**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

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**AMENDMENT NO. 1 TO FORM 10-Q**

 

**Mark One**

**ý****Quarterly Report Pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

 

**for the Quarterly Period Ended March 31,2004.**

 

**or**

 

**o****Transition Report Pursuant to Section 13 or 15(d) of the SecuritiesExchange Act of 1934**

 

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

 

**Commissionfile number:  000-25755**

 

**WORLDGATE COMMUNICATIONS, INC.**

(Exact Name ofRegistrant as Specified in Its Charter)

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

 

**3190Tremont Avenue**

**Trevose,Pennsylvania 19053**

(Address ofPrincipal Executive Offices) (Zip Code)

 

**(215) 354-5100**

(Registrant’sTelephone Number, Including Area Code)

 

Indicate by check markwhether the registrant: (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days.

Yes ýNo o

 

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

Yes oNo ý

 

Indicate by check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).

Yes oNo ý

 

As of May 9, 2004,there were 28,475,538 shares of common stock, par value $.01 per share,outstanding.

 

 

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**EXPLANATORY NOTE**

 

WorldGateCommunications, Inc. (the “Company”) is filing this Amendment No. 1on Form 10-Q/A to amend its Quarterly Report on Form 10-Q for thequarter ended March 31, 2004, as filed with the Securities and ExchangeCommission (the “SEC”) on May 14, 2004 (the “Original Filing”).  The purpose of this Amendment No. 1 isto amend and restate Part I, Item 1 and Item 2 which set forth theaccounting for the warrants and additional investments rights issued in privateplacements of the Company’s common stock during the fourth quarter of 2003 andthe first quarter of 2004.  Thesesecurity components were originally treated as non-cash expenses and with thisamendment are being restated as equity transactions. Accordingly, changes havebeen made to the applicable line items associated with additional paid-incapital, accumulated deficit, general and administrative costs, net loss andnet loss per common share.  In addition, Part I,Item 1, Item 2 and Item 3 and Part II, Item 2, Item 5 and Item 6 have beenamended and restated to reflect certain clarifications made in response to theSEC’s comments as raised in its review of the Company’s registration statementon Form SB-2, as filed with the SEC on May 24, 2005, and annualreport on Form 10-K for the year ended December 31, 2004, as filedwith the SEC on March 31, 2005, and subsequent review of the Company’sregistration statement on Form SB-2/A, as filed with the SEC on August 30,2005, and annual report on Form 10-K/A for the year ended December 31,2004, as filed with the SEC on August 30, 2005. Finally the certificationsattached as Exhibits 31.1, 31.2, 32.1 and 32.2 have been updated to reflect thefiling date of this amendment and interim changes in the regulations applicableto these certifications.  Except asdescribed above, no additions or modifications have been made to this AmendmentNo. 1 to reflect facts or events occurring subsequent to the date of theOriginal Filing.

 

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WORLDGATECOMMUNICATIONS, INC.

 

QUARTERLY REPORTON FORM 10-Q

FOR THE THREEMONTHS ENDED MARCH 31, 2004

 

TABLE OF CONTENTS

 
| PART I.  FINANCIAL INFORMATION                                                                  |   |
|------------------------------------------------------------------------------------------------------|--------|
|                                                                                                 |   |
| Item  1. Financial Statements                                                                        | 4      |
| Item  2. Management’s Discussion And Analysis Of Financial Condition And Results Of  Operations | 12     |
| Item  3. Quantitative And Qualitative Disclosures About Market Risk                                  | 17     |
| Item  4. Controls And Procedures                                                                     | 17     |
|                                                                                                 |   |
| PART II.  OTHER INFORMATION                                                                     |   |
|                                                                                                 |   |
| Item 1. Legal Proceedings                                                                            | 18     |
| Item 2. Changes In  Securities And Use Of Proceeds                                                   | 18     |
| Item 3. Defaults Upon Senior  Securities                                                             | 18     |
| Item 4. Submission Of  Matters To A Vote Of Security Holders                                         | 18     |
| Item 5. Other Information                                                                            | 18     |
| Item 6. Exhibits And Reports On Form 8-K                                                        | 20     |

 

3

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PART I.FINANCIAL INFORMATION

 

# ITEM1.  FINANCIAL STATEMENTS

 

**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDBALANCE SHEETS**

**(Dollarsin Thousands)**

 
| ** **                                                                                                                                                                                            | ** ** | **As of  March 31,** | ** ** | **As of  December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------|------------|------------------------------|------------|
| ** **                                                                                                                                                                                            | ** ** | **2004**                  | ** ** | **2003**                     | ** ** |
| ** **                                                                                                                                                                                            | ** ** | **(Unaudited)**           | ** ** | **(Audited)**                | ** ** |
| ** **                                                                                                                                                                                            | ** ** | **(As restated)**         | ** ** | **(As restated)**            | ** ** |
| ASSETS                                                                                                                                                                                                | ** ** | ** **                | ** ** | ** **                   | ** ** |
| Current assets:                                                                                                                                                                                       |       |                      |       |                         |       |
| Cash  and cash equivalents                                                                                                                                                                            |       | $                         | 3,448      |                         | $          | 3,365 |   |
| Accounts  receivable, less allowance for doubtful accounts of $0 at March 31, 2004  and $381 at December 31, 2003                                                                           |       | 112                       |       | 146                          |       |
| Prepaid  and other assets                                                                                                                                                                             |       | 75                        |       | 199                          |       |
| Total  current assets                                                                                                                                                                                 |       | 3,635                     |       | 3,710                        |       |
|                                                                                                                                                                                                  |       |                      |       |                         |       |
| Property and equipment                                                                                                                                                                                |       | 2,613                     |       | 2,605                        |       |
| Less:  accumulated depreciation and amortization                                                                                                                                                      |       | (1,440                    | )          | (1,338                       | )          |
|                                                                                                                                                                                                  |       |                      |       |                         |       |
| Property  and equipment, net                                                                                                                                                                          |       | 1,173                     |       | 1,267                        |       |
| Deposits and other  assets                                                                                                                                                                            |       | 3                         |       | 140                          |       |
| Total  assets                                                                                                                                                                                         |       | $                         | 4,811      |                         | $          | 5,117 |   |
|                                                                                                                                                                                                  |       |                      |       |                         |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                            |       |                      |       |                         |       |
| Current Liabilities:                                                                                                                                                                                  |       |                      |       |                         |       |
| Accounts payable                                                                                                                                                                                      |       | $                         | 345        |                         | $          | 440 |   |
| Accrued expenses                                                                                                                                                                                      |       | 705                       |       | 594                          |       |
| Accrued compensation  and benefits                                                                                                                                                                    |       | 199                       |       | 238                          |       |
| Deferred rent credit,  current and other                                                                                                                                                              |       | 30                        |       | 30                           |       |
| Total  current liabilities                                                                                                                                                                            |       | 1,279                     |       | 1,302                        |       |
|                                                                                                                                                                                                  |       |                      |       |                         |       |
| Deferred rent credit                                                                                                                                                                                  |       | 128                       |       | 135                          |       |
| Total  liabilities                                                                                                                                                                                    |       | 1,407                     |       | 1,437                        |       |
|                                                                                                                                                                                                  |       |                      |       |                         |       |
| Stockholders’ equity:                                                                                                                                                                            |       |                      |       |                         |       |
| Preferred Stock, $.01  par value, 13,500,000 shares authorized                                                                                                                                        |       | —                    |       | —                       |       |
| Common  stock, $.01 par value, 50,000,000 shares authorized, 27,771,748 shares issued  and outstanding at March 31, 2004 and 25,706,843 shares issued and  outstanding at December 31, 2003 |       | 283                       |       | 262                          |       |
| Additional paid-in  capital                                                                                                                                                                           |       | 203,578                   |       | 201,766                      |       |
| Unearned compensation                                                                                                                                                                                 |       | (400                      | )          | (400                         | )          |
| Accumulated deficit                                                                                                                                                                                   |       | (200,052                  | )          | (197,943                     | )          |
| Less  Treasury Stock, at cost – 500,000 shares as of March 31, 2004 and December 31,  2003                                                                                             |       | (5                        | )          | (5                           | )          |
| Total  stockholders’ equity                                                                                                                                                                      |       | 3,404                     |       | 3,680                        |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                      |       | $                         | 4,811      |                         | $          | 5,117 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

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**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

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

 
| ** **                                                                                                                                                            | ** ** | **Three Months ended March 31** | ** ** |
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------------|------------|
| ** **                                                                                                                                                            | ** ** | **2004**                             | ** ** | **2003** | ** ** |
| ** **                                                                                                                                                            | ** ** | **(As restated)**                    | ** ** | ** ** | ** ** |
| Revenues from operating  activities of continuing operations                                                                                                          |       |                                 |       |   |   |
| Equipment  product revenues earned from third parties                                                                                                                 |       | $                                    | 0          |   | $ | 0 |   |
| Equipment  product revenues earned from related parties                                                                                                               |       | 0                                    |       | 0 |   |
| Service  fee revenues earned from third parties                                                                                                                       |       | 0                                    |       | 0 |   |
| Service  fee revenues earned from related parties                                                                                                                     |       | 0                                    |       | 0 |   |
| Total  revenues from operating activities of continuing operations                                                                                                    |       | 0                                    |       | 0 |   |
| Costs and expenses from  operating activities of continuing operations                                                                                                |       |                                 |       |   |   |
| Cost  of equipment product revenues                                                                                                                                   |       | 0                                    |       | 0 |   |
| Cost  of service fee revenues                                                                                                                                         |       | 0                                    |       | 0 |   |
| Engineering  and development (excluding depreciation and amortization amounts of $0 and  $144 for the three months ended March 31, 2004 and 2003, respectively)  |       | 800                                  |       | 535 |   |
| Sales  and marketing (excluding depreciation and amortization amounts of $0 and $17  for the three months ended March 31, 2004 and 2003, respectively)           |       | 191                                  |       | 86 |   |
| General  and administrative (excluding depreciation and amortization amounts of $102  and $84 for the three months ended March 31, 2004 and 2003,  respectively) |       | 1,044                                |       | 192 |   |
| Depreciation and  amortization                                                                                                                                        |       | 102                                  |       | 0 |   |
| Total costs and  expenses from operating activities from continuing operations                                                                                        |       | 2,137                                |       | 813 |   |
| Loss from operating  activities of continuing operations                                                                                                              |       | (2,137                               | )          | (813 | ) |
| Interest and other  income                                                                                                                                            |       | 7                                    |       | 0 |   |
| Interest and other  expense                                                                                                                                           |       | (1                                   | )          | 0 |   |
| Loss from continuing  operations                                                                                                                                      |       | (2,131                               | )          | (813 | ) |
| Income (loss) from  discontinued operations                                                                                                                           |       | 23                                   |       | (1,072 | ) |
|                                                                                                                                                                  |       |                                 |       |   |   |
| Net loss                                                                                                                                                              |       | $                                    | (2,108     | ) | $ | (1,885 | ) |
|                                                                                                                                                                  |       |                                 |       |   |   |
| Net loss per common  share (basic and diluted)                                                                                                                        |       | $                                    | (0.08      | ) | $ | (0.08 | ) |
| Weighted average common  shares outstanding - basic and diluted                                                                                                       |       | 27,236,662                           |       | 23,578,645 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

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**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(Dollarsin Thousands)**

 
| ** **                                                                                        | ** ** | **Three months ended  March 31,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|----------------------------------------|------------|
| ** **                                                                                        | ** ** | **2004**                               | ** ** | **2003** | ** ** |
| ** **                                                                                        | ** ** | **(As restated)**                      | ** ** | ** ** | ** ** |
| **Cash flows from operating  activities of continuing operations:**                               |       |                                   |       |   |   |
| Net  loss                                                                                         |       | $                                      | (2,131     | ) | $ | (813 | ) |
| Adjustments  to reconcile net loss to cash used in operating activities of continuing  operations |       |                                   |       |   |   |
| Depreciation  and amortization                                                                    |       | 102                                    |       | 0 |   |
| Non-cash  stock based compensation                                                                |       | 1                                      |       | 0 |   |
| Changes  in operating assets and liabilities from continuing operations:                          |       |                                   |       |   |   |
| Accounts  receivable                                                                              |       | 18                                     |       | 0 |   |
| Prepaid  and other assets                                                                         |       | 261                                    |       | 0 |   |
| Accounts  payable                                                                                 |       | (95                                    | )          | 0 |   |
| Accrued  expenses                                                                                 |       | 111                                    |       | 0 |   |
| Accrued  compensation and benefits                                                                |       | (39                                    | )          | 0 |   |
| Other                                                                                             |       | (7                                     | )          | 0 |   |
| Net  cash used in operating activities of continuing operations                                   |       | (1,779                                 | )          | (813 | ) |
| **Cash flows from investing  activities of continuing operations:**                               |       |                                   |       |   |   |
| Capital  expenditures                                                                             |       | (8                                     | )          | 0 |   |
| Net  cash provided by investing activities of continuing operations                               |       | (8                                     | )          | 0 |   |
| **Cash flows from financing  activities of continuing operations:**                               |       |                                   |       |   |   |
| Proceeds  from the issuance of common stock                                                       |       | 1,406                                  |       | 0 |   |
| Proceeds  from the exercise of stock options                                                      |       | 105                                    |       | 0 |   |
| Proceeds  from the exercise of stock rights and warrants                                          |       | 320                                    |       | 0 |   |
| Repayments  of capital leases and notes payable                                                   |       | 0                                      |       | 0 |   |
| Net  cash provided by financing activities of continuing operations                               |       | 1,831                                  |       | 0 |   |
| **Net cash contributed to  continuing operations from discontinued operations**                   |       | 39                                     |       | 345 |   |
| **Net increase (decrease) in cash**                                                               |       | 83                                     |       | (468 | ) |
| **Cash and cash equivalents,  beginning of period**                                               |       | 3,365                                  |       | 589 |   |
| **Cash and cash equivalents, end  of period**                                                     |       | $                                      | 3,448      |   | $ | 121 |   |
|                                                                                              |       |                                   |       |   |   |
| **Cash paid for interest**                                                                        |       | $                                      | 0          |   | $ | 3 |   |
| **Non-cash financing activity:**                                                                  |       |                                   |       |   |   |
| Issuance of note  payable to finance D&O insurance                                            |       | 0                                      |       | 560 |   |

 

The accompanying notesare an integral part of these financial statements.

 

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WORLDGATECOMMUNICATIONS, INC.

NOTES TO CONDENSEDFINANCIAL STATEMENTS

 

(Dollar Amountsare in Thousands, Except for per Share and Share Amounts)

(Unaudited)

 

1.                                       Basisof Presentation.

 

The unaudited financialstatements of WorldGate Communications, Inc. (“WorldGate” or the “Company”)for the three months ended March 31, 2004 and March 31, 2003presented herein have been prepared by the Company pursuant to the rules andregulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to such rules andregulations.  These financial statementsshould be read in conjunction with the financial statements for the year ended December 31,2003 and the notes thereto included in the Company’s Annual Report on Form 10-K.

 

The financial informationin this Report reflects, in the opinion of management, all adjustments of anormal recurring nature necessary to present fairly the results for the interimperiod. Quarterly operating results are not necessarily indicative of theresults that may be expected for the year ending December 31, 2004.

 

2.                                       Restatement

 

The Company has restatedits financial statements for the three months ended March 31, 2004 toamend and restate the accounting for the warrants and additional investmentsrights issued in a private placement of the Company’s common stock during thefourth quarter of 2003 and the first quarter of 2004.  These security components were originallytreated as non-cash expenses and with this restatement have been reflectedagainst the General and Administrative expenses, net loss, accumulated deficitand additional-paid-in capital will be reduced as a result of this restatement.There is no cash impact associated with these restatements. There were alsorelated adjustments to the Company’s consolidated statement of cash flows andconsolidated statement of stockholders’ equity.

 

The effect of therestatement on specific amounts provided in the consolidated financialstatements is as follows:

 
| ** **                     | ** ** | **As of March 31, 2004** | ** ** |
|--------------------------------|------------|-------------------------------|------------|
| **Consolidated Balance Sheet** | ** ** | **As previously reported**    | ** ** | **As restated** | ** ** |
|                           |       |                          |       |   |   |
| Accumulated deficit            |       | $                             | (201,382   | ) | $ | (200,052 | ) |
| Additional-paid-in  capital    |       | 204,908                       |       | 203,578 |   |
| Total stockholders  equity     |       | 3,404                         |       | 3,404 |   |
|                                |            |                               |            |  |  |  |  |

 
| ** **                                                           | ** ** | **For the three months ended March 31, 2004** | ** ** |
|----------------------------------------------------------------------|------------|----------------------------------------------------|------------|
| **Consolidated Statement of Operations**                             | ** ** | **As previously reported**                         | ** ** | **As restated** | ** ** |
|                                                                 |       |                                               |       |   |   |
| General and  Administrative expenses                                 |       | $                                                  | 1,674      |   | $ | 1,044 |   |
| Total  expenses – operating activities of continuing operations |       | 2,767                                              |       | 2,137 |   |
| Net loss                                                             |       | (2,738                                             | )          | (2,108 | ) |
|                                                                 |       |                                               |       |   |   |
| Net loss per share                                                   | Basic      |                                               | $          | (0.10 | ) | $ | (0.08 | ) |
|                                                                 | Diluted    |                                               | (0.10      | ) | (0.08 | ) |

 

In addition, the Companyhas included restatements to reflect certain clarifications made in response tothe SEC’s comments as raised in its review of the Company’s registrationstatement on Form SB-2 as filed with the

 

7

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SEC on May 24, 2005,on Form SB-2/A as filed with the SEC on August 30, 2005 and on Form 10KAas filed with the SEC on August 30, 2005. These restatements includeexpanded clarifications on the preferred stock transaction the Companycompleted in June of 2004, liquidity and going concern considerations andchanges to the Notes to Consolidated Financial Statements.

 

3.                                       Liquidityand Going Concern Considerations.

 

As of March 31, 2004the Company had cash and cash equivalents of $3,448.  The operating cash usage from continuingoperations for the three months ended March 31, 2004 was $1,779.  During the third quarter of 2003, wecompleted a sale of certain assets, including our ITV intellectual propertyrights and our membership interest in TVGateway, LLC, for $3,000 in cash toTVGateway, LLC, a company we were instrumental in forming. Our transaction withTVGateway, LLC, marked a shift in our business away from the ITV business andtoward a new video phone product and associated business.  The funds we received from the sale of assetsto TVGateway, LLC, as well as the funds we received as a result of privateplacements of our securities on December 1, 2003, December 4, 2003, January 21,2004, and April 22, 2004, have permitted us to fund the development of ournew business.

 

In December 2003,and January 2004, WorldGate announced investments aggregating to a totalof $3100 by certain institutional investors. These investors purchased an aggregate of 3,000,000 shares of newlyissued common stock. The investors also received a right, for a limited periodof time, to purchase additional shares of up to 20% of the common stockpurchased by the investors in their investment, at the same price as theirinvestment, and five-year warrants to purchase up to 30% of the common stockpurchased by the investors in their investment, at an exercise price equal to atwenty-five percent premium to their purchase price for the investment.  The purchase price for the 2,000,000 sharespurchased in December 2003 transactions was $0.80 per share, with thewarrants having a $1.00 per share exercise price.  The purchase price for the 1,000,000 sharespurchased in the January 2004 transaction was $1.50 per share, with thewarrants having a $1.875 per share exercise price.  All additional invested rights associatedwith the December 2003 transaction were exercised during January and February of2004, resulting in an incremental investment of $320.

 

In December 2003,WorldGate announced that it reached agreement with Mototech, Inc. for thepurchase of 625,000 shares of newly issued common stock at $0.80 per share, inreturn for future design and engineering services by Mototech.  WorldGate previously announced in November 2003,that it had contracted with Mototech to assist the Company with the design andvolume manufacture of WorldGate’s Ojo personal video phone. The purchase pricefor these shares will be paid by an equivalent reduction in the development andinitial procurement payments that would otherwise be due to Mototech. The valueof this transaction was $600 (based on the closing stock price of $0.96 on thedate of the transaction) of which $200 was recorded as an expense for the yearended December 31, 2003.  Theremaining $400 was recorded as unearned compensation in stockholders equity section inthe accompanying balance sheet.  Mototechis an affiliate of Accton Technology Group, a group of Taiwanese manufacturersthat we believe are well-known in the electronics industry.  They currently manufacture and distribute afull range of high performance, high speed data and computer networkingproducts, including cable set top boxes, home gateways, wireless LANs, hubs,switches, routers, and other related products. In addition, in April 2004, Mototech invested $1,000 to purchase666,666 shares of newly issued common stock at $1.50 per share.

 

Our Company has sufferedrecurring losses from operations and had a net accumulated deficiency of$198,000 as of December 31, 2003, and these issues raise substantial doubtabout our Company’s ability to continue as a going concern. Our short term cashrequirements and obligations include inventory, accounts payable and capitalexpenditures from continuing operations, operating expenses, and leasecommitments. We expect, based on our internal forecasts and assumptionsrelating to our operations (including among others, assumptions regarding ourshort term cash requirements and our projected revenue growth ) that we havesufficient cash on hand to meet our obligations for at least the next twelvemonths.

 

Our ability to generatecash is dependant upon the sale of our Ojo product and on obtaining cash throughcapital markets.  We have not generatedany revenue from commercial shipments of our Ojo product and we do not knowwhen or if we will. Given that our video phone business involves thedevelopment of a new product line with no market penetration, in an undevelopedmarket sector, no assurances can be given that sufficient sales, if any, willmaterialize.

 

Additionally, as needed,we plan to generate cash by turning to the capital markets for funding.  Although we raised $3,345in financing in December 2003 and January 2004, no assurances can begiven that, if pursued, additional financing transactions can beconsummated.  We continue to evaluatepossibilities to obtain additional

 

8

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financing through publicor private equity or debt offerings, bank debt financing, assetsecuritizations, or from other sources, should we need to obtain suchfinancing.  Such additional financingwould be subject to the risk of availability, may be dilutive to our shareholders,or could impose restrictions on operating activities. There can be no assurancethat this additional financing will be available on terms acceptable to us, ifat all.

 

We, however, remainhopeful that sufficient sales will materialize and/or that sufficient fundingcan be developed through ongoing operations or additional financings tocontinue our operations beyond the next twelve months.

 

Our long term cashrequirement obligations are primarily comprised of the items noted above. Wehave no long term debt and our contractual cash requirements and obligationsexisting beyond the next twelve months are comprised solely of the operatinglease commitments described above.  Wehave limited capacity to further reduce our workforce and scale back on capitaland operational expenditures to decrease our cash usage.

 

4.                                       RecentAccounting Pronouncement.

 

On January 1, 2003.WorldGate adopted SFAS No. 143, *Accountingfor Asset Retirement Obligations*, which addresses financialaccounting and reporting for obligations associated with the retirement oftangible long-lived assets and the associated asset retirement costs. Theadoption of SFAS No. 143 did not have any impact on WorldGate’s financialposition or results of operations.

 

On January 1, 2003,WorldGate adopted Financial Accounting Standards Board (FASB) Interpretation No. 45,*Guarantor’s Accounting and DisclosureRequirements for Guarantors, Including Indirect Guarantees of Indebtedness ofOthers*, which requires that upon issuance of a guarantee, theguarantor must recognize a liability for the fair value of the obligation thatit assumes under the guarantee. Guarantors are also required to meet expandeddisclosure obligations. The adoption of Interpretation No. 45 did not havea material impact on WorldGate’s financial position or results of operations.

 

In January 2003,the FASB issued Interpretation No. 46, *Consolidationof Variable Interest Entities*. Interpretation No. 46 addressesconsolidation by business enterprises of variable interest entities, which areentities that either (a) do not have equity investors with vesting rightsor (b) have equity investors that do not provide sufficient financialresources for the entity to support its activities. The interpretation iseffective immediately for variable interest entities created after February 1,2003. In December 2003, the FASB published FASB Interpretation No. 46(revised December 2003), *Consolidationof Variable Interest Entities* (FIN 46(R)). FIN 46(R), among otherthings, defers the effective date of implementation for certain entities. Therevised interpretation is effective for the first interim or annual reportingperiod ending after March 15, 2004, with the exception of structures thatare commonly referred to as special-purpose entities, for which the statementis effective for periods ending after December 15, 2003. The adoption ofInterpretation No. 46 is not expected to have a material impact onWorldGate’s results of operations or financial position.

 

In April 2003, theFASB issued SFAS No. 149, *Amendment ofStatement No. 133 on Derivative Instruments and Hedging Activities*.This statement amends and clarifies financial accounting and reporting forderivative instruments, including certain derivative instruments embedded inother contracts and for hedging activities under SFAS No. 133. SFAS No. 149requires that contracts with comparable characteristics be accounted forsimilarly. The statement is effective for contracts entered into or modifiedafter June 30, 2003 and for hedging relationships designated after June 30,2003. The provisions of SFAS No. 149 generally are to be appliedprospectively only. The adoption of SFAS No. 149 did not have a materialimpact on WorldGate’s results of operations or financial position.

 

In May 2003, theFASB issued SFAS No. 150, *Accountingfor Certain Financial Instruments with Characteristics of both Liabilities andEquity*. SFAS No. 150 establishes standards for classificationand measurement by an issuer of certain financial instruments withcharacteristics of both liabilities and equity. The statement requires that anissuer classify a financial instrument that is within the scope as a liability(or asset in some circumstances). This statement is effective for financialinstruments entered into or modified after May 31, 2003, and otherwise iseffective at the beginning of the first interim period beginning after June 15,2003, except as it relates to consolidated limited-life subsidiaries. The FASBindefinitely deferred the effective date of this statement as it relates tocertain mandatorily redeemable non-controlling interests in consolidatedlimited-life subsidiaries. WorldGate does not have any interest in limited-lifeentities as of December 31, 2003. The adoption

 

9

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of the effectiveprovisions of SFAS No. 150 did not have an impact on WorldGate’s resultsof operations or financial position.

 

In December 2003,the FASB issued SFAS No. 132 (revised 2003), *Employer’s Disclosures about Pensions and Other Postretirement Benefits*.This statement revises employers’ disclosures about pension plans and otherpostretirement benefit plans; however it does not change the measurement orrecognition of those plans required by SFAS No. 87, *Employers’ Accounting for Pensions*, SFAS No. 88,*Employers’ Accounting for Settlements andCurtailments of Defined Benefit Pension Plans and for Termination Benefits*,and SFAS No. 106, *Employers’ Accountingfor Postretirement Benefits Other Than Pensions*. The revisedstatement retains the disclosure requirements contained in the original SFAS No. 132and requires additional disclosures to those in the original statement aboutthe assets, obligations, cash flows, and net periodic benefit cost of definedbenefit pension plans and other defined benefit postretirement plans. Therevised statement is effective for fiscal years ending after December 15,2003.

 

5.                                       Inventories.

 

Inventories aresummarized as follows:

 
| ** **                                   | ** ** | **March 31, 2004** | ** ** | **December 31, 2003** | ** ** |
|----------------------------------------------|------------|-------------------------|------------|----------------------------|------------|
|                                         |       |                    |       |                       |       |
| Raw material (from  discontinued operations) |       | $                       | 1,622      |                       | $          | 1,622 |   |
| Work in progress                             |       | —                  |       | —                     |       |
| Finished goods                               |       | —                  |       | —                     |       |
| Inventory held by  customers and vendors     |       | —                  |       | —                     |       |
| Total inventory                              |       | 1,622                   |       | 1,622                      |       |
| Inventory reserve                            |       | (1,622                  | )          | (1,622                     | )          |
| Inventory, net                               |       | $                       | —     |                       | $          | — |   |

 

6.                                       Stock-BasedCompensation (as restated).

 

The Company accounts forstock-based compensation in accordance with Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees,” as amended by SFAS No. 148,“Accounting for Stock-Based Compensation—Transition and Disclosure”.

 

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

 
| ** **                                                                                                                           | ** ** | **For the Three Month Period** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------------------|------------|
| ** **                                                                                                                           | ** ** | **Ended March 31,**       | ** ** |
| ** **                                                                                                                           | ** ** | **2004**                       | ** ** | **2003** | ** ** |
| ** **                                                                                                                           | ** ** | **(As restated)**              | ** ** | ** ** | ** ** |
| Net loss:                                                                                                                            |       |                           |       |   |   |
| As  reported                                                                                                                         |       | $                              | (2,108     | ) | $ | (1,885 | ) |
| Add:  Stock-based compensation expense included in reported net loss, net of  related tax effects of $0                              |       | 0                              |       | 40 |   |
| Deduct:  Total stock-based employee expense determined under the fair value based  method for all awards, net of related tax effects |       | (2,249                         | )          | (1,420 | ) |
| Pro  forma net loss                                                                                                                  |       | (4,357                         | )          | (3,265 | ) |
|                                                                                                                                 |       |                           |       |   |   |
| Net  Loss per share:                                                                                                                 |       |                           |       |   |   |
| Basic  and diluted – as reported                                                                                                |       | (0.08                          | )          | (0.08 | ) |
| Basic  and diluted – pro forma                                                                                                  |       | (0.16                          | )          | (0.14 | ) |
|                                                                                                                                      |            |                                |            |  |  |  |  |

 

10

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Suchpro forma disclosures may not be representative of future compensation expensebecause options vest over several years and additional grants are made eachyear.

 

7.                                       RelatedParty Transactions.

 

In 1997, the Companyentered into agreements with certain cable operators who are investors.  Revenues recognized from such investors wereapproximately $0 and $57, for the three months ended March 31, 2004 and March 31,2003, respectively. Accounts receivable from such investors amounted toapproximately $0 at March 31, 2004 and $2 at December 31, 2003.

 

The Company hasagreements with some investors for the investors to provide engineering anddevelopment support. As a result of those agreements, the Company has expensedapproximately $0 and $391, respectively, for the three months ended March 31,2004 and March 31, 2003, respectively. Accounts payable to thesestockholders amounted to $316 and $170 at March 31, 2004 and December 31,2003, respectively. Some of these stockholders were suppliers of technology andcomponents for the Company’s discontinued ITV products and services. Theseagreements provided for licensing of technology, as well as contractedservices, including hardware and software development, product testing andcertification, and the creation and development of tools and systems tofacilitate the Company’s engineering efforts. These agreements did not providefor ongoing royalties, purchase provisions, or for any requirement to provideadditional funding to the Company.

 

 In 1998 the Company entered into a leasingarrangement for a building with an entity formed by non-employee investors.Included in deposits and other assets at March 31, 2004 and 2003 is $0 and$750, respectively, related to this lease. The Company has not paid its rent onits current facility since May 2003. As a result, its landlord, 3190 TGeneral, Inc. in September 2003, filed an action in the Court ofCommon Pleas, Bucks County Pennsylvania to perfect its interest to takepossession of the Company’s facility at any time, and to establish damages forpast rent and expenses. Although a judgment has been granted allowing theCompany’s landlord to regain possession of the facility, the Company remains inthe facility and is in the process of negotiating a settlement of its leaseobligation with the landlord in an effort to reduce the Company’s outstandingliability and secure the continued right to occupy the facility with a reducedongoing lease obligation, although there can be no assurance that a settlementcan be obtained. In lieu of monthly rent payments of $104 (offset by monthlysublease payments by TVGateway of $19 during the period February 1, 2003through January 31, 2004), the Company’s landlord has drawn down from itssecurity deposit to satisfy the unpaid rent of $911 as of March 31, 2004.As of March 31, 2004, the amount of the deposit remaining after deductionfor the unpaid rent is $0.  The Companyhas continued to accrue the full rent expense through March 31, 2004.

 

8.                                    TVGatewayJoint Venture and related Cable Operator Agreements.

 

On July 24, 2000,the Company formed a separate joint venture, TVGateway, LLC, with four cableoperators.  As part of this ventureWorldGate entered into a management agreement with TVGateway to provideengineering, operations and administrative support services. In addition toproviding for the terms and conditions under which such services were to beprovided, the management agreement provided for WorldGate and TVGateway tocooperate to transition to TVGateway some or all of the support services beingprovided by WorldGate and/or the employees providing these services. Inaddition, this provision required WorldGate to remain available to providesupport services until July 24, 2005. During 2002 WorldGate and TVGatewayagreed to commence the transition of services pursuant to this provision. Inaddition, the parties agreed that the management agreement would be of nofurther force and effect with respect to the services that are transferred asof the date of completion of the specific transfers. The companies completedthis transition in the first quarter 2003, and accordingly, WorldGate has nowbeen relieved of any continuing obligation to provide such transitionedservices.  Further, WorldGate will nolonger receive future revenues from the management agreement with TVGateway.

 

Revenues for suchservices, which are included in service fee revenue, totaled $0, and $732,respectively for the three months ended March 31, 2004 and 2003. Inaddition, product sales to TVGateway totaled $0 and $1,079 for the three monthsended March 31, 2004 and 2003. Accounts Receivable from TVGateway amountedto $0 at March 31, 2004 and $0 at December 31, 2003. WorldGate wasaccounting for its 18% investment in the TVGateway joint venture, which waspreviously reduced to a carrying value of $0 due to prior losses, under the

 

11

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equity method.

 

On September 30,2003 the Company announced that it had sold to TVGateway, LLC certain ITVintellectual property rights and certain software and equipment related to theITV business, which TVGateway was currently using, for $2,400.  In addition, on August 7, 2003,WorldGate and TVGateway entered into a redemption agreement pursuant to whichTVGateway redeemed WorldGate’s equity interest in TVGateway for $600 incash.  The purchase price for theseassets in the aggregate was $3,000 and was used by the Company to fundcontinuing operations, as well as to develop and distribute its new Ojo videotelephony product. As part of this transaction WorldGate retained aroyalty-free license to certain of the transferred intellectual property rightsand software. At this time the Company does not plan to continue to supportthis interactive television (ITV) business.

 

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

 

9.                                       NetLoss per Share.

 

Basic and diluted netloss per common share is computed by dividing the net loss available to commonstockholders for the period by the weighted average number of shares of commonstock outstanding during the period.  Thecalculation of diluted net loss per common share excludes potential common sharesif the effect is antidilutive.  Potentialcommon shares comprise shares of common stock issuable upon the exercise ofstock options and warrants.  The numberof potential common shares which would have been assumed to be converted in theperiods ended March 31, 2004 and 2003 and have a dilutive effect if theCompany had income from continuing operations, or if the options’ exerciseprice was less than the average market price of the common shares, is 8,065,111and 6,500,833, respectively.

 

# ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIALCONDITION AND  RESULTS OF OPERATIONS.

#  

(Dollar Amountsare in Thousands, Except per Share Amounts)

 

FORWARD-LOOKINGAND CAUTIONARY STATEMENTS.

 

We may from time to timemake written or oral forward-looking statements, including those contained inthe following Management’s Discussion and Analysis of Financial Condition andResults of Operations. The words “estimate,” “project,” “believe,” “intend,” “expect,”and similar expressions are intended to identify forward-looking statements,although not all forward-looking statements contain these identifying words. Inorder to take advantage of the “safe harbor” provisions of the PrivateSecurities Litigation Reform Act of 1995, we are hereby identifying certainimportant factors, which could cause our actual results, performance orachievement to differ materially from those that may be contained in or impliedby any forward-looking statement made by or on behalf of WorldGate.  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 or inability to raiseadditional financing on terms acceptable to us, (2) difficulty indeveloping and implementing marketing and business plans, (3) continuedlosses, (4) industry competition factors and other uncertainty that amarket for our products will develop, (5) challenges associated withbroadband operators (including, uncertainty that they will offer our products,inability to predict the manner in which they will market and price ourproducts and existence of potential conflicts of interests and contractuallimitations impeding their ability to offer our products), (6) departureof one or more key persons,  (7) delistingof our Common Stock from the NASDAQ Small Cap Market, (8) changes inregulatory requirements, and (9) other risks identified in our filingswith the Securities and Exchange Commission. We caution you that the foregoing list of important factors is notintended to be, and is not, exhaustive. We do not undertake to update any forward-looking statement that may bemade from time to time by or on behalf of WorldGate.

 

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Results of Operations:

 

General

 

Our ITV business hashistorically accounted for substantially all of our revenue.  In the third quarter of 2003, we completed asale of significant assets, including our ITV intellectual property rights andour membership interest in TVGateway, LLC. This transaction marked a shift in our business away from the ITVbusiness and toward a new video phone product and related business.  Although we continued to support ourremaining ITV business into the first quarter of 2004, the development of ourvideo phone product has become a primary business focus.

 

Our video phone businesshas not produced revenues to date.  Theextent and timing of future revenues for our business depends on severalfactors, including our ability to develop our video phone product, the rate ofmarket acceptance of our products and the degree of competition from similarproducts.  We cannot predict to whatextent our video phone product will produce revenues, or when, or if, we willreach profitability.

 

Critical AccountingPolicies and Estimates.

 

The consolidatedfinancial statements are prepared in conformity with accounting principlesgenerally accepted in the United States. The preparation of these financial statements required management tomake estimates and assumptions that affect the reported amounts of assets andliabilities and disclosure of contingent assets and liabilities at the date ofthe financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from those estimates.

 

The significantaccounting policies of the Company are described in the notes to theconsolidated financial statements included in the annual report on Form 10-K.  Judgments and estimates of uncertainties arerequired in applying the Company’s accounting policies in many areas.  Following are some of the areas requiringsignificant judgments and estimates: revenue recognition, accounts receivable, inventories, and cash flow andvaluation assumptions in performing asset impairment tests of long-livedassets.

 

Discontinued Operations

 

During the first quarterof 2004 the Company transitioned from the business of developing and sellinginteractive television, or ITV, technology, products and services for use inconjunction with cable TV broadband networks (the “ITV business”) to the developmentof our video phone products as our primary business focus. During the threemonths ended March 31, 2004 the Company had revenues from discontinuedoperations of $82, compared to revenues of $2,165 for the three months ended March 31,2003.  This reduction of $2,083 reflectsservice revenues of $0 and $978 for the three months ended March 31, 2004and 2003, respectively, and equipment revenues of $82 and $1,187 for the threemonths ended March 31, 2004 and 2003, respectively. Concurrently, operatingexpenses, consisting of Research and Development, Marketing and General andAdministration costs were also reduced as a result of the transition from theITV business.  These expenses were $16for the three months ended March 31, 2004, compared to $2,619 for thethree months ended March 31, 2003.

 

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

 

Three Months Ended March 31,2004 and March 31, 2003 (as restated)

 

Revenues.

 

Revenues.  There were no revenues from continuingoperations during the three months ended March 31, 2004 and March 31,2003. Expectation is that revenues from video phones will not be realizeduntil, at the earliest, the third quarter of 2004.

 

13

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Costs and Expenses.

 

Cost of Revenues.  There were no costs of revenues fromcontinuing operations during the three months ended March 31, 2004 and March 31,2003. Expectation is that costs of revenues from video phones will not beincurred until, at the earliest, the third quarter of 2004.

 

Engineering andDevelopment.  Engineering and developmentexpenses primarily consist of compensation, and the cost of design,programming, testing, documentation and support of the Company’s video phoneproduct.  Engineering and developmentcosts were $800 for the three months ended March 31, 2004, compared with$535 for the three months ended March 31, 2003.  This increase of $264, or 49%, reflects theCompany’s increased concentration of its engineering staff, and related costs,for the further and continuing development of our video phone product.

 

Sales and Marketing.  Sales and marketing expenses consistprimarily of compensation, attendance at conferences and trade shows, travelcosts, promotions and other marketing programs related to the introduction ofthe Company’s video phone product.  Salesand marketing costs were $191 for the three months ended March 31, 2004,compared with $86 for the three months ended March 31, 2003.  This increase of $105, or 122%, reflects theincreased effort of staff, and related marketing and promotional expenditures,for the Company’s video phone product.

 

General andAdministrative-as restated.  General andadministrative expenses consist primarily of expenditures for administration,office and facility operations, finance and general management activities,including legal, accounting and professional fees.  General and administrative expenses were $1,044for the three months ended March 31, 2004, compared with $192 for thethree months ended March 31, 2003. This increase of $852, or 444%, is primarily attributable to the Company’stransition of nearly all, or 99%, of its administrative managementcompensation, facility, legal, finance and professional consulting fees towardthe further development of the video phone business.  For the three months ended March 31,2003, video phone related costs were 20% of total General and Administrativeexpenses of $962.

 

Interest and Other Incomeand Interest Expense.  Interest and otherincome and interest expense consist of interest earned on cash and cashequivalents, and interest expense on short-term debt.  Interest and other income decreased from $27for the three months ended March 31, 2003 to $7 for the three months endedMarch 31, 2004, primarily due to declining interest rates.  During the three months ended March 31,2003, the Company earned interest on average cash balances of approximately$3,712 and incurred interest expense related to its insurance financing.  In comparison, during the three months ended March 31,2004 the Company earned interest on average cash balances of approximately$3,878 and incurred interest expense related to its insurance financing.

 

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

 

Liquidity and CapitalResources.

 

As of March 31,2004, our primary source of liquidity consisted of cash and cash equivalentsthat are highly liquid, are of high quality investment grade and havematurities of less than one year.

 

At March 31, 2004,we had cash and cash equivalents of $3,448 (and no short-term investments) ascompared to cash and equivalents of $3,365 (and no short-term investments) at December 31,2003.  Net cash used in continuingoperations was $1,779 for the three months ended March 31, 2004, ascompared to $813 used for the same period in 2003. This increase in net cashused for continuing operations was primarily attributable to the Company’sincrease in expenditures related to the video phone business.  The Company recorded bad debt expense in theamount of $16 from discontinued operations during the three months ended March 31,2004 to reflect its current assessment of the collectability of certainreceivables.

 

Cash provided byinvesting activities from continuing operations during the three months ended March 31,2004, totaled $1,831 compared to $0 provided during the same period in2003.  During the three months ended March 31,2004 net proceeds from our maturing short-term investments were $0 compared to$746 for the three months ended March 31, 2003.  Capital expenditures were $6 and $0 for thethree months ended March 31, 2004 and 2003, respectively.  During the third quarter of 2003, wecompleted a sale of certain assets, including our ITV intellectual propertyrights and our membership interest in TVGateway, LLC, for $3,000 in cash toTVGateway, LLC, a company we were instrumental in forming.

 

14

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Operations and Liquidity.

 

To date, the Company has funded operations primarilythrough private sales of equity securities and through an initial publicoffering of common stock in April 1999. As of March 31, 2004 the Company had cash, and cash equivalents of$3,448.  The operating cash usage fromcontinuing operations for the three months ended March 31, 2004 was$1,779.  As of March 31, 2004 wehave no outstanding debt and our assets are not pledged as collateral.  However, we have not paid our monthly rent of$104 (offset by monthly sublease payments by TVGateway of $19 during the periodFebruary 1, 2003 through January 31, 2004) on our current facilitysince May 2003.  As a result, ourlandlord, a non-employee investor, has perfected its interest to takepossession of our facility at any time and has drawn down from our rent depositto satisfy the unpaid rent of $911 as of March 31, 2004.  As of March 31, 2004 the amount of thedeposit remaining is $0 after deduction for the unpaid rent.  The Company has continued to accrue the fullrent expense through March 31, 2004. We continue to negotiate with our landlord to resolve this matter.  We also continue to evaluate possibilities toobtain additional financing through public or private equity or debt offerings,bank debt financing, asset securitizations, or from other sources.  Such additional financing would be subject tothe risk of availability, may be dilutive to our shareholders, or could imposerestrictions on operating activities. There can be no assurance that this additional financing will beavailable on terms acceptable to us, if at all. The Company has limited capacity to further reduce its workforce andscale back on capital and operational expenditures to decrease cash burn giventhe measures it has already taken to reduce staff and expenses.

 

With the private placement of the Company’s common stock inJanuary 2004, which provided proceeds of $1,500, and the private placementof the Company’s common stock in April 2004 providing proceeds of $1,000,the Company projects it will have sufficient funding to continue operationsinto the fourth quarter of 2004, assuming no additional funding isreceived.  To this end, we have been discussing,and continue to discuss, possible financing transactions with severalparties.  No assurances can be given thata transaction can be consummated prior to the depletion of our availablecash.  We however remain hopeful thatsufficient funding can be obtained to continue the Company’s operations.

 

The report of theindependent registered public accounting firm for the year ended December 31,2003 included an explanatory paragraph stating that our Company had sufferedrecurring losses from operations and had a net accumulated deficiency of$198,000, and that these issues raised substantial doubt about our Company’sability to continue as a going concern. Our short term cash requirements andobligations include inventory, accounts payable and capital expenditures fromcontinuing operations, operating expenses, and lease commitments. We expect,based on our internal forecasts and assumptions relating to our operations(including among others, assumptions regarding our short term cash requirementsand our projected revenue growth ) that we have sufficient cash on hand to meetour obligations for at least the next twelve months.

 

Our ability to generatecash is dependant upon the sale of our Ojo product and on obtaining cashthrough capital markets.  We have notgenerated any revenue from commercial shipments of our Ojo product and we donot know when or if we will. Given that our video phone business involves thedevelopment of a new product line with no market penetration, in an undevelopedmarket sector, no assurances can be given that sufficient sales, if any, willmaterialize.

 

Additionally, as needed,we plan to generate cash by turning to the capital markets for funding.  Although we raised $3,345in financing in December 2003 and January 2004, no assurances can begiven that, if pursued, additional financing transactions can beconsummated.  We continue to evaluatepossibilities to obtain additional financing through public or private equityor debt offerings, bank debt financing, asset securitizations, or from othersources, should we need to obtain such financing.  Such additional financing would be subject tothe risk of availability, may be dilutive to our shareholders, or could imposerestrictions on operating activities. There can be no assurance that thisadditional financing will be available on terms acceptable to us, if at all.

 

We, however, remainhopeful that sufficient sales will materialize and/or that sufficient fundingcan be developed through ongoing operations or additional financings tocontinue our operations beyond the next twelve months.

 

Our long term cashrequirement obligations are primarily comprised of the items noted above. Wehave no long term debt and our contractual cash requirements and obligationsexisting beyond the next twelve months are comprised solely of the operatinglease commitments described above.  Wehave limited capacity to further reduce our workforce and scale back on capitaland operational expenditures to decrease our cash usage.

 

15

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In December 2003, WorldGate reached agreement withMototech, Inc. for the purchase of 625,000 shares of newly issued commonstock at $0.80 per share, in return for future design and engineering servicesby Mototech. WorldGate had previously contracted with Mototech to assist theCompany with the design and volume manufacture of WorldGate’s Ojo personalvideo phone. As compensation for these shares the Company will receive anequivalent reduction in future development and initial procurement paymentsthat would otherwise be due to Mototech. The value of this transaction was $600 (based on the closing stock priceof $0.96 on the date of the transaction) of which $200 was recorded as anexpense for the year ended December 31, 2003.  The remaining $400 wasrecorded as unearned compensation in stockholders equity section in the accompanying balance sheet. Mototech is an affiliate of AcctonTechnology Group, a group of Taiwanese manufacturers that we believe arewell-known in the electronics industry. Mototech currently manufactures anddistributes a full range of high performance high speed data and computernetworking products, including cable set top boxes, home gateways, wirelessLANs, hubs, switches, routers, and other related products. In addition, in April 2004,Mototech invested $1,000 to purchase 666,666 shares of newly issued commonstock at $1.50 per share.

 

16

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# ITEM 3.     QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

#  

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

 

As of March 31,2004, the Company’s cash and cash equivalents were $3,448, most of which weresecurities having a maturity of less than one year, and it had no short-terminvestments.  Due to the average maturityand conservative nature of our investment portfolio, management believes asudden change in interest rates would not have a material effect on the valueof the portfolio. Management estimates that had the average yield of ourinvestments decreased by 100 basis points, our interest income for the threemonths ended March 31, 2004 would have decreased by approximately $18.This estimate assumes that the decrease occurred on the first day of 2004 andreduced the yield of each investment instrument by 100 basis points.  The impact on our future interest income offuture changes in investment yields will depend largely on our totalinvestments.

 

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

 

# ITEM 4.     CONTROLS ANDPROCEDURES.

#  

As of the end of the periodcovered by this Form 10-Q, our management, with the participation of ourchief executive officer and chief financial officer, conducted an evaluation ofthe effectiveness of our disclosure controls and procedures (as defined in Rules 13a-15(e) and15d -15(e) under the Securities Exchange Act of 1934, as amended (the “ExchangeAct”)).

 

Based on that evaluation,our chief executive officer and chief financial officer determined that we havea material weakness (as defined under the standards established by the AmericanInstitute of Certified Public Accountants) that exists with respect to ourreporting of complex transactions. As a result of this material weakness, werestated our financial statements in this Form 10-Q.

 

To address this materialweakness, we have engaged outside experts to provide counsel and guidance inareas where we cannot economically maintain the required expertise internally(e.g., with the appropriate classifications and treatments of complex andnon-routine transactions).

 

As a result of the materialweakness identified with respect to our reporting of complex transactions, thechief executive officer and chief financial officer concluded that ourdisclosure controls and procedures are not designed and effective in ensuringthat the information required to be disclosed by our company in the reportsthat we file and submit under the Exchange Act is recorded, processed,summarized and reported within the time periods specified in the Commission’s rules andforms.  Except as identified above, there have been no changes in ourinternal control over financial reporting that occurred during the quarterended March 31, 2004, that have materially affected, or are reasonablylikely to materially affect, our internal control over financial reporting.

 

17

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PART II.OTHER INFORMATION

 

(Dollar Amountsare in Thousands, Except per Share Amounts)

 

# ITEM1.     LEGALPROCEEDINGS.

#  

We have not paid our renton our current facility since May 2003. As a result, our landlord, 3190 T General, Inc. has filed an actionin the Court of Common Pleas, Bucks County Pennsylvania to perfect its interestto take possession of our facility at any time, and to establish damages forpast rent and expenses.  Although ajudgment has been granted allowing our landlord to regain possession of thefacility, we remain in the facility and in the process of negotiating asettlement of our lease obligation with the landlord in an effort to reduce ouroutstanding liability and secure the continued right to occupy the facilitywith a reduced ongoing lease obligation, although there can be no assurancethat a settlement can be obtained.  Inlieu of rent payments our landlord has been drawing down from our securitydeposit to satisfy the unpaid rent.  Asof February 2004, the security deposit has been fully utilized.

 

ITEM 2.  CHANGES IN SECURITIES ANDUSE OF PROCEEDS.

 

On January 21, 2004, wecompleted a private placement to certain institutional investors of 1,000,000shares of our common stock at a sale price of $1.50 per share, five-yearwarrants to purchase up to 300,000 shares of our common stock at an exerciseprice of $1.875 per share, and additional investment rights to purchase, for alimited period of time, up to 200,000 shares of our common stock at an exerciseprice of $1.50 per share. In addition, we agreed to issue warrants to purchaseup to an additional 10,000 shares of our common stock at an exercise price of$1.875 per share upon the exercise of the additional investment rights.

 

The private placementresulted in gross proceeds to the Company of approximately $1,500. AshendenFinance acted as the Company’s placement agent with respect to the PrivatePlacement and received a fee equal to 3% of the gross proceeds. In addition,Janney Montgomery Scott LLC received a fee equal to 1% of the gross proceedsfrom the Private Placement in connection with its engagement by the Company.

 

The common shares,warrants, and additional investment rights were issued in reliance upon theexemption from the registration requirements of the Securities Act afforded totransactions not involving a public offering by Section 4(2) of that Act andRule 506 thereunder.

 

The resale of thesecurities issued in the private placement was registered on Form SB-2(Registration No. 333-114143). This registration statement covers there-sale of the common stock issued in connection with the January privateplacement, as well as the re-sale of any remaining securities issued inconnection with our December 2004 private placements, and the common stockissuable upon exercise of the warrants, additional investment rights, andadditional investment right warrants.

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

#  

None.

 

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

#  

None.

 

# ITEM5.  OTHERINFORMATION.

#  

*Relationshipwith Motorola, Inc.*

 

On April 28, 2004,we entered into a Development and Distribution Agreement with GeneralInstrument Corporation d/b/a the Broadband Communication Sector of Motorola, Inc.,or Motorola, pursuant to which Motorola has agreed to distribute our Ojo videophone on a worldwide basis. The agreement provides for WorldGate to become theexclusive supplier of broadband video phones to Motorola, and Motorola tobecome the exclusive supplier of our Ojo video phone products. This mutuallyexclusive relationship would also be subject to certain time restrictions, and couldbe extended or terminated under certain circumstances specified in the

 

18

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agreement. Pursuant tothe Development and Distribution Agreement, Motorola will advance $1,000 to usas a credit against product purchases in various installments based upon theachievement of certain milestones relating to the product.

 

As part of theDevelopment and Distribution Agreement with Motorola, we issued a warrant toMotorola to purchase 300,000 shares of our common stock at an exercise price of$1.4375 per share, and we agreed to issue additional warrants to purchase up toan additional 1,950,000 shares of our common stock, upon the achievement ofcertain product and sales milestones, at an exercise price based upon theaverage closing sales price of our common stock during the 20 day periodpreceding the issuance of each warrant. We also granted Motorola a license touse our intellectual property rights relating to the Ojo video phone solely inconnection with their distribution of the Ojo video phone under the Agreement.

 

*PrivatePlacement to Mototech, inc.*

 

On April 23, 2004,we announced that we had completed a private placement of 666,666 shares of ourcommon stock to Mototech, Inc., at a sale price of $1.50 per share,resulting in proceeds to the Company of $1,000. WorldGate previously announced in November 2003 that it hadcontracted with Mototech Inc. to assist the Company with the design and volumemanufacture of WorldGate’s Ojo personal video phone.

 

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#  

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

 

(a)             Exhibits.

 

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

 
| **Exhibit** | ** ** | **Description**                                                                                                                                                                                                                                                                                                                                            |
|-------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|        |       |                                                                                                                                                                                                                                                                                                                                                       |
| 2.1         |       | Asset Purchase  Agreement dated as of August 6, 2003 between the Company and TVGateway,  LLC (1)                                                                                                                                                                                                                                                      |
| 3.1         |       | Amended and Restated  Certificate of Incorporation (2)                                                                                                                                                                                                                                                                                                     |
| 3.2         |       | Amended and Restated  Bylaws (2)                                                                                                                                                                                                                                                                                                                           |
| 4.1         |       | Form of Warrant  issued by the Company to the Purchasers (as defined in the Amended and  Restated Securities Agreement between the Company and the Purchasers dated as  of December 4, 2003) (3)                                                                                                                                                 |
| 4.2         |       | Form of Additional  Investment Right issued by the Company to the Purchasers (as defined in the  Amended and Restated Securities Agreement between the Company and the  Purchasers dated as of December 4, 2003) (3)                                                                                                                             |
| 4.3         |       | Form of  Warrant dated as of January 21, 2004 issued by the Company to the  Purchasers (as defined in the Securities Purchase Agreement dated as of January 21,  2004) (4) (filed as Exhibit 4.1 to the January 8-K)                                                                                                         |
| 4.4         |       | Form of  Additional Investment Right dated as of January 21, 2004 issued by the  Company to the Purchasers (as defined in the Amended and Restated Securities  Agreement dated as of January 21, 2004 between the Company and the  Purchasers) (4) (filed as Exhibit 4.2 to the January 8-K)                                 |
| 10.1        |       | Lease Agreement dated October 7,  1998 between WorldGate and Balanced Capital LLC, as amended by First  Amendment to Lease Agreement dated December 7, 1998 between WorldGate  and Balanced Capital LLC, as further amended by Second Amendment to Lease  Agreement dated December 17, 1998 between WorldGate and Balanced Capital  LLC (5) |
| 10.2        |       | Manufacturing Agreement  between WorldGate and Mototech Inc. dated September 9, 2003 (6)                                                                                                                                                                                                                                                              |
| 10.3        |       | First Amended and  Restated Stockholders’ Agreement dated September 2, 1998 among WorldGate  and the stockholders identified therein (5) (filed as Exhibit 10.16  to the IPO Registration Statement)                                                                                                                                   |
| 10.4        |       | Amendment to First  Amended and Restated Stockholders’ Agreement dated July 21, 2000 among  WorldGate and the stockholders identified therein (7) (filed as Exhibit 10.9  to the 2000 Annual Report)                                                                                                                                   |
| 10.5        |       | Amended and Restated  1996 Stock Option Plan, as amended (7) (filed as Exhibit 10.10 to  the 2000 Annual Report)                                                                                                                                                                                                                                 |
| 10.6        |       | 2001 Employee Stock  Purchase Plan (7) (filed as Exhibit 10.11 to the 2000 Annual  Report)                                                                                                                                                                                                                                                       |
| 10.7        |       | Amended and Restated  Securities Purchase Agreement dated as of December 4, 2003 by and  between the Company and the Purchasers (as defined therein) (8) (filed  as Exhibit 99.1 to the December 8-K)                                                                                                                                  |
| 10.8        |       | Securities Purchase  Agreement dated as of January 21, 2004 by and between the Company and  the Purchasers (as defined therein) (4) (filed as Exhibit 99.1 to the January 8-K)                                                                                                                                                         |
| 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*                                                                                                                                                                                                 |

 

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*                                         Filedherewith.

 

(1)                                  Incorporatedby reference to the exhibits to Exhibit A to the Company’s Proxy Statementdated August 26, 2003.

 

(2)                                  Incorporatedby reference to the exhibits to the Company’s Form 10-Q Report for thequarter ended

 

20

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March 31, 1999.

 

(3)                                  Incorporatedby reference to the exhibits to the Company’s Current Report on Form 8-Kdated December 2, 2003.

 

(4)                                  Incorporated by reference to Exhibit 4.1 tothe Company’s Current Report on Form 8-K dated January 21, 2004 (the “January 8-K”).

 

(5)                                  Incorporatedby reference to the exhibits to the Company’s Registration Statement on Form S-1(Registration No. 333-71997) (the “IPO Registration Statement”).

 

(6)                                  Incorporatedby reference to the exhibits to the Company’s Registration Statement on Form SB-2(Registration No. 333-111571) (the “SB-2”).

 

(7)                                  Incorporatedby reference to the exhibits of the Company’s Annual Report on Form 10-K/Afor the fiscal year ended December 31, 2000, filed August 17, 2001(the “2000 Annual Report”).

 

(8)                                  Incorporatedby reference to the exhibits to the Company’s Current Report on Form 8-Kdated December 4, 2003 (the “December 8-K”).

 

(b)                                 Reportson Form 8-K.

 

During the fiscal quarterended March 31, 2004, the Company filed the following Current Reports on Form 8-K:

 

On March 15, 2004, aCurrent Report on Form 8-K was filed, reporting under items 7 and 12 thatthe Company announced its earnings for the fiscal year ended December 31,2003.

 

On January 21, 2004,a Current Report on Form 8-K was filed, reporting under items 5 and 7 thatthe Company had entered into definitive agreements with certain institutionalinvestors in connection with a private placement of the Company’s common stockraising gross proceeds to the Company of approximately $1,500.

 

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SIGNATURES

 

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

 

 
|   |             | WORLDGATE  COMMUNICATIONS, INC.               |
|--------|------------------|-----------------------------------------------|
|   |             |                                          |
|   |             |                                          |
| Date:  | January 23, 2006 |                                          | /s/ Hal M. Krisbergh |   |
|   |             | Hal M. Krisbergh                              |
|   |             | Chairman and Chief  Executive Officer         |
|   |             | (Principal Executive  Officer)                |
|   |             |                                          |
|   |             |                                          |
| Date:  | January 23, 2006 |                                          | /s/ Joel Boyarski |   |
|   |             | Joel Boyarski                                 |
|   |             | Vice President and  Chief Financial Officer   |
|   |             | (Principal Financial  and Accounting Officer) |
|        |                  |                                               |  |  |  |  |

 

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