssman Group as the lead plaintiff, and the law firm of Zwerling, Schachter and Zwerling, LLP as lead counsel. On November 19, 2007, the plaintiffs filed the Amended Complaint, which generally alleges: (i) defendants made misstatements regarding subscriber line growth and average monthly churn rate; (ii) defendants failed to disclose problems with facsimile transmissions and a pending fax litigation case; (iii) defendants failed to disclose all patent infringement claims and issues; and (iv) that the Directed Share Program suffered from various infirmities. On January 18, 2008, defendants filed their motions to dismiss the Amended Complaint, and briefing on the matter was completed by April 2, 2008, and the Court heard oral argument on October 10, 2008. The Court has not yet ruled on the motion. The firms who served as underwriters to the IPO, pursuant to an indemnification agreement entered into between us and those firms prior to the IPO, have demanded that Vonage reimburse them for the costs and fees incurred by them in defense of the IPO litigation. In addition, three of the firms have demanded that Vonage reimburse them for the costs and fees incurred by them in response to various regulatory inquiries by the Financial Industry Regulatory Authority (formerly the NASD) and the New York Stock Exchange, among other things. Vonage has declined to reimburse these three firms any fees or expenses.

Consumer Class Action Litigations.    We have been named in several purported class actions venued in California, New Jersey, and Washington alleging a wide variety of deficiencies with respect to our business practices, marketing disclosures, email marketing and quality issues for both phone and fax service.

For example, there are various class actions, on behalf of both nationwide and state classes, pending in New Jersey, Washington and California generally alleging that we delayed and/or refused to allow consumers to cancel their Vonage service; failed to disclose procedural impediments to cancellation; failed to adequately disclose that their 30-day money back guarantee does not give consumers 30 days to try out our services; suppressed and concealed the true nature of our services and disseminated false advertising about the quality, nature and terms of our services; imposed an unlawful early termination fee; and invoked unconscionable provisions of our Terms of Service to the detriment of customers. On May 11, 2007, plaintiffs in one action petitioned the Judicial Panel on Multidistrict Litigation (the “Panel”), seeking transfer and consolidation of the pending actions to a single court for coordinated pretrial proceedings. In an Order dated August 15, 2007, the Panel transferred the pending actions to the United States Court for the District of New Jersey, captionedIn re Vonage Marketing and Sales Practices Litigation, MDL No. 1862, Master Docket No. 07-CV-3906 (USDC, D.N.J.). On October 1, 2007, counsel for one group of plaintiffs moved before the Court for Consolidation and Appointment of Co-Lead Counsel of the actions, and requested time to file an Amended Consolidated Complaint. The Court has not yet ruled on the motion.

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Nebraska Public Service Commission.    On November 15, 2007, the Director of the Nebraska Telecommunications Infrastructure and Public Safety Department of the Nebraska Public Service Commission filed a complaint (the “PSC Complaint”) before the Nebraska Public Service Commission (the “NPSC”) alleging that Vonage is required to contribute to the Nebraska Universal Service Fund (“NUSF”) and has failed to do so. The PSC Complaint seeks an order compelling Vonage to contribute to the NUSF, as well as administrative penalties. Vonage is vigorously defending itself against the PSC Complaint. On December 6, 2007,

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Vonage filed its answer. On or about December 20, 2007, Vonage also brought a complaint for declaratory and injunctive relief against the NPSC in the United States District Court for the District of Nebraska. On March 3, 2008, the United States District Court for the District of Nebraska issued a Memorandum and Order granting Vonage’s Motion for a Preliminary Injunction and Declaratory Relief. Specifically, the Court enjoined the NPSC from asserting state jurisdiction over Vonage to force Vonage to contribute to the NUSF and found the NPSC’s assertion of state jurisdiction over Vonage to force Vonage to pay into the NUSF is unlawful as preempted by the Federal Communications Commission.Commission (“FCC”). On April 1, Nebraska filed a Notice of Appeal to the 8^th Circuit Court of Appeals. On April 2, Vonage filed a motion for summary judgment in the district court, arguing the court should grant our permanent injunction. The district court, in a May 9, 2008 order, denied Vonage’s request for summary judgment without prejudice. Briefing before the 8^th Circuit Court of Appeals has been completed. It is unknown whether the Court of Appeals for the 8^th Circuit will grant oral argument or when the parties can expect a decision.

New Mexico Public Service Commission.    On June 27, 2008, the New Mexico Public Regulation Commission (“NMPRC”) filed a complaint for Declaratory Judgment (“NMPRC Complaint”) in the United States District Court for the District of New Mexico, alleging that Vonage is required to contribute to the New Mexico Universal Service Fund (“NMUSF”) and failed to do so. The NMPRC Complaint seeks an order compelling Vonage to contribute to the NMUSF. Vonage is vigorously defending itself against the NMPRC Complaint. On or about July 21, 2008, Vonage filed a motionMotion to dismissDismiss the NMPRC Complaint. The NMPRC filed a response to the Motion to Dismiss. It is not known when the parties can expect a decision on the Motion to Dismiss.

City of New York vs. Verizon and Vonage.On April 21, 2008, the City of New York and the Sheriff of the City of New York filed a complaint (“NYC Complaint”) in New York State Court against Verizon and Vonage, arising out of collection efforts on the $58,000 judgment entered against Vonage in theVerizon vs. Vonage patent litigation. The City alleges that either Verizon or Vonage is liable for $2,900, which represents a poundage fee of 5% of the value of the property sought to be levied upon. On May 13, 2008, Vonage filed a motion to dismiss one count of the NYC Complaint. On May 16, 2008, Verizon filed a motion to dismiss the NYC Complaint in its entirety. Briefing on the various motions is complete. The Court has not yet ruled ondenied both motions and the motions.parties are currently engaged in discovery.

From time to time, in addition to those identified above, Vonage is subject to legal proceedings, claims, investigations and proceedings in the ordinary course of business, including claims of alleged infringement of third-party patents and other intellectual property rights, commercial, employment and other matters. In accordance with GAAP,generally accepted accounting principles, Vonage 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. Litigation is inherently unpredictable. We believe that we have valid defenses with respect to the legal matters pending against Vonage. Given the uncertainty surrounding litigation and our inability to assess the likelihood of a favorable or unfavorable outcome in the above noted matters, it is possible that the resolution of one or more of these matters could have a material adverse effect on our consolidated financial position, cash flows or results of operations.

Regulation

Telephony services are subject to a broad spectrum of state and federal regulations. Because of the uncertainty over whether VoIP should be treated as a telecommunications or information service, we have been involved in a substantial amount of state and federal regulatory activity. Implementation and interpretation of the existing laws and regulations is ongoing and is subject to litigation by various federal and state agencies and courts. Due to the nature of the technology in use, there can be no assurance that we will not be subject to new regulations or existing regulations under new interpretations, and that such changeschange would not introduce material additional costs to our business.

Federal - Local Number Portability

On November 8, 2007, the Federal Communications Commission (“FCC”)FCC released its Order extending Local Number Portability (“LNP”) obligations to interconnected VoIP providers. This requirement of the Order will become effective 30 days after publication of the Order in the Federal Register. The Order was published in the Federal Register on February 21, 2008, and the LNP requirement for interconnected VoIP providers became effective on March 24, 2008.

In addition, the FCC held that validation of LNP requests should be based on no more than four fields for simple ports and those fields should be: (1) 10-digit telephone number; (2) customer account number; (3) 5-digit zip code; and (4) pass code (if applicable). This part of the Order was to become effective on February 6, 2008. On January 11, 2008, Embarq, a local telecommunications carrier, filed a petition asking that the FCC waive the effective date of the four field validation requirement until it implements a new billing system. On

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

February 5, 2008, the FCC waived the requirement for Embarq to comply with the four field validation requirement until September 30, 2008. The FCC also, on its own motion, waived the February 6, 2008 deadline for all other affected companies until July 31, 2008.

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Vonage currently provides LNP. Vonage occasionally faces difficulties in executing port requests in a timely manner. If Vonage is not able to implement port requests in a timely manner after the effective date of the LNP requirement for interconnected VoIP providers, Vonage could be subject to complaints at the FCC and/or an enforcement action by the FCC.

Federal - Disability Access

On September 15, 2007, the FCC released its Order extending the disability access requirements of Section 255 and 225 to interconnected VoIP services and to manufacturers of specially designed equipment used to provide VoIP services. The Order also required interconnected VoIP providers to contribute to the TRS Fund and offer 711 dialing for access to relay services. Vonage has complied effective October 5, 2007.

On October 9, 2007, the FCC’s Consumer and Governmental Affairs Bureau issued an Order granting in part several waiver requests related to VoIP 711 dialing. The Order waives for six months the requirement that interconnected VoIP service providers transmit 711 calls to an appropriate relay provider. On April 4, 2008, the Consumer and Governmental Affairs Bureau extended the waiver until June 30, 2009 for nomadic VoIP providers like Vonage. Under the direction of the FCC waiver, Vonage, as an interconnected VoIP service, is providing reminders to subscribers to dial 911 directly in the event of an emergency.

Federal - E-911

On September 3, 2005, the FCC released its VoIP E-911 Order. Pursuant to the Order, we were required (i) to notify our customers of the differences between the emergency services available through us and those available through traditional telephony providers and to receive affirmative acknowledgment from all of our customers that they understand the nature of the emergency services available through our service and (ii) to provide E-911 services to 100% of our subscribers by November 28, 2005. We have received affirmative acknowledgment from substantially all of our customers that they understand our emergency services and therefore we are substantially in compliance with both aspects of the Order. On November 28, 2005, we filed a petition for extension of time and limited waiver of certain of the enhanced emergency service requirements. To the extent the waiver is necessary and remains ungranted, we are at risk of an enforcement action including fines, penalties and/or an order to cease and desist selling and marketing our services in certain areas where E-911 service is unavailable. We regularly update the FCC on our E-911 deployment efforts. As of JuneSeptember 30, 2008, we have deployed E-911 service to approximately 99% of our U.S. customer base.

On July 23, 2008, the President signed the New and Emerging Technologies 911 Improvement Act of 2008 (“NET 911 Act”) into law. The Act codifies the requirements adopted by the FCC in the VoIP E-911 Order. In addition, the Act provides that IP-enabled voice service providers shall have the same protection from liability for the provision of 911 service as wireless providers and local exchange carriers. Previously, Vonage did not have this protection. Further, the Act provides that IP-enabled voice service providers shall have access to the elements necessary to provide 911 service at the same rates, terms, and conditions as wireless providers. Previously, incumbent local exchange carriers, public service answering points, and others that control these elements were not required to provide access to IP-enabled voice service providers. Under the Act, the FCC must adopt rules to implement the access provisions of the Act within ninety days of July 23, 2008. On October 21, 2008, the FCC released its order implementing the NET 911 Act.

Federal - CALEA

On August 5, 2005, the FCC released an Order extending the obligations of Communications Assistance for Law Enforcement Act (“CALEA”) to interconnected VoIP providers. Under CALEA, telecommunications carriers must assist law enforcement in executing electronic surveillance, which include the capability of providing call content and call-identifying information to a local enforcement agency, or LEA, pursuant to a court order or other lawful authorization.

The FCC required all interconnected VoIP providers to become fully CALEA compliant by May 14, 2007. To date, we have taken significant steps towards CALEA compliance, which include testing the CALEA solution with the FBI and delivering lawful CALEA requests. We have also implemented alternative solutions that allow CALEA access to call content and call-identifying information. The FCC and law enforcement officials have been advised as to our CALEA progress and our efforts at implementing alternative solutions. We could be subject to an enforcement action by the FCC if our CALEA solution is deemed not fully operational.

Federal - CPNI

On April 2, 2007, the FCC released its Order extending the application of the customer proprietary network information (“CPNI”) rules to interconnected VoIP providers. The FCC’s CPNI rules were published with an effective date of December 8, 2007. 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.

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Under the FCC’s existing rules, carriers may not use CPNI without customer approval except in circumstances related to their provision of existing services, and must comply with detailed customer approval processes when using CPNI outside of these 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 enhanced 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. Vonage has implemented additional security measures for CPNI designed to address the new requirements.

State Telecommunications Regulation

In general, the focus of interconnected VoIP telecommunications regulation is at the federal level. On November 12, 2004, the FCC declared that our service is subject to federal regulation and preempted the Minnesota Public Utilities Commission, or MPUC, from imposing certain of its regulations on us. The FCC’s decision was based on its conclusion that our service is interstate in nature and cannot be separated into interstate and intrastate components. On March 21, 2007, the United States Court of Appeals for the 8^th Circuit affirmed the FCC’s declaratory ruling preempting state regulation of Vonage’s service. The 8^th Circuit found that it is impossible for Vonage to separate its interstate traffic from its intrastate traffic because of the nomadic nature of the service. As a result, the 8^th Circuit held that it was reasonable for the FCC to preempt state regulation of Vonage’s service. The 8^th Circuit was clear, however, that the preemptive effect of the FCC’s declaratory ruling may be reexamined if technological advances allow for the separation of interstate and intrastate components of the nomadic VoIP service. Therefore, the preemption of state authority over Vonage’s service hinges on the inability to separate the interstate and intrastate components of the service.

While this ruling does not exempt us from all state oversight of our service, it effectively prevents state telecommunications regulators from imposing certain burdensome and inconsistent market entry requirements and certain other state utility rules and regulations on our service. State regulators continue to probe the limits of federal preemption in their attempts to apply state telecommunications regulation to interconnected VoIP service. The Nebraska Public Service Commission and New Mexico Public Regulatory Commission cases, discussed above under the Litigation section to this note, are examples of state public utility commission attempts to extend traditional state telecommunications regulation to our service. In these cases, the state public utility commissions are seeking to apply state universal service funding requirements to Vonage. Kansas has also asserted that they have jurisdiction to seek state universal service funding from interconnected VoIP providers. Similarly, the Public Utility Commission of Ohio has proposed rules that would apply state fees for Telephone Relay Service to interconnected VoIP service. We expect that state public utility commissions will continue their attempts to apply state telecommunications regulations to interconnected VoIP service.

State and Municipal Taxes

Vonage vs. Commonwealth of Pennsylvania.    On January 8, 2008, Vonage filed a Petition for Review with the Pennsylvania Commonwealth Court, arising out of the Pennsylvania Department of Revenue’s assessment of Sales and Use Tax (“Assessment”) against Vonage. The total amount of the tax at issue, including interest, is $2,003. On March 6, 2008, in order to stay enforcement of the Assessment and proceed with the litigation, Vonage filed with the Court a letter of credit for 120% of the Assessment ($2,185). On June 19,September 18, 2008, the parties agreed tofiled a tentative resolutionStipulation of Judgment, reflecting that the dispute, callingmatter has been resolved for payment of approximately $600 to resolve the matter.$680.

For a period of time, we did not collect or remit state or municipal taxes (such as sales, excise, and ad valorem taxes), fees or surcharges (“Taxes”) on the charges to our customers for our services, except that we have historically complied with the New Jersey sales tax. We have received inquiries or demands from a number of state and municipal taxing and 911 agencies seeking payment of Taxes that are applied to or collected from customers of providers of traditional public switched telephone network services. Although we have consistently maintained that these Taxes do not apply to our service for a variety of reasons depending on the statute or rule that establishes such obligations, a number of states have changed their statutes as part of the streamlined sales tax initiatives and we are now collecting and remitting sales taxes in those states. In addition, a few states address how VoIP providers should contribute to support public safety agencies, and in those states we began to remit fees to the appropriate state agencies. We have also contacted authorities in each of the other states to discuss how we can financially contribute to the 911 system. We do not know how all these discussions will be resolved, but there is a possibility that we will be required to pay or collect and remit some or all of these Taxes in the future. Additionally, some of these Taxes could apply to us retroactively. As such, we have a reserve of $3,807$3,062 at JuneSeptember 30, 2008 as our best estimate of the potential tax exposure for any retroactive assessment. We believe the maximum estimated exposure for retroactive assessments is $13,416$11,683 as of JuneSeptember 30, 2008.

VONAGE HOLDINGS CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(In thousands, except per share amounts)

(Unaudited)

Purchase Obligations

At June 30, 2008, future commitments for purchase obligations include: $4,700 over three years that will enable us to provide broadband internet access to our customers, $1,500 for one year to provide in-store support at national retail outlets, and $12,400 over a three year period to provide customer care technical support to our customers.

Note 3.    Subsequent Events

Convertible Notes Refinancing

As of June 30, 2008, we had a working capital deficit of $239,679, caused primarily by $253,460 of Notes due December 1, 2010 being classified as a current liability since they can be put by the holders on December 16, 2008. On July 22,October 19, 2008, we entered into definitive agreements for a Commitment Letterfinancing consisting of (i) a $130,300 senior secured first lien credit facility (the “First Lien Senior Facility”), including an original issuance discount of $7,200, (ii) a $72,000 senior secured second lien credit facility (the “Second Lien Senior Facility”) and (iii) the sale of $18,000 of the Company’s 20% senior secured third lien notes due 2015 (the “Convertible Notes” and, together with Silver Point establishing the termsFirst Lien Senior Facility and conditions of a $185,000 Initial Financing. Silver Point has also agreed, subject to certain conditions, to use commercially reasonable efforts to assemble a syndicate of other lenders to provide up to $30,000 of Incremental Financing.the Second Lien Senior Facility, the “Financing”). The Financing was consummated on November 3, 2008.

The closingFirst Lien Senior Facility, the Second Lien Senior Facility and the Note Purchase Agreement governing the Convertible Notes contain various covenants and other restrictions that limit our ability and/or the ability of certain of our subsidiaries to engage in specified types of transactions. These covenants and other restrictions may under certain circumstances limit, but not necessarily preclude, our and certain of our subsidiaries’ ability to, among other things: incur, prepay, refinance or modify indebtedness; create liens; pay dividends on or repurchase our capital stock or make other restricted payments; make investments; enter into acquisitions, sales and mergers; enter into sale and leaseback transactions; amend our organizational documents, or amend, modify or waive litigation settlements, key employment agreements or other material contracts; incur marketing expenses in excess of specified thresholds; change the nature of our business or enter into additional lines of business; and enter into transactions with our stockholders and affiliates.

Under the Financing agreements, we are required to maintain a specified minimum fixed charge coverage ratio, maximum leverage ratio and senior secured debt leverage ratio. Additionally, these agreements require us to maintain minimum levels of consolidated adjusted EBIDTA, liquidity and pre-marketing operating income and limit our capital expenditures. Upon the repayment of our obligations under the First Lien Senior Facility and the Second Lien Senior Facility, the covenants will fall-away, but the Note Purchase Agreement for the InitialConvertible Notes will continue to limit our ability to incur indebtedness and make restricted payments. Our ability to comply with such financial and other covenants can be affected by events beyond our control, so we may not be able to comply with these covenants. A breach of any financial or other covenants could result in a default under these agreements. In that case, the lenders and the noteholders could elect to declare due and payable immediately all amounts due under the Financing is expected to occuragreements, including principal, accrued interest, a “make-whole” premium and, in the third quarter of 2008. Silver Point has committed to be allocated $125,000case of the Initial FinancingConvertible Notes, liquidated damages, and it is a conditionmay take action to closing offoreclose upon the Initial Financing that we obtain commitments from a permitted group forcollateral securing the remaining amounts of the Initial Financing. Silver Point may syndicate a portion of its commitment.indebtedness.

We intend to useused the net proceeds of the Initial Financing, less estimated fees and expenses of approximately $21,000 to $24,000, of which approximately $3,000 has been paid as of June 30, 2008, plus cash on hand, to repurchase $253,460 of our existing Notespre-existing convertible notes in a tender offer. We estimate that we have incurred and will incur aggregate costs in connection with the Offer, which we commenced on July 31, 2008. Assuming all holders tender all of their Notes and such Notes are accepted pursuant to the Offer on the expiration date, the aggregate cost to us of such repurchases, for principal, accrued and unpaid interest andFinancing, including all fees and expenses, of between $28,000 and $31,000 of which $12,305 was incurred through September 30, 2008 and included in “Other Assets” in the consolidated balance sheet. We are in the process of determining the accounting impact of the Financing and subsequent extinguishment of the pre-existing convertible notes. Depending on the fair market value of the Financing and mutual lenders in the Financing and pre-existing convertible notes, there may be a material debt extinguishment charge in the fourth quarter. Except for certain fees paid directly to lenders in the Financing which will be approximately $257,600.

There can be no assurance that we will be successfulincluded in completing this or any other refinancing transaction, which raises substantial doubt as to our ability to continue as a going concern. The unaudited consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Appointment of New CEO

On July 29, 2008, we announced that our Board of Directors has appointed Marc Lefar as our Chief Executive Officer. Mr. Lefar replaces Interim CEO Jeffrey Citron, who had assumeddebt extinguishment charge, the additional role in April 2007. Mr. Citron will assume the role of non-executive Chairmanbalance of the Boardfees and expenses are expected to be amortized over the term of Directors and serve as a consultant on long-term strategy.the Financing, using the effective interest method.

Item 2.    Management’s Discussion and Analysis of Financial Condition and Results of Operations

You should read the following discussion together with our consolidated financial statements and the related notes included elsewhere in this Form 10-Q and our audited financial statements included in our Annual Report on Form 10-K. This discussion contains forward-looking statements. These forward-looking statements are based on information available at the time the statements are made and/or management’s belief as of that time with respect to future events and involve risks and uncertainties that could cause actual results and outcomes to be materially different. Important factors that could cause such differences include the Company’s ability to consummate the proposed private debt financing arrangement, which is subject to numerous uncertainties, including but not limited to successful negotiation of definitive documentation for the financing arrangement and satisfaction or waiver of all conditions to closing, which include obtaining stockholder approval of the potential issuance of shares of common stock upon the conversion of convertible notes; the Company’s ability to refinance the Company’s outstanding convertible notes, which can be put to it in December 2008; the Company’s history of net operating losses and the Company’s need for cash to finance the Company’s growth; worsening economic conditions; restrictions in our debt agreements that may limit our operating flexibility; results of pending litigation and intellectual property and other litigation that may be brought against us; the competition we face; our dependence on our customers’ existing broadband connections; differences between our service and traditional phone services, including our 911 service; uncertainties relating to regulation of VoIP services; system disruptions or flaws in our technology; the risk that VoIP does not gain broader acceptance; and other factors that are set forth in the “Risk Factors” in our Annual Report on Form 10-K, in our Quarterly Reports on Form 10-Q and in our Current Reports on Form 8-K. While we may elect to update forward-looking statements at some point in the future, we specifically disclaim any obligation to do so, and therefore, you should not rely on these forward-looking statements as representing our views as of any date subsequent to today.

Overview

We are a leading provider of broadband telephone services with over 2.6 million subscriber lines as of JuneSeptember 30, 2008. Our services use Voice over Internet Protocol, or VoIP, technology, which enables voice communications over the Internet through the conversion and compression of voice signals into data packets. In order to use our service offerings, customers must have access to a broadband Internet connection with sufficient bandwidth (generally 60 kilobits per second or more) for transmitting those data packets.

We earn revenue and generate cash primarily through our broadband telephone service plans, each of which offers a different pricing structure based on a fixed monthly or annual fee. We generate most of our revenue from those fees, substantially all of which we bill to our customers’ credit cards, debit cards or electronic check payments, or ECP, one month in advance.

We have invested heavily in an integrated marketing strategy to build brand awareness and drive response rates that supports our sales and distribution efforts. We acquire customers through a number of sales channels, including our websites, toll free numbers, kiosks in shopping malls and a presence in major retailers located in the United States, Canada and the United Kingdom. We also acquire new customers through Refer-a-Friend, our online customer referral program.

We launched our service in the United States in October 2002, in Canada in November 2004 and in the United Kingdom in May 2005. Since our U.S. launch, we haveinitially experienced rapid revenue and subscriber line growth.growth, which has slowed in recent quarters. While in prior years our revenue has grown, rapidly, we have incurred an accumulated deficit of $1,004,128$1,011,945 from our inception through JuneSeptember 30, 2008. Although our net losses initially were driven primarily by start-up costs and the cost of developing our technology, more recently our net losses have been driven by our growth strategy.patent litigation settlements and investments in marketing. In addition, we plan to continue to invest in research and development and customer care. In 2007, we announced we are seeking to balance growth with profitability. We intend to continue to pursue investments in growth marketing because we believe it will position us as a strong competitor in the long term. Although we believe we will achieve net income in the future, we ultimately may not be successful and we may never achieve net income.

Recent Developments Related to Our Convertible Notes Refinancing

As of JuneSeptember 30, 2008, we had a working capital deficit of $239,679,$248,117, caused primarily by $253,460 of Notes due December 1, 2010 (“Notes”) being classified as a current liability since they can becould have been put to us by the holders on December 16, 2008. On July 22,October 19, 2008, we entered into definitive agreements for a commitment letterfinancing consisting of (i) a $130,300 senior secured first lien credit facility (the “Commitment Letter”“First Lien Senior Facility”), including an original issuance discount of $7,200, (ii) a $72,000 senior secured second lien credit facility (the “Second Lien Senior Facility”) with Silver Point Finance, LLC (“Silver Point”) establishingand (iii) the terms and conditionssale of a $185,000 initial private debt financing (the “Initial Financing”). Silver Point has also agreed, subject to certain conditions, to use commercially reasonable efforts to assemble a syndicate of other lenders to provide up to $30,000 of incremental private debt financing (the “Incremental Financing”).

The closing for the Initial Financing is expected to occur in the third quarter of 2008. Silver Point has committed to be allocated $125,000$18,000 of the InitialCompany’s 20% senior secured third lien notes due 2015 (the “Convertible Notes” and, together with the First Lien Senior Facility and the Second Lien Senior Facility, the “Financing”). The Financing and it is a condition to closing of the Initial Financing that we obtain commitments from a permitted group for the remaining amounts of the Initial Financing. Silver Point may syndicate a portion of its commitment.was consummated on November 3, 2008.

We intend to useused the net proceeds of the Initial Financing, less estimated fees and expenses of approximately $21,000 to $24,000, of which approximately $3,000 has been paid as of June 30, 2008, plus cash on hand, to repurchase $253,460 of our existing Notesconvertible notes in a tender offer (“Offer”), whichoffer. We estimate that we commenced on July 31, 2008. Assuming all holders tender all of their Noteshave incurred and such Notes are accepted pursuant towill incur aggregate costs in connection with the Offer on the expiration date, the aggregate cost to us of such repurchases, for principal, accrued and unpaid interest andFinancing, including all fees and expenses, will be approximately $257,600.of between $28,000 and $31,000.

There can be no assurance that we will be successful in completing this or any other refinancing transaction, which raises substantial doubt as to our ability to continue as a going concern. The unaudited consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty.

Trends in Our Industry and Key Operating Data

A number of trends in our industry have a significant effect on our results of operations and are important to an understanding of our financial statements. Also, the table below includes key operating data that our management uses to measure the growth and operating performance of our business:

Broadband adoption.    The number of U.S. households with broadband Internet access has grown significantly. We expect this trend to continue. We benefit from this trend because our service requires a broadband Internet connection and our potential addressable market increases as broadband adoption increases.

Changing competitive landscape.    We continue to see increasing competition from other companies that offer multiple services such as cable television, video services, voice service and broadband Internet service. These competitors are offering VoIP or other voice services as part of a bundle, in which they offer voice services at a lower price than we do to new subscribers. In addition, we believe several of these competitors are working to develop new integrated offerings that we cannot provide and that could make their services more attractive to customers. We also compete against established alternative voice communication providers 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.

Gross subscriber line additions.    Gross subscriber line additions for a particular period are calculated by taking the net subscriber line additions during that particular period and adding to that the number of subscriber lines that terminated during that period. This number does not include subscriber lines both added and terminated during the period, where termination occurred within the first 30 days after activation. The number does include, however, subscriber lines added during the period that are terminated within 30 days of activation but after the end of the period.

Net subscriber line additions.    Net subscriber line additions for a particular period reflect the number of subscriber lines at the end of the period, less the number of subscriber lines at the beginning of the period.

Subscriber lines.    Our subscriber lines include, as of a particular date, all subscriber lines from which a customer can make an outbound telephone call on that date. Our subscriber lines include fax lines and SoftPhones but do not include our virtual phone numbers or toll free numbers, which only allow inbound telephone calls to customers. Subscriber lines increased from 2,446,4482,524,211 as of JuneSeptember 30, 2007 to 2,612,4402,621,900 as of JuneSeptember 30, 2008. We believe that the increase in our subscriber lines was related to our advertising which includes television, online, direct mail and telemarketing. Although our subscriber lines increased compared to last year, we dohave not expect to sustainsustained our historical subscriber line growth rate on a percentage basis we believe due to a combination of increased competition, a larger customer base, our decrease in marketing costs and increasing saturation among our initial target customer base, which included many early adopters.

Average monthly customer churn.    Average monthly customer churn for a particular period is calculated by dividing the number of customers that terminated during that period by the simple average number of customers during the period, and dividing the result by the number of months in the period. The simple average number of customers during the period is the number of customers on the first day of the period, plus the number of customers on the last day of the period, divided by two. Terminations, as used in the calculation of churn statistics, do not include customers terminated during the period if termination occurred within the first 30 days after activation. Our average monthly customer churn was 3.0% for the three months ended JuneSeptember 30, 2008 comparedand September 30, 2007, respectively. We are working to 2.5% foraddress network quality and improve the three months ended June 30, 2007. We believe this increase was driven, in part, by inconsistent user experience with our service, quality of our customer service and increased competition.in order to decrease churn. We monitor churn on a daily basis and use it as an indicator of the level of customer satisfaction. Other companies may calculate churn differently, and their churn data may not be directly comparable to ours. Customers who have been with us for a year or more tend to have a significantly lower churn rate than customers who have not. Our churn will fluctuate over time due to increased

competitive pressures, market place perception of our services and our ability to provide high quality customer care and network quality and add future innovative products and services.

Average monthly revenue per line.    Average monthly revenue per line for a particular period is calculated by dividing our total revenue for that period by the simple average number of subscriber lines for the period, and dividing the result by the number of months in the period. The simple average number of subscriber lines for the period is the number of subscriber lines on the first day of the period, plus the number of subscriber lines on the last day of the period, divided by two. Our average monthly revenue per line increased slightly to $29.04$28.75 for the three months ended JuneSeptember 30, 2008 compared to $28.38$28.24 for the three months ended JuneSeptember 30, 2007.2007, reflecting a benefit from the reduction in the period over which activation fees are amortized. We continue to expect stability in our pricing environment. In addition, an increasing number of customers are choosing the residential unlimited plan as a result of the first month free promotion, which has a positive effect on longer term average monthly revenue per line.

Average monthly telephony services revenue per line.    Average monthly telephony services revenue per line for a particular period is calculated by dividing our total telephony services revenue for that period by the simple average number of subscriber lines for the period, and dividing the result by the number of months in the period. Our average monthly telephony services revenue per line was $27.92$27.52 for the three months ended JuneSeptember 30, 2008 compared with $27.63$27.32 for the three months ended JuneSeptember 30, 2007, reflecting a benefit from the reduction in the period over which activation fees are amortized.

Average monthly direct cost of telephony services per line.    Average monthly total direct cost of telephony services per line for a particular period is calculated by dividing our direct cost of telephony services for that period by the simple average number of subscriber lines for the period, and dividing the result by the number of months in the period. We use the average monthly total direct cost of telephony services per line to evaluate how effective we are at managing our costs of providing service. Our average monthly total direct cost of telephony services per line remained constant at $7.22was $7.20 for the three months ended JuneSeptember 30, 2008 compared to $7.21$7.30 for the three months ended JuneSeptember 30, 2007.2007 due primarily to the increase in customer base.

Marketing cost per gross subscriber line addition.    Marketing cost per gross subscriber line addition is calculated by dividing our marketing expense for a particular period by the number of gross subscriber line additions during the period. Marketing expense does not include the cost of certain customer acquisition activities, such as rebates and promotions, which are accounted for as an offset to revenues, or customer equipment subsidies, which are accounted for as direct cost of goods sold. As a result, it does not represent the full cost to us of obtaining a new customer.

Marketing cost per gross subscriber line addition of $282.89increased to $272.24 for the three months ended JuneSeptember 30, 2008 was consistent compared to $286.72$206.30 for the three months ended JuneSeptember 30, 2007.2007 due primarily to lower net subscriber line additions compared to the prior year.

Employees.    Employees represent the number of personnel that are on our payroll and exclude temporary or outsourced labor.

Regulation.    Our business has developed in an environment largely free from regulation. However, theThe United States and other countries, have begun to examinehowever, are examining how VoIP services should be regulated, and a number of initiatives could have an impact on our business. For example, the FCC has concluded that wireline broadband Internet access, such as DSL and Internet access provided by cable companies, is an information service and is subject to lighter regulation than telecommunications services. This order may give providers of wireline broadband Internet access the right to discriminate against our services, charge their customers an extra fee to use our service or block our service. More recently, however, the FCC found that a major cable operator’s network management practices, which had the effect of degrading certain applications, were not allowed under the FCC’s network neutrality policy statement. We believe it is unlikely that thissuch blocking or discrimination will occur on a widespread basis, but if it does it would have a material adverse effect on us. Other regulatory initiatives includedevelopments including state efforts to impose state telecommunications regulation on us and the assertion of state regulatory authority over us, local number portability, disability access andFCC’s proposed reforms for the intercarrier compensation system. Complying with regulatory developmentsand universal service funding systems may affect our business by increasing the taxes and regulatory fees we pay and our operating expenses, including legal and consulting fees, or requiring us to make significant capital expenditures.

Operating Revenues

Operating revenues consists of telephony services revenue and customer equipment and shipping revenue.

Telephony services revenue.    Substantially all of our operating revenues are telephony services revenue. In the United States, we offer two residential plans, “Residential Premium Unlimited” and “Residential Basic 500,” and two small business and home office plans, “Small Business Unlimited” and “Small Business Basic.” Each of our unlimited plans offers unlimited domestic calling as well as unlimited calling to Puerto Rico, Canada and selected European countries, subject to certain restrictions, and each of our basic plans offers a limited number of domestic calling minutes per month. Also, we currently offer international calling plans that are bundled with our Residential Premium Unlimited plan where a customer can make calls to a chosen international region. Under our basic plans, we charge on a per minute basis when the number of domestic calling minutes included in the plan is exceeded for a particular month. International calls (except for calls to certain European countries under our unlimited plans and a variety of countries under international calling plans) are charged on a per minute basis. These per minute fees are not included in our monthly subscription fees. We offer similar plans in Canada and the United Kingdom.

We derive most of our telephony services revenue from monthly subscription fees that we charge our customers under our service plans. We also offer residential fax service, virtual phone numbers, toll free numbers and other services, for each of which we charge an additional monthly fee. One business fax line is included with each of our two small office and home office plans, but we charge monthly fees for additional business fax lines. We automatically charge these fees to our customers’ credit cards, debit cards or ECP monthly in

advance. We also automatically charge the per minute fees not included in our monthly subscription fees to our customers’ credit cards, debit cards or ECP monthly in arrears unless they exceed a certain dollar threshold, in which case they are charged immediately.

By collecting monthly subscription fees in advance and certain other charges 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 losses, which are recorded as a reduction to revenue. If a customer’s credit card, debit card or ECP is declined, we generally suspend international calling capabilities as well as the customer’s ability to incur domestic

usage charges in excess of their plan minutes. Historically, in most cases, we are able to correct the problem with the customer within the current monthly billing cycle. Through March 31, 2007, ifIf the customer’s credit card, debit card or ECP could not be successfully processed during twothree billing cycles, (i.e.,we terminate the current and subsequent month’s billing cycle), we terminated the account. Beginning on April 1, 2007, this period was extended to three billings cycles.

We also generate revenue by charging a fee for activating service. We charge an activation fee to our direct channel customers, or those customers who purchase equipment directly from us and to our retail channel customers, or customers who purchase equipment from retail stores. For our direct channel customers, activation fees, together with the related customer acquisition amounts for equipment, arewere deferred and amortized over the estimated average customer relationship period of 60 months. For our retail channel customers, rebates and retailer commissions up to but not exceeding the activation fee, arewere also deferred and amortized over the estimated average customer relationship period of 60 months. Starting January 1, 2008, due to the increase in churn, the customer relationship period was reduced to 48 months for both the direct and retail channel. The amortization of deferred customer equipment expense is recorded to direct cost of goods sold. The amortization of deferred rebates is recorded as a reduction to telephony services revenue. The amortization of deferred retailer commissions is recorded as marketing expense. The impact of this change was not material to the consolidated results of operations.

In the United States, we charge regulatory recovery fees on a monthly basis to defray the costs associated with regulatory consulting and compliance as well as related litigation, E-911 compliance and to cover taxes that we are charged by the suppliers of telecommunications services. In addition, we charge customers Federal USF and related fees, which fees we record as revenue.

Prior to August 15, 2007, we accepted returns of customer equipment up to 30 days. From August 15, 2007 through January 31, 2008, customers had up to 60 days to return equipment. Starting February 1, 2008, returns of customer equipment was reduced back to 30 days. For all subscribers who became our customers from July 1, 2005 to February 1, 2007, we charged a disconnect fee to customers who terminated their service within one year of activation. For subscribers who became customers after February 1, 2007, we charge a disconnect fee to those customers who terminate their service within two years of activation. Disconnect fees are recorded as revenue and are recognized at the time the customer terminates service.

Telephony services revenue is offset by the cost of certain customer acquisition activities, such as rebates and promotions.

Customer equipment and shipping revenue.    Customer equipment and shipping revenue consists of revenue from sales of customer equipment to our wholesalers or directly to customers and retailers. In addition, customer equipment and shipping revenue includes the fees that we charge our customers for shipping any equipment to them.

Operating Expenses

Operating expenses consist of direct cost of telephony services, royalties, direct cost of goods sold, selling, general and administrative expense, marketing expense and depreciation and amortization.

Total direct cost of telephony services.    Total direct cost of telephony services primarily consists of fees that we pay to third parties on an ongoing basis in order to provide our services. These fees include:

Direct cost of goods sold.    Direct cost of goods sold primarily consists of costs that we incur when a customer first subscribes to our service. These costs include:

Selling, general and administrative expense.    Selling, general and administrative expense includes:

Marketing expense.    Marketing expense consists of:

Depreciation and amortization expenses.    Depreciation and amortization expenses include:

Other Income (Expense)

Other Income (Expense) consists of:

After the closing of the proposed private debt financing, assuming no material increase in the interest rate environment, we expect our interest expense to more than double.

Results of Operations

The following table sets forth, as a percentage of consolidated operating revenues, our consolidated statement of operations for the periods indicated:

Summary of Results for the Three and SixNine Months Ended JuneSeptember 30, 2008 and JuneSeptember 30, 2007

Telephony services revenue.    For the quarter ended JuneSeptember 30, 2008, telephony services revenue increased by $18,268,$12,368, or 9%6%, compared to the quarter ended JuneSeptember 30, 2007. This was primarily driven by an increase in the number of subscriber lines, which grew from 2,446,4482,524,211 at JuneSeptember 30, 2007 to 2,612,4402,621,900 at JuneSeptember 30, 2008. The increase in subscriber lines translated into an increase in monthly subscription fees of $10,017,$5,247, regulatory fees that we collect from subscribers of $4,713,$2,928, which included $3,404$2,225 of USF and related fees, and activation fees of $3,415.$3,354. The increase in activation fees included $2,151 for the change in our customer life from 60 months to 48 months in the

first quarter of 2008. Additionally, we experienced a higher volume of international calling by subscribers that generated an increase of $5,382. This was offset by a $3,678 increase in bad debt expense and a $2,946 increase in credits we issued to subscribers.

For the six months ended June 30, 2008, telephony services revenue increased by $45,881, or 12%, compared to the six months ended June 30, 2007. This was primarily driven by an increase in the number of subscriber lines, which grew from 2,446,448 at June 30, 2007 to 2,612,440 at June 30, 2008. The increase in subscriber lines translated into an increase in monthly subscription fees of $27,667, regulatory fees that we collect from subscribers of $9,420, which included $6,652 of USF, and activation fees of $7,404. The increase in activation fees included $4,920$1,875 for the change in our customer life from 60 months to 48 months in the first quarter of 2008. Additionally, we experienced a higher volume of international calling by subscribers that generated an increase of $10,043.$6,037. We also had an $841 increase in the fees we charge for disconnecting our service. This was offset by a $2,917 increase in bad debt expense as we had a high number of customers terminate service with a balance due and a $3,395 increase in credits we issued to subscribers in an $8,056effort to reduce churn.

For the nine months ended September 30, 2008, telephony services revenue increased by $58,249, or 10%, compared to the nine months ended September 30, 2007. This was primarily driven by an increase in the number of subscriber lines, which grew from

2,524,211 at September 30, 2007 to 2,621,900 at September 30, 2008. The increase in subscriber lines translated into an increase in monthly subscription fees of $32,914, regulatory fees that we collect from subscribers of $12,347, which included $8,876 of USF and related fees, and activation fees of $10,759. The increase in activation fees included $6,794 for the change in our customer life from 60 months to 48 months in the first quarter of 2008. Additionally, we experienced a higher volume of international calling by subscribers that generated an increase of $16,079. We also had a $2,341 increase in the fees we charge for disconnecting our service. This was offset by a $10,973 increase in bad debt expense and a $3,337$6,732 increase in credits we issued to subscribers.

Direct cost of telephony services.    For the quarter ended JuneSeptember 30, 2008 compared to 2007, the increase in direct cost of telephony services of $4,251,$2,039, or 8%4%, was primarily due to the USF and related fees imposed by government agencies of $3,404$2,225. There was also an increase in other cost of $234 mainly for implementing new features and termination costs of $140, which are costs to transfer calls to and from the Internet to the public switched telephone network. This was offset by a decrease in our network costs of $292, which includes costs for co-locating in other carriers’ facilities, for leasing phone numbers, routing calls on the Internet, and transferring calls to and from the Internet to the public switched telephone network and E-911 costs and a decrease of taxes that we pay on our purchase of telecommunications services from our suppliers of $2,107.$270.

For the nine months ended September 30, 2008 compared to 2007, the increase in direct cost of telephony services of $7,222, or 4%, was primarily due to the USF and related fees imposed by government agencies of $8,876. Also, there was an increase in our network costs of $1,133,$2,945, which includes costs for co-locating in other carriers’ facilities, for leasing phone numbers, routing calls on the Internet, and transferring calls to and from the Internet to the public switched telephone network and E-911 costs. There is also an increase of $1,019 in other cost mainly for implementing new features. This was offset by a decrease in termination costs of $2,393,$5,385, which are costs to transfer calls to and from the Internet to the public switched telephone network.

For the six months ended June 30, 2008 compared to 2007, the increase in direct cost of telephony services of $5,183, or 5%, was primarily due to the USF fees imposed by government agencies of $6,652. Also, there was an increase in our network costs of $4,022, which includes costs for co-locating in other carriers’ facilities, for leasing phone numbers, routing calls on the Internet, and transferring calls to and from the Internet to the public switched telephone network and E-911 costs. This was offset by a decrease in termination costs of $5,525, which are costs to transfer calls to andtaxes that we pay on our purchase of telecommunications services from the Internet to the public switched telephone network.our suppliers of $235.

Royalty.    The royalty expense of $11,052$11,139 and $21,467$32,606 for the three and sixnine months ended JuneSeptember 30, 2007, respectively, was for the judgment entered against us in our patent litigation with Verizon. No royalty is required subsequent to our October 2007 IP-litigation settlement with Verizon.

Customer equipment and shipping revenue.    For the quarter ended JuneSeptember 30, 2008 compared to 2007, our customer equipment and shipping revenue increased by $3,354,$2,868, or 62%42%, primarily due to an increase in customer equipment sales of $3,502,$2,918, which was offset by the decrease in customer shipping revenue and rebates of $148$49 due to less period over period customer additions.

For the sixnine months ended JuneSeptember 30, 2008 compared to 2007, our customer equipment and shipping revenue increased by $4,418,$7,286, or 37%39%, primarily due to an increase in customer equipment sales of $5,026$11,064 from more expensive devices and more retail devices sold, which was offset by the decrease in customer shipping revenue and rebates of $608$3,777 due to less period over period customer additions.

Direct cost of goods sold.    For the quarter ended JuneSeptember 30, 2008 compared to 2007, the increase in direct cost of goods sold of $7,290,$3,778, or 65%22%, was due to an increase in the cost of customer equipment of $6,907$4,128 including $1,944$1,688 of amortization costs on customer equipment, which were higher for the three months ended JuneSeptember 30, 2008 compared to the three months ended JuneSeptember 30, 2007 due to the increase in subscriber base and the change of our customer life from 60 months to 48 months in the first quarter of 2008. We also incurred additional costs on promotional itemsIn addition, there was an increase in order to reduce churn. Ourwaived activation fees for new customers. This was offset by a decrease in our shipping costs increased slightly by $383of $350 due to higher shipping rates offset by fewer devices shipped for the three months ended June 30, 2008.periods over period customer additions.

For the sixnine months ended JuneSeptember 30, 2008 compared to 2007, the increase in direct cost of goods sold of $16,029,$19,807, or 65%48%, was due to an increase in the cost of customer equipment of $14,299$18,427 including $4,475$6,162 of amortization costs on customer equipment, which were higher for the sixnine months ended JuneSeptember 30, 2008 compared to the sixnine months ended JuneSeptember 30, 2007 due to the increase in subscriber base and the change of our customer life from 60 months to 48 months in the first quarter of 2008. We also incurred additional costs on promotional itemsIn addition, there was an increase in order to reduce churn.waived activation fees for new customers. Our shipping costs increased slightly by $1,730$1,380 due to higher shipping rates offset by fewer devices shipped for the sixnine months ended JuneSeptember 30, 2008.

Selling, general and administrative.    For the quarter ended JuneSeptember 30, 2008 compared to 2007, there was a slight increasethe decrease in selling, general and administrative expenses of $129,$141,104, or less than 1%. This included increases66%, was primarily due to the settlement expenses of $132,951 related to our patent litigation with Sprint, AT&T, Verizon and others recorded in share-based compensation expense of $6,613, outsourced temporary labor of $1,723 and legal settlements of $2,067 offset by decreasesthe quarter ended September 30, 2007. There was also a decrease in professional fees of $5,972,$9,782, primarily related to our past IP-litigation, $2,184 in tax expense for what we potentially might owe for sales taxcosts related to our retail kiosks of $611 and a decrease in severance costs of $3,510$442 related to our reduction-in-force in 2007. This was offset by increases in share-based expense of $1,739, which was primarily related to the separation and consulting agreements with our former interim chief executive officer, salaries, recruiting and outsourced temporary labor of $1,621, and tax expense of $905 as we had an expense reduction in the third quarter of 2007 that was not repeated in the third quarter of 2008.