**UNITED STATES**

**SECURITIES AND EXCHANGECOMMISSION**

**WASHINGTON, DC 20549**

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**FORM 10-Q**

| **Mark One**                                                                                                                                                                                                                                                                              |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **x****Quarterly Report Pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934 for the Quarterly Period Ended June 30, 2007.**                                                                                                                                           |
| ** **                                                                                                                                                                                                                                                                                |
| **or**                                                                                                                                                                                                                                                                                    |
| ** **                                                                                                                                                                                                                                                                                |
| **o****Transition Report Pursuant to Section 13 or 15(d) of the Securities  Exchange Act of 1934 for the Transition Period From               To              .** |

**Commission file number:  000-25755**

**WORLDGATE COMMUNICATIONS, INC.**

(Exact Name ofRegistrant as Specified in Its Charter)

| **Delaware**                                                                                               | ** ** | **23-2866697**                        |
|------------------------------------------------------------------------------------------------------------|------------|---------------------------------------|
| (State of  Incorporation)                                                                                  |       | (I.R.S. Employer  Identification No.) |
|                                                                                                       |       |                                  |
| **3190  Tremont Avenue**                                                                                   |
| **Trevose,  Pennsylvania 19053**                                                                           |
| (Address of  Principal Executive Offices)         (Zip  Code) |
|                                                                                                       |       |                                  |
| **(215)  354-5100**                                                                                        |
| (Registrant’s  Telephone Number, Including Area Code)                                                 |

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

 Yes x  No o

Indicate by check mark whether the registrant is a large acceleratedfiler, an accelerated filer , or a non-accelerated filer.  See definition of “accelerated filer andlarge accelerated filer” in Rule 12b-2 of the Exchange Act.
| Large accelerated  filer o |   | Accelerated filer x |   | Non-accelerated filer o |
|---------------------------------|--------|--------------------------|--------|------------------------------|

Indicate by a check mark whether the registrant is ashell company (as defined in Rule 12b-2 of the Exchange Act).

Yes o  No x

As of August 1, 2007, there were 46,044,524 shares of common stock, parvalue $.01 per share, outstanding.

 

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**WORLDGATECOMMUNICATIONS, INC.**

**QUARTERLY REPORT ON FORM 10-Q**

**FOR THETHREE MONTHS ENDED JUNE 30, 2007**

**TABLE OFCONTENTS**
| **PART I. FINANCIAL  INFORMATION** |   |                                                                                        |
|------------------------------------|--------|---------------------------------------------------------------------------------------------|
|                               |   |                                                                                        |
| Item 1.                            |   | Financial Statements                                                                        |   | 3 |
| Item 2.                            |   | Management’s  Discussion And Analysis Of Financial Condition And Results Of Operations |   | 20 |
| Item 3.                            |   | Quantitative  And Qualitative Disclosures About Market Risk                                 |   | 26 |
| Item 4.                            |   | Controls And  Procedures                                                                    |   | 26 |
|                               |   |                                                                                        |   |   |
| **PART II. OTHER  INFORMATION**    |   |                                                                                        |
|                               |   |                                                                                        |   |   |
| Item 1.                            |   | Legal Proceedings                                                                           |   | 27 |
| Item  1A.                          |   | Risk  Factors                                                                               |   | 27 |
| Item 2.                            |   | Unregistered  Sales Of Equity Securities And Use Of Proceeds                                |   | 27 |
| Item 3.                            |   | Defaults  Upon Senior Securities                                                            |   | 28 |
| Item 4.                            |   | Submission  Of Matters To A Vote Of Security Holders                                        |   | 28 |
| Item 5.                            |   | Other Information                                                                           |   | 28 |
| Item  6.                           |   | Exhibits                                                                                    |   | 28 |

 

2

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# **PART I. FINANCIAL INFORMATION**

# **ITEM1.  FINANCIAL STATEMENTS**

**WORLDGATE COMMUNICATIONS, INC.**

**CONDENSED CONSOLIDATED BALANCE SHEETS**

**( InThousands, Except Share and Per Share Amounts)**
| ** **                                                                                                                                                                                  | ** ** | **June 30,   2007** | ** ** | **December 31,   2006** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|
| ** **                                                                                                                                                                                  | ** ** | **(Unaudited)**               | ** ** | ** **                        | ** ** |
| ASSETS                                                                                                                                                                                      |       |                          |       |                              |       |
| Current assets:                                                                                                                                                                             |       |                          |       |                              |       |
| Cash and cash  equivalents                                                                                                                                                                  |       | $                             | 2,651      |                              | $          | 10,067 |   |
| Trade accounts  receivables, less allowance for doubtful accounts of $0                                                                                                                     |       | 155                           |       | 1,005                             |       |
| Other  receivables                                                                                                                                                                          |       | 12                            |       | 17                                |       |
| Inventory                                                                                                                                                                                   |       | 2,129                         |       | 1,600                             |       |
| Prepaid and  other assets                                                                                                                                                                   |       | 434                           |       | 490                               |       |
| Total current assets                                                                                                                                                                        |       | 5,381                         |       | 13,179                            |       |
| Property and equipment                                                                                                                                                                      |       | 3,298                         |       | 4,494                             |       |
| Less:  accumulated depreciation and amortization                                                                                                                                            |       | (2,312                        | )          | (3,228                            | )          |
| Property and  equipment, net                                                                                                                                                                |       | 986                           |       | 1,266                             |       |
| Deposits and other  assets                                                                                                                                                                  |       | 121                           |       | 121                               |       |
| Total assets                                                                                                                                                                                |       | $                             | 6,488      |                              | $          | 14,566 |   |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                  |       |                          |       |                              |       |
| Current liabilities:                                                                                                                                                                        |       |                          |       |                              |       |
| Accounts payable                                                                                                                                                                            |       | $                             | 1,080      |                              | $          | 1,654 |   |
| Accrued expenses                                                                                                                                                                            |       | 1,186                         |       | 1,240                             |       |
| Accrued  compensation and benefits                                                                                                                                                          |       | 335                           |       | 48                                |       |
| Dividend payable  on Preferred Stock                                                                                                                                                        |       | 0                             |       | 2                                 |       |
| Detachable  Warrants                                                                                                                                                                        |       | 258                           |       | 997                               |       |
| Conversion  option on Preferred Stock                                                                                                                                                       |       | 0                             |       | 11                                |       |
| Conversion  option on convertible debt                                                                                                                                                      |       | 0                             |       | 7,044                             |       |
| Incentive sales  claims liability                                                                                                                                                           |       | 0                             |       | 50                                |       |
| Warranty reserve                                                                                                                                                                            |       | 72                            |       | 85                                |       |
| Deferred  revenues                                                                                                                                                                          |       | 962                           |       | 267                               |       |
| Total current  liabilities                                                                                                                                                                  |       | 3,893                         |       | 11,398                            |       |
| Long term liabilities:                                                                                                                                                                      |       |                          |       |                              |       |
| Convertible  debenture payable (net of unamortized discount of $6,157 at June 30, 2007 and  $8,625 at December 31, 2006)                                                                    |       | 1,493                         |       | 1,025                             |       |
| Total  liabilities                                                                                                                                                                          |       | 5,386                         |       | 12,423                            |       |
|                                                                                                                                                                                        |       |                          |       |                              |       |
| Commitments and  contingencies                                                                                                                                                              |       |                          |       |                              |       |
| Redeemable Preferred  Stock, $.01 par value, 7,550 shares authorized; 0 shares issued and  outstanding at June 30, 2007, and 166 shares at December 31, 2006                                |       | 0                             |       | 141                               |       |
| Stockholders’ equity:                                                                                                                                                                  |       |                          |       |                              |       |
| Preferred Stock, $.01  par value, 13,492,450 shares authorized; 0 shares issued at June 30, 2007 and  December 31, 2006.                                                                    |       | 0                             |       | 0                                 |       |
| Common Stock, $.01 par  value; 120,000,000 shares authorized; 45,189,258 shares issued and  outstanding at June 30, 2007 and 41,535,443 shares issued and outstanding at  December 31, 2006 |       | 452                           |       | 415                               |       |
| Additional paid-in  capital                                                                                                                                                                 |       | 256,615                       |       | 248,393                           |       |
| Accumulated deficit                                                                                                                                                                         |       | (255,965                      | )          | (246,806                          | )          |
| Total  stockholders’ equity                                                                                                                                                            |       | 1,102                         |       | 2,002                             |       |
| Total liabilities and  stockholders’ equity                                                                                                                                            |       | $                             | 6,488      |                              | $          | 14,566 |   |

The accompanying notes are anintegral part of these condensed consolidated financial statements.

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**WORLDGATE COMMUNICATIONS, INC.**

**CONDENSED CONSOLIDATED STATEMENTSOF OPERATIONS**

**(Unaudited)**

**(InThousands, Except Share and per Share Amounts)**
| ** **                                                                                                                                                                                                                                               | ** ** | **Three Months ended June 30,** | ** ** | **Six Months ended June 30,** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-----------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                               | ** ** | **2007**                                            | ** ** | **2006**                                          | ** ** | **2007** | ** ** | **2006** | ** ** |
| Net revenues:                                                                                                                                                                                                                                            |       |                                                |       |                                              |       |   |   |   |   |
| Product revenues                                                                                                                                                                                                                                         |       | $                                                   | 192        |                                              | $          | 122 |   | $ | 391 |   | $ | 590 |   |
| Service revenues                                                                                                                                                                                                                                         |       | 113                                                 |       | 64                                                |       | 224 |   | 106 |   |
| Total net revenues                                                                                                                                                                                                                                       |       | 305                                                 |       | 186                                               |       | 615 |   | 696 |   |
| Cost of revenues                                                                                                                                                                                                                                         |       | 482                                                 |       | 739                                               |       | 831 |   | 1,181 |   |
| Gross margins                                                                                                                                                                                                                                            |       | (177                                                | )          | (553                                              | )          | (216 | ) | (485 | ) |
|                                                                                                                                                                                                                                                     |       |                                                |       |                                              |       |   |   |   |   |
| Engineering and  development (excluding depreciation and amortization amounts of $ 106 and $93  for the three months ended June 30, 2007 and 2006, respectively, and $211 and  $181 for the six months ended June 30, 2007 and 2006, respectively). |       | 1,676                                               |       | 1,540                                             |       | 3,462 |   | 2,994 |   |
| Sales and marketing  (excluding depreciation and amortization amounts of $15 and $15 for the three  months ended June 30, 2007 and 2006, respectively, and $30 and $29 for the  six months ended June 30, 2007 and 2006, respectively)                   |       | 869                                                 |       | 548                                               |       | 1,990 |   | 1,201 |   |
| General and  administrative (excluding depreciation and amortization amounts of $44 and  $76 for the three months ended June 30, 2007 and 2006, respectively, and $93  and $153 for the six months ended June 30, 2007 and 2006, respectively)           |       | 1,439                                               |       | 1,846                                             |       | 2,956 |   | 4,369 |   |
| Depreciation and  amortization                                                                                                                                                                                                                           |       | 165                                                 |       | 184                                               |       | 334 |   | 363 |   |
| Total expenses from operations                                                                                                                                                                                                                           |       | 4,149                                               |       | 4,118                                             |       | 8,742 |   | 8,927 |   |
| Loss from  operations                                                                                                                                                                                                                                    |       | (4,326                                              | )          | (4,671                                            | )          | (8,958 | ) | (9,412 | ) |
| Interest and  other income                                                                                                                                                                                                                               |       | 45                                                  |       | 100                                               |       | 143 |   | 233 |   |
| Change in fair  value of derivative warrants and conversion options                                                                                                                                                                                      |       | 1,036                                               |       | (520                                              | )          | 2,411 |   | (339 | ) |
| Gain on contract  termination                                                                                                                                                                                                                            |       | 0                                                   |       | 0                                                 |       | 0 |   | 1,792 |   |
| Amortization of  debt discount                                                                                                                                                                                                                           |       | (1,185                                              | )          | 0                                                 |       | (2,468 | ) | 0 |   |
| Interest and  other expense                                                                                                                                                                                                                              |       | (120                                                | )          | 0                                                 |       | (256 | ) | 0 |   |
| Net loss                                                                                                                                                                                                                                                 |       | (4,550                                              | )          | (5,091                                            | )          | (9,128 | ) | (7,726 | ) |
| Accretion on  preferred stock, dividends and deemed dividends                                                                                                                                                                                            |       | (16                                                 | )          | (40                                               | )          | (30 | ) | (108 | ) |
| Net loss  available to common stockholders                                                                                                                                                                                                               |       | $                                                   | (4,566     | )                                                 | $          | (5,131 | ) | $ | (9,158 | ) | $ | (7,834 | ) |
|                                                                                                                                                                                                                                                     |       |                                                |       |                                              |       |   |   |   |   |
| Net loss per  common share:                                                                                                                                                                                                                              |       |                                                |       |                                              |       |   |   |   |   |
| Basic and Fully Diluted                                                                                                                                                                                                                                  |       | $                                                   | (0.10      | )                                                 | $          | (0.13 | ) | $ | (0.21 | ) | $ | (0.20 | ) |
| Net loss  available to common stockholders per common share:                                                                                                                                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Basic and Fully Diluted                                                                                                                                                                                                                                  |       | $                                                   | (0.10      | )                                                 | $          | (0.13 | ) | $ | (0.21 | ) | $ | (0.20 | ) |
| Weighted average  common shares outstanding:                                                                                                                                                                                                             |       |                                                |       |                                              |       |   |   |   |   |
| Basic and Fully  Diluted                                                                                                                                                                                                                                 |       | 43,712,837                                          |       | 39,625,256                                        |       | 42,889,905 |   | 39,610,667 |   |

 

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

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**WORLDGATECOMMUNICATIONS, INC.CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(Unaudited)( in Thousands)**
| ** **                                                                      | ** ** | **Six Months ended June 30,** | ** ** |
|---------------------------------------------------------------------------------|------------|---------------------------------------------------|------------|
| ** **                                                                      | ** ** | **2007**                                          | ** ** | **2006** | ** ** |
| Cash flows from  operating activities:                                          |       |                                              |       |   |   |
| Net loss                                                                        |       | $                                                 | (9,128     | ) | $ | (7,726 | ) |
| Adjustments to reconcile net loss to net cash used  in operating activities:    |       |                                              |       |   |   |
| Depreciation and amortization                                                   |       | 334                                               |       | 363 |   |
| Amortization of debt discount                                                   |       | 2,468                                             |       | 0 |   |
| Change in fair value of derivative warrants and  conversion options             |       | (2,411                                            | )          | 339 |   |
| Gain on contract termination                                                    |       | 0                                                 |       | (1,792 | ) |
| Non-cash stock based compensation                                               |       | 685                                               |       | 426 |   |
| Bad debt expense                                                                |       | 25                                                |       | 0 |   |
| Write down of inventory                                                         |       | 293                                               |       | 490 |   |
| Changes in operating assets and liabilities:                                    |       |                                              |       |   |   |
| Trade accounts receivable                                                       |       | 130                                               |       | (712 | ) |
| Other receivables                                                               |       | 5                                                 |       | (9 | ) |
| Inventory                                                                       |       | (126                                              | )          | (646 | ) |
| Prepaid and other assets                                                        |       | 56                                                |       | (191 | ) |
| Accounts payable                                                                |       | (574                                              | )          | (374 | ) |
| Accrued expenses and other current liabilities                                  |       | (104                                              | )          | 604 |   |
| Accrued compensation and benefits                                               |       | 287                                               |       | 260 |   |
| Warranty reserve                                                                |       | (13                                               | )          | (14 | ) |
| Deferred revenue                                                                |       | 696                                               |       | 174 |   |
| Net cash used in operating activities                                           |       | (7,377                                            | )          | (8,808 | ) |
|                                                                            |       |                                              |       |   |   |
| Cash flows from  investing activities:                                          |       |                                              |       |   |   |
| Capital expenditures                                                            |       | (54                                               | )          | (250 | ) |
| Net cash used in investing activities                                           |       | (54                                               | )          | (250 | ) |
|                                                                            |       |                                              |       |   |   |
| Cash flows from  financing activities:                                          |       |                                              |       |   |   |
| Proceeds from issuance of common stock                                          |       | 15                                                |       | 13 |   |
| Net cash provided by financing activities                                       |       | 15                                                |       | 13 |   |
| Net decrease in  cash and cash equivalents                                      |       | (7,416                                            | )          | (9.045 | ) |
| Cash and cash  equivalents, beginning of period                                 |       | 10,067                                            |       | 16,277 |   |
| Cash and cash  equivalents, end of period                                       |       | $                                                 | 2,651      |   | $ | 7,232 |   |
|                                                                            |       |                                              |       |   |   |
| Cash paid for  interest                                                         |       | $                                                 | 0          |   | $ | 0 |   |
| Non-cash  financing activities:                                                 |       |                                              |       |   |   |
| Conversion of preferred stock to common stock                                   |       | $                                                 | 167        |   | $ | 333 |   |
| Conversion of convertible debenture to common stock                             |       | 2,000                                             |       | 0 |   |
| Conversion of derivative liability                                              |       | 5,384                                             |       | 0 |   |
| Accretion on preferred stock                                                    |       | 26                                                |       | 34 |   |
| Dividends payable on preferred stock                                            |       | 0                                                 |       | 2 |   |
| Deemed dividend on conversion of preferred stock                                |       | 0                                                 |       | 68 |   |
| Common stock issued for accrued dividends                                       |       | 6                                                 |       | 10 |   |
| Common stock and  common stock options issued for marketing consulting services |       | 300                                               |       | 0 |   |

 

The accompanying notesare an integral part of these condensed consolidated financial statements.

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**WORLDGATECOMMUNICATIONS, INC.**

**NOTES TOCONDENSED CONSOLIDATED FINANCIAL STATEMENTS**

**(Unaudited)**

**(InThousands, Except Share and per Share Amounts)**

1.                                       Basisof Presentation.

The unauditedcondensed consolidated financial statements of WorldGate Communications, Inc. (“WorldGate”or the “Company”) for the three and six months ended June 30, 2007 and 2006presented herein have been prepared by the Company pursuant to the rules andregulations of the Securities and Exchange Commission for quarterly reports onForm 10-Q.  Certain information andfootnote disclosures normally included in financial statements prepared inaccord­ance with United States generally accepted accounting principles (“GAAP”)have been condensed or omitted pursuant to such rules and regulations.  In addition, the December 31, 2006 unauditedinterim condensed consolidated Balance Sheet was derived from the auditedfinancial statements, but does not include all disclosures required by GAAP.  These financial statements should be read inconjunction with the audited financial statements for the year ended December31, 2006 and the notes thereto included in the Company’s Annual Report on Form10-K.  The accounting policies used inpreparing these unaudited condensed consolidated financial statements arematerially consistent with those described in the audited December 31, 2006financial statements except for the adoption of FIN 48, which is discussed inNote 3.

The financialinformation in this Report reflects, in the opinion of management, all adjustmentsof a normal recurring nature necessary to present fairly the results for theinterim period. Quarterly operating results are not necessarily indicative ofthe results that may be expected for other interim periods or the year endingDecember 31, 2007.

The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States requires management to make estimates andassumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities, as of the date of thefinancial statements, and the reported amount of revenues and expenses duringthe reporting period.   Actualresults could differ from those estimates. Judgments and estimates of uncertainties are required in applying ouraccounting policies in many areas. Following are some of the areas requiring significant judgments andestimates: revenue recognition, accounts receivable, inventory, cash flow andvaluation assumptions in performing asset impairment tests of long-livedassets, deferred revenues, income taxes, stock based compensation, value ofredeemable preferred stock, derivative liabilities, convertible debentures,related warrants and conversion options.

2.                                       Liquidityand Going Concern Considerations.

As of June 30, 2007,the Company had cash and cash equivalents of $2,651.  The operating cashused in operations for the three and six months ended June 30, 2007 was$2,323 and $7,377, respectively. The funds the Company received as aresult of private placements of its securities on December 1, 2003 andDecember 4, 2003, January 21, 2004, April 22, 2004,June 24, 2004, December 15, 2004, August 3, 2005, August 11, 2006 andOctober 13, 2006 have permitted the Company to fund the development of its business.

The Company had $5,386 ofliabilities and substantially all of its assets are pledged as collateral as ofJune 30, 2007. These liabilities include $258 of detachable warrantsrelated to the Company’s private placement of preferred stock in June 2004 and$1,493 of debt (net of unamortized discount of $6,157) related to the Company’sfinancing in August and October 2006.

The Company’s short termcash requirements and obligations include inventory, accounts payable andcapital expenditures from continuing operations and operating expenses.  In addition, the August 2005 privateplacement includes cash payment penalties of 1.5% per month for the period thatthe shares in the transaction fail to be registered. The Registration Statementcovering the shares under the August 2005 private placement was not declaredeffective until June 1, 2006. Until such time as the shares were registered theCompany was subject to the penalty provision in the August 2005 privateplacement. For the three months ended June 30, 2007 and 2006 the Companyrecorded and expensed related penalties of $0 and $599, respectively.  For the six months ended June 30, 2007 and2006, related penalties of $0 and $1,387, respectively, were recorded by theCompany and included in general and administrative expenses in the condensedconsolidated statements of operations. The related unpaid penalty accrued as of June 30, 2007 and December 31,2006 was $157.

Management expects, basedon our internal forecasts and assumptions including among others, assumptionsregarding our short term cash requirements and our projected revenue resultingfrom sales, that we have sufficient cash on hand to meet our obligations wellinto the third quarter of 2007. As shown in the accompanying condensedconsolidated financial statements, we have incurred recurring net losses andhave an accumulated deficit of $255,965 as of June 30, 2007.  In addition, based upon the Company’s currentoperating plans and condition, management estimates that the Company will 

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require additional cashresources during 2007.  The uncertaintiesregarding the availability of continued financing raise substantial doubt aboutour ability to continue as a going concern. The financial statements do not include any adjustments relating to therecoverability of recorded assets or the classification of liabilities thatmight be necessary should we be unable to continue as a going concern.   Additionally, as needed, the Companyplans to generate cash by turning to the capital markets for further funding.

The Company’s ability to generate cash is dependentupon the sale of Ojo products and on obtaining cash through capitalmarkets. The Company began generating revenue from commercial shipment ofthe Ojo product in April 2005.  Initiallyall product sales were conducted through General Instrument, its exclusivedistributor and all revenue was based upon sales of the Company’s products toGeneral Instrument for their distribution to resellers.  In February 2006, its distributorrelationship with General Instrument ended and the Company began to directlydistribute and sell its products.  Withthe completion of the transition activities, the Company now expects revenuesto increase as it continues to roll out its products to the marketplace.Depending on the ramp up of sales and services and the achievable margin, theincreased level of sales and service activity should have a positive impact onthe Company’s cash flows from operations, which should support the Company’sability to meet its cash requirements in the long term. Given that the videophone business involves the development of a new product line with no marketpenetration, in an underdeveloped market sector, no assurances can be giventhat sufficient sales and services, if any, will materialize.

On June 29, 2007, the Company announced that it hadreceived notice from the staff of the NASDAQ Stock Market that they had deniedthe Company’s request for continued listing on the NASDAQ Capital Market.  The Company originally received a notice fromNASDAQ on April 11, 2007, stating that the Company was not in compliance withMarketplace Rule 4310(c)(3), which requires that it have a minimum of $2,500 instockholders’ equity or $35,000 of market value of listed securities or $500 ofnet income from continuing operations for the most recently completed fiscalyear or two of the three most recently completed fiscal years.  On April 17, 2007, the Staff had alsonotified the Company that for the last 30 consecutive business days, the bidprice of the Company’s common stock had closed below the minimum $1.00 pershare requirement for continued inclusion under Marketplace Rule4310(c)(4).  The Company subsequentlyprovided a plan to NASDAQ to achieve and sustain compliance with all of theNASDAQ Capital Market listing requirements, including a time frame forcompleting the plan.  While the Companywas successful in reclassifying some of its debt to equity as included in oursubmitted plan, NASDAQ determined that this alone was not sufficient to enableus to achieve and sustain compliance with Rule 4310(c)(3).  On July 5, 2007, the Company announced thatthe delisting action by the NASDAQ Stock Market had been stayed pending anappeal hearing before the NASDAQ Listing Qualifications Panel, scheduled totake place on August 9, 2007.  In aneffort to comply with Rule 4310(c)(4), on July 20, 2007, the Company’s Board ofDirectors approved a resolution to amend the Certificate of Incorporation toeffect a 1-for-10 reverse stock split.  This resolution is subject tostockholder approval and could be implemented at the discretion ofthe Company.  The Company will address the Rule 4310(c)(3) and Rule4310(c)(4) issue at its hearing with the NASDAQ. The Company’s commonstock will continue to be listed on the NASDAQ Capital Market pending a finalwritten decision by the NASDAQ Listings Qualifications Panel (the “Panel”)subsequent to the August 9, 2007 hearing. There can be no assurance that the Panel will grant the Company’srequest for continued listing.

If the Company’s shares are delisted from the NASDAQCapital Market, they are likely to become subject to the SEC penny stock rules,which could adversely affect the market liquidity of the Company’s common stockand its ability to raise additional capital. No assurances can be given that additional financing transactions can beconsummated.  The Company continues to evaluate possibilities to obtainadditional financing through public or private equity or debt offerings, bankdebt financing, asset securitizations, or from other sources, to obtain suchfinancing. In July 2007, the Company has entered into a six monthexclusive engagement with an investment banker to assist the Company with thisprocess.  The Company has also granted alimited duration option to one of its product distributors to participate in aprivate placement, potentially providing additional funds to the Company (seeNote 18).  Such additional financingwould be subject to the risk of availability, may be dilutive to its stockholders,or could impose restrictions on operating activities. There can be no assurancethat this additional financing will be available on terms acceptable to theCompany, if at all.  If the Company isunable to obtain sufficient funds the Company may reduce the size of theorganization or suspend operations which could have a material adverse impacton its business prospects.

Long term cash requirement obligations are primarilyrelated to the August and October 2006 transactions. The Company has long termdebt as of June 30, 2007 on the balance sheet reflecting the convertibledebentures issued on August 11 and October 13, 2006.

3.                                       RecentAccounting Pronouncements.

In February 2006, the Financial Accounting StandardsBoard (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No.155 ‘‘Accounting for Certain Hybrid Financial Instruments, an amendment of FASBStatements No. 133 and 140’’ (‘‘SFAS 155’’). SFAS 155 clarifies certain issuesrelating to embedded derivatives and beneficial interests in securitizedfinancial assets. The provisions of SFAS 155 are effective for all financialinstruments acquired or 

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issuedfor fiscal years beginning after September 15, 2006. The adoption of SFAS No.155 did not have a material effect on the Company’s condensed consolidatedfinancial position, results of operations or cash flows.

In March 2006, the FASB issued SFAS No. 156,“Accounting for Servicing of Financial Assets” (“SFAS 156”), whichamends SFAS 140, “Accounting for Transfers and Servicing of Financial Assetsand Extinguishments of Liabilities,” with respect to the accounting forseparately recognized servicing assets and servicing liabilities. SFAS 156 permits the choice of the amortization method or the fairvalue measurement method, with changes in fair value recorded in income, forthe subsequent measurement for each class of separately recognized servicingassets and servicing liabilities. The statement is effective for yearsbeginning after September 15, 2006, with earlier adoption permitted. The adoption of SFAS No. 156 did not havea material effect on the Company’s condensed consolidated financial position,results of operations or cash flows.

In June 2006, the FASB issued Interpretation No. 48 “Accountingfor Uncertainty in Income Taxes – an Interpretation of FASB Statement No. 109”(the “Interpretation”).  TheInterpretation establishes for all entities a minimum threshold for financialstatement recognition of the benefit of tax positions, and requires certainexpanded disclosures.  The Interpretationis effective for fiscal years beginning after December 15, 2006, and is to beapplied to all open tax years as of the date of effectiveness.  The adoption of FASB Interpretation  No. 48 did not have a material effect on theCompany’s condensed consolidated financial position or results of operations orcash flows (Note 15).

In September 2006, theFASB issued SFAS No. 157 “Fair Value Measurements,” which defines fair value,establishes a framework for measuring fair value in generally accepted accountingprinciples, and expands disclosures about fair value measurements. Adoption is required for fiscal years beginning after November 15, 2007, andinterim periods within those fiscal years.  Early adoption of SFAS 157 isencouraged.  The Company is currently evaluating the expected effect ofSFAS No.157 on its condensed consolidated financial statements and is currentlynot yet in a position to determine such effects.

In September 2006, FASBratified Emerging Issue Task Force (“EITF”) No. 06-1, “Accounting forConsideration Given by a Service Provider to Manufacturers or Resellers ofEquipment Necessary for an End-Customer to Receive Service from the ServiceProvider”(“EITF 06-1”). This guidance requires theapplication of EITF 01-9, “Accounting for Consideration Given by a Vendor to aCustomer” (“EITF 01-9”), when consideration is given to a reseller ormanufacturer for benefit to the service provider’s end customer. EITF 01-9requires the consideration given be recorded as a liability at the time of thesale of the equipment and, also, provides guidance for the classification ofthe expense. EITF 06-1 is effective for the first annualreporting period beginning after June 15, 2007. The Company has not yetassessed the impact of EITF 06-1 on the Company’s condensedconsolidated financial statements.

In November 2006, theEITF reached a final consensus in EITF Issue 06-6 “Debtor’s Accounting for aModification (or Exchange) of Convertible Debt Instruments” (“EITF 06-6”).  EITF 06-6 addresses the modification of aconvertible debt instrument that changes the fair value of an embeddedconversion option and the subsequent recognition of interest expense for theassociated debt instrument when the modification does not result in a debtextinguishment pursuant to EITF 96-19, “Debtor’s Accounting for a Modificationor Exchange of Debt Instruments”. The consensus should be applied tomodifications or exchanges of debt instruments occurring in interim or annualperiods beginning after November 29, 2006. We do not expect the adoption of EITF 06-6 to have a material impact onthe Company’s condensed consolidated financial position, results of operationsor cash flows.

In November 2006, theFASB ratified EITF Issue No. 06-7, “Issuer’s Accounting for a Previously BifurcatedConversion Option in a Convertible Debt Instrument When the Conversion OptionNo Longer Meets the Bifurcation Criteria in FASB Statement No. 133, Accountingfor Derivative Instruments and Hedging Activities” (“EITF 06-7”). At the timeof issuance, an embedded conversion option in a convertible debt instrument maybe required to be bifurcated from the debt instrument and accounted forseparately by the issuer as a derivative under SFAS 133, based on theapplication of EITF 00-19. Subsequent to the issuance of the convertible debt,facts may change and cause the embedded conversion option to no longer meet theconditions for separate accounting as a derivative instrument, such as when thebifurcated instrument meets the conditions of Issue 00-19 to be classified instockholders’ equity. Under EITF 06-7, when an embedded conversion optionpreviously accounted for as a derivative under SFAS 133 no longer meets thebifurcation criteria under that standard, an issuer shall disclose adescription of the principal changes causing the embedded conversion option tono longer require bifurcation under SFAS 133 and the amount of the liabilityfor the conversion option reclassified to stockholders’ equity. EITF 06-7should be applied to all previously bifurcated conversion options inconvertible debt instruments that no longer meet the bifurcation criteria inSFAS 133 in interim or annual periods beginning after December 15, 2006,regardless of whether the debt instrument was entered into prior or subsequentto the effective date of EITF 06-7.   Theadoption of EITF 06-7, had the effect, that on May 18, 2007, on account of theCompany’s amendment of its convertible debenture, $4,335 of the derivativeliability was reclassified to stockholders’ equity (see Note 7).

In December 2006, theFASB issued FASB Staff Position (“FSP”) EITF 00-19-2 “Accounting forRegistration Payment Arrangements” (“FSP EITF 00-19-2”) which specifies thatthe contingent obligation to make future payments or otherwise transferconsideration under a registration payment arrangement should be separatelyrecognized and measured in 

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accordance with SFAS No. 5, “Accounting forContingencies.”    Adoption of FSP EITF00-19-02 is required for fiscal years beginning after December 15, 2006. Theadoption of FSP EITF 00-19-02 did not have a material impact on the Company’scondensed consolidated financial position, results of operations or cash flows.

InDecember 2006, the FASB ratified the consensuses reached in EITF IssueNo. 06-3, “How Taxes Collected from Customers and Remitted to GovernmentalAuthorities Should Be Presented in the Income Statement (That Is, Gross versusNet Presentation)” (“EITF 06-3”). The EITF reached a consensus that the scopeof the Issue includes any tax assessed by a governmental authority that is bothimposed on and concurrent with a specific revenue-producing transaction betweena seller and a customer, and may include, but is not limited to, sales, use,value added, and some excise taxes. The presentation of taxes within the scopeof this Issue on either a gross or a net basis is an accounting policy decisionthat should be disclosed. Furthermore, for taxes reported on a gross basis, acompany should disclose the aggregate amount of those taxes in interim andannual financial statements for each period for which an income statement ispresented if that amount is significant. The disclosures required under thisconsensus should be applied retrospectively to interim and annual financialstatements for all periods presented, if those amounts are significant. The Company adopted EITF 06-3 onJanuary 1, 2007.  The adoption ofEITF 06-3 did not have a significant impact on its condensed consolidatedfinancial position or results of operations. The Company currently records its sales net of any value added or salestax.

In February 2007, theFASB issued SFAS No. 159 “The Fair Value Option for Financial Assets andFinancial Liabilities – Including an amendment of FASB Statement No. 115” (“SFASNo. 159”), which permits entities to choose to measure many financialinstruments and certain other items at fair value.  The fair value option established by thisStatement permits all entities to choose to measure eligible items at fairvalue at specified election dates. A business entity shall report unrealizedgains and losses on items for which the fair value option has been elected inearnings at each subsequent reporting date. Adoption is required for fiscal years beginning after November 15,2007.  Early adoption is permitted as of the beginning of a fiscal yearthat begins on or before November 15, 2007, provided the entity also elects toapply the provisions of SFAS  No.159. TheCompany is currently evaluating the expected effect of SFAS No.159 on its condensedconsolidated financial statements and is currently not yet in a position todetermine such effects.

4.                                       Inventory.

The Company’s inventoryconsists solely of finished goods.  TheCompany orders and purchases completed, boxed and ready for sale video phoneproducts directly from its supplier.  TheCompany makes no subsequent hardware changes to the products.  The Company does not maintain work in processinventory, component raw materials or supplies, except for very minimalquantities for repair work.  The Companydoes not include tooling, deferred start-up or general and administrative costsin its inventory costs.  The Company alsodoes not maintain specific inventory for any specific long-term contracts orprograms.  The Company tracks and removesinventory only under the “first-in, first-out method” and prices it based uponthe Company’s actual cost unless adjustments are required for obsolescence orfor market valuations.  During the threeand six months ended June 30, 2007, the Company reduced inventory by $277 and$293, respectively, for such adjustments. In addition, in June 2007, theCompany arranged to have 3,324 of reported units previously delivered to aservice provider, with a value of $695, returned to its inventory, which had noimpact on the Company’s results of operations as these units were fullyreserved for at the point of sale. During the three and six months ended June 30, 2006, the Company reducedinventory by $490 for such adjustments.

Inventory as ofJune 30, 2007 and December 31, 2006 is summarized as follows:
|                 | ** ** | **June 30,  2007** | ** ** | **December 31,  2006** | ** ** |
|-----------------|------------|-------------------------|------------|-----------------------------|------------|
| Raw material    |       | $                       | 0          |                        | $          | 0 |   |
| Finished goods  |       | 2,129                   |       | 1,600                       |       |
| Total Inventory |       | $                       | 2,129      |                        | $          | 1,600 |   |

 

5.                                       Stock Based Compensation.

The Company accounts forstock based compensation using the fair value recognition provisions of SFASNo. 123 (Revised 2004), “Share-Based Payment.” The Company recognized stock based compensation expense of $493 and$225, respectively, for the three months ended 

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June 30, 2007 and 2006,and $685 and $426, respectively, for the six months ended June 30, 2007 and2006.  Included in these expenses for thethree and six months ended June 30, 2007, is $300 for non-cash based consultingfees associated with the marketing of the Company’s video phone product, issuedin the form of 375,737 shares of common stock and 100,000 common stockoptions.  Such expenses are included ingeneral and administrative and sales and marketing expenses in the condensedconsolidated statements of operations.

A summary of the Company’sstock plan is presented below:
|                                    | ** ** | **Stock Options** | ** ** | **Weighted-Average  Exercise Price** | ** ** | **Aggregate   Intrinsic Value** | ** ** |
|------------------------------------|------------|------------------------|------------|-------------------------------------------|------------|-------------------------------------------|------------|
|                               |       |                   |       |                                      |       |                                      |       |
| Outstanding,  January 1, 2007 |       | 4,913,689              |       | $                                         | 1.90       |                                      |       |   |
|                               |       |                   |       |                                      |       |                                      |       |
| Granted                            |       | 184,500                |       | $                                         | 0.58       |                                      |       |   |
| Exercised                          |       | 0                      |       | 0                                         |       |                                      |       |
| Cancelled/forfeited                |       | (26,915                | )          | $                                         | 1.65       |                                      |       |   |
| Outstanding,  June 30, 2007   |       | 5,071,274              |       | $                                         | 1.85       |                                      | $          | 39,363 |   |
| Exercisable, June 30,  2007        |       | 3,533,449              |       | $                                         | 1.87       |                                      | $          | 38,704 |   |

 

Thefollowing table summarizes information about stock options outstanding atJune 30, 2007:
| ** **                                  | ** ** | **Stock Options Outstanding** | ** ** | **Stock Options Exercisable**                           | ** ** |
|---------------------------------------------|------------|-----------------------------------------|------------|-------------------------------------------------------------------|------------|
| **Range of Exercise Prices** | ** ** | **Shares**                              | ** ** | **Weighted-  Average  Remaining  Contractual  Life (Years)** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** | **Shares** | ** ** | **Weighted-  Average  Exercise  Price** | ** ** |
| $0.00 - $0.39                               |       | 297,113                                 |       | 5.68                                                              |       | $ | 0.37 |   | 297,113 |   | $ | 0.37 |   |
| $0.40 - $0.59                               |       | 1,161,000                               |       | 6.51                                                              |       | 0.52 |   | 798,875 |   | 0.52 |   |
| $0.60 - $0.89                               |       | 299,492                                 |       | 7.44                                                              |       | 0.60 |   | 291,992 |   | 0.60 |   |
| $0.90 - $1.34                               |       | 783,750                                 |       | 6.50                                                              |       | 1.06 |   | 589,250 |   | 1.06 |   |
| $1.35 - $2.01                               |       | 825,440                                 |       | 7.22                                                              |       | 1.59 |   | 371,587 |   | 1.74 |   |
| $2.02 - $3.02                               |       | 1,090,832                               |       | 5.70                                                              |       | 2.56 |   | 802,985 |   | 2.58 |   |
| $3.03 - $4.53                               |       | 426,012                                 |       | 6.92                                                              |       | 4.23 |   | 220,212 |   | 4.29 |   |
| $4.54 - $6.80                               |       | 112,533                                 |       | 5.47                                                              |       | 5.90 |   | 86,333 |   | 6.05 |   |
| $6.81 - $10.20                              |       | 40,000                                  |       | 3.63                                                              |       | 8.25 |   | 40,000 |   | 8.25 |   |
| $10.21 - $15.30                             |       | 0                                       |       | 0                                                                 |       | 0 |   | 0 |   | 0 |   |
| $15.31 - $22.95                             |       | 31,046                                  |       | 2.61                                                              |       | 20.44 |   | 31,046 |   | 20.44 |   |
| $22.96 - $34.43                             |       | 4,056                                   |       | 3.01                                                              |       | 28.60 |   | 4,056 |   | 28.60 |   |
|                                        |       | 5,071,274                               |       | 6.42                                                              |       | $ | 1.85 |   | 3,533,449 |   | $ | 1.87 |   |

 

The weighted-average fair values of the optionsgranted were $0.34 and $0.36 per option during the three and six months endedJune 30, 2007, respectively. The fair value of each option grant is estimatedon the date of grant using the Black-Scholes fair value option valuation model.The following weighted-average assumptions were used for grants issued duringthe three and six months ended June 30, 2007, respectively: expected volatilityof 83% and 83%; average risk-free interest rates of 4.68% and 4.67%; dividendyield of 0%; and expected lives of 5.2 and 5.3 years.

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6.             Accounting forPreferred Shares and Derivative Shares.

In June 2004, WorldGate completed a private placementof preferred stock. The preferred stock had a dividend rate of 5% per annum,payable quarterly, either in cash or through the issuance of common stock atthe Company’s option. The preferred stock had a staged maturity over threeyears with scheduled payments of one third due after 18 months, one half of theremainder due after 24 months and the balance due after 36 months, and couldhave been redeemed at maturity in cash or, at the Company’s option, subject tocertain conditions that may not be solely under the control of the Company,through the issuance of the number of shares of common stock determined bydividing the liquidation preference of the preferred shares by the then averagemarket price over the ten consecutive trading days prior to the date ofconversion.  On June 23, 2007, the remaining redeemable preferred sharesof 166 were converted into 326,471 shares of common stock.  As part of this private placement the Companywas required to file a registration statement covering the shares of commonstock issuable, including the conversion shares and warrant shares.  If the effectiveness of the registrationstatement lapses, the Company ceases to be listed on certain specifiedexchanges and trading in the Company’s stock is suspended or a change incontrol occurs with respect to the Company, the Company would have beenrequired to settle redemption of the preferred stock with cash instead of itscommon shares.  The private placement includes numerous provisionsintended to protect these institutional investors including a cash paymentpenalty of 1.0% per month of the liquidated value for the unredeemed preferredshares if the registration of the shares lapse and until the registration againbecomes effective.    The Company has notrecorded any liability in connection with these liquidated damage provisions.

Also, as part of the June 2004 private placement theCompany issued five-year warrants to purchase up to 803,190 shares of theCompany’s common stock at an exercise price of $2.69 per share and five-yearwarrants to purchase up to 803,190 shares of the Company’s common stock at anexercise price of $3.14 per share. The investors also received an additionalinvestment right, for a limited period of time, to purchase 1,606,383additional shares of common stock shares at $3.14 a share. The exercise priceof the warrants is subject to adjustment if, at any time after the date thewarrants were issued, the Company issues or sells, or is deemed to have issuedor sold, any shares of the Company’s common stock for per share considerationless than the exercise price of the warrants on the date of such issuance orsale.  Accordingly, the number of common shares that will be issued uponthe exercise of the warrants cannot be predicted.  Through June 30,2007, 125,000 warrants exercisable at $2.69 had been exercised and 51,915warrants exercisable at $3.14 had been exercised.  All of the additionalinvestment rights had been exercised as of June 30, 2006.Based on anti-dilution provisionscontained within this private placement the $2.69 warrants were modified to anexercise price of $1.78 as of June 30, 2007 and the number of outstandingwarrants were increased by 348,863 related to the issuance of convertibledebentures and warrants in August 2006 and October 2006 and as a result of theconversion price related to these issuances. Based on anti-dilution provisions contained within this privateplacement the $3.14 warrants were also modified to an exercise price of $2.01as of June 30, 2007 and the number of outstanding warrants were increased by416,532 related to the issuance of convertible debentures and warrants inAugust 2006 and October 2006 and as a result of the conversion price related tothese issuances.

Ofthe 7,550 preferred shares issued under this private placement, all shares havebeen redeemed as of June 30, 2007.

The terms of the five-year warrants include cashpenalty provisions in the event that the Company fails to meet its obligationsto deliver registered shares to the warrant holder upon exercise and ananti-dilution provision that could result in a variable number of shares to beissued upon warrant exercise. Additionally, the terms and conditions of thewarrants provide for net settlement through cashless exercise whereby theshares delivered to the warrant holder would be readily convertible to cash. Inaccordance with EITF 00-19 and given the terms and conditions of the warrantsas outlined above, the Company has classified the warrants as a liability onits balance sheet measured at fair value using the Black-Scholes option pricingmodel.

The Company accounts for both the conversion optionsand warrants using the fair value method at the end of each quarter, with theresultant gain or loss recognition recorded against earnings. The conversionoption balance was reclassified at fair value to equity with the finalconversion of preferred stock into the Company’s common stock on June 23,2007.  The remaining warrants are valuedusing the Black-Scholes valuation model. Actual common stock price on June 23,2007($0.50), applicable volatility rate (95%), and the period close risk-freeinterest rates (4.85%) for the instrument’s contractual remaining life (2years) (continuously compounded), are the key assumptions used in the valuationcalculation.  The result was a $112 and$750 non cash gain, for the three and six months ended June 30, 2007,respectively, and a non cash charge of $520 and $339, respectively, for the three and six months ended June 30,2006, respectively.  These results wereincluded in the condensed consolidated statements of operations with changes infair value of derivative warrants and conversion options.

At June 30, 2007, afterthe fair value adjustments, the balances of the conversion option derivativeliability and the warrants derivative liability were $0 and $258,respectively.  At December 31, 2006,after the fair value adjustments, the balances of the conversion featuresderivative liability and the warrants derivative liability were $11 and $997,respectively.

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7.             Accounting for SecuredConvertible Debentures and Related Warrants.

On August 11, 2006, theCompany completed a private placement with an institutional investor ofconvertible debentures in the aggregate principal amount of $11,000. These convertible debentures have a maturity of three years, an interest rateof 6% per annum, and are convertible at the option of the investor intoWorldGate common stock at a conversion price equal to the lesser of $1.75 pershare or 90% of the average of the five lowest daily volume weighted averageclosing price (“VWAP”) of the common stock during the fifteen trading daysimmediately preceding the conversion date (subject to adjustment in the eventof stock dividends and splits and certain distributions to stockholders, fundamentaltransactions, and future dilutive equity transactions).  Interest ispayable at maturity, and the Company may elect to pay the interest amount incash or shares of the Company’s common stock. The Company has the intention to, and believes that it will have thefinancial ability to, make all required payments on the convertible debentureswhen due.  As of June 30, 2007, there was$449 of accrued interest.  From August2006 through June 30, 2007, the investor converted $3,350 of the convertibledebt into 4,069,485 shares of the Company’s common stock.  On July 12, 2007, the investors converted anadditional $328 of convertible debt into 840,000 shares of the Company’s commonstock.

The Company received$6,000 ($5,615 net of transaction costs) upon the closing of the transaction onAugust 11, 2006 (the “First Tranche”) and the remaining $5,000 ($4,700 net oftransaction costs) was received on October 13, 2006 (the “Second Tranche”)after receiving stockholder approval on October 11, 2006 and obtaining aneffective registration of the shares of common stock issued and issuable uponconversion of the convertible debentures in the First Tranche.  On May 18,2007, the Company and the investor amended the terms of the secured convertibledebentures to (1) remove the investor’s ability, upon conversion of thedebentures, to demand cash in lieu of shares of common stock, and (2) clarifythat the Company may issue restrictive shares if there is no effectiveregistration statement at the time of conversion.  The terms of theconvertible debentures were amended to permit the Company to reclassify thederivative conversion option liability in the convertible debentures from debtto equity.

The Company has the right to redeem all or any portionof the principal amount of the convertible debentures in cash at any time uponnot less than four business days notice if the closing price of its stock isless than $1.75 per share.  Such early redemption will, however, requirethe Company to pay a 10% prepayment premium.   In addition, withoutany prepayment premium, the Company has the right to force the holder toconvert a maximum of $500 of the principal amount of the convertible debenturesin any thirty day period if, in addition to certain other conditions, for fiveconsecutive trading days, the VWAP of the Company’s common stock is above$1.925 per share but less then $3.50 per share and the daily trading volumeexceeds 200,000 shares.  Additionally,without any prepayment penalty, the Company has the right to force the holderto convert all or any portion of the outstanding principal and interest if, inaddition to certain other conditions, the VWAP of the Company’s common stock isgreater than $3.50 per share for 30 consecutive trading days and the dailytrading volume exceeds 250,000 shares for five days prior.

There are some restrictions on the holder’s right toconvert the convertible debentures.  The holder could not/cannot make anyconversions below $1.75 per share (i) until the earlier of the date registeredcommon stock can be issued pursuant to such conversion or January 1, 2007, (ii)which would exceed $500 in principal amount in any calendar month, or (iii)which would result in the issuance of more than 840,000 shares of our commonstock per calendar month (provided that this maximum share limit will be waivedby the Company unless it elects to pay the holder in cash the difference invalue between 840,000 shares and the number of shares the holder wishes toconvert, up to the $500 per month conversion limit).  On May 31, 2007, the Company waived thismaximum share limit for a certain conversion of $500, and permitted theissuance of an additional 286,634 shares of common stock, in lieu of making acash payment.  If the Company is indefault under the convertible debentures, these limitations are waived. Theholder is also not restricted in making conversions at $1.75.  In no case,however may the holder convert the convertible debentures if it would result inbeneficial ownership of more than 9.99% of the Company’s outstanding commonstock (though this provision can be waived by the holder upon 65 days priornotice).  If the Company, at any time while the convertible debentures areoutstanding, shall (a) pay a stock dividend or otherwise make a distributionor distributions on shares of its common stock or any other equity or equityequivalent securities payable in shares of common stock, (b) subdivideoutstanding shares of common stock into a larger number of shares, (c) combine(including by way of reverse stock split) outstanding shares of common stockinto a smaller number of shares, or (d) issue by reclassification of shares ofthe common stock any shares of capital stock of the Company, then theconvertible debenture holder is entitled to have the conversion price adjustedto correspond to common stock holders’ rights to any such stock dividend, stocksplit, stock combination or reclassification of shares. The $1.75 conversionprice is also subject to a weighted average dilution adjustment if the Companyissues shares (apart from certain excluded issuances) of its capital stock atan effective price of less than $1.75 per share.  The Company also grantedthe convertible debentures holders a security interest in all of itsassets.  Moreover, the Company is required to register the shares ofcommon stock issuable to the investor for resale to the public pursuant to aregistration rights agreement, containing customary terms, conditions andindemnities.  The private placement includes numerous provisions intendedto protect the institutional investor, including a cash payment penalty inwhich the Company shall pay liquidated damages to the selling security holderin the event that (i) a registration statement is not timely filed, (ii) a 

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registrationstatement is not timely declared effective by the SEC or (iii) sales cannot bemade pursuant to the registration statement. Such liquidated damages shall be equal to 1% of the liquidated value ofthe outstanding convertible debentures for each thirty day period in which theCompany fails to satisfy clauses (i), (ii) or (iii) above.  In no event, however, shall liquidateddamages exceed 12% of the aggregate purchase price of $11,000, which is$1,320.  Pursuant to the Amendment andWaiver, dated November 22, 2006, as amended, between the Company and theselling security holder, the parties eliminated liquidated damages for theCompany’s failure to satisfy clauses (i) and (ii) above in connection with theSecond Tranche.  The Company has recordedno liability in connection with these liquidated damage provisions.

In addition, the aggregate number of shares to beissued upon conversion, exercise of the warrants, payment for commitmentshares, and payment of liquidated damages pursuant to the registration rightsagreement has been limited to 61,111,111 shares of common stock.

As part of this private placement, the Company issuedto the investor 177,419 commitment shares of common stock with a fair value atissuance of approximately $222.  The Company also issued five-yearwarrants to purchase a total of up to 2,595,000 shares of WorldGate commonstock, with 1,145,000 of the warrants having an exercise price of $1.85 pershare (with 624,545 of these warrants issued at the closing of the FirstTranche and 520,455 warrants issued at the closing of the Second Tranche),1,100,000 of the shares having an exercise price of $2.35 per share (with600,000 of these warrants issued at the closing of the First Tranche and500,000 warrants issued at the closing of the Second Tranche), and 350,000 warrantshaving an exercise price of $2.60 per share (with 190,909 of these warrantsissued at the closing of the First Tranche and 159,091 warrants issued at theclosing of the Second Tranche).

Regarding the First Tranche, on September 8, 2006, theCompany filed an initial registration statement, No. 333-137216, for 7,975,752shares of common stock, which included 7,798,333 shares underlying theconvertible debentures and 177,419 commitment shares.  This registration statement went effective onSeptember 19, 2006.  On June 25, 2007, the Company filed apost-effective amendment to Registration No. 333-137216, in which the number ofshares to be registered was reduced to 4,828,848.  The registration rights agreementrequires that the Company maintain the effectiveness of such registrationstatement until all of the securities have been sold or until they becomeeligible for sale pursuant to Rule 144(k).  Failure to maintain theeffectiveness of the registration statement may constitute an event of default.

Regarding the Second Tranche, on May 29, 2007, theCompany filed an initial registration statement, No. 333-143323, for 22,024,248shares of common stock, which included 19,429,248 shares underlying theconvertible debentures and 2,595,000 shares issuable upon the exercise ofwarrants.  The Company filed an amendmentto Registration No. 333-143323 on August 6, 2007.  Among other changes, the number of shares tobe registered was reduced from 22,024,248 to 7,716,416, all of which areissuable upon the conversion of the convertible debentures.  The registration rights agreement requiresthat the Company maintain the effectiveness of such registration statementuntil all of the securities have been sold or until they become eligible forsale pursuant to Rule 144(k).  Pursuantto waivers granted by the purchaser of these shares, the Company was givenuntil May 30, 2007 to file a registration statement for these shares.Furthermore such waiver requires that any failure to file this registrationstatement or to cause it to be declared effective will not result in anydamages becoming due thereunder, liquated or otherwise.

Upon any liquidation, dissolution or winding up of theCompany, the holder of the convertible debentures will be entitled to receivethe principal amount of the convertible debentures, together with accrued andunpaid interest, prior to any payment to the holders of the Company’s commonand preferred stock.

The terms of the warrant agreements provide for theadjustment of the exercise price and the number of shares of common stock to beissued upon the Company’s issuance of certain securities deemed to be dilutiveunder the agreement.  Under certain conditions, the holder may exercisethese warrants on a cashless basis.

The market price of theCompany’s common stock cannot be predicted.  Furthermore, subject tothe share limitation, as discussed above, the actual number of shares of theCompany’s common stock that will be required if a conversion of the convertibledebentures is made through the issuance of common stock also cannot bepredicted.  Should the Company’srequirements to issue shares under these convertible debenture agreementsexceed the share limitation, or if it is not listed or quoted for trading on atleast the NASDAQ OTC Bulletin Board, the Company may be required to settle theconversion of the convertible debentures with cash instead of its common stock.

The Company initially accounted for conversion optionsembedded in convertible notes in accordance with SFAS No. 133 “Accountingfor Derivative Instruments and Hedging Activities” (“SFAS 133”) and EITF 00-19 “Accountingfor Derivative Financial Instruments Indexed to, and Potentially Settled in, aCompany’s Own Stock” (“EITF 00-19”) SFAS 133 generally requires companies to bifurcate conversion optionsembedded in convertible notes from their host instruments and to account forthem as free standing derivative financial instruments in accordance with EITF00-19.   EITF 00-19 states that if theconversion option requires net cash settlement in the event of circumstancesthat are not solely within the Company’s 

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controlthat they should be classified as a liability measured at fair value on thebalance sheet.  On May 18, 2007, inconnection with the modification of the terms of the conversion feature,eliminating the cash settlement option, the Company reclassified the remaining$4,335 derivative liability to equity in accordance with the provisions of EITF06-7.

Upon the issuance date there was an insufficientnumber of authorized shares of Common Stock in order to permit exercise of allof the warrants issued on August 11, 2006.  In accordance with EITF 00-19, when there are insufficient authorizedshares, the obligation for the exercise of investor warrants should beclassified as liability measured at fair value on the balance sheet.   Accordingly, on August 11, 2006, theconvertible feature of the convertible debenture and the warrants were recordedas derivative liabilities of $4,446 and $1,269, respectively.  On October 11, 2006 the Company receivedstockholder approval to increase the authorized shares from 80,000,000 to120,000,000.  Upon re-evaluation onOctober 11, 2006, the value of these warrants at October 11, 2006 wasreclassified to equity at fair value in accordance with the provisions of EITF00-19.

As of October 13, 2006, in connection with the SecondTranche, the convertible feature of the convertible debenture was recorded as aderivative liability of $3,449 and the warrants were recorded as additionalpaid in capital of $230.

The Company accounts for the conversion options usingthe fair value method at the end of each quarter, with the resultant gain orloss recognition recorded against earnings. The conversion option was valued atMay 18, 2007, the effective date of the amendment to the convertible debentureto remove the cash settlement option, valued using the Black-Scholes valuation model, applying the actualcommon stock price on May 18, 2007 ($0.53), applicable volatility rate (97 %),and the period close risk-free interest rates ( 4.82% ) for the instrument’sremaining contractual lives of 2.24 for the First Tranche and 2.41 years forthe Second Tranche.

At the initial recordingof the First Tranche issued on August 11, 2006, the sum of the fair values ofthe convertible feature and the warrants, $5,714 in the aggregate, exceeded thenet proceeds of $5,615.   The differenceof $99 was charged to the provision for fair value adjustment, upon issuanceduring the third quarter of 2006.   Accordingly, the Company recorded a discount equal to the face value ofthe convertible debenture, which will be amortized using the effective interestrate method over the three year term. The common stock issued as fees in the transaction was recorded at a netvalue of $0, as there was no residual value remaining.

For the Second Trancheissued on October 13, 2006, the Company recorded a discount of $3,979, which isbeing amortized using the effective interest method over the three year term.

During the three and sixmonths ended June 30, 2007, $1,000 and $2,000 , respectively, in face value ofthe convertible debentures were converted, resulting in the issuance of1,938,744 and 2,923,206, respectively, shares of common stock.  As a result of the conversions, $999 and$1,999 of the discount on the convertible debenture has been charged todiscount amortization and approximately $318 and $1,048 of the conversionoption on the convertible debt was reclassified to additional paid in capitalduring the three and six months ended June 30, 2007, respectively.

For the three and sixmonths ended June 30, 2007, the Company recorded total discount amortization of$1,185 and $2,468 , respectively, and fair value adjustments of the conversionfeature derivative liability and the warrants derivative liability resulted ingains of $924 and $1,661, respectively.

As of June 30, 2007, thebalances of the convertible debentures and the offsetting related discount were$7,650 and $6,157, respectively.

*Liquidated Damages*.

The Company accounts forpotential registration rights liquidated damage obligations in accordance withFSP EITF 00-19-2 “Accounting for Registration Payment Arrangements” (“FSP EITF00-19-2”). The Company adopted this pronouncement during the quarter endedMarch 31, 2007. The adoption of FSP EITF 00-19-2 did not have a material impacton the Company’s condensed consolidated financial position, results ofoperations or cash flows.

8.             WarrantyReserve.

The Company provides awarranty covering defects arising from the sales of its video phone product.This warranty is limited to a specific time period. As of June 30, 2007, theCompany has a reserve of $72 that is based on a percentage of 

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product sales. As of June 30, 2007, the Company has not incurred any materialwarranty costs related to its product. Warranty costs are charged to cost ofrevenues when they are probable and reasonably estimable. While the Companybelieves its estimate at June 30, 2007 is reasonable and adequate, it issubject to change based on the Company’s future sales and experience, which mayrequire an increase or decrease in the Company’s reserve.  During the three and six months ended June30, 2007, the Company reduced its warranty reserve of $85 at December 31, 2006by $5 and $13, respectively.

9.             Commitments andContingencies.

*Leases*

The Company’s currentfive year lease was signed on September 1, 2005 and covers 42,500 square feetat an annual rate of $11.40 per square foot with a 3% increase annually,cancelable by either party with eight months notice, with a termination bytenant also including a six month termination fee.  Total rent expense for each of the threemonths ended June 30, 2007 and 2006 amounted to approximately $163 and $159,respectively.  For the six months endedJune 30, 2007 and 2006, rent expense amounted to approximately $322 and $318,respectively.

In November 2003,the Company entered into a 60 month lease for office equipment. As ofJune 30, 2007, there remains a total of $8 to be paid over the remainingperiod of this lease.  InOctober 2005, the Company entered into a 36 month lease for officeequipment. As of June 30, 2007 there remains a total of $9 to be paid overthe remaining period of this lease.

The future minimumcommitments under non-cancelable leases for the balance of each of the fiscalyears ending December 31 are as follows:
|                                               | ** ** | **(Dollars in  Thousands)** | ** ** |
|-----------------------------------------------|------------|----------------------------------|------------|
| 2007(July 1, 2007  through December 31, 2007) |       | $                                | 261        |   |
| 2008                                          |       | 530                              |       |
| 2009                                          |       | 535                              |       |
| 2010                                          |       | 363                              |       |
| Total                                         |       | $                                | 1,689      |   |

 

*Significant Agreements andTransactions*

The Company has a current multi-year agreement withMototech , an investor, to provide the Company with engineering and developmentsupport. As a result of this agreement, the Company has expensed approximately$67 and $181, respectively for the three months ended June 30, 2007 and 2006,and $186 and $200, respectively, for the six months ended June 30, 2007 and2006.  Accounts payable to this investoramounted to $493 and $1,377 at June 30, 2007 and December 31, 2006, respectively.This agreement provides for contracted services, including hardware andsoftware development, and the creation and development of tools to facilitatethe Company’s engineering efforts. This agreement does not provide for ongoingroyalties, purchase provisions, or for any requirement to provide additionalfunding to the Company.  Net revenuesfrom operations recognized from Mototech were approximately $4 and $2 for thethree months ended June 30, 2007 and 2006, respectively, and $5 and $395,respectively, for the six months ended June 30, 2007 and 2006.   This investor accounted for approximately 1%and 1% of the revenues for the three months ended June 30, 2007 and 2006,respectively, and 1% and 57%, respectively, of the revenues for the six monthsended June 30, 2007 and 2006.  Accountsreceivable from this investor were $2 and $1, respectively, as of June 30, 2007and December 31, 2006.

10.           Net Loss per Share(Basic and Diluted).

Basic and dilutednet loss per common share is computed by dividing the net loss available tocommon stockholders for the period by the weighted average number of shares ofcommon stock outstanding during the period. The calculation of diluted net loss per common share excludes potentialcommon shares if the effect is antidilutive. Potential common shares comprise shares of common stock issuable uponthe exercise of stock options and warrants. The number of potential common shares which would have been assumed tobe converted in each of the three and six months ended June 30, 2007 and have adilutive effect if the Company had income from continuing operations, and ifthe options’ exercise price was less than the average market price of thecommon shares, is 29,925,852, and for each of the three and six months endedJune 30, 2007, the number of shares is 10,937,951.

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11.           Stock Optionsand Warrants.

In October 2004, the Company’s stockholdersapproved the 2003 Equity Incentive Plan (“2003 Plan”). This plan replaced the1996 Plan for new grants. No additional shares were reserved for the new planbut rather all available shares under the 1996 Plan were made available for thenew plan. As with the 1996 Plan, the 2003 Plan includes the same automaticannual increase in the number of shares reserved for use with the plan equal tothe greater of 4% of the then outstanding shares of the Company’s common stockor 1,000,000 shares. In addition to ISOs and NQSOs, the 2003 Plan also providesfor performance based awards and restricted stock.  At June 30, 2007, there were 10,085,730shares reserved under these plans, and 5,071,274 options outstanding.  During the three and six months ended June30, 2007, there were 180,000 and 184,500, respectively, options granted toemployees, directors, and certain professional consultants.  During the three and six months ended June30, 2007, there were no options exercised.

At June 30, 2007 therewere warrants outstanding and exercisable into 7,824,302 shares of the Company’scommon stock.

12.           Equity.

Thefollowing summarizes the transactions in stockholder’s equity from January 1,2007 through June 30, 2007:
| Balance as of January 1,  2007                                        |   | $      | 2,002  |   |
|-----------------------------------------------------------------------|--------|--------|--------|--------|
|                                                                  |   |   |   |
| Issuance of common  stock                                             |   | 16     |   |
| Issuance of common  stock upon conversion of preferred stock          |   | 167    |   |
| Issuance of common  stock upon conversion of convertible debentures   |   | 2,000  |   |
| Reclassification of  conversion option liability                      |   | 5,384  |   |
| Non-cash stock based  compensation                                    |   | 685    |   |
| Issuance of common  stock to settle accrued preferred stock dividends |   | 6      |   |
| Net accretion on  preferred stock and dividends                       |   | (30    | )      |
| Net loss for the six  months ended June 30, 2007                      |   | (9,128 | )      |
|                                                                  |   |   |   |
| Balance as of June 30,  2007                                          |   | $      | 1,102  |   |

 

13.           RevenueRecognition.

Revenue is recognized when persuasive evidence of anarrangement exists, the price is fixed or determinable, the collectibility isreasonably assured, and the delivery and acceptance of the equipment hasoccurred or services have been rendered.  Management exercises judgment inevaluating these factors in light of the terms and conditions of its customercontracts and other existing facts and circumstances to determine appropriaterevenue recognition. Due to the Company’s limited commercial sales history, itsability to evaluate the collectibility of customer accounts requiressignificant judgment. The Company evaluates its equipment customer and servicecustomers’ accounts for collectibility at the date of sale and on an ongoingbasis.

For the year endedDecember 31, 2005, and through mid February 2006, the Company had only onecustomer for the purchase of its product and the agreement with this customerincluded several elements relevant to revenue recognition including:(a) the customer had no general right to return the product; (b) the customer earned warrants upon the purchase of significant videotelephony units and the value of these warrants would result in a reduction ofrecognized revenue (the value of these warrants has been routinely monitored bythe Company and is currently deemed to be insignificant, however, should thevalue of these warrants become material an offset would be made against revenues);(c) penalties are payable to the customer if certain excessive fieldfailure rates are exceeded;  (d) the Company and the customer sharein the benefit achieved by product cost reductions; (e) penalties arepayable to the customer if the Company fails to deliver shipments on a timelybasis; (f) the Company extends to the customer a limited product warrantyfor a term not to exceed three years (the Company maintains a warranty reservebased upon the percentage of product sales consistent with industry comparablefailure rates and the warranty period provided by the agreement).  Beginning in mid February 2006, as a resultof the termination of the General Instrument marketing and distributionagreement, the Company began selling its products to multiple customers and nowevaluates its revenue recognition policy on a customer by customer basis.

Revenues are also offset by a reserve for any pricerefunds and consumer rebates consistent with the EITF Issue 01-9, “Accountingfor Consideration Given by a Vendor to a Customer.”

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As an incentive topromote delivery of the units, a special product launch discount was providedby the Company to a distributor as a quantity restricted reduction to the unitcontract based price in effect.  In addition,the Company offered a forward pricing program to its former distributor and arebate program to consumers, as further incentives for the 2005 holiday season.These incentive programs began in the fourth quarter of 2005 and terminatedduring the first quarter of 2006. Consistent with the EITF Issue 01-9, theCompany has offset its revenues through a reserve for the total estimatedliability for the forward pricing program, and an estimated liabilityassociated with the rebate program.   The forward pricing program was terminated with the termination onFebruary 17, 2006 of the distribution agreement with General Instruments, andthis liability was reversed and recorded as a $212 increase to the gainrealized from termination of this agreement. On March 13, 2006, the Company announced that it was going to offer anew consumer rebate program effective April 1, 2006 and terminating June 30,2006.  At June 30, 2007, there was noestimated liability  associated with thisrebate program.  Also, on March 13, 2006the Company announced a price protection program for certain retailers holdingOjo video phone inventory as of April 1, 2006. At June 30, 2007, there was no estimated liability associated with thisprice protection program.  These rebateand price protection programs were recorded as an offset against revenues for$43 and $ 35, respectively, during the three and six months ended June 30,2006.  During the three and six monthsended June 30, 2007, the Company did not record any further offsets againstrevenues for rebates and price protection. However, with the termination of these programs in 2007, the remainingreserve for rebates and price protection of $46 was reversed to revenues as ofJune 30, 2007.

From June 2006through June 30, 2007, the Company shipped several thousand units, with a salesvalue of $949, to customers with a right of return.  During the three and six months ended June30, 2007, we shipped 357 and 509 units, respectively, with a sales value of $83and $110, respectively, to customers with a right of return.  The Company arranged in June 2007 to have3,324 of the $949 non revenue units, with a value of $695, returned to itsinventory, which had no impact on the Company’s result of operations as theseunits were fully reserved for at the point of sale.  These customers may exercise their right ofreturn only if they do not sell the units to their respective customers.  Revenue for these units was deferred as ofJune 30, 2007 in accordance with SFAS 48 “Revenue Recognition when a Right ofReturn Exists.”  The Company does expect,however, to begin recording the sale of these units as revenue when they aresold by its customers.

As part of ending itsagreement in 2006 with General Instrument, and in anticipation of WorldGateinventory requirements as a result of taking full responsibility for productdistribution, WorldGate negotiated the right to buy back about two-thirds ofthe units sold to General Instrument, valued at approximately $2,765 (basedupon the original sales price to General Instrument), for approximately $1,064.This is less than half of what it would cost the Company to purchase the sameinventory from its manufacturing sources. As a result the Company recorded a reserve for returns and reducedrevenue in the amount of approximately $2,310, during the fourth quarter of2005. In addition, the Company has recorded no revenue for units shipped toGeneral Instrument in 2006 and recorded a gain on termination of this agreementof approximately $1,843 during the twelve months ended December 31, 2006 (ofwhich $1,792 was recorded in the first quarter of 2006) as a result of thelower purchase price of the inventory repurchased from General Instrument($1,393, net of the cost of rework for rebranding the product and theadjustment of the inventory to its current replacement value) and reversal ofthe product refund program reserve ($212) as well as an adjustment of thewarranty reserve for products repurchased ($233), both of which resulted fromtermination of the Company’s agreement with General Instrument.

14.           Risks and uncertainties.

The Company’s primaryline of business is the development of video phone products and technology.Although the Company has realized some revenues for the commercial sale of ourproduct, the revenues to date have not been substantial. Given the early stageof the product and the lack of operating history in the video phone business,it is difficult to predict the Company’s future results.

On April 28, 2004,the Company entered into a multi-year agreement with General Instrument for theworldwide development and distribution of the Ojo personal video phone. Thisagreement provided for General Instrument to be WorldGate’s exclusivedistributor of its broadband video phone products and for WorldGate to beGeneral Instrument’s exclusive supplier of its broadband video phoneproducts.  On February 17, 2006, theCompany mutually agreed with General Instrument to end this agreement.  The ending of this agreement immediatelyterminated this exclusivity for both parties, and accordingly enabled WorldGateto expand its focus in bringing Ojo to the marketplace. In addition to itscurrent role for development and manufacture of Ojo, WorldGate became directlyresponsible for the advertising, marketing, and distribution of its products. Withthe ending of the agreement with General Instrument the Company depends upondistribution partners, including, for example, wholesalers, retailers andservice providers, to provide the worldwide sales and distribution of the Ojovideo phone. If the Company’s partners are not successful, or if theiractivities do not lead to significant sales of its product, its operatingresults will be adversely affected, the Company’s revenue could besignificantly reduced and the Company could lose potential customers.

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The Company also dependson relationships with third parties such as contract manufacturing companies,chip design companies and others who may be sole source providers of keycomponents and services critical for the product the Company is developing in itsvideo phone business. The components and raw materials used in the Company’sOjo video phone product are generally available from a multitude of vendors andare sourced based, among other factors, on reliability, price andavailability.  A formal relationship withMototech has been established for the volume manufacture of Ojo. The Company’sagreement with Mototech allows either party to terminate the agreement with 90days prior notice. If Mototech or other providers of components and/ormanufacturing services do not produce these components or provide theirservices on a timely basis, if the components or services do not meet theCompany’s specifications and quality control standards, or if the components orservices are otherwise flawed, the Company may have to delay product delivery,or recall or replace unacceptable products. In addition, such failures coulddamage the Company’s reputation and could adversely affect its operatingresults. As a result, the Company could lose potential customers and any revenuesthat it may have at that time may decline dramatically.

15.           Accounting for the Uncertainty in IncomeTaxes.

The Company has adoptedthe provisions of Financial Accounting Standards Board (“FASB”) InterpretationNo. 48, “Accounting for Uncertainty in Income Taxes - an interpretation of FASBStatement No. 109”(“FIN 48”), on January 1, 2007.  FIN 48 clarifies the accounting foruncertainty in income taxes recognized in an enterprise’s financial statementsin accordance with SFAS No. 109, “Accounting for Income Taxes,” and prescribesa recognition threshold and measurement process for financial statementrecognition and measurement of a tax position taken or expected to be taken ina tax return.  FIN 48 also providesguidance on derecognition, classification, interest and penalties, accountingin interim period, disclosure and transition.

The Company hasidentified its federal tax return and its state tax return in Pennsylvania as “major”tax jurisdictions, as defined.  Based onthe company’s evaluation, it has been concluded that there are no significantuncertain tax positions requiring recognition in the Company’s financialstatements.  The Company’s evaluation wasperformed for tax years ended 2003 through 2006, the only periods subject toexamination.  The Company believes thatits income tax positions and deductions would be sustained on audit and doesnot anticipate any adjustments that would result in a material change to itsfinancial position.  In addition, thecompany did not record a cumulative effect adjustment related to the adoptionof FIN 48.

The Company’s policy forrecording interest and penalties associated with audits is to record such itemsas a component of income before income taxes. Penalties are recorded in other expense and interest paid or received isrecorded in interest expense or interest income, respectively, in the statementof operations.  There were no amountsaccrued for penalties or interest as of or during the three and six months endedJune 30, 2007.  The Company does notexpect its unrecognized tax benefit position to change during the next twelvemonths.  Management is currently unawareof any issues under review that could result in significant payments, accrualsor material deviations from its position.

16.           Geographical Data.

FinancialInformation Relating to Foreign and Domestic Operations and Export Sales fromContinuing Operations (Dollars in Thousands) for the three and six months endedJune 30, 2007 and June 30, 2006:

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| ** **                                    | ** ** | **2007** | ** ** | **2006** | ** ** |
|-----------------------------------------------|------------|----------|------------|----------|------------|
| **Three  Months Ended June 30:**              |       |     |       |     |       |
| Net revenues by  geographic area:             |       |     |       |     |       |
| United States                                 |       | $        | 303        |     | $          | 181 |   |
| Foreign (*)                                   |       | 2        |       | 5        |       |
| Total                                         |       | $        | 305        |     | $          | 186 |   |
| Net loss (all  from United States operations) |       | $        | (4,550     | )        | $          | (5,091 | ) |
|                                          |       |     |       |     |       |
| **Six  Months Ended June 30:**                |       |     |       |     |       |
| Net revenues by  geographic area:             |       |     |       |     |       |
| United States                                 |       | $        | 605        |     | $          | 291 |   |
| Foreign (**)                                  |       | 10       |       | 405      |       |
| Total                                         |       | $        | 615        |     | $          | 696 |   |
| Net loss (all from  United States operations) |       | $        | (9,128     | )        | $          | (7,726 | ) |

 
| ** **                                                                              | ** ** | **June 30,   2007** | ** ** | **December 31,   2006** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------------------|------------|-----------------------------------|------------|
| Identifiable  assets within the United States                                           |       | $                             | 6,284      |                              | $          | 14,212 |   |
| Identifiable foreign  assets (hardware and tooling for manufacturing) in Taiwan, R.O.C. |       | $                             | 204        |                              | $          | 354 |   |

 

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* Net revenues for thethree months ended June 30, 2007 and 2006, respectively, include net revenuesprimarily derived from sales to customers located in Taiwan, R.O.C. ($2 and $2)and the United Kingdom ($0 and$3).

** Net revenues for thesix months ended June 30, 2007 and 2006, respectively,  include net revenues primarily derived fromsales to customers located in Taiwan, R.O.C. ($3 and $395), Canada ($4 and $0)and the United Kingdom ($0 and $10).

17.           Registration rights –August 2005 private placement.

In August 2005, theCompany sold stock and warrants totaling $17,500 which were subject to aregistration rights agreement.  TheCompany accounts for the registration rights agreement in accordance with FSPEITF 00-19-2.  This private placementincludes numerous provisions intended to protect these institutional investorsincluding a cash payment penalty of 1.5% per month for the period above 120 daysfrom the effective date of the agreement that the shares in the transactionfail to be registered or if the registration statement ceases to be effectivefor more than twenty days.  Theregistration statement covering the shares under this private placement was notdeclared effective until June 1, 2006. Until such time as the shares were registered the Company was subject tothe penalty provision under this private placement. For the years endedDecember 31, 2005 and 2006 the Company recorded and expensed related penaltiesof $535 and $1,114, respectively. The related unpaid penalty accrued as of June30, 2007 was $157.

18.           Subsequent Event.

On June 29, 2007, the Company announced that it hadreceived notice from the staff of the NASDAQ Stock Market that they had deniedthe Company’s request for continued listing on the NASDAQ Capital Market.  The Company originally received a notice fromNASDAQ on April 11, 2007, stating that it was not in compliance withMarketplace Rule 4310(c)(3), which requires that the Company have a minimum of$2,500 in stockholders’ equity or $35,000 of market value of listed securitiesor $500 of net income from continuing operations for the most recentlycompleted fiscal year or two of the three most recently completed fiscal years.  On April 17, 2007, the Staff had alsonotified the Company that for the last 30 consecutive business days, the bidprice of the Company’s common stock had closed below the minimum $1.00 pershare requirement for continued inclusion under Marketplace Rule4310(c)(4).  The Company subsequently provided a plan to NASDAQ to achieveand sustain compliance with all of the NASDAQ Capital Market listingrequirements, including a time frame for completing the plan.  While the Company was successful in reclassifyingsome of its debt to equity as included in the Company’s submitted plan, NASDAQdetermined that this alone was not sufficient to enable the Company to achieveand sustain compliance with Rule 4310(c)(3). On July 5, 2007, the Company announced that the delisting action by theNASDAQ Stock Market had been stayed pending an appeal hearing before the NASDAQListing Qualifications Panel, scheduled to take place on August 9, 2007.  In an effort to comply with Rule 4310(c)(4),on July 20, 2007, the Company’s Board of Directors approved a resolution toamend the Certificate of Incorporation to effect a 1-for-10 reverse stocksplit.  This resolution is subject to stockholder approval and couldbe implemented at the discretion of the Company.  The Company will addressthe Rule 4310(c)(3) and Rule 4310(c)(4) issue at its hearing with theNASDAQ.  The Company’s common stock will continue to be listed on theNASDAQ Capital Market pending a final written decision by the NASDAQ ListingsQualifications Panel (the 

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“Panel”) subsequent to the August 9, 2007hearing.  There can be no assurance thatthe Panel will grant our request for continued listing.

On July 7, 2007, the Company entered into an agreementwith T-MOBILE, USA, INC. providing for the assignment of its rights to theShadow trademark in exchange for a total payment of $500, and a license tocontinue to use the Shadow mark for a period of 24 months.

On July 12, 2007, theinvestors converted an additional $328 of convertible debt into 840,000 sharesof the Company’s common stock.

On August 1, 2007, theCompany extended to an investor group led by one of the Company’s distributorsan option to purchase $10,000 of the Company’s common stock at a price pershare equal to the greater of $0.50 or the current market price, subject to a$0.65 maximum price (the “Purchase Price”). This option extends until December 13, 2007, but can be terminated bythe Company, in its sole discretion, at any time after August 31, 2007.  Coincident with an investment pursuant to theexercise of this option the option agreement provides for the formation andfunding of a joint venture to achieve distribution in China which will be owned70% by WorldGate and 30% by the investor group. The investment would result in the grant of a five-year warrant to theinvestor group to purchase, at a price equal to 120% of the Purchase Price,that number of additional shares of the Company’s common stock equal to 85% ofthe number of shares originally purchased. The investment would also result inthe grant to the investor group of a five-year warrant to purchase, at a priceequal to 120% of the Purchase Price, up to 28,500,000 additional shares ofcommon stock.  This second warranthowever, vests on a prorata basis through the purchase of the Company’s productsby the joint venture during its first year of operations, based upon purchasemilestones, which are in increments of 100,000 units, up to one millionunits.  There can be no assurance thatthis option will be exercised, or if it is exercised, that the transactionwill receive any necessary approval by the shareholders and becompleted.

# ITEM 2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (Dollar amounts contained in this Item 2 are inthousands, except for per share amounts)

**FORWARD-LOOKINGAND CAUTIONARY STATEMENTS**

From time to time,we may make written or oral forward-looking statements, including thosecontained in the following Management’s Discussion and Analysis of FinancialCondition and Results of Operations.  Thewords “estimate,” “project,”“believe,”“intend,” “expect,” and similar expressions are intended to identifyforward-looking statements, although not all forward-looking statements containthese identifying words.  In order totake advantage of the “safe harbor” provisions of the Private SecuritiesLitigation Reform Act of 1995, we are hereby identifying certain importantfactors that could cause our actual results, performance or achievement todiffer materially from those that may be contained in or implied by anyforward-looking statement made by or on our behalf.  The factors, individually or in theaggregate, that could cause such forward-looking statements not to be realizedinclude, without limitation, the following: (1) difficulty in developing andimplementing marketing and business plans, (2) industry competition factors andother uncertainty that a market for our products will develop, (3) challengesassociated with distribution channels, including both the retail distributionchannel and HSD operators (e.g., 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), (4) continuedlosses, (5) difficulty or inability to raise additional financing on termsacceptable to us, (6) departure of one or more key persons, (7) delisting ofour common stock from the NASDAQ Capital Market, (8) changes in regulatoryrequirements, and (9) other risks identified in our filings with the Securitiesand Exchange Commission.  We caution youthat the foregoing list of important factors is not intended to be, and is not,exhaustive.  We do not undertake toupdate any forward-looking statement that may be made from time to time by oron our behalf.

**Results of Operations:**

**General**

Our video phone businesshas not produced significant revenues to date.  The extent and timing offuture revenues for our business depends on several factors, including the rateof market acceptance of our products and the degree of competition from similarproducts.  We cannot predict to what extent our video phone product willproduce revenues, or when, or if, we will reach profitability.

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On April 28, 2004, we entered into a multi-yearagreement with General Instrument Corporation d/b/a the Connected HomeSolutions Business of Motorola, Inc. (“General Instrument”) for theworldwide development and distribution of the Ojo personal video phone. Thisagreement provided for General Instrument to be the exclusive distributor ofour broadband video phone products and for us to be the exclusive supplier ofGeneral Instrument’s broadband video phone products.  On February 17,2006, we mutually agreed with General Instrument to end this agreement.  The end of this agreement immediatelyterminated exclusivity for both parties.  As a result, in addition to ourpreexisting role for development and manufacture of Ojo, we have directresponsibility and control for the advertising, marketing, and distribution ofour products.  Under our agreement with General Instrument, we had beenactive in marketing and promoting our products, and working with GeneralInstrument to distribute Ojo. We have continued the rollout of Ojo using manyof the same distributors, retailers and service providers, and havesubsequently expanded distribution to service providers and retailers aroundthe world.

During the operation ofour current video phone business, we have not been able to reach profitabilityand have generated significant losses. As a result, a report issued by ourindependent registered public accounting firm for the year ended December 31,2006 includes an explanatory paragraph stating that we have suffered recurringlosses from operations and had an accumulated deficit of $247 million as ofDecember 31, 2006 that raises substantial doubt about our ability to continueas a going concern. Our net losses available to common stockholders for thefiscal years ended December 31, 2004, 2005 and 2006 were approximately $20,376,$10,773 and $17,714 respectively. No assurances can be given that either ourhistory of losses or our auditors’ substantial doubt about our ability tocontinue as a going concern will be remedied by the continued rollout of ournew video phone product line or that our business will continue to operate as agoing concern.

*CriticalAccounting Policies and Estimates.*

Our condensedconsolidated financial statements have been prepared in accordance with accountingprinciples generally accepted in the United States.  These generally accepted accountingprinciples require management to make estimates and assumptions that affect thereported amounts of assets and liabilities and disclosure of contingent assetsand liabilities at the date of the financial statements and the reportedamounts of net revenues and expenses during the reporting period.  Actual results could differ from thoseestimates.

Our significantaccounting policies are described in the notes to the consolidated financialstatements included in our annual report on Form 10-K.  Judgments and estimates of uncertainties arerequired in applying our accounting policies in many areas.  Following are some of the areas requiringsignificant judgments and estimates: revenue recognition, accounts receivable, inventory, cash flow andvaluation assumptions in performing asset impairment tests of long-livedassets, income taxes, stock based compensation,value of redeemable preferredstock, convertible debentures and related warrants and conversion options.  Management has discussed the development andselection of these policies with the Audit Committee of  our Board of Directors, and the AuditCommittee of the Board of Directors has reviewed our disclosures of thesepolicies.  There have been no materialchanges to the critical accounting policies or estimates reported in theManagement’s Discussion and Analysis section of the audited financialstatements for the year ended December 31, 2006 as filed with the Securitiesand Exchange Commission.

Three and SixMonths Ended June 30, 2007 and June 30, 2006.

*Revenues.*

Net revenues forthe three and six months ended June 30, 2007 were $305 and $615, respectively,primarily reflecting the  product andservice revenues from our direct distribution of the Ojo product.  The product revenues represent deliveries ofvideo phones.  For the three months endedJune 30, 2007 and June 30, 2006, product revenues were $192 and $122,respectively.  For the six months endedJune 30, 2007 and June 30, 2006, product revenues were $391 and $590,respectively.  The increase of $70, or57%, in product revenues during the three months ended June 30, 2007, withrespect to the comparable period in 2006, primarily reflects increased productshipments to retailers and retail customers. The reduction of $199, or 34%, in product revenues during the six monthsended June 30, 2007, with respect to the comparable period in 2006, primarilyreflects reduced product shipments to service providers partially offset byincreased product shipments to retailers and retail customers.  Also, from June 2006 through June 30, 2007 weshipped several thousand units, with a sales value of $949, to customers with aright of return should the units not be sold through to their customer.  Revenue for these units were deferred as ofJune 30, 2007 in accordance with FAS 48 “Revenue Recognition when a Right ofReturn Exists.”   We arranged in June2007 to have $695 of the $949 non revenue units returned to our inventory.  We do expect, however, to begin recording theremainder of these shipments as revenue as and when these units are sold by ourcustomers.  The service revenuesrepresent service required for the video phone operations over the customer’sinternet connection.  For the threemonths ended June 30, 2007 and June 30, 2006, service revenues were $113 and$64, respectively.  For the six monthsended June 30, 2007 and June 

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30, 2006, servicerevenues were $224 and $106, respectively. The increase in monthly recurring service revenues of $49, or 77%, forthe three months ended June 30, 2007, and $118, or 111%, for the six monthsended June 30, 2007, compared to the respective three and six months ended June30, 2006, reflects the monthly revenue from accumulating video phones purchasedthen activated for the service required for the video phones operations overthe customer’s internet connection.

  During the three and six month periods ended June 30,2007 and June 30, 2006, we provided forward pricing discounts to retailers andcertain service operators in order to help promote distribution and consumerpurchases.  In the case of retail sales,we expect that recurring revenues from service fees will offset any loss on thesale of the product.  This forwardpricing, coupled with inventory adjustments for lower market valuations, hasresulted in a net margin loss for the three and six months ended June 30, 2007of $177 and $216, respectively, and a net margin loss for the three and sixmonths ended June 30, 2006 of $553 and $485, respectively.

As part of ending our agreement with GeneralInstrument during the first quarter of 2006, and in anticipation of ourinventory requirements as a result of taking full responsibility for productdistribution, we negotiated the right to buy back about two-thirds of the unitssold to General Instrument, valued at approximately $2,765 (based upon theoriginal sales price to General Instrument), for approximately $1,064. This isless than half of what it would cost us to purchase the same inventory from itsmanufacturing sources.  As a result werecorded a reserve for returns and reduced revenue in the amount ofapproximately $2,310 during the fourth quarter of 2005. In addition we recordedno revenue for units shipped to General Instrument in the three months endedMarch 31, 2006 and recorded a gain on termination of this agreement ofapproximately $1,792 for the three months ended March 31, 2006, increased to$1,843 for the twelve months ended December 31, 2006, as a result of the lowerpurchase price of this inventory (net of the cost of rework for rebranding theproduct).

*Costs andExpenses*.

*Cost ofRevenues*. Cost of revenues, consists of product and deliverycosts relating to the deliveries of video phones.  For the three months ended June 30, 2007 andJune 30, 2006, the cost of revenues was $482 and $739, respectively.  For the six months ended June 30, 2007 andJune 30, 2006, the cost of revenues was $831 and $1,181, respectively.  Included in these costs for the three and sixmonths ended June 30, 2007 were inventory adjustments for the lower of cost ormarket valuations of $277 and $293, respectively.  For the three and six months ended June 30,2006, these inventory adjustments were $490 and $490, respectively.  These reductions from inventory adjustmentsin 2007, when compared to 2006, primarily accounted for the reduction in thecost for these revenues.

*Engineeringand Development*. Engineering and development expenses primarily consist of compensation,and the cost of design, programming, testing, documentation and support of ourvideo phone product.  Engineering anddevelopment costs were $1,676 for the three months ended June 30, 2007,compared with $1,540 for the three months ended June 30, 2006.  Engineering and development costs were $3,462for the six months ended June 30, 2007, compared with $2,994 for the six monthsended June 30, 2006.  This increase of$136, or 9%, for the three months ended June 30, 2007, and $468,or 16%, for thesix months ended June 30, 2007, when compared to the same periods in 2006,  reflects our increased engineering staff, andrelated costs, for the further and continuing development of its video phoneproduct.

*Sales andMarketing*.  Sales andmarketing expenses consist primarily of compensation (which includescompensation to manufacturer’s representatives and distributors), attendance atconferences and trade shows, travel costs, advertising, promotions and othermarketing programs (which include expenditures for co-op advertising and newmarket development) related to the continued introduction of our video phoneproduct.  Sales and marketing costs were$869 for the three months ended June 30, 2007, compared with $548 for the threemonths ended June 30, 2006.  Sales andmarketing costs were $1,990 for the six months ended June 30, 2007, comparedwith $1,201 for the three months ended June 30, 2006.  This increase of $321, or 59%, for the threemonths ended June 30, 2007, and $789, or 66%, for the six months ended June 30,2007, reflects the increase in advertising, related marketing and promotionalexpenditures and a $300 non-cash stock based consulting fee associated with themarketing of our video phone product, issued in the form of 375,737 shares ofcommon stock and 100,000 common stock options.

*Generaland Administrative*. General and administrative expenses consist primarily of expendituresfor administration, office and facility operations, as well as finance andgeneral management activities, including legal, accounting and professionalfees.  General and administrativeexpenses were $1,439 for the three months ended June 30, 2007, compared with$1,846 for the three months ended June 30, 2006. These expenses were $2,956 forthe six months ended June 30, 2007, compared with $4,369 for the six monthsended June 30, 2006.  This decrease of$407, or 22%, for the three months ended June 30, 2007, and $1,413, or 32%, forthe six months ended June 30, 2007, is primarily attributable to reducedexpenditures during the three and six months ended June 30, 2007 for financialand legal fees of $201 and $369, respectively, and an 

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expenditure of$599 and $1,387, respectively, recorded in the three and six months ended June30, 2006 relating to certain penalties associated with a previousfinancing.  There were no penaltiesrecorded during the first six months of 2007.

*Interestand Other Income and Interest Expense*.  Interest and other income consists ofinterest earned on cash and cash equivalents. Interest expense of $120 and$256, respectively, for the three and six months ended June 30, 2007,  primarily consists of accrued interest on theconvertible debentures issued on August 11, 2006 and October 13, 2006 (see Note7 to our condensed consolidated financial statements for the three and sixmonths ended June 30, 2007).  Interestand other income decreased from $100 for the three months ended June 30, 2006to $45 for the three months ended June 30, 2007, and from $233 for the sixmonths ended June 30, 2006 to $143 for the six months ended June 30, 2007,primarily due to lower average levels of invested funds during the first sixmonths of 2007 compared to the same period in 2006.  During the three months ended June 30, 2007and 2006, we earned interest on its average cash balances which approximated$3,579 and $8,844, respectively, and for the six months ended June 30, 2007 and2006, the interest earned on its average cash balances approximated $5,713 and$11,186, respectively.

*Income Taxes*.  We have incurred net operatinglosses since inception and accordingly had no current income tax provision andhave not recorded any income tax benefit for those losses, since realization ofsuch benefit is currently uncertain.

*NonCash Change in Fair Value of Derivative Warrants and Conversion Options.*For the three months ended June 30, 2007 and June 30, 2006, the non cash changein fair value of derivative warrants and conversion of options was a gain of$1,036 and a loss of $520, respectively. For the six months ended June 30, 2007 and June 30, 2006, the non cashchange in fair value of derivative warrants and conversion of options was again of $2,411 and a loss of $339, respectively. These fair value adjustmentsare primarily a result of changes in our common stock price at each reportingperiod related to our June 2004 private placement of our Series A ConvertiblePreferred Stock and Warrants and our August 11, 2006 and October 13, 2006private placements of secured Convertible Debentures and Warrants.

*Amortizationof Debt Discount*.  Forthe three and six months ended June 30, 2007 the amortization of the debtdiscount was $1,185 and $2,468, respectively, relating to the August 11, 2006and October 13, 2006 private placements of secured Convertible Debentures.  During the three and six months ended June30, 2007, the amortization of debt discount reflected $999 and $1,999 ofconverted debentures and $186 and $469 of discount amortization,respectively.  This discount, at the timeof completion of this private placement on August 11, 2006, was initiallyrecorded for $4,446, and the discount for the October 13, 2006 convertibledebenture issuance was initially recorded as $3,979.  These discounts will be amortized using  the effective interest rate method over thethree year term of the convertible debentures (see Note 7 to our condensedconsolidated financial statements for the three and six months ended June 30,2007).

Liquidity andCapital Resources.

As of June 30, 2007,our primary source of liquidity consisted of cash and cash equivalents that arehighly liquid, are of high quality investment grade and have originalmaturities of less than three months.

As of June 30, 2007,we had cash and cash equivalents of $2,651 as compared to cash and equivalentsof $10,067 as of December 31, 2006. Net cash used in operating activities was $2,323 and $3,210,respectively, for the three months ended June 30, 2007 and 2006.  Net cash used in operating activities was$7,377 and $8,808, respectively, for the six months ended June 30, 2007 and2006. This decrease in net cash used in operating activities was primarilyattributable to our decrease in operating expenses during the three and sixmonths ended June 30, 2007 compared to the same periods in 2006, relatedprimarily to a reduction of expenditures relating to legal and financial servicesof $201and $369, respectively, and a $480 expenditure during the first quarterof 2006 for repurchased products previously sold to General Instrument totaling$1,064, which included the offset of $584 of our accounts receivables.  Bad debt expense was recorded for the threeand six months ended June 30, 2007 of $25 and $25, respectively.  No bad debt expense was recorded for thethree and six months ended June 30, 2006.

Cash used for investingactivities was primarily a result of investments in equipment for productdevelopment and manufacture as well as general administrative and projectmanagement purposes.   For the three andsix month periods ending June 30, 2007, such investments were $16 and $54,respectively.  For the three and sixmonth periods ending June 30 2006, such investments were $58 and $250,respectively.

Cash provided byfinancing activities during the three and six months ended June 30, 2007 wasprimarily the result of employee stock purchases under our 2001 Employee StockPurchase Plan.  Total cash provided byfinancing activities in three and six months ended June 30, 2007 was $6 and$15, respectively, compared to $7 and $13, respectively, during the sameperiods in 2006.

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Operations and Liquidity.

To date, we have funded operations primarily throughmultiple private sales of equity securities, through the issuance ofconvertible debentures and through an initial public offering of common stockin April 1999. The financing secured on August 11, 2006 (see Note 7 to ourcondensed consolidated financial statements for the three and six months endedJune 30, 2007)  has added long term debtto the balance sheet and we have pledged substantially all of our assets ascollateral.  We continue to evaluate thepossibilities to obtain further additional financing through public or privateequity or debt offerings, bank debt financing, asset securitizations, or fromother sources. In July 2007, we entered into a six month exclusive engagementwith an investment banker to assist us with this process.  We have also granted a limited duration optionto one of our product distributors to participate in a private placement,potentially providing additional funds to the Company.  Such additional financing would be subject tothe risk of availability, may be dilutive to our stockholders, or could imposerestrictions on operating activities. If the Company is unable to obtainsufficient funds the Company may reduce the size of its organization or suspendoperations which could have a material adverse impact on its businessprospects.

On June 29, 2007, we announced that we had receivednotice from the staff of the NASDAQ Stock Market that they had denied ourrequest for continued listing on the NASDAQ Capital Market.  We originally received a notice from NASDAQ onApril 11, 2007, stating that we were not in compliance with Marketplace Rule4310(c)(3), which requires that we have a minimum of $2,500 in stockholders’equity or $35,000 of market value of listed securities or $500 of net incomefrom continuing operations for the most recently completed fiscal year or twoof the three most recently completed fiscal years. On April 17, 2007, the Staffhad also notified the Company that for the last 30 consecutive business days,the bid price of the Company’s common stock had closed below the minimum $1.00per share requirement for continued inclusion under Marketplace Rule4310(c)(4).  We subsequently provided a plan to NASDAQ to achieve andsustain compliance with all of the NASDAQ Capital Market listing requirements,including a time frame for completing the plan. While we were successful in reclassifying some of our debt to equity asincluded in our submitted plan, NASDAQ determined that this alone was notsufficient to enable us to achieve and sustain compliance with Rule4310(c)(3).  On July 5, 2007, weannounced that the delisting action by the NASDAQ Stock Market had been stayedpending an appeal hearing before the NASDAQ Listing Qualifications Panel,scheduled to take place on August 9, 2007. In an effort to comply with Rule 4310(c)(4), on July 20, 2007, theCompany’s Board of Directors approved a resolution to amend the Certificate ofIncorporation to effect a 1-for-10 reverse stock split.  This resolutionis subject to stockholder approval and could be implemented at thediscretion of the Company.  We will address the Rule 4310(c)(3) and Rule4310(c)(4) issue at the Hearing.  Our common stock will continue to belisted on the NASDAQ Capital Market pending a final written decision by theNASDAQ Listings Qualifications Panel (the “Panel”) subsequent to the August 9,2007 hearing.  There can be no assurancethat the Panel will grant our request for continued listing.

Thereport of the independent registered public accounting firm for the year endedDecember 31, 2006 includes an explanatory paragraph stating that we havesuffered recurring losses from operations and had an accumulated deficit of$246,806, and that these issues raised substantial doubt about our  ability to continue as a going concern. Ourshort term cash requirements and obligations include inventory, accountspayable and capital expenditures from continuing operations and operatingexpenses.   In addition, the August 2005private placement includes cash payment penalties of 1.5% per month for theperiod that the shares in the transaction fail to be registered. TheRegistration Statement covering the shares under this private placement was notdeclared effective until June 1, 2006. Until such time as the shares were registered we were subject to thepenalty provision under this private placement. For the three and six monthsended June 30, 2007, we recorded and expensed related penalties of $0 and $0,respectively.  For the three and sixmonths ended June 30, 2006, we recorded and expensed related penalties of $599and $1,387, respectively.  The relatedunpaid penalties accrued as of June 30, 2007 and December 31, 2006 was$157.  On July 25, 2006, we amended theterms of the additional investment right that was granted to an investor aspart of the August 2005 private placement, with respect to a portion of sharesof common stock purchasable thereunder and agreed to apply $158 of accruedpenalties towards the exercise price of such amended additional investmentright, for the purchase of 129,950 shares of common stock. The penalties hadaccrued with respect to our inability to register the shares acquired by suchinvestor in the private placement within 120 days of the transaction.  In consideration for this amendment andapplication of the exercise proceeds the investor agreed to forego any cashpayment of the penalties other than as available through the proceeds of theexercise of the amended investment right and to grant us a release of allclaims relating to the late registration of the private placement shares, otherthan the aforesaid penalties.  The amended additional investment rightprovides that the investor thereof may purchase the 129,950 shares of commonstock for a period of 760 days beginning June 1, 2006 for an exercise price of$1.515 per share.  The terms of the additional investment rights withrespect to the remaining 1,424,050 shares of common stock purchasablethereunder remain unchanged.  On July 26,2006 this investor exercised the additional investment right for129,950 shares.  On July 31, 2006the amended additional investment right with respect to the remaining 1,424,050shares of common stock expired.   OnDecember 12, 2006 we amended the terms of the warrants that were granted to aninvestor as part of the August 2005 private placement, with respect to aportion of shares of common stock purchasable thereunder and agreed to apply$315 of accrued penalties towards the exercise price of such amended warrants,for the purchase of 279,255 shares of common stock. In addition, the exerciseprice of 47,412 of the warrants was changed to $1.41 per share.  The penalties had accrued with respect to ourinability to register the shares acquired 

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by such investorin the private placement within 120 days of the transaction.  In consideration for this amendment andapplication of the exercise proceeds the investor agreed to forego any cashpayment of the penalties other than as available through the proceeds of theexercise of the amended warrant and to grant to us a release of all claimsrelating to the late registration of the private placement shares, other thanthe aforesaid penalties.  The amended warrants provide that the investorthereof may purchase the 326,667 shares of common stock for a period of 1,330days beginning December 12, 2006 for an exercise price of $1.41 pershare.  The terms of the warrants with respect to the remaining shares ofcommon stock purchasable thereunder remain unchanged.  On December 19, 2006 this investor exercisedthe warrants for the purchase of 279,255 shares.

The ending of the GeneralInstrument agreement on February 17, 2006 placed additional cash burdens on usand impacted our cash requirements and usage. As part of ending its agreement with General Instrument, and in anticipationof our inventory requirements as a result of taking full responsibility forproduct distribution, we negotiated the right to buy back about two-thirds ofthe units sold to General Instrument, valued at approximately $2,765 (basedupon the original sales price to General Instrument), for approximately $1,064.This is less than half of what it would cost us to purchase the same inventoryfrom its manufacturing sources.  For moredetails, refer to Note 2 to our condensed consolidated financial statements forthe three and six months ended June 30, 2007.

Management expects, basedon our internal forecasts and assumptions including among others, assumptionsregarding our short term cash requirements and our projected revenue resultingfrom sales, that we have sufficient cash on hand to meet our obligations wellinto the third quarter of 2007. As shown in the accompanying consolidatedfinancial statements, we have incurred recurring net losses and have anaccumulated deficit of $255,965 as of June 30, 2007.  These factors raise substantial doubt aboutour ability to continue as a going concern. The financial statements do notinclude any adjustments relating to the recoverability of recorded assets orthe classification of liabilities that might be necessary should we be unableto continue as a going concern.  Additionally,as needed, the Company plans to generate cash by turning to the capital marketsfor further funding.

Our ability to generatecash is dependent upon the sale of our Ojo product and on obtaining cashthrough capital markets.  We began generating revenue from commercialshipment of our Ojo product in April 2005 and we expect revenues to increase asthe product continues to roll out to the marketplace. Depending on the ramp upof sales and the achievable margins, the increased level of sales activityshould have a positive impact on our cash flows from operations, which willsupport our ability to meet our cash requirements in the long term. Given thatour video phone business involves the development of a new product line with nomarket penetration, in an underdeveloped market sector, no assurances can begiven that sufficient sales, if any, will materialize. During the three and sixmonths ended June 30, 2007, we provided forward pricing discounts toretailers  and certain service operatorsales in order to help promote distribution and consumer purchases.  In the case of retail sales, we expect thatrecurring revenues from service fees will offset any loss on the sale of theproduct.  This forward pricing, coupledwith inventory adjustments for obsolescence and lower market valuations, hasresulted in a net margin loss for the three and six months ended June 30, 2007of $177 and $216, respectively.

We, however, remainhopeful that sufficient sales will materialize and/or that sufficient fundingcan be developed through ongoing operations or further additional financings tocontinue our operations beyond 2007.

Our long term cashrequirement obligations are primarily comprised of the items noted above andthe financing secured on August 11, 2006 and October 13, 2006 (see Note 7 toour condensed consolidated financial statements for the three and six monthsended June 30, 2007).

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ITEM 3.   QUANTITATIVE AND QUALITATIVEDISCLOSURES ABOUT MARKET RISK.

Interest RateRisk.  Our exposure to market riskrelated to changes in interest rates relates primarily to our investmentportfolio.  We invest in instruments thatmeet high credit quality standards, and we limit the amount of credit exposurewith respect to any one issue, issuer and type of investment.

As of June 30,2007, the Company’s cash and cash equivalents were $2,651, which were comprisedof securities having a maturity of less than three months.  Due to the average maturity and conservativenature of our investment portfolio, management believes a sudden change ininterest rates would not have a material effect on the value of the portfolio.Manage­ment estimates that had the average yield of our investments decreasedby 100 basis points, our interest income for the three months ended June 30,2007 would have decreased by approximately $37. This estimate assumes that thedecrease occurred on the first day of 2007 and reduced the yield of eachinvestment instrument by 100 basis points. The impact on our future interest income of future changes in investmentyields will depend largely on our total investments.

Foreign CurrencyExchange Risk.  Although we transactbusiness in various foreign countries substantially all of our revenues andcosts to date have been denominated in U.S. dollars.  Although our agreement with Mototech, Inc.(not an affiliate of General Instruments or Motorola), our contractmanufacturer in Taiwan, is denominated in U.S. dollars, their material acquisitioncosts are subject to exchange rate changes that could impact our product costs.

# ITEM 4.    CONTROLS ANDPROCEDURES.

We maintain disclosure controls and procedures (asdefined in Exchange Act Rule 13a-15(e) and 15d-15(e))  that are designed to ensure that informationrequired to be disclosed in reports that we file or submit under the SecuritiesExchange Act of 1934 is recorded, processed, summarized, and reported withinthe time periods specified in the Securities and Exchange Commission’s rulesand forms, and that such information is accumulated and communicated to ourmanagement, including our Chief Executive Officer and Chief Financial Officer,as appropriate to allow timely decisions regarding the required disclosures. Indesigning and evaluating the disclosure controls and procedures, we recognizethat any controls and procedures, no matter how well designed and operated, canprovide only reasonable assurance of achieving the desired control objectives.

As previously reported in our Form 10-K for the yearended December 31, 2006, we identified material weaknesses with respect to theCompany’s application of GAAP with regard to the recording of inventory at thelower of cost or market value.  Toaddress the material weakness related to the application of GAAP with regard tothe recording of inventory at the lower of cost or market value the Companyimplemented a detailed closing procedure which analyzes the inventory regardingits carrying cost at closing compared to its actual unit selling pricesrealized during the current period reported, and subsequent to the reportedclosing date, to ensure that period ending inventory is properly reported,documented and is consistent with GAAP.

We carried out an evaluation, under the supervisionand with the participation of management, including our Chief Executive Officerand Chief Financial Officer, of the effectiveness of the design and operationof our disclosure controls and procedures as of June 30, 2007.  As a result of the actions taken with respectto the Company’s application of GAAP with regard to the recording of inventoryat the lower of cost or market value, the Chief Executive Officer and ChiefFinancial Officer concluded that as of June 30, 2007, we no longer have amaterial weakness (as defined under standards established by the Public CompanyAccounting Oversight Board)  that existswith respect to the Company’s application of GAAP with regard to the recordingof inventory at the lower of cost or market value and our disclosure controlsand procedures are designed and were effective in ensuring that the informationrequired to be disclosed by our Company in the reports that we file and submitunder the Exchange Act is recorded, processed, summarized and reported withinthe time periods specified in the Commission’s rules and forms.

Other than the above noted change in control procedureduring the first six months of 2007, there has been no other changes in ourinternal control over financial reporting that occurred during the three andsix months ended June 30, 2007 that have materially affected, or are reasonablylikely to materially affect, our internal control over financialreporting.  The Company is alsoimplementing a financial system that it believes will improve the internalcontrol over financial reporting and will eliminate any identifieddeficiencies.

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**PART II.OTHER INFORMATION**

# ITEM 1.   LEGAL PROCEEDINGS.

None.

ITEM 1A.  RISK FACTORS

There are nomaterial changes from the risk factors previously disclosed in our annualreport on Form 10-K for the fiscal year ended December 31, 2006 in response toItem 1A of Form 10-K.

Our common stock is currently listed on the NASDAQCapital Market, which has requirements for the continued listing ofstock.  On April 11, 2007, the Company received a notice from thestaff of the Nasdaq Stock Market (the “Staff”) stating that the Company doesnot comply with Marketplace Rule 4310(c)(3) (the “Rule”).  The Rulerequires the Company to have a minimum of $2,500,000 in stockholders’ equity or$35,000,000 market value of listed securities or $500,000 of net income fromcontinuing operations for the most recently completed fiscal year or two of thethree most recently completed fiscal years.  The Staff requested in thisnotice that the Company provide the Staff with the Company’s specific plan toachieve and sustain compliance with all of The Nasdaq Capital Market listingrequirements, including the time frame for completion of the plan.  TheCompany subsequently provided the Staff with its plan to regain and maintaincompliance with the Rule (the “Submission”).  On June 25, 2007, the Company received a notice fromthe Staff stating that, based on the Staff’s review, the Submission andsubsequent conversations with the Company, the Staff had determined to deny theCompany’s request for continued listing on the Nasdaq Capital Market becausethe Company has not provided an adequate definitive plan to regain compliancewith the Rule and sustain compliance over an extended period of time (the “StaffDetermination”).  The Company has filedan appeal of the Staff Determination by requesting a hearing (the “Hearing”)before a Nasdaq Listing Qualifications Panel (the “Panel”), which has stayedthe delisting and suspension of trading the Company’s common stock.  TheHearing will occur on August 9, 2007.  There can be no assurance that thePanel will grant the Company’s request for continued listing.

On April 17, 2007, the Staff had also notified theCompany that for the last 30 consecutive business days, the bid price of theCompany’s common stock had closed below the minimum $1.00 per share requirementfor continued inclusion under Marketplace Rule 4310(c)(4).  In an effortto comply with Rule 4310(c)(4), on July 20, 2007, the Company’s Board ofDirectors approved a resolution to amend the Certificate of Incorporation toeffect a 1-for-10 reverse stock split.  This resolution is subject tostockholder approval and could be implemented at the discretion of theCompany.  The Company will address the Rule 4310(c)(3) and Rule 4310(c)(4)issue at the Hearing.

If our shares aredelisted from the NASDAQ Capital Market, they are likely to become subject tothe SEC penny stock rules, which could adversely affect the market liquidity ofour common stock. These rules impose additional sales practice requirements onbroker-dealers that sell low-priced securities to persons other thanestablished customers and institutional accredited investors; and require thedelivery of a disclosure schedule explaining the nature and risks of the pennystock market. As a result, the ability or willingness of broker-dealers to sellor make a market in our common stock might decline, and you could find it moredifficult to sell your stock.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES ANDUSE OF PROCEEDS.

As disclosed in ourquarterly report on Form 10-Q for the quarterly period ended June 30, 2006, weentered into a purchase agreement with an institutional investor on August 11,2006 pursuant to which we issued a convertible debenture in the principalamount of $6,000,000 to the investor.  For the three and six months endedJune 30, 2007, the investor converted $1,000,000 and $2,000,000, respectively,of this convertible debt into 1,938,744 and 2,923,206 shares, respectively, ofthe Company’s common stock.  In July2007, the investor converted an additional $328,000 of convertible debt into840,000 shares of the Company’s common stock.

The shares issued uponconversion of the convertible debenture were issued in reliance upon theexemption from the registration requirements of the Securities Act of 1933afforded to transactions not involving a public offering by Section 4(2) ofthat Act and Rule 506 thereunder.  OnOctober 11, 2006, an effective registration was obtained for the shares ofcommon stock issued and issuable upon conversion of this debenture.

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# ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None.

# ITEM 4.   SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

None.

# ITEM 5.  OTHERINFORMATION.

None.

ITEM 6.  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.
| Exhlibit | ** ** | **Description**                                                                                                                                                                  |
|----------|------------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1      |       | Amended and Restated Certificate of Incorporation  (2)                                                                                                                           |
| 3.2      |       | Amended and Restated Bylaws (1)                                                                                                                                                  |
| 3.3      |       | Certificate of Amendment to Certificate of  Incorporation, dated October 18, 2004 (2)                                                                                            |
| 3.4      |       | Certificate of Designations, Preferences and Rights  of the Series A Convertible Preferred Stock of the Company dated June 23,  2004 (2)                                         |
| 4.1      |       | Securities Purchase Agreement, dated as of August  11, 2006, by and among the Company and Cornell Capital Partners, LP (3)                                                       |
| 4.2      |       | Investor Registration Rights Agreement, dated August  11, 2006, by and among the Company and Cornell Capital Partners, LP (3)                                                    |
| 4.3      |       | Amended and Restated Secured Convertible Debenture issued  by the Company to Cornell Capital Partners, LP pursuant to the Securities  Purchase Agreement, dated May 18, 2007 (4) |
| 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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* Filed herewith

(1) Incorporated by reference to the exhibits to our Form 10-QReport for the quarter ended March 31, 1999, as filed on May 28, 1999.

(2) Incorporated by reference to the exhibits to our Form 10-QReport for the quarter ended September 30, 2004, as filed on November 17, 2004.

(3) Incorporated by reference to the exhibits to our Form 10-QReport for the quarter ended June 30, 2006 as filed on August 14, 2006.

(4)  Incorporated by reference to the exhibits toour Form 8-K filed May 24, 2007.

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**SIGNATURES**

Pursuant to therequirements of the Securities Exchange Act of 1934, the registrant has dulycaused this report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 
|        |           | WORLDGATE COMMUNICATIONS, INC.               |   |
|--------|----------------|----------------------------------------------|--------|
|   |           |                                         |   |   |
|   |           |                                         |   |   |
| Dated: | August 9, 2007 | /s/ Hal M. Krisbergh                         |   |   |
|   |           | Hal M. Krisbergh                             |   |   |
|   |           | Chairman and Chief Executive Officer         |   |   |
|   |           | (Principal Executive Officer)                |   |   |
|   |           |                                         |   |   |
|   |           |                                         |   |   |
| Dated: | August 9, 2007 | /s/ Joel Boyarski                            |   |   |
|   |           | Joel Boyarski                                |   |
|   |           | Vice President and Chief Financial Officer   |   |
|   |           | (Principal Financial and Accounting Officer) |   |

 

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