** **

**DRAFT 08/13/04**

** **

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

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**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 June 30, 2004.**

 

**or**

 

**o****Transition Report Pursuant to Section 13 or15(d) of the Securities Exchange Act of 1934**

 

**for****the Transition Period From                   To                   .**

 

**Commission file number:  000-25755**

 

**WORLDGATE COMMUNICATIONS, INC.**

(Exact Name of Registrant as Specified in ItsCharter)

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

 

**3190 Tremont Avenue**

**Trevose, Pennsylvania 19053**

(Address of Principal ExecutiveOffices)        (Zip Code)

 

**(215) 354-5100**

(Registrant’s Telephone Number, IncludingArea Code)

 

Indicate by check mark whether the registrant: (1) has filed allreports required to be filed by Section 13 or 15(d) of the SecuritiesExchange Act of 1934 during the preceding 12 months (or for such shorter periodthat the registrant was required to file such reports), and (2) has beensubject to such filing requirements for the past 90 days.

Yes ý No o

 

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

Yes o No ý

 

As of August 6, 2004, there were 28,225,590 shares of commonstock, par value $.01 per share, outstanding.

 

 

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WORLDGATE COMMUNICATIONS, INC.

 

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED JUNE 30, 2004

 

TABLE OF CONTENTS

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

 

2

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PART I. FINANCIAL INFORMATION

 

# ITEM 1. FINANCIAL STATEMENTS

#  

**WORLDGATE COMMUNICATIONS, INC.CONSOLIDATED BALANCE SHEETS**

 

**(Dollars in Thousands)**

 
| ** **                                                                                                                                                                                                       | ** ** | **June 30,  2004** | ** ** | **December 31,  2003** | ** ** |
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------|------------|-----------------------------|------------|
|                                                                                                                                                                                                             |       | **(Unaudited)**         |       | **(Audited)**               |       |
| ASSETS                                                                                                                                                                                                           |       |                    |       |                        |       |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Current assets:                                                                                                                                                                                                  |       |                    |       |                        |       |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Cash and cash equivalents                                                                                                                                                                                        |       | $                       | 10,306     |                        | $          | 3,365 |   |
| Accounts receivable, less allowance for  doubtful accounts of $0 at June 30, 2004 and $381 at December 31,  2003                                                                                       |       | 102                     |       | 146                         |       |
| Prepaid and other assets                                                                                                                                                                                         |       | 348                     |       | 199                         |       |
| Total current assets                                                                                                                                                                                             |       | 10,756                  |       | 3,710                       |       |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Property and equipment                                                                                                                                                                                           |       | 2,635                   |       | 2,605                       |       |
| Less: accumulated depreciation and  amortization                                                                                                                                                                 |       | (1,541                  | )          | (1,338                      | )          |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Property and equipment, net                                                                                                                                                                                      |       | 1,094                   |       | 1,267                       |       |
| Deposits and other assets                                                                                                                                                                                        |       | 0                       |       | 140                         |       |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Total assets                                                                                                                                                                                                     |       | $                       | 11,850     |                        | $          | 5,117 |   |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                                        |       |                    |       |                        |       |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Current Liabilities:                                                                                                                                                                                             |       |                    |       |                        |       |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Accounts payable                                                                                                                                                                                                 |       | $                       | 146        |                        | $          | 440 |   |
| Accrued expenses                                                                                                                                                                                                 |       | 1,072                   |       | 594                         |       |
| Accrued compensation and benefits                                                                                                                                                                                |       | 278                     |       | 238                         |       |
| Dividend payable on Preferred Stock                                                                                                                                                                              |       | 7                       |       | 0                           |       |
| Detachable warrants                                                                                                                                                                                              |       | 1,390                   |       | 0                           |       |
| Notes payable                                                                                                                                                                                                    |       | 256                     |       | 0                           |       |
| Conversion option on Preferred Stock                                                                                                                                                                             |       | 1,840                   |       | 0                           |       |
| Beneficial conversion option on Preferred  Stock                                                                                                                                                                 |       | 1,714                   |       | 0                           |       |
| Deferred revenues                                                                                                                                                                                                |       | 300                     |       | 0                           |       |
| Deferred rent credit                                                                                                                                                                                             |       | 150                     |       | 30                          |       |
| Total current liabilities                                                                                                                                                                                        |       | 7,153                   |       | 1,302                       |       |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Deferred rent credit                                                                                                                                                                                             |       | 0                       |       | 135                         |       |
| Total liabilities                                                                                                                                                                                                |       | $                       | 7,153      |                        | $          | 1,437 |   |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Redeemable Preferred Stock                                                                                                                                                                                       |       | $                       | 2,187      |                        | $          | 0 |   |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Stockholders’ equity:                                                                                                                                                                                       |       |                    |       |                        |       |
|                                                                                                                                                                                                             |       |                    |       |                        |       |
| Preferred Stock, $.01 par value, 13,500,000  shares authorized                                                                                                                                                   |       | $                       | 0          |                        | $          | 0 |   |
| Redeemable Preferred Stock, $.01 par value,  shares authorized,  7,550 shares issued  and outstanding at June 30, 2004, and 0   outstanding at December 31, 2003                             |       | 0                       |       | 0                           |       |
| Common stock, $.01 par value, 50,000,000  shares authorized,  28,225,590 shares  issued and outstanding at June 30, 2004   and 25,706,843 shares issued and outstanding at December 31, 2003 |       | 282                     |       | 262                         |       |
| Additional paid-in capital                                                                                                                                                                                       |       | 206,329                 |       | 202,466                     |       |
| Unearned compensation                                                                                                                                                                                            |       | (400                    | )          | (400                        | )          |
| Accumulated deficit                                                                                                                                                                                              |       | (203,701                | )          | (198,643                    | )          |
| Less Treasury Stock, at cost – 500,000  shares as of December 31, 2003                                                                                                                                 |       | 0                       |       | (5                          | )          |
| Total stockholders’ equity                                                                                                                                                                                  |       | 2,510                   |       | 3,680                       |       |
| Total liabilities and stockholders’ equity                                                                                                                                                                  |       | $                       | 11,850     |                        | $          | 5,117 |   |

 

The accompanying notes are an integral partof these financial statements.

 

3

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**WORLDGATE COMMUNICATIONS, INC.**

**CONSOLIDATED STATEMENTS OF OPERATIONS**

**(Unaudited)**

**(Dollars in Thousands, Except per ShareAmounts)**

 
| ** **                                                                                                                                                                                                                                                   | ** ** | **Three Months ended June 30,** | ** ** | **Six Months ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                   | ** ** | **2004**                             | ** ** | **2003**                           | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                                                                                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Revenues from operating activities of  continuing operations                                                                                                                                                                                                 |       | $                                    | 0          |                               | $          | 0 |   | $ | 0 |   | $ | 0 |   |
| Engineering and development (excluding  depreciation and amortization amounts of $102 and $76 for the three months  ended June 30, 2004 and 2003, respectively, and $204 and $220 for the  six months ended June 30, 2004 and 2003, respectively). |       | 799                                  |       | 727                                |       | 1,599 |   | 1,263 |   |
| Sales and marketing (excluding depreciation  and amortization amounts of $0 and $24 for the three months ended  June 30, 2004 and 2003, respectively, and $0 and $50 for the six months  ended June 30, 2004 and 2003, respectively).              |       | 408                                  |       | 139                                |       | 599 |   | 225 |   |
| General and administrative (excluding  depreciation and amortization amounts of $0 and $83 for the three months  ended June 30, 2004 and 2003, respectively, and $0 and $167 for the six  months ended June 30, 2004 and 2003, respectively).      |       | 1,012                                |       | 506                                |       | 2,685 |   | 697 |   |
| Depreciation and amortization                                                                                                                                                                                                                                |       | 102                                  |       | 0                                  |       | 204 |   | 0 |   |
| Total costs and expenses from operating  activities from continuing operations                                                                                                                                                                               |       | 2,321                                |       | 1,372                              |       | 5,087 |   | 2,185 |   |
| Loss from operating activities of  continuing operations                                                                                                                                                                                                     |       | (2,321                               | )          | (1,372                             | )          | (5,087 | ) | (2,185 | ) |
| Interest and other income                                                                                                                                                                                                                                    |       | 13                                   |       | 0                                  |       | 20 |   | 0 |   |
| Interest and other expense                                                                                                                                                                                                                                   |       | (2                                   | )          | 0                                  |       | (3 | ) | 0 |   |
| Loss from continuing operations                                                                                                                                                                                                                              |       | (2,310                               | )          | (1,372                             | )          | (5,070 | ) | (2,185 | ) |
| Income (loss) from discontinued operations                                                                                                                                                                                                                   |       | 7                                    |       | (1,627                             | )          | 29 |   | (2,699 | ) |
|                                                                                                                                                                                                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Net loss                                                                                                                                                                                                                                                     |       | (2,303                               | )          | (2,999                             | )          | (5,041 | ) | (4,884 | ) |
| Dividend attributable to preferred  shareholders                                                                                                                                                                                                             |       | (16                                  | )          | 0                                  |       | (16 | ) | 0 |   |
| Net loss applicable to common shareholders                                                                                                                                                                                                                   |       | $                                    | (2,319     | )                                  | $          | (2,999 | ) | $ | (5,057 | ) | $ | (4,884 | ) |
|                                                                                                                                                                                                                                                         |       |                                 |       |                               |       |   |   |   |   |
| Net loss per common share (basic and  diluted)                                                                                                                                                                                                               |       | $                                    | (0.08      | )                                  | $          | (0.13 | ) | $ | (0.18 | ) | $ | (0.21 | ) |
| Weighted average common shares outstanding  - basic and diluted                                                                                                                                                                                              |       | 27,898,268                           |       | 23,579,861                         |       | 27,380,133 |   | 23,579,256 |   |

 

The accompanying notes are an integral partof these financial statements.

 

4

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**WORLDGATE COMMUNICATIONS, INC.**

**CONSOLIDATED STATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(Dollars in Thousands)**

 
| ** **                                                                                       | ** ** | **Six months ended  June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|
| ** **                                                                                       | ** ** | **2004**                            | ** ** | **2003** | ** ** |
| **Cash flows from  operating activities of continuing operations:**                              |       |                                |       |   |   |
| Net loss                                                                                         |       | $                                   | (5,070     | ) | $ | (2,185 | ) |
| Adjustments to reconcile net loss to cash  used in operating activities of continuing operations |       |                                |       |   |   |
| Depreciation and amortization                                                                    |       | 204                                 |       | 0 |   |
| Financing costs – beneficial conversion  interest                                           |       | 11                                  |       | 0 |   |
| Non-cash stock based compensation                                                                |       | 631                                 |       | 0 |   |
| Changes in operating assets and liabilities  from continuing operations:                         |       |                                |       |   |   |
| Accounts receivable                                                                              |       | 28                                  |       | 0 |   |
| Prepaid and other assets                                                                         |       | 247                                 |       | 0 |   |
| Accounts payable                                                                                 |       | (294                                | )          | 357 |   |
| Accrued expenses                                                                                 |       | 477                                 |       | 359 |   |
| Accrued compensation and benefits                                                                |       | 40                                  |       | 521 |   |
| Other                                                                                            |       | 285                                 |       | 0 |   |
| Net cash used in operating activities of  continuing operations                                  |       | (3,441                              | )          | (948 | ) |
| **Cash flows from  investing activities of continuing operations:**                              |       |                                |       |   |   |
| Capital expenditures                                                                             |       | (30                                 | )          | 0 |   |
| Net cash provided by investing activities  of continuing operations                              |       | (30                                 | )          | 0 |   |
| **Cash flows from  financing activities of continuing operations:**                              |       |                                |       |   |   |
| Proceeds from the issuance of common stock                                                       |       | 2,509                               |       | 0 |   |
| Proceeds from the issuance of redeemable  preferred stock                                        |       | 7,111                               |       | 0 |   |
| Proceeds from the exercise of stock options                                                      |       | 126                                 |       | 0 |   |
| Proceeds from the exercise of stock rights  and warrants                                         |       | 620                                 |       | 0 |   |
| Net cash provided by financing activities  of continuing operations                              |       | 10,366                              |       | 0 |   |
| **Net cash  contributed to continuing operations from discontinued operations**                  |       | 46                                  |       | 1,122 |   |
| **Net increase  (decrease) in cash**                                                             |       | 6,941                               |       | 174 |   |
| **Cash and cash  equivalents, beginning of period**                                              |       | 3,365                               |       | 589 |   |
| **Cash and cash  equivalents, end of period**                                                    |       | $                                   | 10,306     |   | $ | 763 |   |
|                                                                                             |       |                                |       |   |   |
| **Cash paid for  interest**                                                                      |       | $                                   | 2          |   | $ | 9 |   |
| **Non-cash financing  activity:**                                                                |       |                                |       |   |   |
| Issuance  of note payable to finance D&O insurance                                           |       | 256                                 |       | 560 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

5

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

 

(Dollar Amounts are in Thousands, Except forper Share and Share Amounts)

(Unaudited)

 

1.                                       Basisof Presentation.

 

The unaudited financial statements of WorldGate Communications, Inc.(“WorldGate” or the “Company”) for the three and six months ended June 30,2004 presented herein have been prepared by the Company pursuant to the rulesand regulations of the Securities and Exchange Commission for quarterly reportson Form 10-Q.  Certain information andfootnote disclosures normally included in financial statements prepared inaccordance with generally accepted accounting principles have been condensed oromitted pursuant to such rules and regulations. These financial statements should be read in conjunction with thefinancial statements for the year ended December 31, 2003 and the notesthereto included in the Company’s Annual Report on Form 10-K.

 

The financial information in this Report reflects, in the opinion ofmanagement, all adjustments of a normal recurring nature necessary to present fairlythe results for the interim period. Quarterly operating results are notnecessarily indicative of the results that may be expected for the year endingDecember 31, 2004.

 

2.                                       Liquidityand Going Concern Considerations.

 

As of June 30, 2004 the Company had cash and cash equivalents of$10,306. The operating cash usage from continuing operations for the three andsix months ended June 30, 2004 was $1,662 and $3,441, respectively.  During the third quarter of 2003, wecompleted a sale of certain assets, including our ITV intellectual propertyrights and our membership interest in TVGateway, LLC, for $3,000 in cash toTVGateway, LLC, a company we were instrumental in forming. Our transaction withTVGateway, LLC, marked a shift in our business away from the ITV business andtoward a new video phone product and associated business.  The funds we received from the sale of assetsto TVGateway, LLC, as well as the funds we received as a result of privateplacements of our securities on December 1, 2003, December 4, 2003,January 21, 2004, April 22, 2004, and June 23, 2004, havepermitted us to fund the development of our new business.

 

In December 2003 and January 2004, WorldGate receivedinvestments aggregating to a total of $3,100 by certain institutional investors.  These investors purchased an aggregate of3,000,000 shares of newly issued common stock. The investors also received aright, for a limited period of time, to purchase additional shares of up to 20%of the common stock purchased by the investors in their investment, at the sameprice as their investment, and five-year warrants to purchase up to 30% of thecommon stock purchased by the investors in their investment, at an exerciseprice equal to a twenty-five percent premium to their purchase price for theinvestment.  The purchase price for the 2million shares purchased in December 2003 transactions was $0.80 pershare, with the warrants having a $1.00 per share exercise price.  The purchase price for the 1 million sharespurchased in the January 2004 transaction was $1.50 per share, with thewarrants having a $1.875 per share exercise price.  All additional investment rights associatedwith the December 2003 transaction were exercised during January andFebruary of 2004, resulting in an incremental investment of $320.  All additional investment rights associatedwith the January 2004 transaction were exercised in May 2004, resulting inan incremental investment of $300.

 

In December 2003, WorldGate announced that it reached agreementwith Mototech, Inc. for the purchase of 625,000 shares of newly issued commonstock at $0.80 per share, in return for future design and engineering servicesby Mototech.  WorldGate previouslyannounced in November 2003, that it had contracted with Mototech to assistthe Company with the design and volume manufacture of WorldGate’s Ojo personalvideo phone. The purchase price for these shares will be paid by an equivalentreduction in the development and initial procurement payments that wouldotherwise be due to Mototech.  Mototechis an affiliate of Accton Technology Group. They currently manufacture and distribute a full range of highperformance high speed data and computer networking products, including cableset top boxes, home gateways, wireless LANs, hubs, switches, routers, and otherrelated products.  In addition, inApril 2004, Mototech invested $1 million to purchase 666,666 shares ofnewly issued common stock at $1.50 per share.

 

InJune 2004, WorldGate completed a private placement of 7,550 shares of itsSeries A Preferred Stock at a stated value of $1000 per share, which preferredstock is convertible into the Company’s common stock at a

 

6

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conversion price of $2.35 pershare; five-year warrants to purchase up to 803,190 shares of our common stockat an exercise price of $2.69 per share; and five-year warrants to purchase upto 803,190 shares of our common stock at an exercise price of $3.14 per share.The investors also received an additional investment right, for a limitedperiod of time, to purchase 1,606,383 additional shares of common stock sharesat $3.14 a share.

 

The Company has $7,153 of liabilities and its assets are not pledged ascollateral as of June 30, 2004. The Company continues to evaluate possibilitiesto obtain additional financing through public or private equity or debtofferings, bank debt financing, asset securitizations, or from othersources.  Such additional financing wouldbe subject to the risk of availability, may be dilutive to our shareholders, orcould impose restrictions on operating activities. There can be no assurancethat this additional financing will be available on terms acceptable to theCompany, if at all. The Company has limited capacity to further reduce itsworkforce and scale back on capital and operational expenditures to decreaseits cash usage given the measures it has already taken to reduce staff andexpenses.

 

The consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and thesatisfaction of liabilities and commitments in the normal course ofbusiness.  Therefore, the financialstatements do not include any adjustments relating to the Company’s ability tooperate as a going concern.  Theappropriateness of using the going concern basis in the future, however, willbe dependent upon the Company’s ability to address its liquidity needs asdescribed above.  There is no assurancethat the Company will be able to address its liquidity needs through the measuresdescribed above on acceptable terms and conditions, or at all, and accordingly,there is substantial doubt about the Company’s ability to continue as a goingconcern.  The independent auditors’report for the year ended December 31, 2003 includes an explanatoryparagraph stating that because the Company has suffered recurring losses fromoperations and has a net accumulated deficiency of $198 million, those issuesraise substantial doubt about the Company’s ability to continue as a goingconcern.

 

3.                                       RecentAccounting Pronouncement.

 

In January 2003, the FASB issued Interpretation No. 46, *Consolidation of Variable Interest Entities*.Interpretation No. 46 addresses consolidation by business enterprises ofvariable interest entities, which are entities that either (a) do not haveequity investors with vesting rights or (b) have equity investors that do notprovide sufficient financial resources for the entity to support itsactivities. The interpretation is effective immediately for variable interestentities created after February 1, 2003. In December 2003, the FASBpublished FASB Interpretation No. 46 (revised December 2003), *Consolidation of Variable Interest Entities*(FIN 46(R)). FIN 46(R), among other things, defers the effective date ofimplementation for certain entities. The revised interpretation is effectivefor the first interim or annual reporting period ending after March 15,2004, with the exception of structures that are commonly referred to asspecial-purpose entities, for which the statement is effective for periodsending after December 15, 2003. The adoption of Interpretation No. 46 didnot have a material impact on WorldGate’s results of operations or financialposition.

 

In May 2003, the FASB issued SFAS No. 150, *Accounting for Certain Financial Instruments with Characteristics ofboth Liabilities and Equity*. SFAS No. 150 establishes standards forclassification and measurement by an issuer of certain financial instrumentswith characteristics of both liabilities and equity. The statement requiresthat an issuer classify a financial instrument that is within the scope as aliability (or asset in some circumstances). This statement is effective forfinancial instruments entered into or modified after May 31, 2003, andotherwise is effective at the beginning of the first interim period beginningafter June 15, 2003, except as it relates to consolidated limited-lifesubsidiaries. The FASB indefinitely deferred the effective date of thisstatement as it relates to certain mandatorily redeemable non-controllinginterests in consolidated limited-life subsidiaries. WorldGate does not haveany interest in limited-life entities as of December 31, 2003. Theadoption of the effective provisions of SFAS No. 150 did not have an impact onWorldGate’s results of operations or financial position.

 

In December 2003, the FASB issued SFAS No. 132 (revised 2003), *Employer’s Disclosures about Pensions and OtherPostretirement Benefits*. This statement revises employers’disclosures about pension plans and other postretirement benefit plans; howeverit does not change the measurement or recognition of those plans required bySFAS No. 87, *Employers’ Accounting forPensions*, SFAS No. 88, *Employers’Accounting for Settlements and Curtailments of Defined Benefit Pension Plansand for Termination Benefits*, and SFAS No. 106,

 

7

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*Employers’ Accounting forPostretirement Benefits Other Than Pensions*. Therevised statement retains the disclosure requirements contained in the originalSFAS No. 132 and requires additional disclosures to those in the originalstatement about the assets, obligations, cash flows, and net periodic benefitcost of defined benefit pension plans and other defined benefit postretirementplans. The revised statement is effective for fiscal years ending afterDecember 15, 2003.

 

4.                                       Inventories.

 

Inventories are summarized as follows:

 
| ** **                              | ** ** | **June 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------------|------------|------------------------|------------|----------------------------|------------|
|                                    |       |                   |       |                       |       |
| Raw material                            |       | $                      | 1,622      |                       | $          | 1,622 |   |
| Work in progress                        |       | —                 |       | —                     |       |
| Finished goods                          |       | —                 |       | —                     |       |
| Inventory held by customers and vendors |       | —                 |       | —                     |       |
| Total inventory                         |       | 1,622                  |       | 1,622                      |       |
| Inventory reserve                       |       | (1,622                 | )          | (1,622                     | )          |
| Net inventory                           |       | $                      | —     |                       | $          | — |   |

 

5.                                       Stock-BasedCompensation.

 

The Company accounts for stock-basedcompensation in accordance with Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees,” and related interpretations.

 

The Company applies Accounting Principles Board Opinion No. 25,“Accounting for Stock Issued to Employees” and relatedinterpretations in accounting for its plans, and accordingly, no compensationcost has been recognized for the Company’s fixed stock basedcompensation. Had compensation cost been determined consistent with SFAS No.123, as amended by SFAS No. 148, the Company’s net loss would have beenincreased to the following pro forma amounts:

 
| ** **                                                                                                                           | ** ** | **For the Three Month Period  Ended June 30,** | ** ** | **For the Six Month Period  Ended June 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2004**                                            | ** ** | **2003**                                          | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                                                                                                                 |       |                                                |       |                                              |       |   |   |   |   |
| Net loss:                                                                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| As reported                                                                                                                          |       | $                                                   | (2,319     | )                                                 | $          | (2,999 | ) | $ | (5,041 | ) | $ | (4,884 | ) |
| Add:  Stock-based compensation expense included in reported net loss, net of  related tax effects of $0                              |       | 0                                                   |       | 0                                                 |       | 631 |   | 40 |   |
| Deduct: Total stock-based employee expense  determined under the fair value based method for all awards, net of related  tax effects |       | (520                                                | )          | (1,350                                            | )          | (1,083 | ) | (2,770 | ) |
| Pro forma net loss                                                                                                                   |       | $                                                   | (2,839     | )                                                 | $          | (4,349 | ) | $ | (5,493 | ) | $ | (7,614 | ) |
|                                                                                                                                 |       |                                                |       |                                              |       |   |   |   |   |
| Net Loss  per share:                                                                                                                 |       |                                                |       |                                              |       |   |   |   |   |
| Basic and  diluted – as reported                                                                                                |       | $                                                   | (0.08      | )                                                 | $          | (0.13 | ) | $ | (0.18 | ) | $ | (0.21 | ) |
| Basic and  diluted - pro forma                                                                                                       |       | $                                                   | (0.10      | )                                                 | $          | (0.18 | ) | $ | (0.20 | ) | $ | (0.32 | ) |

 

8

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Such pro forma disclosures may not berepresentative of future compensation expense because options vest over severalyears and additional grants are made each year.

 

6.          Related Party Transactions.

 

In 1997, the Company entered into agreements with certain cableoperators who are investors.  Revenuesrecognized from such investors were approximately $0 and $65, respectively, forthe three months ended June 30, 2004 and 2003, and approximately $0 and$136, respectively, for the six months ended June 30, 2004 and 2003.Accounts receivable from such investors amounted to approximately $0 atJune 30, 2004 and $2 at December 31, 2003.

 

The Company has agreements with some investors to provide engineeringand development support. As a result of those agreements, the Company hasexpensed approximately $0 and $165, respectively, for the three months endedJune 30, 2004 and 2003, and approximately $0 and $556, respectively, forthe six months ended June 30, 2004 and 2003. Accounts payable to thesestockholders amounted to $528 and $170 at June 30, 2004 andDecember 31, 2003, respectively. Some of these stockholders were suppliersof technology and components for the Company’s discontinued ITV products andservices. These agreements provided for licensing of technology, as well ascontracted services, including hardware and software development, producttesting and certification, and the creation and development of tools andsystems to facilitate the Company’s engineering efforts. These agreements didnot provide for ongoing royalties, purchase provisions, or for any requirementto provide additional funding to the Company.

 

In 1998 the Company entered into a leasing arrangement for a buildingwith an entity formed by non-employee investors. Included in deposits and otherassets at June 30, 2004 and 2003 is $0 and $750, respectively, related tothis lease. We have not paid our rent on our current facility since May 2003.As a result, our landlord, 3190 T General, Inc. in September 2003, filedan action in the Court of Common Pleas, Bucks County Pennsylvania to perfectits interest to take possession of our facility at any time, and to establishdamages for past rent and expenses. In lieu of rent payments our landlord hasdrawn from our security deposit to satisfy the unpaid rent and such deposit hasnow been fully depleted. A judgment was also granted allowing our landlord toregain possession of the facility, although we remain in the facility, albeitin substantially reduced space. During this process we attempted to negotiate asettlement of our lease obligation with the landlord in an effort to reduce ouroutstanding liability and secure the continued right to occupy the facilitywith a reduced ongoing lease obligation. We also worked with the landlord tosecure other tenants for the unused space. However, we were informed by thelandlord that this process was complicated by the requirement for thelandlord’s mortgage holder to approve any such amendments to our lease as wellas any arrangements with other prospective tenants. The landlord was not ableto obtain such approvals from the mortgage holder and ultimately the landlordand the landlord’s mortgage holder reached an agreement for the landlord’smortgage holder to become a successor to the landlord’s interest in theproperty. We have already commenced negotiations directly with the mortgageholder’s representatives to secure the continued right to occupy the facilitywith a reduced ongoing lease obligation, and are currently awaiting a proposalfrom the mortgage holder, although there can be no assurance that an agreementcan be reached with the mortgage holder. Concurrently we are exploring otherfacility opportunities in the event an agreement cannot be reached. In lieu ofmonthly rent payments of $104 (offset by monthly sublease payments by TVGatewayof $19 during the period February 1, 2003 through January 31, 2004),the Company’s landlord has drawn down from its security deposit to satisfy $750of the unpaid rent of $1,223 as of June 30, 2004. As of June 30,2004, the amount of the deposit remaining after deduction for the unpaid rentis $0.  The Company has continued toaccrue the full rent expense through June 30, 2004.

 

7.          TVGateway Joint Ventureand related Cable Operator Agreements.

 

On July 24, 2000, the Company formed aseparate joint venture, TVGateway, LLC, with four cable operators.  As part of this venture WorldGate enteredinto a management agreement with TVGateway to provide engineering, operationsand administrative support services. In addition to providing for the terms andconditions under which such services were to be provided, the managementagreement provided for WorldGate and TVGateway to cooperate to transition toTVGateway some or all of the support services being provided by WorldGateand/or the employees providing these services. In addition, this provisionrequired WorldGate to remain available to provide support services until July 24,2005. During 2002 WorldGate and TVGateway agreed to

 

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commence the transition of services pursuant to thisprovision. In addition, the parties agreed that the management agreement wouldbe of no further force and effect with respect to the services that aretransferred as of the date of completion of the specific transfers. Thecompanies completed this transition in the first quarter 2003, and accordingly,WorldGate has now been relieved of any continuing obligation to provide suchtransitioned services.  Further,WorldGate will no longer receive future revenues from the management agreementwith TVGateway.

 

Revenues for such services, which areincluded in service fee revenue, totaled $0, and $732, respectively for thethree months ended June 30, 2004 and 2003, and $0 and $788, respectively,for the six months ended June 30, 2004 and 2003. In addition, productsales to TVGateway totaled $0 and $0 for the three months ended June 30,2004 and 2003, respectively, and $0 and $1,079, respectively, for the sixmonths ended June 30, 2004 and 2003. Accounts Receivable from TVGatewayamounted to $0 at June 30, 2004 and $0 at December 31, 2003.WorldGate was accounting for its 18% investment in the TVGateway joint venture,which was previously reduced to a carrying value of $0 due to prior losses,under the equity method.

 

OnSeptember 30, 2003 the Company announced that it had sold to TVGateway,LLC certain ITV intellectual property rights and certain software and equipmentrelated to the ITV business, which TVGateway was currently using, for$2,400.  In addition, on August 7,2003, WorldGate and TVGateway entered into a redemption agreement pursuant towhich TVGateway redeemed WorldGate’s equity interest in TVGateway for $600 incash.  The purchase price for theseassets in the aggregate was $3,000 and was used by the Company to fundcontinuing operations, as well as to develop and distribute its new Ojo videotelephony product. As part of this transaction WorldGate retained aroyalty-free license to certain of the transferred intellectual property rightsand software. At this time the Company has completely exited from theinteractive television (ITV) business.

 

Inconnection with the Asset Purchase Agreement we entered into with TVGateway forthe sale of certain ITV Business assets, we have an obligation to indemnifyTVGateway for any losses from breaches of our representations or warranties inthe Asset Purchase Agreement that occur within twelve months after the closingdate of the TVGateway transaction or within the applicable statute oflimitations period for claims relating to our ownership of our assets, paymentof our taxes, and our compliance with applicable laws, if longer. Ourindemnification obligations are limited by an overall cap of $500 on the amountof the indemnification. Although we know of no breaches of our representationsor warranties, the payment of any such indemnification obligations wouldadversely impact our cash resources and our ability to pursue our video phonebusiness.

 

8.               Net Loss per Share.

 

Basic and diluted net loss per common share is computed by dividing thenet loss available to common stockholders for the period by the weightedaverage number of shares of common stock outstanding during the period.  The calculation of diluted net loss percommon 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 endedJune 30, 2004 and 2003 and have a dilutive effect if the Company hadincome from continuing operations, or if the options’ exercise price was lessthan the average market price of the common shares, is 12,968,818 and5,932,513, respectively.

 

# ITEM 2.  MANAGEMENT’SDISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OFOPERATIONS.

#  

(Dollar Amounts are in Thousands, Except perShare Amounts)

 

FORWARD-LOOKING AND CAUTIONARY STATEMENTS.

 

The Company may from time to time make written or oral forward-lookingstatements, including those contained in the following Management’s Discussionand Analysis of Financial Condition and Results of Operations. The words “estimate,”“project,” “believe,” “intend,” “expect,” and similar expressions are intendedto identify forward-looking statements, although not all forward-lookingstatements contain these identifying words. 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, which could causeour actual results, performance or achievement to differ materially from thosethat may be contained in or implied by any forward-looking statement made by oron behalf

 

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of WorldGate.  The factors, individually or in theaggregate, that could cause such forward-looking statements not to be realizedinclude, without limitation, the following: (1) difficulty or inability toraise additional financing on terms acceptable to us, (2) difficulty indeveloping and implementing marketing and business plans, (3) continued losses,(4) industry competition factors and other uncertainty that a market for ourproducts will develop, (5) challenges associated with broadband operators(including, uncertainty that they will offer our products, inability to predictthe manner in which they will market and price our products and existence ofpotential conflicts of interests and contractual limitations impeding theirability to offer our products), (6) departure of one or more key persons,  (7) delisting of our Common Stock from theNASDAQ Small Cap Market, (8) changes in regulatory requirements, and (9) otherrisks identified in our filings with the Securities and ExchangeCommission.  We caution you that theforegoing list of important factors is not intended to be, and is not,exhaustive.  We do not undertake toupdate any forward-looking statement that may be made from time to time by oron behalf of WorldGate.

 

Results of Operations:

 

Critical Accounting Policies and Estimates.

 

The consolidated financial statements are prepared in conformity withaccounting principles generally accepted in the United States.  The preparation of these financial statementsrequired management to make estimates and assumptions that affect the reportedamounts of assets and liabilities and disclosure of contingent assets andliabilities at the date of the financial statements and the reported amounts ofrevenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

 

The significant accounting policies of the Company are described in thenotes to the consolidated financial statements included in the annual report onForm 10-K.  Judgments and estimates ofuncertainties are required in applying the Company’s accounting policies inmany areas.  Following are some of theareas requiring significant judgments and estimates:  revenue recognition, accounts receivable,inventories, and cash flow and valuation assumptions in performing assetimpairment tests of long-lived assets.

 

Discontinued Operations

 

During the first quarter of 2004 the Company transitioned from thebusiness of developing and selling interactive television, or ITV, technology,products and services for use in conjunction with cable TV broadband networks(the “ITV business”) to the development of our video phone products as ourprimary business focus. During the three months ended June 30, 2004 theCompany had revenues from discontinued operations of $7, compared to revenuesof $391 for the three months ended June 30, 2003. For the six months endedJune 30, 2004 and 2003, respectively, revenues were $89 and $2,556 respectively.This reduction reflects service revenues of $7 and $342, respectively, for thethree months ended June 30, 2004 and 2003, and for the six months endedJune 30, 2004 and 2003, service revenues were $7and $1,320 respectively. Equipment revenues were $0 and $49 for the threemonths ended June 30, 2004 and 2003, respectively, and $82 and $1,236,respectively, for the six months ended June 30, 2004 and 2003.Concurrently, operating expenses, consisting of Research and Development, Marketingand General and Administration costs were also reduced as a result of thetransition from the ITV business.  Theseexpenses were $0 for the three months ended June 30, 2004, compared to$755 for the three months ended June 30, 2003, and $16 and $2,561,respectively, for the six months ended June 30, 2004 and 2003.

 

The information in our quarter to quarter comparisons below representsonly our results from continuing operations.

 

Three and Six Months Ended June 30, 2004 and June 30, 2003

 

Revenues.

 

Revenues.  There were no revenues from continuingoperations during the three and six months ended June 30, 2004 andJune 30, 2003. We expect that revenues from video phones will not berealized until, at the earliest, the fourth quarter of 2004.

 

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Costs and Expenses.

 

Cost of Revenues.  There were no costs of revenues fromcontinuing operations during the three and six months ended June 30, 2004and June 30, 2003. We expect that costs of revenues from video phones willnot be incurred until, at the earliest, the fourth quarter of 2004.

 

Engineering and Development.  Engineering and development expensesprimarily consist of compensation, and the cost of design, programming,testing, documentation and support of the Company’s video phone product.  Engineering and development costs were $799for the three months ended June 30, 2004, compared with $727 for the threemonths ended June 30, 2003. For the six months ended June 30, 2004and June 30, 2003, engineering and development expenses were $1,599 and$1,263, respectively. These increases of $72 and $336, respectively, or 10% and27%, respectively, for the three and six months ended June 30, 2004,reflect the Company’s increased concentration of its engineering staff, and relatedcosts, for the further and continuing development of its video phone product.

 

Sales and Marketing.  Sales and marketing expenses consistprimarily of compensation, attendance at conferences and trade shows, travelcosts, promotions and other marketing programs related to the introduction ofthe Company’s video phone product.  Salesand marketing costs were $408 for the three months ended June 30, 2004,compared with $139 for the three months ended June 30, 2003. For the sixmonths ended June 30, 2004 and 2003, sales and marketing expenses were$599 and $225, respectively. These increases of $269 and $374, respectively, or193% and 166%, respectively, for the three and six months ended June 30,2004, reflect the increased marketing and promotional expenditures, primarilyrelated to trade shows attendance, for the Company’s video phone product.

 

General and Administrative.  General and administrative expenses consistprimarily of expenditures for administration, office and facility operations,finance and general management activities, including legal, accounting andprofessional fees.  General andadministrative expenses were $1,012 for the three months ended June 30,2004, compared with $506 for the three months ended June 30, 2003. For thesix months ended June 30, 2004 and 2003, general and administrativeexpenses were $2,685 and $697, respectively. The increases of $506 and $1,988,respectively, or 100% and 285%, respectively, for the three and six monthsended June 30, 2004, are attributable primarily to the Company’stransition of nearly all, or 99%, of its administrative managementcompensation, facility, legal, finance and professional consulting fees towardthe further development of the video phone business, and a one time non cashcharge of $631 reflecting a Black Scholes estimate of the value of the warrantsissued as part of the private placement of the Company’s stock to certaininstitutional investors in January 2004. For the three and six months ended June 30, 2003, video phonerelated costs were 60% and 39%, respectively, of total General andAdministrative expense of $845 and $1,807, respectively.

 

Interest and Other Income and InterestExpense. Interest and other income and interest expense consist of interestearned on cash and cash equivalents, and interest expense on short-termdebt.  Interest and other incomeincreased from $12 for the three months ended June 30, 2003 to $13 for thethree months ended June  30, 2004, and decreasedfrom $39 for the six months ended June 30, 2003 to $20 for the six monthsended June 30, 2004, primarily due to declining interest rates.  During the three and six months endedJune 30, 2003, the Company earned interest on average cash balances ofapproximately $8,963 and $10,913, respectively, and incurred interest expenserelated to its insurance financing.  Incomparison, during the three and six months ended June 30, 2004 theCompany earned interest on average cash balances of approximately $3,878 and$4,817, respectively, and incurred interest expense related to its insurancefinancing.

 

Income Taxes.  The Company has incurred net operating lossessince inception and accordingly had no income taxes and has not recorded anyincome tax benefit for those losses.

 

Liquidity and Capital Resources.

 

As of June 30, 2004, our primary source of liquidity consisted ofcash and cash equivalents that are highly liquid, are of high qualityinvestment grade and have maturities of less than one year.

 

At June 30, 2004, we had cash and cash equivalents of $10,306 (andno short-term investments) as compared to cash and equivalents of $3,365 (andno short-term investments) at December 31, 2003.  Net cash used in continuing operations was$3,441 for the six months ended June 30, 2004, as compared to $2,813 usedfor the same period in 2003. This increase in net cash used for continuingoperations was primarily attributable to the Company’s increase in expendituresrelated to the video phone business.  TheCompany recorded bad debt

 

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expense in the amount of $16 fromdiscontinued operations during the six months ended June 30, 2004 toreflect its current assessment of the collectability of certain receivables.

 

Cash provided by investing activities from continuing operations duringthe three months ended June 30, 2004, totaled $10,366 compared to $0provided during the same period in 2003. During the six months ended June 30, 2004 net proceeds from ourmaturing short-term investments were $0 compared to $3,218 for the six monthsended June 30, 2003.  Capitalexpenditures were $30 and $0 for the six months ended June 30, 2004 and2003, respectively.

 

Operations and Liquidity.

 

To date, the Company has funded operations primarilythrough private sales of equity securities and through an initial publicoffering of common stock in April 1999. As of June 30, 2004 the Company had cash, and cash equivalents of$10,306. The operating cash usage from continuing operations for the six monthsended June 30, 2004 was $3,441. As of June 30, 2004 we have $256 ofoutstanding debt and our assets are not pledged as collateral.  However, we have not paid our monthly rent of$104 (offset by monthly sublease payments by TVGateway of $19 during the periodFebruary 1, 2003 through January 31, 2004) on our current facilitysince May 2003.  As a result, ourlandlord, a non-employee investor, has perfected its interest to takepossession of our facility at any time and has drawn down from our rent depositto satisfy $750 of the unpaid rent of $1,223 as of June 30, 2004.  As of June 30, 2004 the amount of thedeposit remaining is $0 after deduction for the unpaid rent.  The Company has continued to accrue the fullrent expense through June 30, 2004. We continue to negotiate to resolve this matter (refer to Part II, ItemI Legal Proceedings).  We also continueto evaluate possibilities to obtain additional financing through public orprivate equity or debt offerings, bank debt financing, asset securitizations,or from other sources.  Such additionalfinancing would be subject to the risk of availability, may be dilutive to ourshareholders, or could impose restrictions on operating activities.  There can be no assurance that thisadditional financing will be available on terms acceptable to us, if atall.  The Company has limited capacity tofurther reduce its workforce and scale back on capital and operationalexpenditures to decrease cash burn given the measures it has already taken toreduce staff and expenses.

 

With the private placement of the Company’s commonstock, together with additional rights and warrants, resulting in the aggregategross proceeds received of $1.5 million in January 2004, the privateplacement of the Company’s common stock in April 2004 providing proceedsof $1,000, and the June 2004 private placement of Company’s redeemablepreferred stock aggregating proceeds to the Company of $7.55 million, theCompany projects it will have sufficient funding to continue operations intothe third quarter of 2005, assuming no additional funding is received andassuming no impact from sales. Depending on the timing and magnitude of theramp up of video phone sales, we expect that our current cash may be sufficientto get the company to a cash breakeven position.  No assurances can be given that sufficientsales, if any, will materialize, or that a funding transaction can beconsummated prior to the depletion of our available cash.  We however remain hopeful that sufficientfunding can be developed through funding or ongoing operations to continue theCompany’s operations.  The independentauditors’ report for the year ended December 31, 2003 included anexplanatory paragraph stating that because the Company has suffered recurringlosses from operations and has a net accumulated deficiency of $199 million,those issues raise substantial doubt about the Company’s ability to continue asa going concern.

 

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# ITEM 3.  QUANTITATIVE ANDQUALITATIVE DISCLOSURES 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 with respectto any one issue, issuer and type of investment.

 

As of June 30, 2004, the Company’s cash and cash equivalents were$10,306, most of which were securities having a maturity of less than one year,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, our interestincome for the six months ended June 30, 2004 would have decreased byapproximately $30. This estimate assumes that the decrease occurred on thefirst day of 2004 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 Exchange Risk.  The principal portion of our current businessis in the United States and substantially all of our costs to date have beendenominated in U.S. dollars.  As aresult, adverse movements in foreign currency exchange rates would not have amaterial adverse effect on us.

 

# ITEM 4.  CONTROLS AND PROCEDURES.

 

As of the end of the period covered by thisForm 10-Q, the Company’s principal executive and principal financial officers,including its chief executive officer and chief financial officer, conducted anevaluation of the effectiveness of the Company’s disclosure controls andprocedures. Based on that evaluation, the chief executive officer and chieffinancial officer concluded that the Company’s disclosure controls andprocedures were effective. There have been no changes in the Company’s internalcontrol over financial reporting that occurred during the period ended June 30,2004, that have materially affected, or are reasonably likely to materiallyaffect, the Company’s internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

(Dollar Amounts are in Thousands, Except perShare Amounts)

 

# ITEM 1. LEGAL PROCEEDINGS.

#  

The Company has not paid its rent on its current facility since May2003. As a result, our landlord, 3190 T General, Inc. in September 2003,filed an action in the Court of Common Pleas, Bucks County Pennsylvania toperfect its interest to take possession of our facility at any time, and toestablish damages for past rent and expenses. In lieu of rent payments ourlandlord has drawn from our security deposit to satisfy the unpaid rent andsuch deposit has now been fully depleted. A judgment was also granted allowingour landlord to regain possession of the facility, although we remain in thefacility, albeit in substantially reduced space. During this process weattempted to negotiate a settlement of our lease obligation with the landlordin an effort to reduce our outstanding liability and secure the continued rightto occupy the facility with a reduced ongoing lease obligation. We also workedwith the landlord to secure other tenants for the unused space. However, wewere informed by the landlord that this process was complicated by therequirement for the landlord’s mortgage holder to approve any such amendmentsto our lease as well as any arrangements with other prospective tenants. Thelandlord was not able to obtain such approvals from the mortgage holder andultimately the landlord and the landlord’s mortgage holder reached an agreementfor the landlord’s mortgage holder to become a successor to the landlord’sinterest in the property. We have already commenced negotiations directly withthe mortgage holder’s representatives to secure the continued right to occupythe facility with a reduced ongoing lease obligation, and are currentlyawaiting a proposal from the mortgage holder, although there can be noassurance that an agreement can be reached with the mortgage holder.Concurrently we are exploring other facility opportunities in the event anagreement cannot be reached.

 

# ITEM 2.  CHANGES IN SECURITIES ANDUSE OF PROCEEDS.

Instruments Defining the Rights of Holders of Our Registered Securities

 

On June 17, 2004, our board of directors authorized 7,550 sharesof Series A Convertible Preferred Stock.  The rights, preferences and privileges ofholders of the outstanding preferred stock are subject to, and may be adverselyaffected by, the rights of holders of shares of any additional preferred stockwhich we may designate and issue in the future.

 

The holders of the preferred stock may convert their shares into ourcommon stock at an initial conversion price of $2.35 per share. The conversionprice adjusts in the event of stock dividends and splits and certaindistributions to stockholders, fundamental transactions, and future equitytransactions. The number of shares of common stock issuable upon conversion ofthe preferred stock increases with any accrued but unpaid dividends on thepreferred stock, and changes in inverse proportion to the conversion price. Wehave the right to require conversion of the preferred stock into common stockupon achieving certain price targets with respect to our common stock and thesatisfaction of certain other conditions.

 

The preferred stock has a dividend rate of 5% per annum, payablequarterly and in preference to the payment of any dividend on our common stock.The dividends may be paid either by cash or, subject to certain conditions,through the issuance of common stock at our option (with stock payments beingmade at a 10% discount to the then current market price). The preferred stockhas a staged maturity over three years with scheduled payments of one third dueafter 18 months, one half of the remainder due after 24 months andthe balance due after 36 months. The preferred stock may be redeemed atmaturity in cash or, subject to certain conditions, through the issuance ofcommon stock, at our option (with stock payments being made at the then currentmarket price).

 

Upon any liquidation, dissolution or winding up of our company, afterpayment of all debts and liabilities of our company, but prior to any paymentto the holders of common stock, the holders of the preferred stock will beentitled to receive the stated value of their preferred shares plus accrued butunpaid dividends. Holders of the preferred stock generally have no votingrights, but are entitled to veto certain actions which would have the effect ofchanging, altering, or diluting their shares. In connection with the issuanceof the preferred stock, the Company agreed to indemnify the purchasers inconnection with actions that may be instituted against them by ourshareholders, except for actions based upon a breach by such purchaser,violation by them of state or federal securities laws or fraud, grossnegligence, willful misconduct or malfeasance. We do not believe suchindemnification obligations

 

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are material to our Company.

 

Sales of Unregistered Securities

 

(1)                                  On April 23,2004, we completed a private placement of 666,666 shares of our common stockwith Mototech Inc., at a sale price of $1.50 per share. The privateplacement resulted in gross proceeds to us of $1 million.

 

The common stock was issued in reliance upon the exemption from theregistration requirements of the Securities Act afforded to transactions notinvolving a public offering by Section 4(2) of that Act and Rule 506thereunder.

 

(2)                                  On April 28,2004, we entered into a Development and Distribution Agreement with GeneralInstrument Corporation d/b/a the Broadband Communication Sector ofMotorola, Inc., or Motorola. In connection with the Development andDistribution Agreement with Motorola, we issued a warrant to Motorola topurchase 300,000 shares of our common stock at an exercise price of $1.4375 pershare, and agreed to issue additional warrants to purchase up to an additional1,950,000 shares of our common stock, upon the achievement of certain productand sales milestones, at an exercise price based upon the average closing salesprice of the our common stock during the 20 day period preceding theissuance of each warrant.

 

The warrants were issued in reliance upon the exemption from theregistration requirements of the Securities Act afforded to transactions notinvolving a public offering by Section 4(2) of that Act and Rule 506thereunder.

 

(3)                                  On June 11,2004, we entered into an agreement with Sejin America to settle a dispute withrespect to certain inventory alleged to have been purchased by the Company. Inconnection with the agreement, we issued 39,035 shares of our common stock toSejin America in full settlement of the dispute. The common stock was issued inreliance upon the exemption from the registration requirements of theSecurities Act afforded to transactions not involving a public offering bySection 4(2) of that Act and Rule 506 thereunder.

 

(4)                                  On June 24,2004, we completed a private placement of 7,550 shares of our preferred stockat a sale price of $1000 per share, which preferred stock is convertible intoour common stock at a conversion price of $2.35 per share; five-year warrantsto purchase up to 803,190 shares of our common stock at an exercise price of$2.69 per share; and five-year warrants to purchase up to 803,190 shares of ourcommon stock at an exercise price of $3.14 per share. The investors alsoreceived an additional investment right, for a limited period of time, topurchase 1,606,383 additional shares of common stock shares at $3.14 a share.

 

The private placement resulted in gross proceeds to the Company of$7,550,000. The Company paid fees to Janney Montgomery Scott LLC, AshendenFinance & Cie SA and Sloan Securities LLC, based upon the proceedsreceived by the Company from certain of the Investors participating in thisfinancing. The aggregate fees payable to these entities was less than sixpercent of the gross proceeds.

 

The preferred shares, warrants, and additional investment rights wereissued in reliance upon the exemption from the registration requirements of theSecurities Act afforded to transactions not involving a public offering bySection 4(2) of that Act and Rule 506 thereunder.

 

# ITEM 3.  DEFAULTS UPON SENIORSECURITIES.

#  

None.

 

# ITEM 4.  SUBMISSION OF MATTERS TO AVOTE OF SECURITY HOLDERS.

#  

None.

 

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# ITEM 5. OTHER INFORMATION.

#  

None.

 

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# ITEM 6.  EXHIBITS AND REPORTS ON FORM 8-K.

#  

(a) Exhibits.

 
| 3.1    |   | Amended and Restated Certificate of Incorporation(1)                                                                                                                                                                                                                                                                                                 |
|--------|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 3.2    |   | Amended and Restated Bylaws(1)                                                                                                                                                                                                                                                                                                                       |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 3.3    |   | Form of Certificate of Designations, Preferences and Rights of the  Series A Convertible Preferred Stock of the Company (2) (filed as Exhibit 3.1  to the June 8-K)                                                                                                                                                                             |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 4.1    |   | Form of Series A Warrant dated as of June 24, 2004 issued by the  Company to the Investors (as defined in the Securities Purchase Agreement  dated as of June 24, 2004 between the Company and the Investors)(2)                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 4.2    |   | Form of Series B Warrant dated as of June 24, 2004 issued by the  Company to the Investors (as defined in the Securities Purchase Agreement  dated as of June 24, 2004 between the Company and the Investors)(2)                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 4.3    |   | Form of Series C Warrant dated as of June 24, 2004 issued by the  Company to the Investors (as defined in the Securities Purchase Agreement  dated as of June 24, 2004 between the Company and the Investors)(2)                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.1   |   | Development and Distribution Agreement dated as of April 28,  2004 between the Company, WorldGate Services, Inc. and General Instrument  Corporation d/b/a the Broadband Communication Sector of Motorola, Inc.(3)  (filed as Exhibit 99.1 to the July 8-K) (Portions of this agreement are  subject to a confidential treatment request.) |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 10.2   |   | Securities Purchase Agreement dated as of June 24, 2004 by and  between the Company and the Investors (as defined therein)(2) (filed as  Exhibit 99.1 to the June 8-K)                                                                                                                                                                     |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 31.1   |   | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of  2002*                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 31.2   |   | Certification pursuant to Section 302 of the Sarbanes-Oxley Act of  2002*                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 32.1   |   | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of  2002*                                                                                                                                                                                                                                                                            |
|   |   |                                                                                                                                                                                                                                                                                                                                                 |
| 32.2   |   | Certification pursuant to Section 906 of the Sarbanes-Oxley Act of  2002*                                                                                                                                                                                                                                                                            |

 

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*              Filedherewith.

 

(1)                                  Incorporated byreference to the exhibits to our Form 10-Q Report for the quarter endedMarch 31, 1999.

 

(2)                                  Incorporated byreference to the exhibits to our Current Report on Form 8-K datedJune 25, 2004 (the “June 8-K”).

 

(3)                                  Incorporated byreference to the exhibits to our Current Report on Form 8-K filedJuly 13, 2004 (the “July 8-K”).

 

(b)  Reportson Form 8-K.

 

During the fiscal quarter ended June 30,2004, the Company filed the following Current Reports on Form 8-K:

 

On June 25, 2004, a Current Report on Form 8-K was filed,reporting under items 5 and 7 that the Company had completed a privateplacement of $7.55 million of its Series A Convertible Preferred Stock andWarrants with several institutional investors.

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934,  the registrant hasduly caused this

 

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report to be signed on its behalf by the undersignedthereunto duly authorized.

 

 
|   |            | WORLDGATE COMMUNICATIONS, INC.                                                           |
|--------|-----------------|------------------------------------------------------------------------------------------|
|   |            |                                                                                     |
|   |            |                                                                                     |
| Date:  | August 16, 2004 |                                                                                     | /s/ Hal M. Krisbergh |   |
|   |            | Hal M. Krisbergh                                                                         |
|   |            | Chairman and Chief Executive Officer  (Principal Executive Officer)                      |
|   |            |                                                                                     |
|   |            |                                                                                     |
| Date:  | August 16, 2004 |                                                                                     | /s/ Joel Boyarski |   |
|   |            | Joel Boyarski                                                                            |
|   |            | Vice President and Chief Financial Officer  (Principal Financial and Accounting Officer) |
|        |                 |                                                                                          |  |  |  |

 

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