**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON,DC 20549**

 

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**AMENDMENT NO. 1**

**FORM 10-Q**

 

**Mark One**

 

| **ý**                                                                                                                                                                     | ** ** | **Quarterly Report Pursuant to Section 13 or 15(d)  of the Securities Exchange Act of 1934**  |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------------------------------------------------|
|                                                                                                                                                                           |
| **for the Quarterly Period Ended March 31, 2005.**                                                                                                                             |
| ** **                                                                                                                                                                     |
| **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.**

(ExactName of Registrant as Specified in Its Charter)

 

| **Delaware**              | **23-2866697**                        |
|---------------------------|---------------------------------------|
| (State  of Incorporation) | (I.R.S.  Employer Identification No.) |

 

| **3190 Tremont Avenue**                   | ** ** | ** **  |
|-------------------------------------------|------------|-------------|
| **Trevose, Pennsylvania**                 | ** ** | **19053**   |
| (Address  of Principal Executive Offices) |       | (Zip  Code) |

 

**(215)354-5100**

(Registrant’sTelephone Number, Including Area Code)

 

Indicate by check mark whether theregistrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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 ý No o

 

Indicate by check mark whether the registrantis an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o No ý

 

As of May 9, 2005, there were 33,756,436shares of common stock, par value $.01 per share, outstanding.

 

 

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**WORLDGATECOMMUNICATIONS, INC.**

** **

**QUARTERLYREPORT ON FORM 10-Q**

**FOR THETHREE MONTHS ENDED MARCH 31, 2005**

** **

**TABLE OF CONTENTS**

 
| PART II. FINANCIAL  INFORMATION                                                                       |   |
|-------------------------------------------------------------------------------------------------------|--------|
|                                                                                                  |   |
| Item 1. Financial  Statements                                                                         | 3      |
| Item  2. Management’s Discussion And Analysis Of Financial Condition And Results Of  Operations. | 11     |
| Item  3. Quantitative And Qualitative Disclosures About Market Risk.                                  | 15     |
| Item 4.  Controls And Procedures.                                                                     | 15     |
|                                                                                                  |   |
| PART  II. OTHER INFORMATION                                                                           |   |
|                                                                                                  |   |
| Item 1. Legal  Proceedings.                                                                           | 16     |
| Item  2. Unregistered Sales of Equity Securities And Use Of Proceeds.                                 | 16     |
| Item 3.  Defaults Upon Senior Securities.                                                             | 16     |
| Item 4.  Submission Of Matters To A Vote Of Security Holders.                                         | 16     |
| Item 5. Other  Information.                                                                           | 16     |
| Item 6.  Exhibits And Reports On Form 8-K.                                                            | 17     |

 

2

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**PARTI. FINANCIAL INFORMATION**

# **ITEM1.  FINANCIAL STATEMENTS**

** **

**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(DOLLARSIN THOUSANDS)**

 
| ** **                                                                                                                                                                                           | ** ** | **As of  March 31,**  | ** ** | **As of  December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------|------------|-------------------------|------------|
| ** **                                                                                                                                                                                           | ** ** | **2005  (Unaudited)** | ** ** | **2004  (Audited)**     | ** ** |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| ASSETS                                                                                                                                                                                               |       |                  |       |                    |       |
| Current assets:                                                                                                                                                                                      |       |                  |       |                    |       |
| Cash and cash equivalents                                                                                                                                                                            |       | $                     | 9,929      |                    | $          | 11,840 |   |
| Other receivables                                                                                                                                                                                    |       | 12                    |       | 28                      |       |
| Inventory, net                                                                                                                                                                                       |       | 99                    |       | 46                      |       |
| Prepaid and other assets                                                                                                                                                                             |       | 355                   |       | 184                     |       |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| Total current assets                                                                                                                                                                                 |       | 10,395                |       | 12,098                  |       |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| Property and equipment                                                                                                                                                                               |       | 3,609                 |       | 3,530                   |       |
| Less: accumulated depreciation and amortization                                                                                                                                                      |       | (1,985                | )          | (1,815                  | )          |
| Property and equipment, net                                                                                                                                                                          |       | 1,624                 |       | 1,715                   |       |
| Deposits and other assets                                                                                                                                                                            |       | 9                     |       | 9                       |       |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| Total assets                                                                                                                                                                                         |       | $                     | 12,028     |                    | $          | 13,822 |   |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| LIABILITIES  AND STOCKHOLDERS’ DEFICIENCY                                                                                                                                                       |       |                  |       |                    |       |
| Current  liabilities:                                                                                                                                                                                |       |                  |       |                    |       |
| Accounts payable                                                                                                                                                                                     |       | $                     | 258        |                    | $          | 222 |   |
| Accrued expenses                                                                                                                                                                                     |       | 841                   |       | 951                     |       |
| Accrued compensation and benefits                                                                                                                                                                    |       | 241                   |       | 540                     |       |
| Dividend payable on Preferred Stock                                                                                                                                                                  |       | 82                    |       | 85                      |       |
| Detachable Warrants                                                                                                                                                                                  |       | 3,527                 |       | 5,583                   |       |
| Notes payable                                                                                                                                                                                        |       | 0                     |       | 37                      |       |
| Conversion option on Preferred Stock                                                                                                                                                                 |       | 5,417                 |       | 8,612                   |       |
| Deferred revenues                                                                                                                                                                                    |       | 190                   |       | 369                     |       |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| Total liabilities                                                                                                                                                                                    |       | 10,556                |       | 16,399                  |       |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| Commitments                                                                                                                                                                                          |       | 0                     |       | 0                       |       |
| Redeemable Preferred Stock; 6,675 shares outstanding at March 31,  2005, and 6,775 outstanding at December 31, 2004                                                                        |       | 3,382                 |       | 2,995                   |       |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| Stockholders’ deficiency:                                                                                                                                                                       |       |                  |       |                    |       |
| Preferred Stock, $.01 par value, 13,500,000 shares authorized; shares  issued 7,550 at March 31, 2005 and December 31, 2004                                                                |       | 0                     |       | 0                       |       |
| Common Stock, $.01 par value; 80,000,000 shares authorized,  31,716,189 shares issued and outstanding at March 31, 2005 and  30,865,777 shares issued and outstanding at December 31, 2004 |       | 317                   |       | 308                     |       |
| Additional paid-in  capital                                                                                                                                                                          |       | 215,418               |       | 213,863                 |       |
| Accumulated deficit                                                                                                                                                                                  |       | (217,645              | )          | (219,743                | )          |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| Total stockholders’ deficiency                                                                                                                                                                  |       | (1,910                | )          | (5,572                  | )          |
|                                                                                                                                                                                                 |       |                  |       |                    |       |
| Total liabilities and stockholders’ deficiency                                                                                                                                                  |       | $                     | 12,028     |                    | $          | 13,822 |   |

** **

Theaccompanying notes are an integral part of these financial statements.

 

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**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

**(Dollarsin Thousands, Except per Share Amounts)**

 

 
| ** **                                                                                                   | ** ** | **Three Months ended March 31,** | ** ** |
|--------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** |
| Revenues                                                                                                     |       | $                                     | 179        |   | $ | 0 |   |
| Cost of revenues                                                                                             |       | 125                                   |       | 0 |   |
| Gross margins                                                                                                |       | 54                                    |       | 0 |   |
|                                                                                                         |       |                                  |       |   |   |
| Engineering and development (excluding depreciation and amortization  amounts of $66, and $0, respectively). |       | 1,305                                 |       | 800 |   |
| Sales and marketing (excluding depreciation and amortization amounts  of $8 and $0, respectively).           |       | 379                                   |       | 191 |   |
| General and administrative (excluding depreciation and amortization  amounts of $97 and $102, respectively). |       | 847                                   |       | 1,674 |   |
| Depreciation and amortization                                                                                |       | 171                                   |       | 102 |   |
|                                                                                                         |       |                                  |       |   |   |
| Total expenses from continuing operations                                                                    |       | 2,702                                 |       | 2,767 |   |
|                                                                                                         |       |                                  |       |   |   |
| Loss from operating activities of continuing operations                                                      |       | (2,648                                | )          | (2,767 | ) |
| Interest and other income                                                                                    |       | 66                                    |       | 7 |   |
| Change in fair value of warrants and conversion options                                                      |       | 5,176                                 |       | 0 |   |
| Interest and other expense                                                                                   |       | 0                                     |       | (1 | ) |
| Income (loss) from continuing operations                                                                     |       | 2,594                                 |       | (2,761 | ) |
|                                                                                                         |       |                                  |       |   |   |
| Income from discontinued operations                                                                          |       | 0                                     |       | 23 |   |
| Net income (loss)                                                                                            |       | 2,594                                 |       | (2,738 | ) |
| Accretion on preferred stock and dividends                                                                   |       | (495                                  | )          | 0 |   |
| Net income (loss) available to common stockholders                                                           |       | $                                     | 2,099      |   | $ | (2,738 | ) |
|                                                                                                         |       |                                  |       |   |   |
| Income (loss) from continuing operations per common share:                                                   |       |                                  |       |   |   |
| Basic                                                                                                        |       | $                                     | 0.08       |   | $ | (0.10 | ) |
| Fully Diluted                                                                                                |       | $                                     | 0.07       |   | $ | (0.10 | ) |
| Income from discontinued operations per common share:                                                        |       |                                  |       |   |   |
| Basic                                                                                                        |       | $                                     | 0.00       |   | $ | 0.00 |   |
| Fully Diluted                                                                                                |       | $                                     | 0.00       |   | $ | 0.00 |   |
| Net income (loss) per common share:                                                                          |       |                                  |       |   |   |
| Basic                                                                                                        |       | $                                     | 0.08       |   | $ | (0.10 | ) |
| Fully Diluted                                                                                                |       | $                                     | 0.07       |   | $ | (0.10 | ) |
| Net income (loss) available to common shareholders per common share:                                         |       |                                  |       |   |   |
| Basic                                                                                                        |       | $                                     | 0.07       |   | $ | (0.10 | ) |
| Fully Diluted                                                                                                |       | $                                     | 0.07       |   | $ | (0.10 | ) |
| Weighted average common shares outstanding:                                                                  |       |                                  |       |   |   |
| Basic                                                                                                        |       | 31,582,115                            |       | 27,236,662 |   |
| Fully Diluted                                                                                                |       | 38,334,855                            |       | 27,236,662 |   |
|                                                                                                              |            |                                       |            |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these financial statements.

 

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**WORLDGATECOMMUNICATIONS, INC.CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)(Dollars in Thousands)**

 
| ** **                                                                                                                   | ** ** | **Three Months ended March 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|------------|
| ** **                                                                                                                   | ** ** | **2005**                              | ** ** | **2004** | ** ** |
|                                                                                                                         |       |                                  |       |   |   |
| Cash flows from operating activities:                                                                                        |       |                                  |       |   |   |
| Net income (loss)                                                                                                            |       | $                                     | 2,594      |   | $ | (2,738 | ) |
| Income from discontinued operations                                                                                          |       | 0                                     |       | (23 | ) |
| Adjustments to reconcile net income (loss) to net operating cash flow  from operating activities from continuing operations: |       |                                  |       |   |   |
| Depreciation and amortization                                                                                                |       | 171                                   |       | 102 |   |
| Change in fair value of warrants and conversion options                                                                      |       | (5,176                                | )          | 0 |   |
| Non-cash stock based compensation                                                                                            |       | 1                                     |       | 631 |   |
| Changes in operating assets and liabilities:                                                                                 |       |                                  |       |   |   |
| Other receivable                                                                                                             |       | 16                                    |       | 0 |   |
| Inventory                                                                                                                    |       | (53                                   | )          | 0 |   |
| Prepaid and other assets                                                                                                     |       | (209                                  | )          | 261 |   |
| Accounts payable                                                                                                             |       | 36                                    |       | (95 | ) |
| Accrued expenses                                                                                                             |       | (110                                  | )          | 111 |   |
| Accrued compensation and benefits                                                                                            |       | (299                                  | )          | (39 | ) |
| Other                                                                                                                        |       | (179                                  | )          | (7 | ) |
| Net operating cash flow from continuing operations                                                                           |       | (3,208                                | )          | (1,797 | ) |
| Net operating cash flow from discontinued operations                                                                         |       | 0                                     |       | 57 |   |
| Net cash used in operating activities                                                                                        |       | (3,208                                | )          | (1,740 | ) |
|                                                                                                                         |       |                                  |       |   |   |
| Cash flows from investing activities of continuing operations:                                                               |       |                                  |       |   |   |
| Capital expenditures                                                                                                         |       | (80                                   | )          | (8 | ) |
| Net cash used in investing activities                                                                                        |       | (80                                   | )          | (8 | ) |
|                                                                                                                         |       |                                  |       |   |   |
| Cash flows from financing activities of continuing operations:                                                               |       |                                  |       |   |   |
| Proceeds from issuance of common stock                                                                                       |       | 12                                    |       | 1,406 |   |
| Proceeds from the exercise of stock options                                                                                  |       | 204                                   |       | 105 |   |
| Proceeds from the exercise of stock rights and warrants                                                                      |       | 1,161                                 |       | 320 |   |
| Net cash provided by financing activities                                                                                    |       | 1,377                                 |       | 1,831 |   |
| **Net (decrease) increase in cash and equivalents**                                                                          |       | (1,911                                | )          | 83 |   |
| **Cash and cash equivalents, beginning of period**                                                                           |       | 11,840                                |       | 3,365 |   |
| **Cash and cash equivalents, end of period**                                                                                 |       | $                                     | 9,929      |   | $ | 3,448 |   |
| ** **                                                                                                                   |       |                                  |       |   |   |
| Non-cash financing activities                                                                                                |       |                                  |       |   |   |
| Conversion of preferred stock to common stock                                                                                |       | $                                     | 100        |   | $ | 0 |   |
|                                                                                                                              |            |                                       |            |  |  |  |  |  |  |

 

Theaccompanying notes are an integral part of these financial statements.

 

5

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** **

**WORLDGATE COMMUNICATIONS, INC.**

**NOTES TO CONDENSED FINANCIAL STATEMENTS**

** **

**(Dollar Amounts are in Thousands, Except for per Share and ShareAmounts)**

**(Unaudited)**

 

1.                             Basisof Presentation.

 

               The unaudited financial statements ofWorldGate Communications, Inc. (“WorldGate” or the “Company”) for the threemonths ended March 31, 2005 and March 31, 2004 presented herein have beenprepared by the Company pursuant to the rules and regulations of the Securitiesand Exchange Commission for quarterly reports on Form 10-Q.  Certain information and footnote disclosuresnormally included in financial statements prepared in accord­ance withgenerally accepted accounting principles have been condensed or omittedpursuant to such rules and regulations. These financial statements should be read in conjunction with thefinancial statements for the year ended December 31, 2004 and the notes theretoincluded in the Company’s Annual Report on Form 10-K.

 

               The financial information in this Reportreflects, in the opinion of management, all adjustments of a normal recurringnature necessary to present fairly the results for the interim period.Quarterly operating results are not necessarily indicative of the results thatmay be expected for the year ending December 31, 2005.

 

2.                            Liquidity and Going Concern Considerations.

 

                As of March 31, 2005 the Company had cash and cashequivalents of $9,929. The operating cash usage from continuing operations forthe three months ended March 31, 2005 was $3,208. The funds we received as aresult of private placements of our securities on December 1, 2003, December 4,2003, January 21, 2004, April 22, 2004, June 24, 2004 and December 15, 2004,have permitted us to fund the development of our new business.

 

                In December 2003 and January 2004, WorldGate receivedproceeds from investments aggregating $3,100 by certain institutionalinvestors. These investors purchased an aggregate of 3,000,000 shares of newlyissued common stock. The investors also received a right, for a limited periodof time, to purchase additional shares of up to 20% of the common stockpurchased by the investors in their investment, at the same price as theirinvestment, and five-year warrants to purchase up to 30% of the common stockpurchased by the investors in their investment, at an exercise price equal to atwenty-five percent premium to their purchase price for the investment. Thepurchase price for the 2 million shares purchased in the December 2003 transactionswere $0.80 per share, with the warrants having a $1.00 per share exerciseprice. The purchase price for the 1 million shares purchased in the January2004 transaction was $1.50 per share, with the warrants having a $1.875 pershare exercise price. All additional investment rights associated with theDecember 2003 transaction were exercised during January and February of 2004,resulting in an incremental investment of $320. All additional investmentrights associated with the January 2004 transaction were exercised in May 2004,resulting in an incremental investment of $300. A portion of the warrants andadditional investment right warrants associated with the December 2003 andJanuary 2004 transactions were exercised in December 2004 and January 2005,resulting in an incremental investment of $925.

 

                In June 2004, WorldGate completed a private placement of 7,550 shares ofits Series A Preferred Stock at a stated value of $1,000 per share, whichpreferred stock is convertible into the Company’s common stock at a conversionprice of $2.35 per share; five-year warrants to purchase up to 803,190 sharesof our common stock at an exercise price of $2.69 per share; and five-yearwarrants to purchase up to 803,190 shares of our common stock at an exercise priceof $3.14 per share. The investors also received an additional investment right,for a limited period of time, to purchase 1,606,383 additional shares of commonstock at $3.14 a share. In November and December 2004 and January 2005, 875preferred shares were converted to common stock.  In April 2005, an additional 4,250 preferredshares were converted into common stock. In December 2004 and January 2005, 1,606,383 additional investmentrights were exercised, resulting in an incremental investment of $5,044.

 

                InDecember 2004, WorldGate completed a private placement of 208,333 shares of ourcommon stock to K. Y. Chou, president of Mototech, at a sales price of $2.40per shares, which resulted in additional gross proceeds to the Company of$500,000.  In connection with thisplacement the Company granted warrants to Mr. Chou to purchase up to 62,500shares of our common stock at an exercise price of $2.88 per share.

 

6

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                TheCompany has $10,556 of liabilities and its assets are not pledged as collateralas of March 31, 2005. These liabilities include $9,026 related to the Company’sprivate placement of Series A Preferred Stock, and $190 of advanced fundsreceived from Motorola for future shipments of video phones in accordance withthe Agreement signed in April 2004.

 

                TheCompany continues to evaluate possibilities to obtain additional financingthrough public or private equity or debt offerings, bank debt financing, assetsecuritizations, or from other sources, should it need to obtain suchfinancing. Such additional financing would be subject to the risk ofavailability, may be dilutive to our shareholders, or could impose restrictionson operating activities. There can be no assurance that this additional financingwill be available on terms acceptable to the Company, if at all. The Companyhas limited capacity to further reduce its workforce and scale back on capitaland operational expenditures to decrease its cash usage given the measures ithas already taken to reduce staff and expenses.

 

                Theconsolidated financial statements have been prepared on a going concern basis,which contemplates the realization of assets and the satisfaction ofliabilities and commitments in the normal course of business. Therefore, thefinancial statements do not include any adjustments relating to the Company’sability to operate as a going concern. The appropriateness of using the goingconcern basis in the future, however, will be dependent upon the Company’sability to address its liquidity needs as described above. There is noassurance that the Company will be able to address its liquidity needs throughthe measures described above on acceptable terms and conditions, or at all, andaccordingly, there is substantial doubt about the Company’s ability to continueas a going concern. The independent auditors’ report for the year endedDecember 31, 2004 included an explanatory paragraph stating that because theCompany had suffered recurring losses from operations and had a net accumulateddeficiency of $220 million, those issues raised substantial doubt about theCompany’s ability to continue as a going concern.

 

*Accounting for Preferred Sharesand Derivative Shares [Restated]*

 

                Thefollowing information has been restated to provide a more complete descriptionof the accounting method and policy related to redeemable preferred shares andderivative shares.

 

In June 2004, WorldGatecompleted a private placement of redeemable preferred stock. The Series AConvertible Preferred Stock has attached warrants and conversion options.  Specifically, the holders of the PreferredStock may convert their shares into our common stock at a conversion price of$2.35 per share.  In addition the Companymay force conversion of the Preferred Stock into common stock if the Companyachieves certain price targets for its common stock and satisfaction of certainother conditions.  In either event theconversion price is subject to adjustment in the event the Company enters intoanother transaction which is dilutive to the subject transaction.  As part of this transaction, the Company hasalso issued five-year warrants to purchase 1.6 million shares of the Company’scommon stock, one-half of the warrants at an exercise price of $2.69 per shareand the remaining half at an exercise price of $3.14 per share.  The preferred stock has a dividend rate of 5%per annum, payable quarterly, either by cash or through the issuance of commonstock at the Company’s option.  ThePreferred Stock has a staged maturity over three years with one-third of thepreferred stock to be redeemed after 18 months, one-third after 24 months andone-third after 36 months, and may be redeemed at maturity in cash or, subjectto certain conditions, through the issuance of an indeterminable number ofshares of common stock, at the Company’s option (with stock payments being madeat the then current market price).  Ofthe 7,550 preferred shares issued under this private placement, all but 875 shareshave been redeemed as of March 31, 2005.

 

EITF Issue D-98, paragraph4, states that Rule 5.02.28 of Regulation S-X requires securities withredemption features that are not solely within the control of the issuer to berecorded as a liability outside of permanent equity.  The value ascribed to the redeemablepreferred stock upon initial issuance, i.e. at June 24, 2004, was the amountreceived in the transaction minus the value ascribed to the conversion optionand warrants.    This initial value ofthe redeemable preferred stock is accreted up to the redemption value (theamount received in the transaction) over the future relevant periods using theinterest method.

 

The conversion options andwarrants are considered embedded derivative instruments under SFAS No. 133,paragraph 11a, and are classified as liabilities.  The company identifies and measures thesederivatives 

 

7

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under the fair value method at the end ofeach quarter, and their value is marked to market at the end of each reportingperiod with the gain or loss recognition recorded against earnings.  We continue to revalue these instruments eachquarter to reflect their current value in light of the current market price ofour common stock.  The warrants and conversion options arevalued using the Black-Scholes valuation model. Actual period close common stock prices, applicable volatility rates,and the period close risk-free interest rate for the instrument’s expectedremaining life (continuously compounded), are the key assumptions used in thevaluation calculation.  The WorldGateshare price changed from $4.99 per share at the end of December 31, 2004 to$3.90 as of March 31, 2005, making the embedded warrants and preferred stockconversion elements less valuable, and therefore less costly, relative to theirstrike price. The result was the $5.2 million non cash gain for thequarter.  Also, it is important to notethat this periodic marked to market addition to or deduction from earnings hasno cash effect over the life of the instruments, with the cumulative non-cashmark-to-market adjustments of gains and losses offsetting and netting to $0.

 

 

3.                            Recent Accounting Pronouncement.

 

                In November 2004, the FASB issued SFAS no. 151 “InventoryCosts” which amends the guidance in ARB No. 43, Chapter 4 “Inventory Pricing,”to clarify the accounting for abnormal amounts of idle facility expense,freight, handling costs, and wasted material (spoilage).  Paragraph 5 of ARB 43, Chapter 4, previouslystated that under some circumstances, items such as idle facility expense,excessive spoilage, double freight and rehandling costs may be so abnormal asto require treatment as current period charges.”  SFAS No. 151 requires that those items berecognized as current-period charges regardless of whether they meet thecriterion of “so abnormal.”  In addition,SFAS No. 151 requires that allocation of fixed production overheads to thecosts of conversion be based on the normal capacity of the productionfacilities.  SFAS No. 151 shall beeffective for inventory costs incurred during fiscal years beginning after June15, 2005.  Earlier application ispermitted for inventory costs incurred during fiscal years beginning after thedate SFAS No. 151 was issued.  SFAS No.151 shall be applied prospectively.  TheCompany does not expect the adoption of SFAS No. 151 to have a material effecton its consolidated financial statements.

 

                In December 2004, the FASB issued SFAS No. 153 “Exchangesof Nonmonetary Assets” which amends APB Opinion No. 29, “Accounting for NonmonetaryTransactions.”  APB No. 29 is based onthe principle that exchanges of nonmonetary assets should be measured based onthe fair value of the assets exchanged. The guidance in that Opinion, however, included certain exceptions tothat principle.  SFAS No. 153 amends APBNo. 29 to eliminate the exception for nonmonetary exchanges of similarproductive assets and replaces it with a general exception for exchanges ofnonmonetary assets that do not have commercial substance.  A nonmonetary exchange has commercialsubstance if the future cash flows of the entity are expected to changesignificantly as a result of the exchange. SFAS No. 153 is effective for nonmonetary asset exchanges occurring infiscal periods beginning after June 15, 2005. Earlier application is permitted for nonmonetary asset exchangesoccurring in fiscal periods beginning after the date SFAS No. 153 wasissued.  SFAS No. 153 is to be appliedprospectively.  The Company does notexpect the adoption of SFAS No. 153 to have a material effect on itsconsolidated financial statements.

 

                In December 2004, the FASB issued SFAS No. 123 (R), “Share-BasedPayment” that focuses primarily on accounting for transactions in which anentity obtains employee services in share-based payment transactions. Thisstatement replaces SFAS No. 123, “Accounting for Stock-Based Compensation”, andsupersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”Beginning with our annual periods that begin after June 15, 2005, we will berequired to expense the fair value of employee stock options and similarawards. As a public company, we are allowed to select from two alternativetransition methods, each having different reporting implications.  The impact of SFAS No. 123 (R) has not beendetermined at this time.

 

                In March 2005, the Financial Accounting StandardsBoard (FASB) issued Interpretation No. 47 (FIN 47) to clarify the guidanceincluded in SFAS No. 143, “Accounting for Asset Retirement Obligations”.  FIN 47 requires companies to recognize a liabilityfor the fair value of a legal obligation to perform asset retirement activitiesthat are conditional on a future event if the amount can be reasonablyestimated.  If amounts cannot bereasonably estimated, certain disclosures will be required about theunrecognized asset retirement obligations. The interpretation is required to be adopted in the first quarter of2006.  We are currently evaluating theinterpretation to determine the effect on our financial statements and relateddisclosures.

 

8

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4.        Inventories.

 

                 Inventories as ofMarch 31, 2005 and December 31, 2004 are summarized as follows:

 
| ** **                                   | ** ** | **March 31, 2005** | ** ** | **December 31, 2004** | ** ** |
|----------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| Raw material (from  discontinued operations) |       | $                  | 1,622      |                  | $          | 1,622 |   |
| Finished goods (from  continuing operations) |       | 99                 |       | 46                    |       |
| Total Inventory                              |       | 1,721              |       | 1,668                 |       |
| Inventory Reserve                            |       | (1,622             | )          | (1,622                | )          |
| Inventory, net                               |       | $                  | 99         |                  | $          | 46 |   |

 

5.        Stock-BasedCompensation.

 

           The Company accountsfor stock-based compensation in accordance with Accounting Principles BoardOpinion No. 25, “Accounting for Stock Issued to Employees,” as amended by SFASNo. 148, “Accounting for Stock-Based Compensation—Transition and Disclosure”.

 

           The Company applies AccountingPrinciples Board Opinion No. 25, “Accounting for Stock Issued to Employees” andrelated interpretations in accounting for its plans, and accordingly, nocompensation cost has been recognized for the Company’s fixed stock basedcompensation.  Had compensation cost beendetermined consistent with SFAS No. 123, as amended by SFAS No. 148, theCompany’s net loss would have been increased to the following pro formaamounts:

 
| ** **                                                                                                                         | ** ** | **For the Three Month Period** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                         | ** ** | **Ended March 31,**            | ** ** |
| ** **                                                                                                                         | ** ** | **2005**                       | ** ** | **2004** | ** ** |
|                                                                                                                               |       |                           |       |   |   |
| Income (loss) from continuing operations                                                                                           |       | $                              | 2,594      |   | $ | (2,761 | ) |
| Income from discontinued operations                                                                                                |       | 0                              |       | 23 |   |
| Net income (loss)                                                                                                                  |       | 2,594                          |       | (2,738 | ) |
| Accretion on preferred stock and dividends                                                                                         |       | (495                           | )          | 0 |   |
| Net income (loss) available to common shareholders, as reported                                                                    |       | 2,099                          |       | (2,738 | ) |
| Add: Stock-based employee compensation expense included in reported  net income (loss), net of related tax effects                 |       | 0                              |       | 0 |   |
| Deduct: Total stock-based employee compensation expense determined  under fair value based method for all awards, net of tax of $0 |       | (194                           | )          | (2,249 | ) |
| Pro forma net income (loss)                                                                                                        |       | $                              | 1,905      |   | $ | (4,987 | ) |
| Net income (loss) per share:                                                                                                       |       |                           |       |   |   |
|                                                                                                                               |       |                           |       |   |   |
| Income (loss) from continuing operations:                                                                                          |       |                           |       |   |   |
| Basic                                                                                                                              |       | $                              | 0.08       |   | $ | (0.10 | ) |
| Fully Diluted                                                                                                                      |       | $                              | 0.07       |   | $ | (0.10 | ) |
| Income from discontinued operations:                                                                                               |       |                           |       |   |   |
| Basic                                                                                                                              |       | $                              | 0.00       |   | $ | 0.00 |   |
| Fully Diluted                                                                                                                      |       | $                              | 0.00       |   | $ | 0.00 |   |
| Net income (loss):                                                                                                                 |       |                           |       |   |   |
| Basic                                                                                                                              |       | $                              | 0.08       |   | $ | (0.10 | ) |
| Fully Diluted                                                                                                                      |       | $                              | 0.07       |   | $ | (0.10 | ) |
| Net income (loss) available to common shareholders:                                                                                |       |                           |       |   |   |
| Basic                                                                                                                              |       | $                              | 0.07       |   | $ | (0.10 | ) |
| Fully Diluted                                                                                                                      |       | $                              | 0.07       |   | $ | (0.10 | ) |
| Net income (loss) available to common shareholders — pro forma:                                                               |       |                           |       |   |   |
| Basic                                                                                                                              |       | $                              | 0.06       |   | $ | (0.18 | ) |
| Fully Diluted                                                                                                                      |       | $                              | 0.05       |   | $ | (0.18 | ) |
|                                                                                                                                    |            |                                |            |  |  |  |  |  |  |

 

9

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           Such pro forma disclosures may not berepresentative of future compensation expense because options

vest over several years and additional grantsare made each year.

 

6.     Commitments andContingencies.

 

*Leases*

 

                In1998 the Company entered into a leasing arrangement for a building with anentity formed by non-employee investors. The Company stopped paying rent onthis lease in May 2003, and in lieu of rent payments the Company’s landlord,3190 T General, Inc. (an entity formed by non-employee investors in theCompany), began drawing down the security deposit for the facility. Prior tostopping rent payments, the Company had commenced negotiations with itslandlord for an amendment of its lease to reduce the space commitment and therent payable. These negotiations were not successful, and in September 2003,the Company’s landlord filed an action in the Court of Common Pleas, BucksCounty Pennsylvania to perfect its interest to take possession of the Company’sfacility, and to establish damages for past rent and expenses. Although ajudgment was granted allowing the Company’s landlord to regain possession ofthe facility, the Company remained in the facility and continued negotiationswith its landlord. During 2004, the landlord deeded the facility to itsmortgage holders and negotiations commenced with GMAC as representative for themortgage holders. These negotiations were successful and in June 2004 theCompany’s lease was amended to reduce the lease obligation in line with theCompany’s current space requirements, and to bring the Company current withrespect to all outstanding back rent. In November 2003, the Company enteredinto a 60 month lease for office equipment. As of March 31, 2005 there remainsa total of $21 to be paid over the remaining period of the lease.

 

* Significant Agreements and Transactions*

 

                In1997, the Company entered into agreements with certain customers who areinvestors. Revenues from continuing operations recognized from such investorswere approximately $179 and $0, respectively, for the three months ended March31, 2005 and 2004. One of these investors accounted for 100% of the revenuesfor the three months ended March 31, 2005. Advances received from this investorwere $190 as of March 31, 2005 and are included in deferred revenue in theaccompanying balance sheet.

 

                Revenues,included in discontinued operations, were recognized from such investors ofapproximately $0 and $1, respectively, for the three months ended March 31,2005 and 2004. Accounts receivable from such investors were $0 as of March 31,2005 and December 31, 2004.

 

                TheCompany has a current agreement with an investor, and previously had agreementswith certain other investors, to provide the Company with engineering anddevelopment support. As a result of those agreements, the Company has expensedapproximately $102 (included in continuing operations) and $0 (included indiscontinued operations), for the three months ended March 31, 2005 and March31, 2004, respectively. Accounts payable to these investors amounted to $180and $117 at March 31, 2005 and December 31, 2004, respectively. Some of thesestockholders were suppliers of technology and components for the Company’sdiscontinued ITV products and services. These agreements provided for licensingof technology, as well as contracted services, including hardware and softwaredevelopment, product testing and certification, and the creation anddevelopment of tools and systems to facilitate the Company’s engineeringefforts. These agreements did not provide for ongoing royalties, purchaseprovisions, or for any requirement to provide additional funding to theCompany.

 

 

7.     Net Loss per Share.

 

                Basic and dilutednet income (loss) per common share is computed by dividing the net income(loss) available to common stockholders for the period by the weighted averagenumber of shares of common stock outstanding during the period.  The calculation of diluted net income (loss)per common share excludes potential common shares if the effect isantidilutive.  Potential common sharescomprise shares of common stock issuable upon the exercise of stock options andwarrants.  The number of potential commonshares which would have been assumed to be converted in the periods ended March31, 2005 and 2004 and have a dilutive effect if the 

 

10

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Company had income from continuing operations, or if the options’exercise price was less than the average market price of the common shares, is862,250 and 8,065,111, respectively.

 

# ITEM2.   MANAGEMENT’S DISCUSSION AND ANALYSISOF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

**FORWARD-LOOKINGAND CAUTIONARY STATEMENTS**

 

        We may from time to timemake written or oral forward-looking statements, including those contained inthe following Management’s Discussion and Analysis of Financial Condition andResults of Operations.  The words “estimate,”“project,”“believe,” “intend,” “expect,”and similar expressions are intended to identify forward-looking statements,although not all forward-looking statements contain these identifyingwords.  In order to take advantage of the“safe harbor” provisions of the Private Securities Litigation Reform Act of1995, we are hereby identifying certain important factors that could cause ouractual results, performance or achievement to differ materially from those thatmay be contained in or implied by any forward-looking statement made by or onour behalf.  The factors, individually orin the aggregate, that could cause such forward-looking statements not to berealized include, without limitation, the following: (1) difficulty indeveloping and implementing marketing and business plans, (2) industrycompetition factors and other uncertainty that a market for our products willdevelop, (3) challenges associated with HSD operators (including, uncertaintythat they will offer our products, inability to predict the manner in whichthey will market and price our products and existence of potential conflicts ofinterests and contractual limitations impeding their ability to offer ourproducts), (4) continued losses, (5) difficulty or inability to raiseadditional financing on terms acceptable to us, (6) departure of one or morekey persons, (7) delisting of our Common Stock from the NASDAQ Small CapMarket, (8) changes in regulatory requirements, and (9) other risks identifiedin our filings with the Securities and Exchange Commission.  We caution you that the foregoing list ofimportant factors is not intended to be, and is not, exhaustive.  We do not undertake to update anyforward-looking statement that may be made from time to time by or on ourbehalf.

 

 

Results of Operations:

 

General

 

                OurITV business has historically accounted for substantially all of ourrevenue.  In the third quarter of 2003,we completed a sale of significant assets, including our ITV intellectualproperty rights and our membership interest in TVGateway, LLC.  This transaction marked a shift in ourbusiness away from the ITV business and toward a new video phone product andrelated business.  Although we continuedto support our remaining ITV business into the first quarter of 2004, thedevelopment of our video phone product became a primary business focus.

 

                Ourvideo phone business has not produced significant revenues to date.  The extent and timing of future revenues forour business depends on several factors, including the rate of marketacceptance of our products and the degree of competition from similarproducts.  We cannot predict to whatextent our video phone product will produce revenues, or when, or if, we willreach profitability.

 

 

 

 

Critical Accounting Policies and Estimates.

 

        The consolidated financialstatements are prepared in conformity with accounting principles generallyaccepted in the United States.  Thepreparation of these financial statements required management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period.  Actual results coulddiffer from those estimates.

 

        The significant accountingpolicies of the Company are described in the notes to the consolidatedfinancial statements included in the annual report on Form 10-K.  Judgments and estimates of uncertainties arerequired in applying the Company’s accounting policies in many areas.  Following are some of the areas requiringsignificant 

 

11

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judgments and estimates:  revenuerecognition, accounts receivable, inventories, and cash flow and valuationassumptions in performing asset impairment tests of long-lived assets.

 

The preparation of financial statements inconformity with accounting principles generally accepted in the United Statesrequires management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities, at the date the financial statements and the reported amount ofrevenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

        The information in ourquarter-to-quarter comparisons below represents only our results fromcontinuing operations.

 

Three Months Ended March 31, 2005 and March 31, 2004

 

        Revenues.

 

Revenues. Revenues from continuing operations for the three monthsended March 31, 2005 were $179. These revenues represent initial deliveries ofvideo phones for pre-market testing. There were no revenues from continuingoperations during the three months ended March 31, 2004.

 

**       **Costs and Expenses.

 

Cost of Revenues. The cost of revenues from continuing operationsconsisted of product and delivery costs relating to the initial deliveries ofvideo phones was $125 for the three months ended March 31, 2005. There were nocosts of revenues from continuing operations during the three months endedMarch 31, 2004.

 

Engineering and Development. Engineering and development expenses primarily consist of compensation,and the cost of design, programming, testing, documentation and support of theCompany’s video phone product. Engineering and development costs were $1,305 for the three months endedMarch 31, 2005, compared with $800 for the three months ended March 31,2004.  This increase of $505, or 63%,reflects the Company’s increased concentration of its engineering staff, andrelated costs, for the further and continuing development of its video phoneproduct.

 

Sales and Marketing.  Sales andmarketing expenses consist primarily of compensation, attendance at conferencesand trade shows, travel costs, promotions and other marketing programs relatedto the introduction of the Company’s video phone product.  Sales and marketing costs were $379 for thethree months ended March 31, 2005, compared with $191 for the three monthsended March 31, 2004.  This increase of$188, or 98%, reflects the increased effort of staff, and related marketing andpromotional expenditures associated with the launch of the Company’s videophone product.

 

General and Administrative. General and administrative expenses consist primarily of expendituresfor administration, office and facility operations, finance and generalmanagement activities, including legal, accounting and professional fees.  General and administrative expenses were $847for the three months ended March 31, 2005, compared with $1,674 for the threemonths ended March 31, 2004. This decrease of $827, or 49%, is primarilyattributable to certain non-recurring expenses incurred during the three monthsended March 31, 2004 that were not incurred during the three months ended March31, 2005. These expenses consisted of a non cash charge of $631 reflecting aBlack Scholes estimate of the value of the warrants issued as part of theprivate placement of the Company’s stock to certain institutional investors inJanuary 2004, an expense for sales taxes of $125, and a $242 reduction in rentexpense from the $303 recorded during the three months ended March 31, 2004 to$61 recorded for the three months ended March 31, 2005.

 

       Interest and Other Incomeand Interest Expense. Interest and other income and interest expense consist ofinterest earned on cash and cash equivalents, and interest expense onshort-term debt. Interest and other income increased from $7 for the threemonths ended March 31, 2004 to $66 for the three months ended March 31, 2005,primarily due to additional interest income earned on a higher level ofinvested funds. During the three months ended March 31, 2005, the Companyearned interest on average cash balances of approximately $11,026 and incurredinterest expense related to its insurance financing. In comparison, during thethree months ended March 31, 2004 the Company earned interest on average cashbalances of approximately $3,878 and incurred interest expense related to itsinsurance financing.

 

12

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Income Taxes.  TheCompany has incurred net operating losses since inception and accordingly hadno income taxes and has not recorded any income tax benefit for those losses.

 

Changein the Fair Value of Warrants and Conversion Options.  The warrants and conversion options areconsidered embedded derivative instruments under SFAS No. 133, paragraph 11a,and are classified as liabilities.  Thecompany identifies and measures these derivatives under the fair value methodat the end of each quarter, and their value is marked to market at the end ofeach reporting period with the gain or loss recognition recorded againstearnings.  We continue to revalue theseinstruments each quarter to reflect their current value in light of the currentmarket price of our common stock.  The warrants and conversion options arevalued using the Black-Scholes valuation model. Actual period close common stock prices, applicable volatility rates,and the period close risk-free interest rate for the instrument’s expectedremaining life (continuously compounded), are the key assumptions used in thevaluation calculation.  The WorldGateshare price changed from $4.99 per share at December 31, 2004 to $3.90 as ofMarch 31, 2005, making the embedded warrants and preferred stock conversionelements less valuable, and therefore less costly, relative to their strikeprice. The result was the $5.2 million non cash gain for the quarter endedMarch 31, 2005.  Also, it is important tonote that these periodic marked to market addition to or deduction fromearnings has no cash effect over the life of the instruments, with thecumulative non-cash mark-to-market adjustments of gains and losses offsettingand netting to $0.

 

        Liquidity and CapitalResources.

 

       As of March 31, 2005, ourprimary source of liquidity consisted of cash and cash equivalents that arehighly liquid, are of high quality investment grade and have maturities of lessthan 90 days.

 

At March 31, 2005, we had cash and cash equivalents of $9,929 (and noshort-term investments) as compared to cash and equivalents of $11,840 (and noshort-term investments) at December 31, 2004. Net cash used in continuing operations was $3,208 for the three monthsended March 31, 2005, as compared to $1,797 used for the same period in 2004.This increase in net cash used for continuing operations was primarilyattributable to the Company’s increase in expenditures related to the videophone business.  The Company recorded baddebt expense in the amount of $16 from discontinued operations during the threemonths ended March 31, 2004 to reflect its current assessment of thecollectability of certain receivables.

 

Cash provided by financing activities from continuing operations duringthe three months ended March 31, 2005, totaled $1,377 compared to $1,831provided during the same period in 2004. Capital expenditures were $80 and $8for the three months ended March 31, 2005 and 2004, respectively.

 

        Operations and Liquidity.

 

Todate, the Company has funded operations primarily through private sales ofequity securities and through an initial public offering of common stock inApril 1999.  As of March 31, 2005the Company had cash, and cash equivalents of $9,929.  The operating cash usage from continuingoperations for the three months ended March 31, 2005 and 2004 was $3,208 and$1,797, respectively. As of March 31, 2005 we have no outstanding debt and ourassets are not pledged as collateral. From time to time opportunities arise forus to obtain additional financing through public or private equity or debtofferings, bank debt financing, asset securitizations, or from othersources.  Such additional financing, ifobtained, could provide additional cash for working capital, acceleratedengineering and development activities and potential acquisitions. While wecontinue to evaluate such opportunities, it should be noted that any additionalfinancing may be dilutive to our shareholders, or could impose restrictions onoperating activities. Furthermore, there can be no assurance that anyadditional financing will remain available to us on terms acceptable, if atall.

 

Withthe private placement of our common stock, together with additional rights andwarrants, aggregate gross proceeds received of $1.5 million in January 2004,the private placement of our common stock in April 2004 providing proceeds of$1.0 million, the June 2004 private placement of our redeemable preferred stockproviding proceeds of $7.55 million, the December 2004 private placement ofcommon stock of $500, the exercise of additional investment rights and warrantsof $6.8 million in January, February, May and December 2004 and January andFebruary 2005, and the exercise by employees and former employees of optionsthroughout 2004 and January and February 2005 providing aggregate proceeds of$900; we project we will have sufficient funding to continue operations through2005, without additional financing, and assuming no impact from sales. We dohowever have an obligation to pay dividends on, as well as to redeem, ouroutstanding Series A Preferred Stock upon

 

13

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 maturity, or at the earlier option of a holderof these securities. Under certain limited circumstances we may be forced to makesuch payments and redemptions with cash instead of shares of our common stock.In such event our ability to fund continuing operations would be negativelyimpacted. The report of the registered independent public accounting firm forthe year ended December 31, 2004 included an explanatory paragraph stating thatbecause the Company had suffered recurring losses from operations and had a netaccumulated deficiency of $220 million, these issues raised substantial doubtabout the Company’s ability to continue as a going concern. No assurances canbe given that sufficient sales, if any, will materialize, or that, if pursued,a financing transaction can be consummated. We however remain hopeful thatsales will materialize and/or that sufficient funding can be developed throughongoing operations or additional financings to continue our operations.

 

14

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# ITEM3.   QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.

 

        Interest Rate Risk.  Our exposure to market risk related tochanges in interest rates relates primarily to our investment portfolio.  We invest in instruments that meet highcredit quality standards, and we limit the amount of credit exposure withrespect to any one issue, issuer and type of investment.

 

        As of March 31, 2005, theCompany’s cash and cash equivalents were $9,929, having a maturity of less than90 days, and it had no short-term investments. Due to the average maturity and conservative nature of our investmentportfolio, management believes a sudden change in interest rates would not havea material effect on the value of the portfolio. Manage­ment estimates that hadthe average yield of our investments decreased by 100 basis points, ourinterest income for the three months ended March 31, 2005 would have decreasedby approximately $24. This estimate assumes that the decrease occurred on thefirst day of 2005 and reduced the yield of each investment instrument by 100basis points.  The impact on our futureinterest income of future changes in investment yields will depend largely onour total investments.

 

        Foreign Currency ExchangeRisk.  Although we transact business invarious foreign countries, the principal portion of our business is in theUnited States and substantially all of our revenues and costs to date have beendenominated in U.S. dollars.  Althoughour agreement with Mototech, our contract manufacturer in Taiwan, isdenominated in U.S. dollars, their material acquisition costs are subject toexchange rate changes that could impact our product costs.

 

# ITEM4.   CONTROLS AND PROCEDURES.

 

                Asof the end of the period covered by this Form 10-Q, our management, with theparticipation of our chief executive officer and chief financial officer,conducted an evaluation of the effectiveness of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d -15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)).

 

                Basedon that evaluation, our chief executive officer and chief financial officer determinedthat we have a material weakness (as defined under the standards established bythe American Institute of Certified Public Accountants) that exists withrespect to our reporting of complex transactions. As a result of this materialweakness, we restated our financial statements in our June 30, 2004 10-QA.

 

                Toaddress this material weakness, we have engaged outside experts to providecounsel and guidance in areas where we cannot economically maintain therequired expertise internally (e.g., with the appropriate classifications andtreatments of complex and non-routine transactions).

 

                As aresult of the material weakness identified with respect to our reporting ofcomplex transactions, the chief executive officer and chief financial officerconcluded that our disclosure controls and procedures are not designed andeffective in ensuring that the information required to be disclosed by ourcompany in the reports that we file and submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the Commission’s rules and forms. Except as identified above, there have been no changes in our internalcontrol over financial reporting that occurred during the quarter ended March31, 2005, that have materially affected, or are reasonably likely to materiallyaffect, our internal control over financial reporting.

 

15

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PART II. OTHERINFORMATION

 

(Dollar Amounts are in Thousands, Except per Share Amounts)

 

# ITEM1.   LEGAL PROCEEDINGS.

 

None

 

# ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS.

                OnJune 24, 2004, we completed a private placement that resulted in the issuanceof 7,550 shares of Series A preferred stock at a sale price of $1000 per share(which preferred stock is convertible into our common stock at a conversionprice of $2.35 per share), five-year warrants to purchase up to 803,190 sharesof our common stock at an exercise price of $2.69 per share, and five-yearwarrants to purchase up to 803,190 shares of our common stock at an exerciseprice of $3.14 per share. The investors also received an additional investmentright, for a limited period of time, to purchase 1,606,383 additional shares ofcommon stock shares at $3.14 a share. The June 2004 private placement resultedin gross proceeds to our Company of $7,550,000. From November 2004 throughApril 15, 2005, holders of the Series A preferred stock from the June 24, 2004private placement have converted 5,125 of their shares, resulting in theissuance of 2,180,851 shares of our common stock based upon the $2.35conversion price. Furthermore, between January 2004 and April 18, 2005, theinvestors from the 2003 and 2004 private placements have exercised warrants andadditional investment rights resulting in additional gross proceeds ofapproximately $7,089,000 and the issuance of 3,134,048 shares.

 

# ITEM3.  DEFAULTS UPON SENIOR SECURITIES.

 

                None.

 

# ITEM4.   SUBMISSION OF MATTERS TO A VOTE OFSECURITY HOLDERS.

 

                None.

 

# ITEM5.  OTHER INFORMATION.

 

                None.

 

16

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# ITEM6.  EXHIBITS AND REPORTS ON FORM 8-K.

 

(a)   Exhibits.

 

                Thefollowing is a list of exhibits filed as part of this report on Form 10-Q.  Where so indicated by footnote, exhibits thatwere previously filed are incorporated by reference.  For exhibits incorporated by reference, thelocation of the exhibit in the previous filing is indicated parentheticallyexcept in those situations where the exhibit number was the same as set forthbelow.

 
| **Exhibit** | ** ** | **Description**                                                                                                                                  |
|-------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1         |       | Amended  and Restated Certificate of Incorporation (3)                                                                                           |
| 3.2         |       | Amended  and Restated Bylaws (1)                                                                                                                 |
| 3.3         |       | Certificate  of Amendment to Certificate of Incorporation, dated October 18, 2004 (3)                                                            |
| 3.4         |       | Certificate  of Designations, Preferences and Rights of the Series A Convertible Preferred  Stock of the Company dated June 23, 2004 (2)         |
| 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

(1) Incorporated by reference to the exhibitsto our Form 10-Q Report for the quarter ended March 31, 1999.

(2) Incorporated by reference to the exhibitsto the Company’s Proxy Statement to shareholders filed September 30, 2004.

(3)Incorporated by reference to the exhibitsto our Form 10-Q Report for the quarter ended September 30, 2004, asfiled on November 17, 2004.

 

17

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SIGNATURES

 

                Pursuantto the requirements of the Securities Exchange Act of 1934,  the registrant has duly caused this report tobe signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 
|   |            | WORLDGATE COMMUNICATIONS,  INC.               |
|--------|-----------------|-----------------------------------------------|
|   |            |                                          |
| Date:  | August 29, 2005 | /s/ Hal M. Krisbergh                          |
|   |            | Hal M. Krisbergh                              |
|   |            | Chairman and Chief  Executive Officer         |
|   |            | (Principal Executive  Officer)                |
|   |            |                                          |
| Date:  | August 29, 2005 | /s/ Joel Boyarski                             |
|   |            | Joel Boyarski                                 |
|   |            | Vice President and Chief  Financial Officer   |
|   |            | (Principal Financial and  Accounting Officer) |

 

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