UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 WASHINGTON,
D.C. 20549
  FORM
10-Q
  ý
                
                QUARTERLY
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934For
      the quarterly period ended March 31, 2009ORo
                
                TRANSITION
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THESECURITIES
      EXCHANGE ACT OF 1934For
      the transition period from ________________ to
      ________________
 
 Commission
file number:  000-25755
 
 WORLDGATE
COMMUNICATIONS, INC.
 (Exact
name of registrant as specified in its charter)
 
 Delaware
                
                23-2866697(State
      or other jurisdiction of
                
                (I.R.S.
      Employerincorporation
      or organization)
                
                Identification
      No.)3190
      Tremont Avenue
                  Trevose,
      Pennsylvania
                
                19053(Address
      of principal executive offices)
                
                (Zip
      Code)
 
 (215)
354-5100
 (Registrant’s
telephone number, including area code)
 
 [None]
 (Former
name, former address and former fiscal year, if changed since last
report)
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days.
 Yes ý                                    No  o
 
 Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding
12 months (or for such shorter period that the registrant was required to submit
and post such files).
 Yes o                                    No  o
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer or a smaller reporting
company.  See the definitions of “large accelerated filer,”
“accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act of
1934.
 
 Large
      accelerated filer o
                
                Accelerated
      filer  oNon-accelerated filer  o  (Do not check if a smaller reporting company)
                
                Smaller reporting company  ý
 
 Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Securities Exchange Act of
1934).Yes oNo  ý
 
 Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date.
 
 Class
                    
                    Outstanding
      at May 5, 2009Common
      Stock, $0.01 par value per share
                    
                    321,368,500
      shares
  
 
 WORLDGATE
COMMUNICATIONS, INC.
 
 QUARTERLY
REPORT ON FORM 10-Q
 FOR
THE THREE MONTHS ENDED MARCH 31, 2009
 
 TABLE
OF CONTENTS
 
 PART
      I. FINANCIAL INFORMATION
                    
                    3ITEM
      1.  FINANCIAL STATEMENTS
                    
                    3ITEM
      2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION
      AND RESULTS OF OPERATIONS
                    
                    18ITEM
      3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
      RISK
                    .
                    23ITEM
      4T.  CONTROLS AND PROCEDURES.
                    
                    24PART
      II. OTHER INFORMATION
                    
                    24ITEM
      1.  LEGAL PROCEEDINGS.
                    
                    24ITEM
      2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
      PROCEEDS.
                    
                    25ITEM
      3.  DEFAULTS UPON SENIOR SECURITIES.
                    
                    25ITEM
      4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY
      HOLDERS.
                    
                    25ITEM
      5.  OTHER INFORMATION.
                    
                    25ITEM
      6.  EXHIBITS.
                    
                    25
  2
  PART
I. FINANCIAL INFORMATION
 ITEM
1.  FINANCIAL STATEMENTS
 
 WORLDGATE
COMMUNICATIONS, INC.
 CONDENSED
CONSOLIDATED BALANCE SHEETS
 (Dollars
In Thousands, Except Share Amounts)
 
 March
      31,
                    2009
                
                
                December
      31,
                    2008
      *(Unaudited)ASSETSCurrent
      assets:Cash
      and cash equivalents
                
                $
                320
                
                
                $
                429Trade
      accounts receivables, less allowance for doubtful accounts of $157 at
      March 31, 2009 and $0 at December
31,   2008
                
                
                851
                
                
                
                1,019Other
      receivables
                
                
                0
                
                
                
                1Inventory,
      net
                
                
                1,059
                
                
                
                1,176Prepaid
      and other current assets
                
                
                104
                
                
                
                160Total
      current assets
                
                
                2,334
                
                
                
                2,785Property and equipment, net
                
                
                219
                
                
                
                234Deposits
      and other assets
                
                
                66
                
                
                
                66Total assets
                
                $
                2,619
                
                
                $
                3,085LIABILITIES
      AND STOCKHOLDERS’  DEFICIENCYCurrent
      liabilities :Accounts
      payable
                
                $
                1,860
                
                
                $
                1,750Accrued
      expenses
                
                
                1,693
                
                
                
                1,420Accrued
      compensation and benefits
                
                
                230
                
                
                
                173Detachable
      warrants
                
                
                1,320
                
                
                
                4,360Warranty
      reserve
                
                
                27
                
                
                
                17Deferred
      revenues and income
                
                
                980
                
                
                
                1,762Notes
      Payable
                
                
                780
                
                
                
                0Convertible
      debentures payable (net of unamortized discount of $2,188
      at  March 31, 2009 and $2,287 at December 31,
    2008
                
                
                1,892
                
                
                
                1,793Total
      current liabilities
                
                
                8,782
                
                
                
                11,275Commitments
      and contingenciesStockholders’
      deficiency:Preferred
      Stock, $.01 par value, 13,492,450 shares authorized; 0 shares issued at
      March 31, 2009 and December 31, 2008
                
                
                0
                
                
                
                0Common
      Stock, $.01 par value; 700,000,000 and 200,000,000shares authorized at
      March 31, 2009 and December 31, 2008, respectively; and 118,906,345 shares
      issued and outstanding at March 31, 2009 and December 31,
      2008..
                
                
                1,189
                
                
                
                1,189Additional
      paid-in capital
                
                
                259,791
                
                
                
                261,478Accumulated
      deficit
                
                
                (267,143
                )
                
                
                (270,857
                )Total
      stockholders’ deficiency
                
                
                (6,163
                )
                
                
                (8,190
                )Total
      liabilities and stockholders’ deficiency
                
                $
                2,619
                
                
                $
                3,085
 
 *
Condensed from audited financial statements
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  3
 
 .WORLDGATE COMMUNICATIONS,
INC.
 CONDENSED
CONSOLIDATED STATEMENTS OF OPERATIONS
 (Unaudited)
 (Dollars
In Thousands, Except Share And Per Share Amounts)
 
 Three Months ended March 31,2009
                
                
                2008Net
      revenues:Product
      revenues
                
                $
                349
                
                
                $
                19Service
      revenues
                
                
                93
                
                
                
                35Other
      revenues
                
                
                796
                
                
                
                60Total
      net revenues
                
                
                1,238
                
                
                
                114Cost
      of revenues
                
                
                914
                
                
                
                38Gross
      margins
                
                
                324
                
                
                
                76Engineering
      and development expenses (excluding depreciation and amortization of $25
      and $50 for the three months ended March 31, 2009 and 2008,
      respectively).
                
                
                642
                
                
                
                577Sales
      and marketing expenses (excluding depreciation and amortization of $9 and
      $15 for the three months ended March 31, 2009 and 2008,
      respectively)
                
                
                38
                
                
                
                219General
      and administrative expenses (excluding depreciation and amortization of $6
      and $34 for the three months ended March 31, 2009 and 2008,
      respectively)
                
                
                865
                
                
                
                899Depreciation
      and amortization
                
                
                40
                
                
                
                99Total
      expenses from operations
                
                
                1,585
                
                
                
                1,794Loss
      from operations
                
                
                (1,261
                )
                
                
                (1,718
                )Other
      Income (expense)Interest
      and other income
                
                
                8
                
                
                
                8Change in fair value of derivative warrants and
      conversion options
                
                
                3,925
                
                
                
                129Income
      from service fee contract termination
                
                
                348
                
                
                
                0Amortization
      of debt discount
                
                
                (683
                )
                
                
                (218
                )Interest
      and other expense
                
                
                (72
                )
                
                
                (90
                )Total
      other income (expense), net
                
                
                3,526
                
                
                
                (171
                )Net
      income (loss)
                
                
                2,265
                
                
                
                (1,889
                )Net
      income (loss) per common share:Basic
                
                $
                0.02
                
                
                $
                (0.03
                )Fully
      Diluted
                
                $
                0.02
                
                
                $
                (0.03
                )Weighted
      average common shares outstanding:Basic
                
                
                118,906,345
                
                
                
                56,948,343Fully
      Diluted
                
                
                120,824,031
                
                
                
                56,948,343
 
 The accompanying notes are an integral
part of these condensed consolidated financial statements.
  4
 
 WORLDGATE
COMMUNICATIONS, INC.
 CONDENSED
CONSOLIDATED STATEMENTS OF CASH FLOWS
 (Unaudited)
 (in
Thousands)
 
 Three Months ended March 31,2009
                
                
                2008Cash
      flows from operating activities:Net
      income (loss)
                
                $
                2,265
                
                
                $
                (1,889
                )Adjustments
      to reconcile net income (loss) to net cash used in operating
      activities:Depreciation and
    amortization
                
                
                40
                
                
                
                99Amortization
      of debt discount
                
                
                683
                
                
                
                218Bad
      debt expense
                
                
                157
                
                
                
                0Change
      in fair value of derivative warrants and conversion
options
                
                
                (3,925
                )
                
                
                (129
                )Loss
      on disposal of fixed assets
                
                
                1
                
                
                
                0Inventory
      reserve
                
                
                600
                
                
                
                0Non-cash
      stock based compensation
                
                
                64
                
                
                
                125Changes
      in operating assets and liabilities:Trade
      accounts receivable
                
                
                11
                
                
                
                78Other
      receivables
                
                
                1
                
                
                
                (3
                )Inventory
                
                
                (482
                )
                
                
                (231
                )Prepaid
      and other current assets
                
                
                56
                
                
                
                (173
                )Deposits
      and other assets
                
                
                0
                
                
                
                55Accounts
      payable
                
                
                109
                
                
                
                608Accrued
      expenses and other current liabilities
                
                
                273
                
                
                
                (93
                )Accrued
      compensation and benefits
                
                
                57
                
                
                
                119Warranty
      reserve
                
                
                10
                
                
                
                (30
                )Deferred
      revenues and other income
                
                
                (782
                )
                
                
                460Net
      cash used in operating activities
                
                
                (862
                )
                
                
                (786
                )Cash
      flows used in investing activities:Capital
      expenditures
                
                
                (27
                )
                
                
                0Cash
      flows from financing activities:Proceeds
      from issuance of common stock
                
                
                0
                
                
                
                1Proceeds
      from the issuance of notes
                
                
                780
                
                
                
                0Net
      cash provided by financing activities
                
                
                780
                
                
                
                1Net
      decrease in cash and cash equivalents
                
                
                (109
                )
                
                
                (785
                )Cash
      and cash equivalents, beginning of period
                
                
                429
                
                
                
                1,081Cash
      and cash equivalents, end of period
                
                $
                320
                
                
                $
                296Non-cash
      financing activities:Cumulative
      effect on a change in accounting principle on (See Note
6):Detachable
      warrants
                
                $
                885
                
                
                $
                0Additional
      Paid in Capital
                
                
                (1,751
                )
                
                
                0Accumulated
      deficit
                
                
                1,449
                
                
                
                0Conversion
      of convertible debenture to common stock
                
                
                0
                
                
                
                1
 
 The
accompanying notes are an integral part of these condensed consolidated
financial statements.
  5
  WORLDGATE
COMMUNICATIONS, INC.
 NOTES
TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 (Unaudited)
 (Dollars
In Thousands, Except per Share Amounts)
 
 1.
              
              Basis
      of Presentation.
  The unaudited condensed consolidated
financial statements of WorldGate Communications, Inc. (“WorldGate” or the
“Company”) for the three months ended March 31, 2009 and 2008 presented herein
have been prepared by the Company pursuant to the rules and regulations of the
Securities and Exchange Commission for quarterly reports on Form
10-Q.  Certain information and footnote disclosures normally included
in financial statements prepared in accordance with United States generally
accepted accounting principles (“GAAP”) have been condensed or omitted pursuant
to such rules and regulations.  In addition, the December 31, 2008
condensed consolidated balance sheet was derived from the audited financial
statements, but does not include all disclosures required by
GAAP.  These financial statements should be read in conjunction with
the audited financial statements for the year ended December 31, 2008 and the
notes thereto included in the Company’s Annual Report on Form
10-K.  The accounting policies used in preparing these unaudited
condensed consolidated financial statements are materially consistent with those
described in the audited December 31, 2008 financial statements.
  The financial information in this
Report reflects, in the opinion of management, all adjustments of a normal
recurring nature necessary to present fairly the results for the interim
periods. Quarterly operating results are not necessarily indicative of the
results that may be expected for other interim periods or the year ending
December 31, 2009.
  The preparation of financial statements
in conformity with accounting principles generally accepted in the United States
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities and disclosure of contingent assets and
liabilities, as of the date of the financial statements, and the reported amount
of revenues and expenses during the reporting period.   Actual
results could differ from those estimates.  Judgments and estimates of
uncertainties are required in applying the Company’s accounting policies in many
areas.  Following are some of the areas requiring significant
judgments and estimates: revenue recognition, inventory valuation, deferred
revenues, stock-based compensation, valuation of derivative liabilities, related
warrants and deferred tax asset valuation allowance.
  2.
              
              Liquidity
      and Going Concern Considerations
  Cash.  As of March
31, 2009, the Company had cash and cash equivalents of $320.  The Company’s
cash used in operations was $862 during the three months ended March 31,
2009.   The funds the Company received as a result of notes
issued totaling $780 during the three months ended March 31, 2009, and the
payments related to the March 31, 2008 transaction with Aequus (See Note 13),
have provided the financing for the on-going operations of the
Company.
  Liabilities.  The
Company had $8,782 of liabilities and substantially all of its assets are
pledged as collateral as of March 31, 2009.  These liabilities include
$695 of detachable warrants related to the Company’s private placement of
preferred stock in June 2004 and $625 of derivative warrants and $1,892 of debt
(net of unamortized discount of $2,188) related to the Company’s financing in
August and October 2006.
  Short Term Cash
Requirements.  At March 31, 2009, the Company’s short term cash
requirements and obligations include payment for finished, excess and obsolete
inventory, accounts payable from continuing operations and operating expenses
and the repayment of the August and October 2006 secured convertible debenture
transactions which mature in August and October of 2009 (collectively, the
“Convertible Debt”) and are reflected as current debt as of March 31,
2009.  The Convertible Debt has an interest rate of 6% per annum and
can be converted to common stock at the holder’s option.  The
convertible debentures payable, net of unamortized discounts of $2,188 and
$2,287, had a balance of $1,892 and $1,793, respectively, as of March 31, 2009
and December 31, 2008 (See Note 6).  As of March 31, 2009 and December
31, 2008, accrued interest was $1,038 and $978, respectively.
  Net Losses and Impact on
Operations.  The Company has incurred recurring net losses and
has an accumulated deficit of $267,143, stockholder deficiency of $6,163 and a
working capital deficit of $6,448 as of March 31, 2009.  The Company
also experienced severe cash shortfalls, deferred payment of some of its
operating expenses, and elected to shut down its operations for a period of time
during 2008. Further curtailments of its operations may be necessary in the
future.  These factors raise substantial doubt about the Company’s
ability to continue as a going concern as of March 31, 2009.  The
financial statements do not include any adjustments that might be necessary
should the Company be unable to continue as a going concern.
  6
  Aequus.  In October
2008, Aequus Technologies Corp. (“Aequus”) failed to pay to WorldGate $953 owed
to WorldGate for the purchase of video phones, and as a result the Company
terminated its reseller agreement with Aequus.  The Company has most
of the units sold to Aequus in its possession and will attempt to sell the units
elsewhere to recover the $953. There can be no assurance that WorldGate will be
able to sell the units and recover the $953 owed by Aequus.  The
Company continues to believe that the Video Relay Services and Video Remote
Interpreting markets provide an attractive opportunity for the sale of video
phones and has opened discussions and has initiated shipments of video phones
with other Video Relay Services / Video Remote Interpreting service
providers.   In addition, on January 27, 2009, the Company
resolved arbitration proceedings with Aequus, and in full satisfaction of the
outstanding arbitration claim Aequus agreed to terminate any obligation on the
part of the Company to provide certain prepaid engineering services pursuant to
a previous agreement with Aequus.  As a result of the arbitration, the
Company retained $725 of the approximately $900 prepaid by Aequus for these
engineering services.
  Vendor Payable.  On
January 28, 2009, in exchange for a vendor’s agreement to reduce an outstanding
obligation to the vendor, the Company issued a promissory note in the amount of
$30, to this vendor.  $20 of this note was paid on April 1, 2009 and
$10 of the note is payable on July 15, 2009.
  Advance of Purchase Price by WGI
Investor.  On February 4, 2009 and March 24, 2009, the Company,
in exchange for cash received, issued promissory notes for $550 and $200
respectively to WGI Investor LLC (“WGI”). Both notes were an advance of the cash
consideration payable by WGI at the closing of the transactions contemplated by
the Securities Purchase Agreement, dated December 12, 2008, between WGI and the
Company.   The notes had a maturity date of May 1, 2009 and had
interest payable at six percent per annum.  On April 6, 2009, upon
closing of the transactions contemplated by the Securities Purchase Agreement,
the two notes were cancelled pursuant to their terms.
  WGI and ACN
Transactions.  On April 6, 2009, the Company completed a
private placement of securities to WGI pursuant to the terms of a Securities
Purchase Agreement dated December 12, 2008.  In connection with the
transaction, the Company issued to WGI an aggregate of 202,462,155 shares of
itscommon stock, representing approximately 63% of the total number of issued
and outstanding shares of the Company’s common stock, as well as a warrant to
purchase up to approximately 140.0 million shares of the Company’s common stock
in certain circumstances (the “Anti-Dilution Warrant”) in exchange for (i) cash
consideration of $1,450 (of which $750 had been previously advanced to the
Company by WGI), (ii) the cancellation of convertible debentures held by WGI
under which approximately $5,100 in principal and accrued interest was
outstanding as of March 31, 2009, and (iii) the cancellation of certain
outstanding warrants held by WGI (the “Private Placement”).   In
December 2008, WGI had acquired from YA Global Investments, L.P. (“YA Global”)
the convertible debentures that the Company had previously issued to YA Global
and the outstanding warrants to purchase the Company’s common stock then held by
YA Global.  The Company expects to use the proceeds from the Private
Placement primarily for working capital purposes.
 
 WGI is a private investment fund whose
ownership includes owners of ACN, Inc. (“ACN”), a direct seller of
telecommunications services and a distributor of video
phones.  Concurrently with the closing of the Private Placement, the
Company entered into a commercial relationship with ACN pursuant to which the
Company will design and sell video phones to ACN (the “Commercial
Relationship”).  As part of the Commercial Relationship, the Company
entered into two agreements, a Master Purchase Agreement pursuant to which ACN
has committed to purchase three hundred thousand videophones over a two-year
period and a Software Development and Integration and Manufacturing Assistance
Agreement pursuant to which ACN has committed to provide the Company with $1,200
to fund associated software development costs.  In connection with the
Commercial Relationship, the Company granted ACN a warrant to purchase up to
approximately 38.2 million shares of its common stock at an exercise price of
$0.0425 per share (the “ACN Warrant”).  The ACN Warrant will vest
incrementally based on ACN’s purchases of video phones under the Commercial
Relationship.
  Future Cash Flows and
Financings.  The Company’s ability to generate cash is
dependent upon the sale of its products and services and on obtaining cash
through the private or public issuance of debt or equity securities.  Given
that the Company’s video phone business involves the development of a new
product line with no market penetration in an underdeveloped market sector, no
assurances can be given that sufficient sales, if any, will materialize. The
lack of success of the Company’s sales efforts could also have an adverse
ability to raise additional financing.
  Based on
management’s internal forecasts and assumptions, including, among others, the
receipt of the payments which are currently committed to the Company, including
the payments by ACN, Inc.  (“ACN”) to the Company for services (See
Note 16), and assumptions regarding its short term cash requirements, the
Company currently believes that it will have sufficient cash on hand to meet its
obligations into the third quarter of 2009.  However, there can be no
assurance given that these assumptions are correct or that the revenue
projections associated with product sales and services to ACN will materialize
to a level that will provide the Company with sufficient capital to operate its
business.
  7
  The
Company continues to evaluate possibilities to obtain additional financing
through public or private equity or debt offerings or from other
sources.  In addition the Company plans to explore additional service
and distribution sales opportunities. There can be no assurance given, however,
that the Company’s efforts will be successful or that any additional financing
will be available and can be consummated on terms acceptable to the Company, if
at all. There can also be no assurance given that any additional sales can
be achieved through additional service and distribution
opportunities.  If the Company is unable to obtain sufficient funds,
the Company may be required to further reduce the size of the organization or
suspend operations which could have a material adverse impact on its business
prospects.
  3.
              Recent
      Accounting Pronouncements.
  In
December 2007, the Financial Accounting Standards Board (“FASB”) issued
Statement of Accounting Standard (“SFAS”) No. 141R, “Business Combinations,”
which replaces SFAS No. 141, “Business Combinations.”  SFAS No. 141R
establishes principles and requirements for determining how an enterprise
recognizes and measures the fair value of certain assets and liabilities
acquired in a business combination, including noncontrolling interests,
contingent considerations, and certain acquired contingencies. SFAS No. 141R
also requires acquisition-related transaction expenses and restructuring costs
to be expensed as incurred rather than capitalized as a component of the
business combination. SFAS No. 141R is applicable prospectively to business
combinations for which the acquisition date is on or after January 1, 2009.
The adoption of SFAS No. 141R will have an impact on accounting for businesses
acquired after the effective date of this pronouncement.
  In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial Statements—An Amendment of ARB No. 51.”  SFAS
No. 160 establishes accounting and reporting standards for the noncontrolling
interest in a subsidiary (previously referred to as minority
interests).  SFAS 160 also requires that a retained
noncontrolling interest upon the deconsolidation of a subsidiary be initially
measured at its fair value. Upon the adoption of SFAS No. 160, the Company will
be required to report any noncontrolling interests as a separate component of
consolidated stockholders’ equity. The Company will also be required to present
any net income allocable to noncontrolling interest and net income attributable
to the stockholders of the Company separately in its consolidated statements of
operations. SFAS No. 160 is effective for fiscal years, and interim periods
within those fiscal years, beginning on or after January 1,
2009.  The implementation of SFAS No. 160 would require retroactive
adoption of the presentation and disclosure requirements for existing minority
interests, with all other requirements of SFAS No. 160 to be applied
prospectively. As the Company does not have noncontrolling interests in any
subsidiary, the adoption of SFAS No. 160 did not have any impact upon the
Company’s consolidated financial position or results of operations.
  In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments
and Hedging Activities an amendment of FASB Statement No. 133,” which amends and
expands the disclosure requirements of SFAS 133 to require qualitative
disclosure about objectives and strategies for using derivatives, quantitative
disclosures about fair value amounts of and gains and losses on derivative
instruments, and disclosures about credit-risk-related contingent features in
derivative agreements. This statement is effective beginning January 1,
2009. The adoption of SFAS 161 did not have a material impact upon the Company’s
consolidated financial position or results of operations.
  In June
2008, the FASB ratified EITF No. 07-5, “Determining Whether an Instrument (or an
Embedded Feature) is Indexed to an Entity’s Own Stock” (“EITF
07-5”).  EITF 07-5 provides that an entity should use a two-step
approach to evaluate whether an equity-linked financial instrument (or embedded
feature) is indexed to its own stock, including evaluating the instrument’s
contingent exercise and settlement provisions.  EITF 07-5 is effective
for financial statements issued for fiscal years beginning after December 15,
2008. Early application is not permitted. Upon adoption of EITF 07-5 on January
1, 2009, the Company has determined that certain warrants issued on August 11,
2006 and October 13, 2006 were not equity-linked financial instruments, and
accordingly, were derivative instruments.  The Company has recorded
the fair value of these instruments and the resulting cumulative effect of this
change in accounting method, as of January 1, 2009 (See Note 6).
  4.
              Inventory.
  The
Company’s inventory consists primarily of finished goods equipment to be sold to
customers. The cost is determined on a first-in, first-out cost basis. A
periodic review of inventory quantities on hand is performed in order to
determine and record a provision for excess and obsolete inventories. Factors
related to current inventories such as technological obsolescence and market
conditions are analyzed to determine estimated net realizable values. A
provision is recorded to reduce the cost of inventories to the estimated net
realizable values. To motivate trials and sales of the Ojo, which is the
Company’s main product, the Company has historically subsidized, and may in the
future continue to subsidize, certain of its product sales to customers that
result in sales of inventory below cost.  Any significant
unanticipated changes in the factors noted above could have an impact on the
value of the Company’s inventory and its reported operating
results.  At March 31, 2009 and December 31, 2008 the Company’s
inventory balance was $1,059 and $1,176, respectively (net of a reserve of $600
and $0, respectively for excess and obsolete inventory that is not expected
to be utilized in the continued development of the video
phone).  Under an agreement with Aequus dated March 31, 2008,
Aequus purchased $1,153 of units which were agreed to be held by the Company
until shipped to Aequus customers.  Included in the inventory balance
reported on the balance sheet as of March 31, 2009 are remaining Aequus units
not yet shipped to Aequus customers totaling $760.
  8
  5.
              Stock
      Based Compensation.
  The
Company accounts for stock based compensation in accordance with the provisions
of SFAS No. 123 (Revised 2004), “Share-Based Payment” (“SFAS No.
123(R)”).   SFAS No. 123(R) requires that all stock based
compensation be recognized as an expense in the financial statements, and that
such cost be measured at the fair value of the award.  SFAS No. 123(R)
also requires that excess tax benefits related to stock option exercises be
reflected as financing cash inflows instead of operating inflows.  As
a result, the Company’s net income (loss) before taxes for the three months
ended March 31, 2009 and 2008 included approximately $64
and  $125 of stock based compensation.  The stock based
compensation expense is included in general and administrative expense in the
condensed consolidated statements of operations.
  Consistent
with the requirements of SFAS 123(R), the Company has selected a
“with-and-without” approach regarding the accounting for the tax effects of
share-based compensation awards.  This approach is consistent with
intraperiod allocation guidance in SFAS No. 109, “Accounting for Income Taxes,”
and EITF Topic D-32, “Intraperiod Tax Allocation of the Tax Effect of Pretax
Income from Continuing Operations.”
  A summary
of awards under the Company’s 2003 Equity Incentive Plan is presented below:
  Stock Options
                    
                    
                    Weighted-Average
                      Exercise Price
                    
                    
                    Aggregate
                      Intrinsic ValueOutstanding,
      January 1, 2009
                    
                    
                    6,080,364
                    
                    
                    $
                    0.27
                    
                    
                    $
                    0Granted
                    
                    
                    11,500
                    
                    
                    $
                    0.32Exercised
                    
                    
                    0
                    
                    
                    
                    0Cancelled/forfeited
                    
                    
                    (39,306
                    )
                    
                    $
                    1.39Outstanding,
      March 31, 2009
                    
                    
                    6,052,558
                    
                    
                    $
                    0.27
                    
                    
                    $
                    951,134Exercisable,
      March 31, 2009
                    
                    
                    3,541,251
                    
                    
                    $
                    0.35
                    
                    
                    $
                    528,900
 
 As of
March 31, 2009, there was $428 of total unrecognized compensation arrangements
granted under the Plan.  The cost is expected to be recognized through
2012.
  Options
granted during the three months ended March 31, 2009 vest over four years and
expire in ten years from the date of grant under the Plan. The weighted-average
fair values of the options granted were $0.30. The fair value of each option
grant is estimated on the date of grant using the Black-Scholes fair value
option valuation model. The following weighted-average assumptions were used for
these grants: expected volatility of 157%; average risk-free interest rates of
2.00%; dividend yield of 0%; and expected life of 6.25 years.
  The
following table summarizes information about stock options outstanding at March
31, 2009:
  Stock Options Outstanding
                                  
                                  Stock Options ExercisableRange of Exercise Prices
                                  
                                  Shares
                                  
                                  Weighted-
                                    Average
                                    Remaining
                                    Contractual
                                    Life (Years)
                                  
                                  Weighted-
                                    Average
                                    Exercise
                                    Price
                                  
                                  Shares
                                  
                                  Weighted-
                                    Average
                                    Exercise
                                    Price$0.00
      - $0.39
                                  
                                  5,364,066
                                  
                                  6.55
                                  
                                  $
                                  0.11
                                  
                                  2,927,759
                                  
                                  $
                                  0.11$0.40
      - $0.59
                                  
                                  64,000
                                  
                                  7.84
                                  
                                  0.49
                                  
                                  26,500
                                  
                                  0.48$0.60
      - $0.89
                                  
                                  289,492
                                  
                                  5.73
                                  
                                  0.60
                                  
                                  289,492
                                  
                                  0.60$0.90
      - $1.34
                                  
                                  6,500
                                  
                                  3.32
                                  
                                  1.20
                                  
                                  6,500
                                  
                                  1.20$1.35
      - $2.01
                                  
                                  81,500
                                  
                                  5.04
                                  
                                  1.72
                                  
                                  56,500
                                  
                                  1.78$2.02
      - $3.02
                                  
                                  193,000
                                  
                                  3.98
                                  
                                  2.39
                                  
                                  193,000
                                  
                                  2.39$3.03
      - $4.53
                                  
                                  54,000
                                  
                                  5.95
                                  
                                  3.60
                                  
                                  41,500
                                  
                                  3.59Total
                                  
                                  6,052,558
                                  
                                  6.41
                                  
                                  $
                                  0.27
                                  
                                  3,541,251
                                  
                                  $
                                  0.35
 
 Restricted
shares were granted on October 3, 2007 and December 20, 2007 to certain senior
executives that vest upon the achievement of certain performance
criteria:
  ·
              10%
      of the shares vest upon achieving each of a 10%, 20%, 30% 40% and 50%
      increase for the Company in total gross revenue in a quarter over its
      third quarter 2007 total gross revenue shown on its statement of
      operations as reported in the SEC
filings;
  ·
              25%
      of the shares vest upon the Company achieving each of (1) a quarterly
      operating cash break-even (defined as zero or positive “net cash provided
      by operations” consistent with or as reported on the “Consolidated
      Statement  of Cash Flows” excluding strategic transactions such
      as the Aequus transaction) and (2) a 10% net income as a percent of
      revenue.
  9
  These
restricted shares had a fair value of $198 on their dates of grant of October 3,
2007 and December 20, 2007. The criteria for these restricted shares were
amended to clarify that the criteria is intended to refer to transactions and
revenue, operating cash flow and income generated in the ordinary course of the
Company’s business, and not to extraordinary transactions.  As of
March 31, 2009, it was determined that is was more likely than not that the
restricted shares would be not be earned and therefore there was no compensation
expense recorded for these grants.
  The
following table is the summary of the Company’s nonvested restricted shares as
of March 31, 2009.
  Restricted
                      SharesNonvested
      as of January 1, 2009
                    
                    
                    833,000Granted
                    
                    
                    0Vested
                    
                    
                    0Cancelled/forfeited
                    
                    
                    0Nonvested
      as of March 31, 2009
                    
                    
                    833,000
  6.
              Accounting
      for Secured Convertible Debentures and Related
  Warrants.
  As
discussed in Note 16, the Company completed a transaction with WGI Investor, LLC
on April 6, 2009 in which the convertible debentures described below were
cancelled.
  General Terms of Convertible
Debentures.  On August 11, 2006 and October 13, 2006, the
Company completed a private placement with an institutional investor of
convertible debentures in the aggregate principal amount of
$11,000.  The Company received $6,000 ($5,615, net of transaction
costs) upon the closing of the transaction on August 11, 2006 (the “First
Tranche”) and the remaining $5,000 ($4,700, net of transaction costs) was
received on October 13, 2006 (the “Second Tranche”).   The
convertible debentures have a maturity of three years, an interest rate of 6%
per annum, and are convertible at the option of the investors into WorldGate
common stock at a conversion price equal to the lesser of $1.75 per share or 90%
of the average of the five lowest daily volume weighted closing price (“VWAP”)
of the common stock during the fifteen trading days immediately preceding the
conversion date (subject to adjustment in the event of stock dividends and
splits and certain distributions to stockholders, fundamental transactions, and
future dilutive equity transactions).  Interest is payable at
maturity, and the Company may elect to pay the interest amount in cash or shares
of its common stock.  The Company also granted the holder of
convertible debentures a security interest in substantially all of its
assets.  Upon any liquidation, dissolution or winding up of the Company,
the holders of the convertible debentures will be entitled to receive the
principal amount of the convertible debentures, together with accrued and unpaid
interest, prior to any payment to the holders of the Company’s common and
preferred stock.  There was approximately $1,038 of accrued interest
as of March 31, 2009.  Through March 31, 2009, the investor converted
$6,920 of the convertible debentures into 75,191,392 shares of the Company’s
common stock.
  Amendment To Convertible
Debentures.  On May 18, 2007, the Company and the investor
amended the terms of the convertible debentures to remove the investor’s
ability, upon conversion of the debenture, to demand cash in lieu of shares of
common stock and to clarify that the Company may issue restricted shares if
there is no effective registration statement at the time of conversion. This
amendment of the terms of the convertible debenture resulted in the Company
reclassifying the derivative conversion option liability embedded in the
convertible debentures from debt to equity.
  Restrictions on Convertible
Debentures.  The holder cannot make any conversions below $1.75
per share (i) which would exceed $500 in principal amount in any calendar month
or (ii) which would result in the issuance of more than 840,000 shares of the
Company’s common stock per calendar month (provided that this maximum share
limit will be waived by the Company unless it elects to pay the holder in cash
the difference in value between 840,000 shares and the number of shares the
holder wishes to convert, up to the $500 per month conversion
limit).  If the Company is in default under the convertible
debentures, these limitations are waived. The holder is also not restricted in
making conversions at $1.75.
  10
  In no
case, however, may the holder convert the convertible debentures if it would
result in beneficial ownership of more than 9.99% of the Company’s outstanding
common stock (though this provision can be waived by the holder upon 65 days
prior notice).
  In
addition, the aggregate number of shares to be issued upon conversion, exercise
of the warrants (described below), payment for commitment shares (described
below), and payment of liquidated damages (described below) has been limited to
61,111,111 shares of common stock.  In December 2008, the share
limitation of the aggregate number of shares to be issued was increased to
75,368,811 shares of common stock.
  Accounting for Convertible
Debentures.  The Company initially accounted for conversion
options embedded in the convertible debentures in accordance with SFAS
No. 133 “Accounting for Derivative Instruments and Hedging Activities”
(“SFAS 133”) and EITF 00-19 “Accounting for Derivative Financial Instruments
Indexed to, and Potentially Settled in, a Company’s Own Stock”
(“EITF 00-19”)  SFAS 133 generally requires companies to
bifurcate conversion options embedded in convertible debentures from their host
instruments and to account for them as free standing derivative financial
instruments in accordance with EITF 00-19.   EITF 00-19 states
that if the conversion option requires net cash settlement in the event of
circumstances that are not solely within the Company’s control that they should
be classified as a liability measured at fair value on the balance
sheet.  Effective January 1, 2007, the Company adopted the provisions
of EITF Issue No. 06-7, “Issuer’s Accounting for a Previously Bifurcated
Conversion Option in a Convertible Debt Instrument When the Conversion Option No
Longer Meets the Bifurcation Criteria in Financial Accounting Standards Board
(“FASB”) Statement No. 133, Accounting for Derivative Instruments and
Hedging Activities” (“EITF 06-7”).  Under EITF 06-7, at the time of
issuance, an embedded conversion option in a convertible debt instrument may be
required to be bifurcated from the debt instrument and accounted for separately
by the issuer as a derivative under SFAS 133, based on the application of
EITF 00-19. Subsequent to the issuance of the convertible debt, facts may change
and cause the embedded conversion option to no longer meet the conditions for
separate accounting as a derivative instrument, such as when the bifurcated
instrument meets the conditions of Issue 00-19 to be classified in stockholders’
equity. Under EITF 06-7, when an embedded conversion option previously accounted
for as a derivative under SFAS 133 no longer meets the bifurcation criteria
under that standard, an issuer shall disclose a description of the principal
changes causing the embedded conversion option to no longer require bifurcation
under SFAS 133 and the amount of the liability for the conversion option
reclassified to stockholders’ equity.
  Prior to
the May 18, 2007 amendment, subject to the share limitation, as discussed above,
the actual number of shares of the Company’s common stock that would be required
if a conversion of the convertible debentures was made through the issuance of
common stock could not be predicted.  If the Company’s requirements to
issue shares under these convertible debentures had exceeded the share
limitation, or if it was not listed or quoted for trading on at least the OTCBB,
the Company could have been required to settle the conversion of the convertible
debentures with cash instead of its common stock.
  Through
May 18, 2007, the Company accounted for the conversion options using the fair
value method at the end of each quarter, with the resultant gain or loss
recognition recorded against earnings.  On May 18, 2007 the Company
and the investor amended the terms of the secured convertible debentures to
remove the investor’s ability, upon conversion of the debentures, to demand cash
in lieu of shares of common stock and to clarify that the Company may issue
restricted shares if there is no effective registration statement at the time of
conversion.  This amendment of the terms of the convertible debentures
permitted the Company to reclassify $5,384 of the embedded derivative conversion
option liability to stockholders’ equity.  The discount on the
convertible debentures of $5,240 is based on amortization until
October 2009.
  At
the closing of the First Tranche, the sum of the fair values of the conversion
feature and the warrants was $5,714 in the aggregate, which exceeded the net
proceeds of $5,615.  The difference of $99 was charged to the
provision for fair value adjustment, upon issuance during the third quarter of
2006.   Accordingly, the Company recorded a discount equal to the
face value of the convertible debentures, which will be amortized using the
effective interest rate method over the three year term.  The common
stock issued as fees in the transaction was recorded at a net value of $0, as
there was no residual value remaining.
  At
October 13, 2006, in connection with the closing of the Second Tranche, the
convertible feature of the convertible debentures was recorded as a derivative
liability of $3,449 and the warrants were recorded as additional paid in capital
of $230.  For the Second Tranche issuance on October 13, 2006, the
Company recorded a discount of $3,979, which is being amortized using the
effective interest method over the three year term.
  During
the three months ended March 31, 2009 and 2008, $0 and $1, respectively in face
value of the convertible debentures was converted, resulting in the issuance of
0 and 1 shares of common stock, respectively.  As a result of the
amortization and conversion, $683 and $218, respectively, of the discount on the
convertible debenture has been charged to discount amortization for three months
ended March 31, 2009 and 2008.
  11
  At March
31, 2009, the balances of the convertible debentures and the offsetting related
discount were $4,080 and $2,188, respectively.
  Adoption
of EITF 07-5.On January 1,
2009, in connection with the adoption of EITF 07-5, the Company determined that
warrants issued on August 11, 2006 and October 13, 2006 were not indexed to the
Company’s own stock, as defined.  Accordingly, the Company determined
that these warrants were derivative instruments, and on January 1, 2009,
recorded derivative liabilities of $479 and $406 for each of the August 11, 2006
and October 13, 2006 warrants, respectively.  At January 1, 2009, the
Company determined the fair value of the warrant derivative liability using the
Black-Scholes valuation model, applying the actual common stock price on January
1, 2009 ($0.38), applicable volatility rate (242%), and the period close
risk-free interest rate (0.27%) for the instruments’ remaining contractual lives
of 2.61 years for the August 2006 tranche and 2.78 years for the October 2006
tranche.  In connection with recording the warrant derivative
liabilities, the Company determined the cumulative effect of a change in
accounting principle as if they were recorded at inception, and increased the
debt discount related to the October 13, 2006 tranche by $584, reduced
additional paid in capital by $1,752 for the previously recorded equity value of
the warrants and decreased accumulated deficit by $1,449 for inception to
adoption date mark to market and discount amortization adjustments.
  The
following warrants were issued under the August 2006 tranche and the October
2006 tranche and remained outstanding at March 31, 2009:
  Tranche
                            
                            Exercise Price
                            
                            
                            Warrant SharesAugust
      2006
                            
                            $
                            1.85
                            
                            
                            
                            624,545$
                            2.35
                            
                            
                            
                            600,000$
                            2.60
                            
                            
                            
                            190,909October
      2006
                            
                            $
                            1.85
                            
                            
                            
                            520,455$
                            2.35
                            
                            
                            
                            500,000$
                            2.60
                            
                            
                            
                            159,091
 
 7.
              Accounting
      for Derivative Instruments.
  The
Company accounts for certain warrants, including the warrants issued as part of
the June 2004 private placement of preferred stock and the warrants issued as
part of the August and October 2006 private placement of convertible debentures,
as a derivative liability using the fair value method at the end of each
quarter, with the resultant gain or loss recognition recorded against
earnings.  The Company recognized a total non-cash gain of $3,925 and
a total non-cash gain of $129 for the three months ended March 31, 2009 and
March 31, 2008, respectively for these derivative warrants, based on the
following criteria, each of which impact on the fair value of the derivative,
using the Black-Scholes valuation model:
  Derivative instruments issued
                            
                            June 2004 Private Placement
                              Warrants
                            
                            
                            August/October 2006 Private
                              Placement WarrantsCriteria
                            
                            March 31, 2009
                            
                            
                            March 31, 2008
                            
                            
                            March 31, 2009
                            
                            
                            March 31, 2008Closing
      common stock price
                            
                            $
                            0.29
                            
                            
                            $
                            0.07
                            
                            
                            $
                            0.29
                            
                            
                            
                            N/AApplicable
      volatility rates
                            
                            
                            114
                            %
                            
                            
                            134
                            %
                            
                            
                            232
                            %
                            
                            
                            N/ARisk-free
      interest rates
                            
                            
                            0.21
                            %
                            
                            
                            1.56
                            %
                            
                            
                            0.27
                            %
                            
                            
                            N/AContractual
      life of instrument
                            
                            0.25
      years
                            
                            
                            1.25
      years
                            
                            
                            2.36
      / 2.54 years
                            
                            
                            
                            N/A
  12
  The
following table summarizes the derivative instruments (warrants) liability for
the three months ended March 31, 2009 (See Note 6):
  June 2004 Private
                          Placement
                        
                        
                        August and October
                          2006 Private Placement
                        
                        
                        TotalOutstanding,
      December 31, 2008
                        
                        $
                        4,360
                        
                        
                        $
                        0
                        
                        
                        $
                        4,360Cumulative
      effect of the change in accounting principal, January 1, 2009 (See Note
      6)
                        
                        
                        0
                        
                        
                        
                        885
                        
                        
                        
                        885Net
      cash change in fair value
                        
                        
                        (3,665
                        )
                        
                        
                        (260
                        )
                        
                        
                        (3,925
                        )Outstanding,
      March 31, 2009
                        
                        $
                        695
                        
                        
                        $
                        625
                        )
                        
                        $
                        1,320
 
 8.
              Fair Value of Financial
      Instruments
  SFAS No.
157, “Fair Value Measurements” (“SFAS 157”), defines fair value, establishes a
framework for
 measuring
fair value in accordance with generally accepted accounting principles, and
expands disclosures about the price that would be received to sell an asset, or
paid to transfer a liability in an orderly transaction between market
participants at the measurement date.  SFAS 157 applies to all assets and
liabilities that are measured and reported on a fair value basis.
 
 SFAS 157
establishes a three-tier fair value hierarchy which prioritizes the inputs used
in measuring fair
 value as
follows:
 
 Level 1 –
Observable inputs such as quoted prices in active markets;
 Level 2 –
Inputs, other than the quoted prices in active markets, that are observable
either directly or indirectly;
 Level 3 –
Unobservable inputs in which there is little or no market data, which require
the reporting entity to
develop its own assumptions.
  The
following are the Company’s major categories of liabilities measured at fair
value on a recurring basis
 at March
31, 2009, categorized by the SFAS 157 fair value hierarchy:
 
 Fair Value Measurements at
March 31, 2009 Using Significant Unobservable Inputs:
 
 Description
                    
                    (Level 3)Liabilities:Derivatives
                    
                    $
                    1,320
 
 The following is a reconciliation of
the beginning and ending balances for the Company’s liabilities measured at fair
value on a recurring basis using significant unobservable inputs (Level 3)
during the three months ended
 March 31,
2009:
 
 Fair Value Measurements
Using Significant Unobservable Inputs (Level 3):
 
 Description
                        
                        DerivativesLiabilities:Balance,
      January 1, 2009
                        
                        $
                        4,360Cumulative
      effect of the change in accountingPrincipal,
      January 1, 2009 (See Note 7)
                        
                        
                        885Total
      change in fair value included in operations
                        
                        
                        (3,925
                        )Balance, March 31, 2009
                        
                        $
                        1,320
 
 The change in fair value recorded for
Level 3 liabilities for the periods above are reported in other income (expense)
on the consolidated statement of operations.
  13
  9.
                Commitments
      and Contingencies.
  The
Company’s prior five year lease was signed on September 1, 2005 and covered
42,500 square feet at an annual rate of $11.40 per square foot with a 3%
increase annually, cancelable by either party with eight months notice, with a
termination by tenant also including six months termination fee.  In
March 2008, the parties agreed in principle to a new lease effective retroactive
to April 1, 2008 (and the cancellation of the current lease with no termination
cost) for a smaller space within the current facility consisting of
approximately 17,000 square feet at an annual fee of $7 per square foot. The
Company relocated into this smaller space in April 2008. This new lease was
executed in April 2009 and is cancelable by either party upon 90 days
notice with no termination costs. Total rent expense for the three months
ended March 31, 2009 and March 31, 2008 amounted to approximately $43 and $120,
respectively.
  In
December 2008, the Company entered into a 60 month lease for office
equipment. As of March 31, 2009, there remains an aggregate of $41 to be paid
over the remaining period of the terms of the leases.
  The future minimum contractual rental
commitments under non-cancelable leases for each of the fiscal years ending
December 31 are as follows:
  2009
      (April 1 to December 31,2009)
                    
                    $
                    82010
                    
                    
                    112011
                    
                    
                    112012
                    
                    
                    11Total
                    
                    $
                    41
  10.
              Net
      Income (Loss) per Share (Basic and
Diluted).
  The Company displays earnings per share
in accordance with SFAS No. 128, “Earnings Per Share.”  SFAS No. 128
requires dual presentation of basic and diluted earnings per share
(“EPS”).  Basic EPS includes no dilution and is computed by dividing
net income (loss) attributable to common shareholders by the weighted average
number of common shares outstanding for the period.  Diluted EPS
includes under the “if converted method” of SFAS No. 128 the
potential  dilution that could occur if securities or other contracts
to issue common stock were exercised or converted into common stock. Outstanding
stock options, warrants and other potential stock issuances are not included in
the computation when they are not in the money and their effect would be
anti-dilutive.  The following table presents the shares used in the
computation of fully diluted earnings (loss) per share for the three months
ended March 31, 2009 and March 31, 2008:
  For the three months ended March 31,2009
                    
                    
                    2008Numerator
      for diluted EPS calculation:Net
      income
                    
                    $
                    2,265
                    
                    
                    $
                    (1,889
                    )Denominator
      for diluted EPS calculation:Basic
      weighted average common sharesoutstanding
                    
                    
                    118,906,345
                    
                    
                    
                    56,948,343Effect
      of dilutive stock options
                    
                    
                    1,917,686
                    
                    
                    
                    0Total
      shares –diluted basis
                    
                    
                    120,824,031
                    
                    
                    
                    56,948,343Basic
      EPS
                    
                    $
                    0.02
                    
                    
                    $
                    (0.03
                    )Diluted
      EPS
                    
                    $
                    0.02
                    
                    
                    $
                    (0.03
                    )
 
 Potential
common shares excluded from net income (loss) per share for the three months
ended March 31, 2009, and March 31, 2008 were 21,772,220 and 70,225,209,
respectively because their effect would be anti-dilutive.  Potential
common shares comprise shares of common stock issuable upon the exercise of
stock options, unvested restricted stock and warrants, and upon the conversion
of convertible debentures irrespective of whether such securities are in the
money.
  14
  11.
              Warrants.
 
 A summary
of the Company’s warrant activity for the three months ended March 31, 2009, is
as follows:
 
 Warrants
                          
                          
                          Weighted Average
                            Exercise Price
                          
                          
                          Weighted
                            Average
                            Remaining
                            Contract
                            LifeOutstanding,
      January 1, 2009
                          
                          
                          20,146,311
                          
                          
                          $
                          0.96
                          
                          
                          
                          1.26Granted
                          
                          
                          0Expired/cancelled
                          
                          
                          (110,500
                          )
                          
                          
                          (1.88
                          )Outstanding,
      March 31, 2009
                          
                          
                          20,035,811
                          
                          
                          $
                          0.94
                          
                          
                          
                          1.02Exercisable,
      March 31, 2009
                          
                          
                          20,035,811
 
 12.
              Stockholders’
      Deficiency.
  The following summarizes the
transactions in stockholders’ deficiency from January 1, 2009 through March 31,
2009:
 
 Common
                      Stock
                    
                    
                    Additional
                      Paid in
                      Capital
                    
                    
                    Accumulated
                      Deficit
                    
                    
                    TotalBalance
      as of December 31, 2008
                    
                    $
                    1,189
                    
                    
                    $
                    261,478
                    
                    
                    $
                    (270,857
                    )
                    
                    $
                    (8,190
                    )Cumulative
      effect of a change in accounting principle
                    
                    
                    0
                    
                    
                    
                    (1,751
                    )
                    
                    
                    1,449
                    
                    
                    
                    (302
                    )Balance
      as of January 1, 2009
                    
                    
                    1,189
                    
                    
                    
                    259,727
                    
                    
                    
                    (269,408
                    )
                    
                    
                    (8,492
                    )Non-cash
      stock based compensation
                    
                    
                    0
                    
                    
                    
                    64
                    
                    
                    
                    0
                    
                    
                    
                    64Net
      income for the three months ended March 31, 2009
                    
                    
                    0
                    
                    
                    
                    0
                    
                    
                    
                    2,265
                    
                    
                    
                    2,265Balance
      as of March 31, 2009
                    
                    $
                    1,189
                    
                    
                    $
                    259,791
                    
                    
                    $
                    (267,143
                    )
                    
                    $
                    (6,163
                    )
 
 13.           Revenue
Recognition.
  Revenue
is recognized when persuasive evidence of an arrangement exists, the price is
fixed or determinable, the collectibility is reasonably assured, and the
delivery and acceptance of the equipment has occurred or services have been
rendered.  Management exercises judgment in evaluating these factors in
light of the terms and conditions of its customer contracts and other existing
facts and circumstances to determine appropriate revenue recognition. Due to the
Company’s limited commercial sales history, its ability to evaluate the
collectibility of customer accounts requires significant judgment. The Company
continually evaluates accounts of its equipment customers and service customers
for collectibility at the date of sale and on an ongoing basis.
  Revenues
are also offset by a reserve for any price refunds and consumer rebates
consistent with the EITF Issue 01-9, “Accounting for Consideration Given by a
Vendor to a Customer.”
  During
the three months ended March 31, 2008, the Company shipped approximately 9 units
with a sales value of $2 to customers with a right of return.  These
customers may exercise their right of return only if they do not sell the units
to their respective customers.  Revenue and cost for these units were
deferred in accordance with SFAS 48 “Revenue Recognition when a Right of Return
Exists.”
  From June
2007 through March 2008 the Company shipped its video phone product to
Aequus.  As part of its June 2007 agreement with Aequus, the Company
began to recognize product revenue at the time of shipment of its video phone.
In addition, the Company also began to receive service fee revenues based on a
percentage of the fees earned by Aequus and for which the customer has received
service. The Company recognizes this service fee revenue upon confirmation from
Aequus of the fees they have earned.   The Company also receives
service fee revenues from end consumers which are recognized after the services
have been performed.
  15
  On March
31, 2008, the Company entered into a new agreement with Aequus and Snap
Telecommunications Inc. (“Snap!VRS”). This new agreement provides for the (i)
resolution of a dispute with Aequus regarding amounts the Company claimed were
owed to the Company by Aequus and the termination by the Company of video phone
service to Aequus, (ii) payment to the Company by Aequus of approximately $5,000
in scheduled payments over ten months commencing March 31, 2008, (iii) agreement
to arbitrate approximately $1,354 claimed by the Company to be owed by Aequus
and (iv) purchase of an additional $1,475 of video phones by
Aequus.
  ·
              $5,000 of Payments to the
      Company.  The $5,000 of payments in the agreement are
      related to multiple deliverables to Aequus that have standalone value with
      objective and reliable evidence of fair value, and include the following:
      (i) a specified amount of non recurring engineering (“NRE”, with a fair
      value of $900), (ii) support and transition training to Aequus to operate
      its own data center (“Training,” with an estimated fair value of $358),
      (iii) continued use of the WorldGate video phone service center during the
      transition (with an estimated fair value of $230), and (iv) the
      elimination of  previously agreed service fees (“contract termination
      fee”, with a residual fair value of $3,512). These deliverables are all
      separate units of accounting in accordance with EITF No. 00-21, “Revenue
      Arrangements with Multiple
Deliverables.”
  The
Company recognized revenue for the NRE and Training and support as the service
was provided. For the three months ended March 31, 2009 and 2008, revenue of
$796 and $0, respectively, was recognized for NRE, and no revenue was recognized
for training and support.  The revenue of $796 in the quarter ended
March 31, 2009 includes $725 related to the settlement of the dispute with
Aequus wherein the settlement eliminated $725 of the Company’s $900 obligation
to provide NRE to Aequus and was credited to NRE services provided under a
previous agreement with Aequus.  The Training was expected to be
performed over approximately 7 months. Revenue from the use of the video phone
service center was recognized on a straight-line basis over the expected period
of use, which was approximately 7 months.  Since collectibility was not
reasonably assured, the contract termination fee was recognized as other income
on a straight line basis over the ten months that the $5,000 was
paid.  For the three months ended March 31, 2009 and 2008, other
income was recorded for the contract termination fee of $348 and $0,
respectively.  As of March 31, 2009, the Company had received payment
of $1,475 toward the purchase of video phone units and all of the $5,000 agreed
payments.
  ·
              Arbitration.  On
      January 27, 2009, the Company resolved the outstanding arbitration with
      Aequus, and in full satisfaction of the outstanding arbitration claim
      Aequus agreed to terminate any obligation on the part of the Company to
      provide certain prepaid engineering services pursuant to the March 31,
      2008 Agreement with Aequus (Aequus had prepaid approximately $900 for
      these engineering services of which $725 was allocated to the settlement
      which is recorded as revenue during the three months ended March 31,
      2009).
  ·
              Purchase of
      Units.  Units purchased per the March 31, 2008 agreement
      with Aequus are initially held by the Company pending shipment to Aequus
      customers.  Revenue for these units held by the Company pending
      shipment to the ultimate customer is deferred, per the SEC Staff
      Accounting Bulletin Topic 13A(3)(a) (Bill and Hold
      Arrangements).  Revenue for the units held is recognized as and
      when the units are shipped to the Aequus customers.  For the
      three months ended March 31, 2009 and 2008, the Company did not ship units
      to Aequus customers, and therefore no revenue was
    recognized.
  The
Company accounts for stock warrants issued to third parties, including
customers, in accordance with the provisions of the Emerging Issues Task Force
96-18, “Accounting for Equity Instruments That Are Issued to Other Than
Employees for Acquiring, or in Conjunction with Selling, Goods or Services,” and
EITF 01-9, “Accounting for Consideration Given by a Vendor to a Customer
(Including a Reseller of the Vendor’s Products)” (“EITF 01-9”).  In
connection with the Commercial Relationship entered into with ACN in April 2009,
the Company granted ACN a warrant to purchase up to approximately 38,200,000
shares of common stock at an exercise price of $0.0425 per
share.  This warrant will vest incrementally based on ACN’s purchases
of videophones under the Commercial Relationship.  Under the
provisions of EITF 96-18, the Company records a charge for the fair value of the
portion of the warrant earned from the point in time when vesting of the warrant
becomes probable. Final determination of fair value of the warrant occurs upon
actual vesting. EITF 01-9 requires that the fair value of the warrant be
recorded as a reduction of revenue to the extent of cumulative revenue recorded
from that customer. Accordingly, the application of these accounting guidelines
will require the Company’s reported revenue from the Commercial Relationship to
be reduced to reflect the fair value of the warrant granted to ACN pursuant to
the Commercial Relationship and the excess fair value of the equity issued in
the Private Placement.
  16
  14.           Risks
and uncertainties.
  In
addition to the risks and uncertainties regarding the Company’s relationship
with Aequus and Snap!VRS and WGI and ACN as discussed above under “Liquidity and
Going Concern Considerations” the Company also depends on relationships with
third parties such as contract manufacturing companies, chip design companies
and others who may be sole source providers of key components and services
critical for the product the Company is developing in its video phone
business.  The components and raw materials used in the Company’s Ojo
video phone product, as well as the vendors providing the parts necessary for
the Ojo, are constantly changing which may result in the discontinuation and/or
the unavailability of certain parts possibly resulting in additional product
development to accommodate changes in vendor and replacement parts and may
render some parts as excess and obsolete.  Parts are sourced based,
among other factors, on reliability, price and availability.. A formal
relationship with Mototech has been established for the volume manufacture of
the Ojo. The Company’s non exclusive agreement with Mototech allows either party
to terminate the agreement with 90 days prior notice. At the present time
Mototech is the Company’s sole manufacturer of its video phones.  If
Mototech or other providers of components and/or manufacturing services do not
produce these components or provide their services on a timely basis, if the
components or services do not meet the Company’s specifications and quality
control standards, or if the components or services are otherwise flawed, the
Company may have to delay product delivery, or recall or replace unacceptable
products. In addition, such failures could damage the Company’s reputation and
could adversely affect its operating results. As a result, the Company could
lose potential customers and any revenues that it may have at that time may
decline dramatically.
  15.           Accounting
for the Uncertainty in Income Taxes.
  The
Company has  adopted the provisions of Financial Accounting Standards
Board (“FASB”) Interpretation No. 48, “Accounting for Uncertainty in Income
Taxes - an interpretation of FASB Statement No. 109”(“FIN 48”), on January 1,
2007.  FIN 48 clarifies the accounting for uncertainty in income taxes
recognized in an enterprise’s financial statements in accordance with SFAS No.
109, “Accounting for Income Taxes,” and prescribes a recognition threshold and
measurement process for financial statement recognition and measurement of a tax
position taken or expected to be taken in a tax return.  FIN 48 also
provides guidance on recognition, classification, interest and penalties,
accounting in interim period, disclosure and transition.  Our ability
to utilize our net operating loss carryforwards and credit carryforwards may be
subject to annual limitations as a result of prior or future changes in
ownership and tax law as defined under Section 382 of the Internal Revenue
Code of 1986. Such limitations are based on our market value at the time of
ownership change multiplied by the long-term tax-exempt rate supplied by the
Internal Revenue Service.
  Upon
completing an analysis as required by Section 382, it was determined that during
July 2008, the Company experienced a change of ownership as defined under
Section 382. As a result of this change, the Company’s net operating loss
carryforward will be limited. Due to the limitations imposed by Section 382, the
Company will be unable to utilize significant amounts of its net operating loss
and the remaining amounts will be subject to an annual limitation of $326. The
federal net operating loss projected to be lost is $230,280 resulting in $7,160
remaining to be carried forward subject to annual limitations. The state net
operating loss projected to be lost is $182,760 resulting in $7,160 remaining to
be carried forward subject to annual limitations. The state net operating losses
are also limited by state law due to maximum utilization limits. The federal
research and experimentation credit will also be subject to an annual
limitation.  Due to the limitation, all but $144 of the credit is
lost.  The federal credits remaining will expire in
2028.  All state research and experimentation credit carryovers have
been refunded and no state credit remains.
  Future
issuances of common stock may further affect this analysis which might cause
additional limitation on our ability to utilize net operating loss
carryforwards.  We have determined that upon closing of the Private
Placement pursuant to which WGI acquired shares of our common stock representing
63% of our outstanding common stock, our ability to utilize our remaining net
operating loss carryforwards and credit carryforwards will again be subject to
additional annual limitations as a result of current tax law as defined under
Section 382.
  The
Company has identified its federal tax return and its state tax return in
Pennsylvania as “major” tax jurisdictions, as defined in FIN
48.  Based on the Company’s evaluation, it concluded that there are no
significant uncertain tax positions requiring recognition in the Company’s
financial statements.  The Company’s evaluation was performed for tax
years ended 2005 through 2008, the only periods subject to
examination.  The Company believes that its income tax positions and
deductions would be sustained on audit and does not anticipate any adjustments
that would result in a material change to its financial position.
  The
Company’s policy for recording interest and penalties associated with audits is
not to record such items as a component of income before income
taxes.  Penalties are recorded in other expense and interest paid or
received is recorded in interest expense or interest income, respectively, in
the statement of operations.  There were no amounts accrued for
penalties or interest as of or during the three months ended March 31, 2009 and
2008.  The Company does not expect its unrecognized tax benefit
position to change during the next twelve months.  Management is
currently unaware of any issues under review that could result in significant
payments, accruals or material deviations from its position.
  17
  16.           Subsequent
Events
  Closing of Private
Placement.  On April 6, 2009, the Company completed the Private
Placement of securities to WGI, pursuant to the terms of a Securities Purchase
Agreement dated December 12, 2008.  In connection with the
transaction, the Company issued to WGI an aggregate of 202,462,155 shares of the
Company’s common stock, representing approximately 63% of the total number of
issued and outstanding shares of the Company’s common stock, as well as a
warrant to purchase up to 140.0 million shares of the Company’s common stock in
certain circumstances, in exchange for (i) cash consideration of $1,450 (of
which $750 had been previously advanced to the Company by WGI (See Note 2)),
(ii) the cancellation of convertible debentures held by WGI under which
approximately $5,100 in principal and accrued interest was outstanding as of
March 31, 2009, and (iii) the cancellation of certain outstanding warrants held
by WGI.   In December 2008, WGI Investor, LLC had acquired from YA
Global Investments, L.P. (“YA Global”) the convertible debentures previously
issued by the Company to YA Global and the outstanding warrants to purchase the
Company’s common stock then held by YA Global.  The Company expects to
use the proceeds from the Private Placement primarily for working capital
purposes.
  Terms of Anti-Dilution
Warrant.  The Anti-Dilution Warrant entitles WGI to purchase up
to 140.0 million shares of the Company’s common stock at an exercise price of
$0.01 per share to the extent the Company issues any capital stock upon the
exercise or conversion of (i) any warrants, options and other purchase rights
that are outstanding as of April 6, 2009 (“Existing Contingent Equity”), (ii) up
to 19.7 million shares underlying future options, warrants or other purchase
rights issued by the Company after April 6, 2009 (“Future Contingent Equity”),
or (iii) the ACN Warrant described below.  The Anti-Dilution Warrant
is designed to ensure that WGI may maintain 63% of the issued and outstanding
shares of the Company’s capital stock in the event that any of the Company’s
capital stock is issued in respect to the Existing Contingent Equity, the Future
Contingent Equity or the ACN Warrant.  The term of the Anti-Dilution
Warrant is ten years from the date of issuance, and the shares subject to the
Anti-Dilution Warrant will be decreased proportionally upon the expiration of
Existing Contingent Equity, Future Contingent Equity and the ACN
Warrant.
  ACN Commercial Relationship and ACN
Warrant.  WGI is a private investment fund whose ownership
includes owners of ACN, a direct seller of telecommunications services and a
distributor of video phones.  Concurrently with the closing of the
Private Placement, the Company entered into the Commercial Relationship with ACN
pursuant to which the Company will design and sell video phones to
ACN.  As part of the Commercial Relationship, the Company entered into
two agreements:, a Master Purchase Agreement pursuant to which ACN has committed
to purchase three hundred thousand videophones over a two-year period and a
Software Development and Integration and Manufacturing Assistance Agreement
pursuant to which ACN has committed to provide the Company with $1,200 to fund
associated software development costs.  In connection with the
Commercial Relationship, the Company granted ACN a warrant to purchase up to
approximately 38.2 million shares of the Company’s common stock at an exercise
price of $0.0425 per share.  The ACN Warrant will vest incrementally
based on ACN’s purchases of video phones under the Commercial
Relationship.
  Registration Rights and Governance
Agreement.  In connection with the Private Placement, the
Company entered into a Registration Rights and Governance Agreement with WGI and
ACN (the “Rights Agreement”) granting them certain rights with respect to the
securities purchased in the Private Placement.  Under the terms of the
Rights Agreement, the Company has agreed to file a registration statement on
Form S-3 covering the resale of any shares held by WGI and ACN and to maintain
its effectiveness for a minimum period of time.  In addition, WGI and
ACN have the right to require the Company to file additional registration
statements covering the resale of such securities to the extent they are not
covered by an effective registration statement and will be entitled to
“piggy-back” registration rights on all future registrations by the Company
(with certain limitations) and on any demand registrations of any other
investors, subject to customary underwriters’ cutbacks to reduce the number of
shares to be registered in view of market conditions.
  Pursuant
to the terms of the Rights Agreement, the Company granted WGI and ACN preemptive
rights to purchase a pro rata portion of any common stock or other securities
convertible into common stock issued by the Company, except for shares issued
under board-approved employee benefit plans, conversions of Existing Contingent
Equity or upon exercise of the Anti-Dilution Warrant or the ACN
Warrant.  The Rights Agreement also gives WGI the right to nominate a
total of four of the seven members of the Company’s board of
directors.  This nomination right will be reduced by one director for
each reduction in its beneficial ownership of common stock (including any
warrants or other purchase rights) below thresholds of 50%, 43%, 29% and 14% of
the Company’s voting stock.  To the extent that such nomination right
decreases, the corresponding number of WGI nominees will offer to tender their
resignation for acceptance by the board of directors.
  Compensation to
Directors.  On April 29, 2009, the board of directors approved
a grant of options to purchase 100,000 shares of the Company’s common stock to
each of the directors (other than Robert Stevanovski, Gregory Provenzano and
David Stevanovski) in lieu of the automatic grants provided under the Company’s
2003 Equity Incentive Plan.
  ITEM
2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS (Dollar amounts contained in this Item 2 are in thousands,
except for share and per share amounts)
  18
  FORWARD-LOOKING
AND CAUTIONARY STATEMENTS
 
 We may
from time to time make written or oral forward-looking statements, including
those contained in the following Management’s Discussion and Analysis of
Financial Condition and Results of Operations.  The words “estimate,”
“project,” “believe,” “intend,” “expect,” and similar expressions are intended
to identify forward-looking statements, although not all forward-looking
statements contain these identifying words.  In order to take advantage of
the “safe harbor” provisions of the Private Securities Litigation Reform Act of
1995, we are hereby identifying certain important factors that could cause our
actual results, performance or achievement to differ materially from those that
may be contained in or implied by any forward-looking statement made by or on
our behalf.  The factors, individually or in the aggregate, that could
cause such forward-looking statements not to be realized include, without
limitation, the following: (1) difficulty in developing and implementing
marketing and business plans, (2) industry competition factors and other
uncertainty that a market for our products will develop, (3) challenges
associated with distribution channels, including both the retail distribution
channel and  high speed data operators (e.g., uncertainty that they
will offer our products, inability to predict the manner in which they will
market and price our products and existence of potential conflicts of interests
and contractual limitations impeding their ability to offer our products),
(4) continued losses, (5) difficulty or inability to raise additional
financing on terms acceptable to us, (6) departure of one or more key
persons, (7) changes in regulatory requirements, (8) delisting of our
common stock from the OTCBB and (9) other risks identified in our filings
with the Securities and Exchange Commission, including the risks identified in
“Item 1A. Risk Factors” in our Annual Report on Form 10-K for the fiscal year
ended December 31, 2008.  We caution you that the foregoing list of
important factors is not intended to be, and is not, exhaustive.  We do not
undertake to update any forward-looking statement that may be made from time to
time by us or on our behalf, other than as required by the federal securities
law.
 
 General
  We are
engaged in the business of developing and selling video phone products and
services.  Our video phone business has not produced significant
revenues to date.  The extent and timing of future revenues for our
business depends on several factors, including the rate of market acceptance of
our products and the degree of competition from similar products.  We
cannot predict to what extent our video phone product will produce revenues, or
when, or if, we will reach profitability.
 
 Relationship with Aequus
Technologies.  In the spring of 2006, we entered into a
multiyear agreement with Aequus Technologies Corp. (“Aequus”) to purchase Ojo
video phones through its wholly owned subsidiary Snap Telecommunications Inc.
(“Snap!VRS”), a provider of Video Relay Services (“VRS”) and Video Remote
Interpreting (“VRI”) services for the deaf and hard of hearing.  In
the spring of 2007, we announced an expansion of our relationship with Aequus
and Snap!VRS agreeing to work collaboratively to develop the preferred VRS phone
for the VRS community.  From 2006, we were reliant on the Aequus
relationship as our primary customer relationship.
 
 On
February 4, 2008, we issued a current report on Form 8−K indicating that we were
in a dispute with Aequus over the payment of significant monies that we believed
Aequus owed to us.  The refusal by Aequus to pay such monies had
contributed to a shortfall in our available operating cash needed to continue
operations, and accordingly, on January 30, 2008, we shut down our operations.
The Form 8−K further indicated that this was a first step to winding down our
business, which would occur if we were not able to secure payment of the monies
believed to be owed to us by Aequus, and/or new financing.
 
 On March
31, 2008, we entered into a new agreement with Aequus and Snap!VRS. This new
agreement provides for the (i) resolution of a dispute with Aequus regarding
amounts we claimed were owed to us by Aequus and the termination by us of video
phone service to Aequus, (ii) payment to us by Aequus of approximately $5,000 in
scheduled payments over ten months commencing March 31, 2008, (iii) agreement to
arbitrate approximately $1,354 claimed by us to be owed by Aequus and (iv)
purchase of an additional $1,475 of video phones by Aequus.
  In
October 2008, Aequus failed to pay $953 owed to us for the purchase of video
phones, and as a result we terminated our reseller agreement with
Aequus.  We have most of the units sold to Aequus in our possession
and will attempt to sell the units elsewhere to recover the $953.  We
continue to believe that the Video Relay Services and Video Remote Interpreting
markets provide an attractive opportunity for the sale of video phones and have
opened discussions and have initiated shipments of video phones with other Video
Relay Services / Video Remote Interpreting service
providers.   In addition, on January 27, 2009, we resolved
arbitration proceedings with Aequus, and in full satisfaction of the outstanding
arbitration claim Aequus agreed to terminate any obligation on our part to
provide certain prepaid engineering services pursuant to a previous agreement
with Aequus.  As a result of the arbitration, we retained $725 of the
approximately $900 prepaid by Aequus for these engineering
services.
  19


Relationship with WGI and
ACN.   On April 6, 2009, we completed a private placement
of securities to WGI Investor LLC (“WGI”, or the “Investor”), pursuant to the
terms of a Securities Purchase Agreement dated December 12, 2008.  In
connection with the transaction, we issued to WGI an aggregate of 202,462,155
shares of our common stock, representing approximately 63% of the total number
of issued and outstanding shares of our common stock, as well as a warrant to
purchase up to approximately 140.0 million shares of our common stock in certain
circumstances (the “Anti-Dilution Warrant”) in exchange for (i) cash
consideration of $1,450 (of which $750 had been previously advanced to us by
WGI), (ii) the cancellation of convertible debentures held by WGI under which
approximately $5,100 in principal and accrued interest was outstanding as of
March 31, 2009, and (iii) the cancellation of certain outstanding warrants held
by WGI (the “Private Placement”).   In December 2008, WGI had acquired
from YA Global Investments, L.P. (“YA Global”) the convertible debentures that
we had previously issued to YA Global and the outstanding warrants to purchase
our common stock then held by YA Global.  We expect to use the
proceeds from the Private Placement primarily for working capital
purposes.
 
 WGI is a private investment fund whose
ownership includes owners of ACN, Inc. (“ACN”), a direct seller of
telecommunications services and a distributor of video
phones.  Concurrently with the closing of the Private Placement, we
entered into a commercial relationship with ACN pursuant to which we will design
and sell video phones to ACN (the “Commercial Relationship”).  As part
of the Commercial Relationship, we entered into two agreements, a Master
Purchase Agreement pursuant to which ACN has committed to purchase three hundred
thousand videophones over a two-year period and a Software Development and
Integration and Manufacturing Assistance Agreement pursuant to which ACN has
committed to provide us with $1,200 to fund associated software development
costs.  In connection with the Commercial Relationship, we granted ACN
a warrant to purchase up to approximately 38.2 million shares of our common
stock at an exercise price of $0.0425 per share (the “ACN
Warrant”).  The ACN Warrant will vest incrementally based on ACN’s
purchases of video phones under the Commercial Relationship.
 
 We
account for stock warrants issued to third parties, including customers, in
accordance with the provisions of the Emerging Issues Task Force 96-18,
“Accounting for Equity Instruments That Are Issued to Other Than Employees for
Acquiring, or in Conjunction with Selling, Goods or Services,” and EITF 01-9,
“Accounting for Consideration Given by a Vendor to a Customer (Including a
Reseller of the Vendor’s Products)” (“EITF 01-9”).  In connection with
the Commercial Relationship entered into with ACN in April 2009, we granted ACN
a warrant to purchase up to approximately 38,200,000 shares of our common stock
at an exercise price of $0.0425 per share.  This warrant will vest
incrementally based on ACN’s purchases of videophones under the Commercial
Relationship.  Under the provisions of EITF 96-18, we record a charge
for the fair value of the portion of the warrant earned from the point in time
when vesting of the warrant becomes probable. Final determination of fair value
of the warrant occurs upon actual vesting. EITF 01-9 requires that the fair
value of the warrant be recorded as a reduction of revenue to the extent of
cumulative revenue recorded from that customer. Accordingly, the application of
these accounting guidelines will require our reported revenue from the
Commercial Relationship to be reduced to reflect the fair value of the warrant
granted to ACN pursuant to the Commercial Relationship and the excess fair value
of the equity issued in the Private Placement.
  Critical
Accounting Policies and Estimates.
 
 Our condensed consolidated financial
statements have been prepared in accordance with accounting principles generally
accepted in the United States.  These generally accepted accounting
principles require management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities at the date of the financial statements and the reported amounts
of net revenues and expenses during the reporting period.  Actual
results could differ from those estimates.
 
 Our significant accounting policies are
described in the Management’s Discussion and Analysis section and the notes to
the consolidated financial statements included in our annual report on Form 10-K
for the fiscal year ended December 31, 2008.  Judgments and estimates
of uncertainties are required in applying our accounting policies in many
areas.  Following are some of the areas requiring significant
judgments and estimates:  revenue recognition, inventory valuation,
stock based compensation, deferred revenues, deferred tax asset valuation
allowances and valuation of derivative liabilities and related
warrants.  Management has discussed the development and selection of
these policies with the Audit Committee of our Board of Directors, and the Audit
Committee of the Board of Directors has reviewed our disclosures of these
policies.  There have been no material changes to the critical
accounting policies or estimates reported in the Management’s Discussion and
Analysis section or the audited financial statements for the year ended December
31, 2008 as filed with the Securities and Exchange Commission.
  20
 
 Results
of Operations:
  Three Months Ended March 31, 2009 and
March 31, 2008.
 
 Revenues.
 
 Net
revenues for the three months ended March 31, 2009 and 2008 were $1,238 and
$114, respectively, and reflect product, service and other
revenues.  The increase of $1,124, or 986%, in these revenues during
the three months ended March 31, 2009, with respect to the comparable period in
2008, primarily reflects the increases in product, service, and other revenues
during the three months ended March 31, 2009, when compared to the comparable
period in 2008.  The total revenue increase includes an increase in
other revenue of $736 primarily realized from non recurring engineering
services, related to the settlement of the dispute with Aequus wherein the
settlement eliminated $725 of our $900 obligation to provide NRE to Aequus(See
Note 13 of the accompanying financial statements).  Product revenues
were $349 and $19, respectively, for the three months ended March 31, 2009 and
2008.  The increase in product revenues during the three months ended
March 31, 2009, when compared to the same period in 2008, was
$330.  Total service revenues were $93 and $35, respectively, for the
three months ended March 31, 2009 and 2008.  The increase in service
revenues during the three months ended March 31, 2009, when compared to the same
period in 2008, was $58, or 166%.  The increases in both product and
service revenues for the three months ended March 31, 2009, when compared to the
same period in 2008, primarily reflects the shutting down of our operations from
January 30, 2008 through March 11, 2008 as a result of our cash shortfall
related in part to a dispute with our largest customer over the payment of
significant monies which we believed was owed to us and the customer’s refusal
to make such payments.
 
 Gross profit of $324 and $76,
respectively, was reported for the three month period ended March 31, 2009 and
2008.  For the three months ended March 31, 2009, gross margin was
reduced by $600 relating to the establishment of an inventory reserve for
certain excess and obsolete inventory.  Before this adjustment, gross
margin for the three months ended March 31, 2009 was $924, or 75%, compared to
$76, or 67%, for the same period in 2008.  This improvement in gross
profit was primarily the result of the increase in revenue from the
non-recurring engineering (NRE), training and service center usage revenues
recognized from our agreement with Aequus, with the respective costs of
these increased revenues having been previously incurred and recorded in 2008
(See Note 13 of the accompanying financial statements), and increased selling
prices and lower unit costs of the product shipped during the three months ended
March 31, 2009 compared to the same period in 2008.
 
 Costs and
Expenses.
 
 Cost of Revenues. The cost of
revenues, consisting of product and delivery costs relating to the deliveries of
video phones, and direct costs related to non-recurring engineering services
revenues, was $914 and $38, respectively, for the three months ended March 31,
2009 and 2008.  Primarily accounting for this increase in cost of
revenues of $876 for the three  months ended March 31, 2009, compared
to the same periods in 2008, were increased costs recorded at March 31, 2009 of
$600 to establish an inventory reserve for certain excess and
obsolete  inventory that may not be utilized in the future development
of our video phones.  The cost of video phones shipped to customers
was $294 and $17, respectively for the three months ended March 31, 2009 and
2008.  Increased shipments during the three months ended March 31,
2009, compared to this same period in 2008, additionally contributed to the
increase in cost of revenues.  The reduced shipments during the three
months ended March 31, 2008 was the result of shutting down of our operations
from January 30, 2008 through March 11, 2008 as a result of our cash shortfall
related in part to a dispute with our largest customer over the payment of
significant monies which we believed was owed to us and the customer’s refusal
to pay such monies.
 
 Engineering and
Development.  Engineering and development expenses primarily
consist of compensation, and the cost of design, programming, testing,
documentation and support of our video phone product.  Engineering and
development costs were $642 and $577, respectively, for the three months ended
March 31, 2009 and 2008.  This increase of $65, or 11%, for the three
months ended March 31, 2009, compared to the same period in 2008, primarily
reflects an increase in staffing.
 
 Sales and
Marketing.  Sales and marketing expenses consist primarily of
compensation (which includes compensation to manufacturer’s representatives and
distributors), attendance at conferences and trade shows, travel costs,
advertising, promotions and other marketing programs (which include expenditures
for co-op advertising and new market development) related to the continued
introduction of our video phone product.  Sales and marketing costs
were $38 and $219, respectively, for the three months ended March 31, 2009,
compared with the three months ended March 31, 2008.  This decrease of
$181, or 83%, is primarily the result of reduced marketing, customer service and
promotional expenditures of $3 and $46, respectively, for the three months ended
March 31, 2009 compared to the same period in 2008, $38 of credits received from
certain marketing vendors in settlement of our unpaid obligations during the
three months ended March 31, 2009, and $87 reduction in customer service center
costs in the three months ended March 31, 2009 compared to the same period in
2008.
 
 General and
Administrative.  General and administrative expenses consist
primarily of expenditures for administration, office and facility operations, as
well as finance and general management activities, including legal, accounting
and professional fees.  General and administrative expenses were $865
and $899, respectively, for the three months ended March 31, 2009, compared to
the three months ended March 31, 2008.  This decrease of $34, or 4%,
is primarily attributable to reduced rent of $77, a reduction in consulting
expenses of $24, and $98 of credits received from certain vendors in settlement
of unpaid obligations by us, partially offset by the establishment of a bad debt
reserve at March 31, 2009 of $157 relating to certain product shipped and
invoiced to a customer that has not paid.  There was no bad debt
expense recorded or a reserve established as of March 31, 2008.
  21
 
 Interest and Other Income and
Interest Expense.  Interest and other income consisted of
interest earned on cash and cash equivalents.  Interest and other
income were $8 and $8, respectively, for the three months ended March 31, 2009
and 2008.  During the three months ended March 31, 2009 and 2008, we
earned interest on an average cash balance of approximated $356 and $568,
respectively.  During the three months ended March 31, 2009, we
received a $7 membership fee refund, which was not received during the same
period in 2008.  Interest expense was $72 and $90, respectively, for
the three months ended March 31, 2009 and 2008, primarily consisting of accrued
interest on the convertible debentures issued on August 11, 2006 and October 13
2006.
 
 Income from Service Fee Contract
Termination.During the three months ended March 31, 2009 and
2008, we realized $348 and $0, respectively, of other income resulting from the
payment from Aequus for the elimination of previously agreed service fees with
Aequus as stated in our March 31, 2008 agreement with Aequus, which we realized
over a ten month period (See Note 13 of the accompanying financial
statements).
 
 Income Taxes.  We
have incurred net operating losses since inception and accordingly had no
current income tax provision and have not recorded any income tax benefit for
those losses, since realization of such benefit is currently
uncertain.
 
 Non Cash Change in Fair Value of
Derivative Warrants and Conversion Options. For the three months ended
March 31, 2009 and 2008, the non cash change in fair value of derivative
warrants was a gain of $3,925 and $129, respectively. These fair value
adjustments are primarily a result of changes in our common stock price during
each reporting period and anti-dilution provisions that increased the number of
outstanding warrants and reduced the warrant exercise price as of March 31, 2008
(See Note 7 of the accompanying financial statements) related to our June 2004
private placement of our Series A Convertible Preferred Stock and Warrants and
our August 11, 2006 and October 13, 2006 private placements of secured
Convertible Debentures and Warrants.
 
 Amortization of Debt
Discount. For the three months ended March 31, 2009 and 2008, the
amortization of the debt discount was $683 and $218, respectively, relating to
the normal amortization of the August 11, 2006 and October 13, 2006 private
placements of secured convertible debentures.  This increase is
principally the result of the application of the effective interest rate method
to determine the monthly amortization of the discount over the term of the
convertible debentures.  This method increases the periodic
amortization charged as the convertible debentures reach maturity (See Note 6 of
the accompanying financial statements).
 
 Liquidity
and Capital Resources
 
 As of
March 31, 2009, our primary source of liquidity consisted of proceeds from notes
issued, the sale of stock and convertible debentures and from the sale of Ojo
video phones.  Cash and cash equivalents are highly liquid, are of
high quality investment grade and have original maturities of less than three
months.
 
 As of
March 31, 2009, we had cash and cash equivalents of $320.  We utilized
cash from operations of $862 during the three months ended March 31,
2009.
 
 Our short
term cash requirements and obligations include inventory, accounts payable and
capital expenditures from continuing operations and operating
expenses.
 
 Cash used
in investing activities for the three months ended March 31, 2009 was primarily
a result of capital expenditures of $27 for investments in equipment for product
development and manufacture.
 
 Cash
provided by financing activities during the three months ended March 31, 2009
and 2008 was $780 and $1, respectively.  During the three months ended
March 31, 2009, we issued notes totaling $780 (See Note 2 of the accompanying
financial statements).
 
 Operations and Liquidity.
  We have
incurred recurring net losses and have an accumulated deficit of $267,143,
stockholder’s deficiency of $6,163 and a working capital deficit of $6,448 as of
March 31, 2009.  We have also experienced severe cash shortfalls,
deferred payment of some of our operating expenses, and shut down operations for
a period of time in early 2008 to conserve our cash.  At least in the
short term we do not expect to generate sufficient cash from operations and will
likely need to secure additional cash financing and to increase product
sales.  No assurances can be given that we will be able to obtain the
necessary cash for us to continue as a going concern.  These factors
raise substantial doubt about our ability to continue as a going
concern.  The accompanying financial statements do not include any
adjustments that might be necessary should we be unable to continue as a going
concern.
  22
 
 We had
$8,782 of liabilities and substantially all of our assets were pledged as
collateral as of March 31, 2009. These liabilities include $695 of detachable
warrants related to our private placement of preferred stock in June 2004, and
$625 of detachable warrants and $1,892 of debt (net of unamortized discount of
$2,188) related to our financing in August and October 2006.
 
 Short
term cash requirement obligations as of March 31, 2009 were primarily related to
the August and October 2006 secured convertible debenture transactions which
mature in 2009.  The convertible debentures had an interest rate of 6%
per annum and could be converted to common stock at the holder’s option. We had
current debt as of March 31, 2009 on the balance sheet reflecting the
convertible debentures issued on August 11 and October 13, 2006.  The
convertible debentures payable, net of unamortized discounts of $2,188 and
$2,287, had a balance of $1,892 and $1,793, respectively, as of March 31, 2009
and December 31, 2008 (See Note 6 of the accompanying financial
statements).  As of March 31, 2009 and December 31, 2008, accrued
interest was $1,038 and $978, respectively.  The convertible debentures
were canceled in April 2009 (See Note 16 of the accompanying financial
statements) in connection with the Private Placement transaction with
WGI.
 
 In
December 2008, WGI acquired from YA Global Investments, L.P. (“YA Global”) the
secured convertible debentures we previously issued to YA Global and the
outstanding warrants to purchase our common stock then held by YA
Global.  On April 6, 2009, we completed the Private Placement pursuant
to which we issued and sold to WGI a total of 202,462,155 shares of our common
stock, representing approximately 63% of our outstanding stock, as well as a
warrant to purchase up to approximately 140.0 million shares of our common stock
in certain circumstances, in exchange for (i) total cash consideration of
$1,450, (ii) the cancellation of debentures held by WGI under which
approximately $5,100 in principal and accrued interest was outstanding at March
31, 2009, and (iii) the cancellation of certain of our outstanding warrants to
purchase an aggregate of 2,595,000 shares of our common stock held by
WGI.
 
 In
October 2008 Aequus Technologies Corp. (“Aequus”) failed to pay to us $953 owed
to us for the purchase of video phones, and as a result we terminated our
reseller agreement with Aequus.  We have most of the units sold to
Aequus in our possession and will attempt to sell the units elsewhere to recover
the $953. There can be no assurance that we will be able to sell the units and
recover the $953 owed by Aequus.  We continue to believe that the VRS
and VRI markets provide an attractive opportunity for the sale of video phones
and have opened discussions with other VRS/VRI service providers.
 
 On
January 27, 2009, we resolved the outstanding NRE Arbitration with Aequus, and
in full satisfaction of the outstanding arbitration claim Aequus agreed to
terminate any obligation on our part to provide certain prepaid engineering
services pursuant to the March 31, 2008 Agreement with Aequus (Aequus had
prepaid approximately $900 for these engineering services of which $725 was
allocated to the settlement).
 
 Our
ability to generate cash is dependent upon the sale of our Ojo product, our
ability to enter into arrangements to provide services, and on obtaining cash
through the private or public issuance of debt or equity securities.  Given
that our video phone business involves the development of a new product line
with no market penetration in an underdeveloped market sector, no assurances can
be given that sufficient sales, if any, will materialize. The lack of success of
our sales efforts could also have an adverse ability to raise additional
financing.
 
 Based on
management’s internal forecasts and assumptions, including, among others, the
receipt of the payments which are currently committed to us, such as the
remaining payments under our agreements with ACN pursuant to the Commercial
Relationship, and assumptions regarding our short term cash requirements, we
currently believe that we will have sufficient cash on hand to meet our
obligations into the third quarter of 2009. However, there can be no assurance
given that these assumptions are correct or that the revenue projections
associated with product sales and services to ACN will materialize to a level
that will provide us with sufficient capital to operate our business.
 
 We
continue to evaluate possibilities to obtain additional financing through public
or private equity or debt offerings, asset securitizations, or from other
sources.  In addition the Company plans to explore additional service
and distribution sales opportunities.There
can be no assurance given, however, that our efforts will be successful or that
any additional financing will be available and can be consummated on terms
acceptable to us, if at all.There can
also be no assurance given that any additional sales can be achieved through
additional service and distribution opportunities. If we are unable to
obtain sufficient funds we may be required to further reduce the size of the
organization or suspend operations which could have a material adverse impact on
our business.
 
 ITEM
3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
 Not required
  23
 
 ITEM
4T.  CONTROLS AND PROCEDURES.
 
 Evaluation of Disclosure
Controls and Procedures.
 
 The
Company maintains disclosure controls and procedures (as defined in Rule
13a-15(e) and 15d-15(e) of Securities Exchange Act of 1934)  that are
designed to ensure that information required to be disclosed in reports that it
files or submits under the Securities Exchange Act of 1934 is recorded,
processed, summarized, and reported within the time periods specified in the
Securities and Exchange Commission’s rules and forms, and that such information
is accumulated and communicated to its management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding the required disclosures. In designing and evaluating the disclosure
controls and procedures, the Company recognizes that any controls and
procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives.
 
 As
previously reported in our Form 10-K for the year ended December 31, 2008, we
carried out an evaluation, under the supervision and with the participation of
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of its disclosure controls and
procedures as of December 31, 2008.  The Company’s Chief Executive
Officer and Chief Financial Officer determined that the Company had a material
weakness related to the lack of internal GAAP expertise to assist with the
accounting and reporting of complex financial transactions.  The
limited Company resources as well as the Company’s focus and efforts toward
keeping the Company solvent contributed to the material weakness.  As
a result, the Chief Executive Officer and Chief Financial Officer concluded that
as of December 31, 2008, its disclosure controls and procedures were not
designed properly and were not effective in ensuring that the information
required to be disclosed by the Company in the reports that we file and submit
under the Securities Exchange Act of 1934 is recorded, processed, summarized and
reported within the time periods specified in the Commission’s rules and
forms.
 
 We
carried out an evaluation, under the supervision and with the participation of
management, including our Chief Executive Officer and Chief Financial Officer,
of the effectiveness of the design and operation of our disclosure controls and
procedures as of March 31, 2009.  As a result of the evaluation, the
Chief Executive Officer and Chief Financial Officer concluded that, as of March
31, 2009, the material weakness identified at December 31, 2008 still existed as
the Company’s focus was on obtaining funding to continue operations and did not
pursue remedies to the material weakness in accounting for complex
transactions.  The staff additions to the Company required to maintain
internal GAAP expertise, and to assist with the accounting and reporting of
complex financial transactions necessary to meet the required compliance
guidelines are costly and are expected to negatively impact future
financial results.  In addition, there is no assurance that the necessary
resources required for remedy of our material weakness will be available, and
even if they are available there is no assurance that we will be able to
conclude that our reporting systems are appropriately designed or effective, or
that a material weakness will not be found in our internal controls over
financial reporting, which could result in a material misstatement in future
financial statements.
 
 Change in Internal Control
over Financial Reporting.
 
 No change
in our internal control over financial reporting occurred during our most recent
fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.  The
Company is also still in the process of implementing a financial system that it
believes will improve the internal control over financial reporting and will
eliminate any identified deficiencies.
 
 PART
II. OTHER INFORMATION
 
 ITEM
1.  LEGAL PROCEEDINGS.
 
 Although
from time to time we may be involved in litigation as a routine matter in
conducting our business, we are not currently involved in any litigation which
we believe is material to our operations or balance sheet. During the first
fiscal quarter 2008 we were involved in a dispute with Aequus
Technologies.  We entered into an agreement with Aequus, effective
March 31, 2008, that provided for the resolution of a dispute with Aequus
regarding amounts we claimed were owed to us by Aequus including, (i) payment to
us by Aequus of $5 million in scheduled payments over the next ten months, (ii)
agreement to arbitrate approximately $1.4 million that we claimed were owed to
us by Aequus for NRE costs, and (iii) purchase of an additional $1.5 million of
video phones by Aequus.  In October 2008, however, Aequus failed to
pay us approximately $1 million that we were owed for the purchase of video
phones, and as a result we terminated our reseller agreement with
Aequus.  We are reviewing our possible remedies to recover the $1
million, including selling Aequus inventory we hold in our
possession.
  24
 
 On
January 27, 2009, we resolved the outstanding NRE Arbitration with Aequus, and
in full satisfaction of the outstanding arbitration claim Aequus agreed to
terminate any obligation on our part to provide certain prepaid engineering
services pursuant to the March 31, 2008 Agreement with Aequus (Aequus had
prepaid approximately $900,000 for these engineering services of which $725,000
was allocated to the settlement).
 
 ITEM
2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS.
 
 None.
 
 ITEM
3.  DEFAULTS UPON SENIOR SECURITIES.
 
 None
 
 ITEM
4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.
 
 (a)
              We
      held a special meeting of stockholders on March 20,
  2009.
  (b)
              N/A
  (c)
              The
      special meeting was held pursuant to the terms of the Securities Purchase
      Agreement, dated December 12, 2008, between WGI and the
      Company.  The matters voted upon at the Special Meeting and the
      votes cast with respect to such matters were as
  follows:
  Proposals
                                          
                                          For
                                          
                                          
                                          Against
                                          
                                          
                                          Abstain
                                          
                                          
                                          Broker
                                            Non-
                                            Votes1.
                                          
                                          To
      approve an amendment to the Company's Amended and Restated Certificate of
      Incorporation to increase the total number of authorized shares of Common
      Stock to 700,000,000 shares
                                          
                                          
                                          67,859,735
                                          
                                          
                                          
                                          863,634
                                          
                                          
                                          
                                          905,090
                                          
                                          
                                          
                                          02.
                                          
                                          To
      approve the issuance and sale of the Company's common stock and warrants
      to WGI as part of the Private Placement
                                          
                                          
                                          68,808,405
                                          
                                          
                                          
                                          662,590
                                          
                                          
                                          
                                          157,465
                                          
                                          
                                          
                                          0
 
 ITEM
5.  OTHER INFORMATION.
 
 None.
 
 ITEM
6.  EXHIBITS.
  The
following is a list of exhibits filed as part of this report on Form
10-Q.  Where so indicated by footnote, exhibits that were previously
filed are incorporated by reference.  For exhibits incorporated by
reference, the location of the exhibit in the previous filing is indicated
parenthetically except in those situations where the exhibit number was the same
as set forth below.
  Exhibit
                      
                      Description3.1
                      
                      Restated
      Certificate of Incorporation reflecting all amendments through March 31,
      2009*10.1
                      
                      Promissory
      Note, dated February 4, 2009, in the amount of $550, issued to WGI
      Investor LLC*10.2
                      
                      Promissory
      Note, dated March 24, 2009, in the amount of $200, issued to WGI Investor
      LLC*31.1
                      
                      Certification
      of Chief Executive Officer Pursuant to Rule 13a-14(a)*31.2
                      
                      Certification
      of Chief Financial Officer Pursuant to Rule 13a-14(a)*32.1
                      
                      Certification
      of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted
      by Section 906 of the Sarbanes-Oxley Act of 2002**32.2
                      
                      Certification
      of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted
      by Section 906 of the Sarbanes-Oxley Act of
  2002**
 *
Filed herewith
 **
Furnished herewith
  25
 
 SIGNATURES
 
 Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.
 
 WORLDGATE
      COMMUNICATIONS, INC.Dated:       May
      15, 2009
                          /s/ Robert StevanovskiRobert
      StevanovskiInterim  Chief
      Executive Officer(Principal
      Executive Officer)Dated:       May
      15, 2009
                          /s/ Joel BoyarskiJoel
      BoyarskiVice
      President and Chief Financial Officer(Principal
      Financial and Accounting Officer)
  26