**DRAFT 8-12 B**

 

 

**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON, DC 20549**

 

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**FORM 10-Q**

 

| **Mark One**                                                                                                                                                                   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| **ý****Quarterly Report Pursuant to Section 13 or 15(d) of  the Securities Exchange Act of 1934**                                                                         |
|                                                                                                                                                                           |
| **for the Quarterly Period Ended June 30, 2003.**                                                                                                                              |
|                                                                                                                                                                           |
| **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 of Registrant as Specified in Its Charter)

 

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

 

Indicate by check mark whetherthe registrant: (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor such shorter period that the registrant was required to file such reports),and (2) has been subject to such filing requirements for the past 90 days.

Yes ýNo o

 

Indicate by check mark whetherthe registrant is an accelerated filer (as defined in Rule 12b-2 of the ExchangeAct.

Yes oNo ý

 

As of August 5, 2003, therewere 23,580,876 shares of common stock, par value $.01 per share, outstanding.

 

 

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WORLDGATE COMMUNICATIONS, INC.

 

QUARTERLY REPORT ON FORM 10-Q

FOR THE THREE MONTHS ENDED JUNE 30, 2003

 

TABLE OF CONTENTS

 
| PART I  | FINANCIAL INFORMATION |
|---------|-----------------------|
|    |                  |   |
| Item 1. |                  | Financial Statements |
| Item 2. |                  | Management’s Discussion and Analysis of  Financial Condition and Results of Operations |
| Item 3. |                  | Quantitative and Qualitative Disclosures  about Market Risk |
| Item 4. |                  | Controls and Procedures |
|    |                  |   |
| PART II | OTHER INFORMATION     |
|    |                  |   |
| Item 1. |                  | Legal Proceedings |
| Item 2. |                  | Changes in Securities and Use of Proceeds |
| Item 3. |                  | Defaults upon Senior Securities |
| Item 4. |                  | Submission of Matters to a Vote of Security  Holders |
| Item 5. |                  | Other Information |
| Item 6. |                  | Exhibits and Reports on Form 8-K |

 

2

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**PART I. FINANCIAL INFORMATION**

 

**ITEM 1. FINANCIAL STATEMENTS**

 

**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATED BALANCESHEETS**

**(Unaudited)**

**(Dollars inThousands)**

 
|                                                                                                                                                                                      |   | **June 30,  2003** |   | **December  31,  2002** |   |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|--------------------|--------|-------------------------|--------|
| ASSETS                                                                                                                                                                                    |   |               |   |                    |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Current assets:                                                                                                                                                                           |   |               |   |                    |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Cash and cash equivalents                                                                                                                                                                 |   | $                  | 763    |                    | $      | 589 |   |
| Short -term investments                                                                                                                                                                   |   | —             |   | 3,218                   |   |
| Accounts receivable, less allowance for  doubtful accounts of $769 at June 30, 2003 and $1,596 at December 31, 2002                                                                       |   | 371                |   | 1,407                   |   |
| Accounts receivable due from related  parties                                                                                                                                             |   | 139                |   | 1,186                   |   |
| Inventory                                                                                                                                                                                 |   | 2,687              |   | 3,962                   |   |
| Prepaid and other assets                                                                                                                                                                  |   | 594                |   | 281                     |   |
| Total current assets                                                                                                                                                                      |   | 4,554              |   | 10,643                  |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Property and equipment                                                                                                                                                                    |   | 5,070              |   | 5,109                   |   |
| Less: accumulated depreciation and  amortization                                                                                                                                          |   | (3,010             | )      | (2,605                  | )      |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Property and equipment, net                                                                                                                                                               |   | 2,060              |   | 2,504                   |   |
| Deposits and other assets                                                                                                                                                                 |   | 758                |   | 872                     |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Total assets                                                                                                                                                                              |   | $                  | 7,372  |                    | $      | 14,019 |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                                                                                 |   |               |   |                    |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Current Liabilities:                                                                                                                                                                      |   |               |   |                    |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Notes Payable                                                                                                                                                                             |   | $                  | — |                    | $      | 50 |   |
| Accounts payable                                                                                                                                                                          |   | 450                |   | 775                     |   |
| Accounts payable due to related party                                                                                                                                                     |   | 159                |   | 453                     |   |
| Accrued expenses                                                                                                                                                                          |   | 579                |   | 779                     |   |
| Accrued compensation and benefits                                                                                                                                                         |   | 269                |   | 1,132                   |   |
| Contractual obligations related to equity  financing                                                                                                                                      |   | 3,283              |   | 3,283                   |   |
| Deferred rent credit, current and other                                                                                                                                                   |   | 30                 |   | 87                      |   |
| Total current liabilities                                                                                                                                                                 |   | 4,770              |   | 6,559                   |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Deferred rent credit                                                                                                                                                                      |   | 150                |   | 165                     |   |
| Total liabilities                                                                                                                                                                         |   | 4,920              |   | 6,724                   |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Stockholders’ equity:                                                                                                                                                                |   |               |   |                    |   |
|                                                                                                                                                                                      |   |               |   |                    |   |
| Preferred Stock, $.01 par value, 13,500,000  shares authorized                                                                                                                            |   | —             |   | —                  |   |
| Common stock, $.01 par value, 50,000,000  shares authorized, 23,579,887 shares issued and outstanding at June 30, 2003  and 23,577,963 shares issued and outstanding at December 31, 2002 |   | 236                |   | 236                     |   |
| Additional paid-in capital                                                                                                                                                                |   | 194,431            |   | 193,391                 |   |
| Warrant for Common Stock                                                                                                                                                                  |   | 1,911              |   | 1,911                   |   |
| Accumulated deficit                                                                                                                                                                       |   | (194,121           | )      | (189,238                | )      |
| Less Treasury Stock, at cost – 500,000  shares as of June 30, 2003 and December 31, 2002                                                                                             |   | (5                 | )      | (5                      | )      |
| Total stockholders’ equity                                                                                                                                                           |   | 2,452              |   | 7,295                   |   |
| Total liabilities and stockholders’ equity                                                                                                                                           |   | $                  | 7,372  |                    | $      | 14,019 |   |

 

The accompanying notes are an integral partof these financial statements.

 

3

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**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

**(Dollars inThousands, Except per Share Amounts)**

 
|                                                                                                                                                                                                                                                               |   | **Three  Months ended June 30,** |   | **Six Months  ended June 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|--------|----------------------------------|--------|--------------------------------|--------|
|                                                                                                                                                                                                                                                               |   | **2003**                         |   | **2002**                       |   | **2003** |   | **2002** |   |
|                                                                                                                                                                                                                                                               |   |                             |   |                           |   |   |   |   |   |
| Revenues                                                                                                                                                                                                                                                           |   |                             |   |                           |   |   |   |   |   |
| Equipment product revenues earned from  third parties                                                                                                                                                                                                              |   | $                                | 36     |                           | $      | (86 | ) | $ | 131 |   | $ | 188 |   |
| Equipment product revenues earned from  related parties                                                                                                                                                                                                            |   | 13                               |   | (7                             | )      | 1,105 |   | 24 |   |
| Service fee revenues earned from third  parties                                                                                                                                                                                                                    |   | 234                              |   | 298                            |   | 422 |   | 651 |   |
| Service fee revenues earned from related  parties                                                                                                                                                                                                                  |   | 108                              |   | 3,712                          |   | 898 |   | 6,230 |   |
| Total revenues                                                                                                                                                                                                                                                     |   | 391                              |   | 3,917                          |   | 2,556 |   | 7,093 |   |
| Costs and expenses                                                                                                                                                                                                                                                 |   |                             |   |                           |   |   |   |   |   |
|                                                                                                                                                                                                                                                               |   |                             |   |                           |   |   |   |   |   |
| Cost of equipment product revenues                                                                                                                                                                                                                                 |   | 1,250                            |   | 2,462                          |   | 1,890 |   | 3,643 |   |
| Cost of service fee revenues                                                                                                                                                                                                                                       |   | 20                               |   | 3,499                          |   | 803 |   | 5,855 |   |
| Engineering and development (excluding  depreciation and amortization amounts of $76 and $149 for the three months  ended June 30, 2003 and 2002, respectively, and $220 and $299 for the six  months ended June30, 2003 and June 30, 2002, respectively).         |   | 874                              |   | 2,476                          |   | 1,945 |   | 4,791 |   |
| Sales and marketing (excluding depreciation  and amortization amounts of $24 and $82 for the three months ended June 30,  2003 and 2002, respectively, and $50 and $163 for the six months ended June  30, 2003 and June 30, 2002, respectively).                  |   | 231                              |   | 833                            |   | 572 |   | 1,509 |   |
| General and administrative (excluding  depreciation and amortization amounts of $83 and $87 for the three months  ended June 30, 2003 and June 30, 2002, respectively, and $167 and $173 for  the six months ended June 30, 2003 and June 30, 2002, respectively). |   | 845                              |   | 807                            |   | 1,807 |   | 1,358 |   |
| Depreciation and amortization                                                                                                                                                                                                                                      |   | 177                              |   | 318                            |   | 422 |   | 635 |   |
| Goodwill impairment                                                                                                                                                                                                                                                |   | 0                                |   | 3,006                          |   | 0 |   | 3,006 |   |
| Total costs and expenses                                                                                                                                                                                                                                           |   | 3,397                            |   | 13,401                         |   | 7,439 |   | 20,797 |   |
| Loss from operations                                                                                                                                                                                                                                               |   | (3,006                           | )      | (9,484                         | )      | (4,883 | ) | (13,704 | ) |
| Interest and other income                                                                                                                                                                                                                                          |   | 12                               |   | 39                             |   | 39 |   | 105 |   |
| Interest and other expense                                                                                                                                                                                                                                         |   | (5                               | )      | (34                            | )      | (40 | ) | (35 | ) |
|                                                                                                                                                                                                                                                               |   |                             |   |                           |   |   |   |   |   |
| Net loss                                                                                                                                                                                                                                                           |   | $                                | (2,999 | )                              | $      | (9,479 | ) | $ | (4,884 | ) | $ | (13,634 | ) |
|                                                                                                                                                                                                                                                               |   |                             |   |                           |   |   |   |   |   |
| Net loss per common share (basic and  diluted)                                                                                                                                                                                                                     |   | $                                | (0.13  | )                              | $      | (0.40 | ) | $ | (0.21 | ) | $ | (0.58 | ) |
|                                                                                                                                                                                                                                                               |   |                             |   |                           |   |   |   |   |   |
| Weighted average common shares outstanding  - basic and diluted                                                                                                                                                                                                    |   | 23,579,861                       |   | 23,573,122                     |   | 23,579,256 |   | 23,570,714 |   |

 

The accompanying notes are an integral partof these financial statements.

 

4

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**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(Dollars inThousands)**

 
|                                                                    |   | **Six months  ended  June 30,** |   |
|-------------------------------------------------------------------------|--------|---------------------------------|--------|
|                                                                    |   | **2003**                        |   | **2002** |   |
| **Cash flows from operating activities:**                               |   |                            |   |   |   |
| Net loss                                                                |   | $                               | (4,884 | ) | $ | (13, 634 | ) |
| Adjustments to reconcile net loss to cash  used in operating activities |   |                            |   |   |   |
| Depreciation and amortization                                           |   | 422                             |   | 635 |   |
| Bad debt expense                                                        |   | 257                             |   | 309 |   |
| Amortization of deferred compensation                                   |   | 0                               |   | 127 |   |
| Non-cash stock based compensation                                       |   | 40                              |   | 0 |   |
| Impairment of goodwill                                                  |   | 0                               |   | 3,006 |   |
| Provision for inventory                                                 |   | 1,040                           |   | 1,431 |   |
| Loss on the disposition of fixed assets                                 |   | 8                               |   | 0 |   |
| Changes in operating assets and  liabilities:                           |   |                            |   |   |   |
| Accounts receivable                                                     |   | 1,826                           |   | 1,088 |   |
| Inventories                                                             |   | 235                             |   | 361 |   |
| Prepaid and other assets                                                |   | 361                             |   | (258 | ) |
| Accounts payable                                                        |   | (619                            | )      | 305 |   |
| Accrued expenses                                                        |   | (200                            | )      | (265 | ) |
| Accrued compensation and benefits                                       |   | (863                            | )      | (354 | ) |
| Other                                                                   |   | (72                             | )      | (10 | ) |
| Net cash used in operating activities                                   |   | (2,449                          | )      | (7,259 | ) |
| **Cash flows from investing activities:**                               |   |                            |   |   |   |
| Capital expenditures                                                    |   | 0                               |   | (68 | ) |
| Proceeds from maturities of short-term  investments, net                |   | 3,218                           |   | 5,719 |   |
| Proceeds from sale of equipment                                         |   | 14                              |   | 0 |   |
| Net cash provided by investing activities                               |   | 3,232                           |   | 5,651 |   |
| **Cash flows from financing activities:**                               |   |                            |   |   |   |
| Proceeds from issuance of common stock                                  |   | 1                               |   | 10 |   |
| Proceeds from notes payable                                             |   | 0                               |   | 443 |   |
| Repayments of capital leases and notes  payable                         |   | (610                            | )      | (98 | ) |
| Net cash provided by (used in) financing  activities                    |   | (609                            | )      | 355 |   |
| Net increase (decrease) in cash                                         |   | 174                             |   | (1,253 | ) |
| Cash and cash equivalents, beginning of  period                         |   | 589                             |   | 3,356 |   |
| Cash and cash equivalents, end of period                                |   | $                               | 763    |   | $ | 2,103 |   |
|                                                                    |   |                            |   |   |   |
| Cash paid for interest                                                  |   | $                               | 9      |   | $ | 35 |   |
| **Non-cash financing activity:**                                        |   |                            |   |   |   |
| Issuance of note payable to finance  D&O insurance                  |   | 560                             |   | 0 |   |

 

The accompanying notes are anintegral part of these financial statements.

 

5

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED FINANCIAL STATEMENTS

 

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

(Unaudited)

 

1.                                       Basis ofPresentation.

 

The unauditedfinancial statements of WorldGate Communications, Inc. (“WorldGate” or the“Company”) for the three months ended June 30, 2003 presented herein have beenprepared by the Company pursuant to the rules and regulations of the Securitiesand Exchange Commission for quarterly reports on Form 10-Q.  Certain information and footnote disclosuresnormally included in financial statements prepared in accord­ance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations.  These financialstatements should be read in conjunction with the financial statements for theyear ended December 31, 2002 and the notes thereto included in the Company’sAnnual Report on Form 10-K.

 

The financialinformation in this Report reflects, in the opinion of management, alladjustments of a normal recurring nature necessary to present fairly theresults for the interim period. Quarterly operating results are not necessarilyindicative of the results that may be expected for the year ending December 31,2003.

 

2.                                       Liquidity andGoing Concern Considerations

 

As of June 30, 2003 the Company had cash and cash equivalents of$763.  The operating cash usage for thethree and six months ended June 30, 2003 was $1,123 and $2,449, respectively.Subsequent to June 30, 2003, the Company entered into a definitive assetpurchase agreement (the "Agreement") to sell to TVGateway, LLCcertain interactive television ("ITV") intellectual property rightsand certain software and furniture also related to the ITV business andcurrently being used by TVGateway, for $2.4 million in cash, to be paid atclosing which is expected to be in September or October, 2003.  In addition, concurrently with the executionof the Agreement, WorldGate and TVGateway entered into a redemption agreementpursuant to which TVGateway redeemed WorldGate's equity interest in TVGatewayfor $600,000 in cash, paid concurrently with the execution of the redemptionagreement.  The purchase price for theseassets in the aggregate will be $3 million, and will be used to fund continuingoperations, as well as to develop and distribute new products and services forthe broadband market.  The initial $600,000payment, in addition to the cash on hand, is expected to provide sufficient funds to continue operations throughthe closing of the Agreement.  Inconnection with this transaction the Company will incur certain costsassociated with soliciting shareholder approval for the transaction as well ascertain advisor fees for the transaction. Upon closing of the TVGateway transaction and receipt of the $2.4million from TVGateway (less these associated costs,) the Company projects itwill have sufficient funding to continue operations into the first quarter of2004, assuming no additional funding is received.  The Company has retained a royalty free license to theintellectual property rights and assets sold to TV Gateway and plans tocontinue providing the WorldGate service to its customers.  Accordingly the Company expects to continueto receive revenues from the operation of this business, although given theCompany’s going concern considerations no assurances can be provided as to theamount and collectability of such revenues or to the period such revenues willcontinue to be received.

 

TheCompany has no outstanding debt and its assets are not pledged ascollateral.  The Company continues toevaluate possibilities to obtain additional financing through public or privateequity or debt offerings, bank debt financing, asset securitizations or fromother sources.  Such additionalfinancing would be subject to the risk of availability, may be dilutive to ourshareholders, or could impose restrictions on operating activities.  There can be no assurance that thisadditional financing will be available on terms acceptable to the Company, ifat all.  The Company has limited capacityto further reduce its workforce and scale back on capital and operational expendituresto decrease cash burn given the measures it has already taken to reduce staffand expenses.

 

Theunaudited consolidated financial statements have been prepared on a goingconcern basis, which contemplates the realization of assets and the satisfactionof liabilities and commitments in the normal course of business.  Therefore, the financial statements do notinclude any adjustments relating to the Company’s ability to operate as a goingconcern.  The appropriateness of usingthe going concern basis in the future, however, will be dependent upon theCompany’s ability to address its liquidity needs as described above.  There is no assurance that the Company willbe able to address its liquidity needs through the measures described above onacceptable terms and conditions, or at all, and, accordingly, there issubstantial doubt about the Company’s ability to continue as a going concernbeyond the first quarter of 2004, assuming the receipt of proceeds from theTVGateway transaction.

 

6

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3.                                       Agreement with Argentine customer

 

In 2001, the Companysold $742 worth of deployment equipment, keyboards and other items to a cableoperator in Argentina who at the time, was not experiencing economicdifficulties. Shortly after the sale, the country of Argentina encounteredeconomic difficulties that adversely affected our Argentine customer’sfinancial position. Our Argentine customer made a $400 payment on the equipmentpurchased but was having difficulties satisfying the remaining unpaid portionof their invoice. During the second quarter of 2002, after further negotiationswith our Argentine customer, the Company believed that the best course ofaction to salvage value from the remaining $342 unpaid balance was to agree toa cash payment of $55, take back a portion of the keyboards previously soldworth $150 which was recorded as a reduction in revenues, and write off theremaining unsatisfied portion of their invoice of $137 as general andadministrative expense. The keyboards taken back from our customer can beresold to other cable operators in Spanish speaking countries. It is not anormal policy or practice of the Company to take back inventory previouslysold; it was done only due to the extenuating circumstances. Our Argentinecustomer has made the cash payment stipulated in the agreement and is nowpaying their monthly service fees on a regular basis.

 

4.                                       Inventories.

 

Inventoriesare summarized as follows:

 

|                                    |   | **June 30,  2003** |   | **December  31, 2002** |   |
|-----------------------------------------|--------|--------------------|--------|------------------------|--------|
|                                    |   |               |   |                   |   |
| Raw Material                            |   | $                  | 1,782  |                   | $      | 2,479 |   |
| Work in Progress                        |   | —             |   | 2                      |   |
| Finished Goods                          |   | 364                |   | 865                    |   |
| Inventory held by customers and vendors |   | 541                |   | 616                    |   |
|                                    |   | $                  | 2,687  |                   | $      | 3,962 |   |

 

5.                                       Stock-BasedCompensation

 

The Companyaccounts for stock-based compensation in accordance with Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees,” as amended bySFAS No. 148, “Accounting for Stock-Based Compensation—Transition andDisclosure”.

 

The Company applies Accounting PrinciplesBoard Opinion No. 25, “Accounting for Stock Issued to Employees” and relatedinterpretations in accounting for its plans, and accordingly, no compensationcost has been recognized for the Company’s fixed stock based compensation.  Had compensation cost been determinedconsistent with SFAS No. 123, as amended by SFAS No. 148, the Company’s netloss would have been increased to the following pro forma amounts:

 

7

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|                                                                                                                                 |   | **For the  Three Month Period  Ended June 30,** |   | **For the  Six Month Period  Ended June 30,** |   |
|--------------------------------------------------------------------------------------------------------------------------------------|--------|-------------------------------------------------|--------|-----------------------------------------------|--------|
|                                                                                                                                 |   | **2003**                                        |   | **2002**                                      |   | **2003** |   | **2002** |   |
|                                                                                                                                 |   |                                            |   |                                          |   |   |   |   |   |
| Net loss:                                                                                                                            |   |                                            |   |                                          |   |   |   |   |   |
| As reported                                                                                                                          |   | $                                               | (2,999 | )                                             | $      | (9,479 | ) | $ | (4,884 | ) | $ | (13,634 | ) |
| Add: Stock-based compensation  expense included in reported net loss, net of related tax effects of $0                               |   | —                                          |   | 55                                            |   | 40 |   | 127 |   |
| Deduct: Total stock-based employee expense  determined under the fair value based method for all awards, net of related  tax effects |   | (1,350                                          | )      | (1,317                                        | )      | (2,770 | ) | (2,737 | ) |
| Pro forma net loss                                                                                                                   |   | $                                               | (4,349 | )                                             | $      | (10,741 | ) | $ | (7,614 | ) | $ | (16,244 | ) |
|                                                                                                                                 |   |                                            |   |                                          |   |   |   |   |   |
| Net Loss per share:                                                                                                                  |   |                                            |   |                                          |   |   |   |   |   |
| Basic and diluted—as reported                                                                                                   |   | $                                               | (0.13  | )                                             | $      | (0.40 | ) | $ | (0.21 | ) | $ | (0.58 | ) |
| Basic and diluted—pro forma                                                                                                     |   | $                                               | (0.18  | )                                             | $      | (0.46 | ) | $ | (0.32 | ) | $ | (0.69 | ) |

 

Such pro forma disclosures may not be representative of futurecompensation expense because options

vestover several years and additional grants are made each year.

 

6.                                       RelatedParty Transactions.

 

In 1997, theCompany entered into agreements with cable operators who are investors.  Revenues recognized from such investors wereapproximately $65 and $85, respectively, for the three months ended June 30,2003 and June 30, 2002 and approximately $136 and $180, respectively for thesix months ended June 30, 2003 and June 30, 2002. Accounts receivable from suchinvestors amounted to approximately $139 at June 30, 2003 and $97 at December31, 2002.

 

The Companyhas agreements with some investors to provide engineering and developmentsupport.  As a result of theseagreements, the Company has expensed approximately $165 and $632, respectively,for the three months ended June 30, 2003 and June 30, 2002 and approximately$556 and $1,152, respectively, for the six months ended June 30, 2003 and June30, 2002.  Accounts payable to thesestockholders amounted to $159 and $468 at June 30, 2003 and December 31, 2002,respectively.  These stockholders aresuppliers of technology and components for the Company’s products andservices.  These agreements provide forlicensing of technology, as well as contracted services, including hardware andsoftware development, product testing and certification, and the creation anddevelopment of tools and systems to facilitate the Company’s engineeringefforts.  These agreements do notprovide for ongoing royalties, purchase provisions, nor for any requirement toprovide additional funding to the Company.

 

In 1998 theCompany entered into a leasing arrangement for a building with an entity formedby non-employee investors.  Included indeposits and other assets at June 30, 2003 is $750 related to this lease.  The Company did not pay their rent on theircurrent facility for the months of June, July and August 2003.  Subsequent to June 30, 2003, thecorresponding monthly and operating amounts which approximate $85 per month havebeen deducted by our landlord from the deposit referenced above which is thesecurity deposit the Company maintains with respect to the building.  Although the Company and the non-employeeinvestor are in the process of trying to negotiate a settlement, thenon-employee investor has perfected his interest to potentially enable him totake possession of the facility in the event the settlement discussions are notsuccessful.

 

7.                                       TVGatewayJoint Venture and related Cable Operator Agreements

 

On July 24, 2000, the Company formed aseparate joint venture, TVGateway, LLC, with four cable operators.  As part of this venture WorldGate enteredinto a management agreement with TVGateway to provide engineering, operationsand administrative support services. In addition to providing for the terms andconditions

 

8

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under which such services were to be provided the management agreementcontained a provision providing for WorldGate and TVGateway to cooperate totransition to TVGateway some or all of the support services being provided byWorldGate and/or the employees providing these services. In addition, thisprovision required WorldGate to remain available to provide support servicesuntil July 24, 2005. During 2002 WorldGate and TVGateway agreed to commence thetransition of services pursuant to this provision. In addition, the partiesagreed that the management agreement shall be of no further force and effectwith respect to the services that are transferred as of the completion of thespecific transfers. The companies completed this transition in first quarter2003 and accordingly, WorldGate has now been relieved of any continuingobligation to provide such transitioned services.

 

Revenues for such services, which areincluded in service fee revenue, totaled $56, and $3,646, respectively for thethree months ended June 30, 2003 and 2002, and $788 and $6,085, respectively,for the six months ended June 30, 2003 and 2002.  In addition, product sales to TVGateway totaled $0 and $16 forthe three months ended June 30, 2003 and 2002, and $1,079 and $37,respectively, for the six months ended June 30, 2003 and 2002.  Accounts Receivable from TVGateway amountedto $0 at June 30, 2003 and $1,089 at December 31, 2002. WorldGate isaccounting for its 18% investment in the joint venture, which was previouslyreduced to a carrying value of $0 due to prior losses, under the equity method.

 

On August 7, 2003 the Company announced that it entered into adefinitive agreement to sell to TVGateway, LLC certain ITV intellectualproperty rights and certain software and equipment related to the ITV businesswhich TVGateway was currently using, for $2.4 million in cash, to be paid atclosing.  In addition, concurrently withthe execution of the Agreement, WorldGate and TVGateway entered into aredemption agreement pursuant to which TVGateway redeemed WorldGate's equityinterest in TVGateway for $600,000 in cash, paid concurrently with theexecution of the redemption agreement. The purchase price for these assets in the aggregate will be $3 millionand will be used by the Company to fund continuing operations, as well as todevelop and distribute new products and services for the broadband market.  As part of this transaction WorldGate retaineda royalty-free license to the transferred intellectual property rights andsoftware, and with such license the Company plans to continue to support itsinteractive television (“ITV”) customers.

 

*Related Cable Operator Agreements*

 

In 2000, and concurrently with the formationof the TVGateway joint venture, the Company entered into multi-year agreementswith four cable operators for the digital deployment of the Company’s ITV -service to a predetermined number of households. In addition to the deploymentagreements, the cable providers purchased an aggregate of 1,531,211 shares ofthe Company’s Common Stock yielding proceeds to the Company of $24,530. Thesesame cable operators were issued warrants to purchase additional shares ofCommon Stock which will vest at varying rates based on the deployment of theCompany’s ITV service on the cable operator’s digital cable system.

 

Furthermore,the Company entered into a supply agreement with the cable operators wherebythe Company agreed to supply these cable operators, on a pro rata basis,products that pertain to the development and deployment of the WorldGateservice. The Company initially recorded a liability in the amount of $5,110related to this obligation. The recorded amount was based on the Company’s bestestimate of what it would cost to satisfy the contractual obligation to thevarious cable operators. The Company’s policy has been not to adjust theliability after it has been established. Any future change in the contractualobligation liability would be a reclassification to additional paid in capital.When equipment credits are utilized by the cable operators, the value of theequipment is reflected in its entirety in the cost of revenues. The equipmentcredit expires on August 24, 2003. At June 30, 2003, the Company had aremaining liability of $3,283 for the anticipated cost of satisfying thisobligation.

 

8.                                       NetLoss per Share

 

Basic anddiluted net loss per common share is computed by dividing the net lossavailable to common stockholders for the period by the weighted average numberof shares of common stock outstanding during the period.  The calculation of diluted net loss percommon share excludes potential common shares if the effect isantidilutive.  Potential common sharescomprise shares of common stock issuable upon the exercise of stock options andwarrants.  The number of potentialcommon shares which would have been assumed to be converted in the periodsended June 30, 2003 and 2002 and have a dilutive effect if the Company hadincome from continuing operations is 5,932,513 and 6,424,384, respectively.

 

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ITEM 2.   MANAGEMENT’S DISCUSSION AND ANALYSIS OFFINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

(Dollar Amounts are inThousands, Except per Share Amounts)

 

FORWARD-LOOKING AND CAUTIONARY STATEMENTS.

 

We may fromtime to time make written or oral forward-looking statements, including thosecontained in the following Management’s Discussion and Analysis of FinancialCondition and Results of Operations. The words “estimate,” “project,” “believe,” “intend,” “expect,” andsimilar expressions are intended to identify forward-looking statements,although not all forward-looking statements contain these identifyingwords.  In order to take advantage ofthe “safe harbor” provisions of the Private Securities Litigation Reform Act of1995, we are hereby identifying certain important factors which could cause ouractual results, performance or achievement to differ materially from those thatmay be contained in or implied by any forward-looking statement made by or onbehalf of WorldGate.  The factors,individually or in the aggregate, that could cause such forward-looking  statements not to be realized include, withoutlimitation, the following: (1) difficulty or inability to raise additionalfinancing on terms acceptable to us, (2) difficulty in developing andimplementing marketing and business plans, (3) continued losses, (4) loss ofany one of our large customers, (5) industry competition factors and otheruncertainty that a market for our products will develop, (6) challengesassociated with broadband operators (including, uncertainty that they willoffer our products, inability to predict the manner in which they will marketand price our products and existence of potential conflicts of interests andcontractual limitations impeding their ability to offer our products), (7)departure of one or more key persons, (8) delisting of our Common Stock from the NASDAQ Small Cap Market, (9)changes in regulatory requirements, and (10) other risks identified in ourfilings with the Securities and Exchange Commission.  We caution you that the foregoing list of important factors isnot intended to be, and is not, exhaustive. We do not undertake to update any forward-looking statement that may bemade from time to time by or on behalf of WorldGate.

 

Results of Operations:

 

Critical Accounting Policiesand Estimates

 

Theconsolidated financial statements are prepared in conformity with accountingprinciples generally accepted in the United States.  The preparation of these financial statements required managementto make estimates and assumptions that affect the reported amounts of assetsand liabilities and disclosure of contingent assets and liabilities at the dateof the financial statements and the reported amounts of revenues and expensesduring the reporting period.  Actualresults could differ from those estimates.

 

Thesignificant accounting policies of the Company are described in the notes tothe consolidated financial statements included in the annual report on Form10-K.  Judgments and estimates ofuncertainties are required in applying the Company’s accounting policies inmany areas.  Following are some of theareas requiring significant judgments and estimates:  revenue recognition, accounts receivable, inventories, and cashflow and valuation assumptions in performing asset impairment tests oflong-lived assets.

 

Three and Six Months Ended June30, 2003 and June 30, 2002

 

Revenues

 

Revenues.  Revenues decreased to $391 for the threemonths ended June 30, 2003, or 90%, from $3,917 for the three months ended June30, 2002.  Revenues also decreased 64%from $7,093 for the six months ended June 30, 2002 to $2,556 for the six monthsended June 30, 2003.    A substantialportion of the revenue decrease for the three months ended June 30, 2003, ascompared to the three months ended June 30, 2002, is attributable to reducedconsulting fees with TVGateway.  For thesix months ended June 30, 2003, a substantial portion of the revenue decrease,when compared to the six months ended June 30, 2002, is also attributable toreduced consulting fees with TVGateway, partially offset by increased equipmentsales with TVGateway during the first quarter of 2003.  As a result of the transition of services toTVGateway, we do not expect to receive any

 

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significant revenues fromconsulting fees or equipment sales from TVGateway in the future.  For the three months ended June 30, 2003consulting fee revenues with TVGateway were $56, or 98% below such consultingfees of $3,646 for the three months ended June 30, 2002.  For the six months ended June 30, 2003consulting fee revenues from TVGateway were $788, or 87% below such consultingfees of $6,085 for the six months ended June 30, 2002.  For the three months ended June 30, 2003,equipment sold to TVGateway was $0, compared to $16 for the three months endedJune 30, 2002.  For the six months endedJune 30, 2003, equipment sold to TVGateway was $1,079, compared to $37 for thesix months ended June 30, 2002.  At June30, 2002 we had deployed our services in 72 cable systems with approximately581,000 Revenue Generating Units.  As ofJune 30, 2003 we had deployed our services in 67 cable systems, representingapproximately 582,000 Revenue Generating Units.  For the three months ended June 30, 2003, we derived revenues of$342, or 87%, from service fees consisting of consulting fees, subscriber feesand advertising fees, and $49, or 13%, from the delivery of headends, keyboards,and related equipment products.  For thethree months ended June 30, 2002, we derived revenues of $4,010, or 102%, fromservice fee revenues partially offset by the return of headends and keyboardsthat totaled $93, or 2%.  For the sixmonths ended June 30, 2003, we derived revenues of $1,320, or 52%, from servicefee revenues and $1,236, or 48%, from the delivery of equipment.  For the six months ended June 30, 2002, wederived revenues of $6,881, or 97%, from service fees and $212, or 3%, from thedelivery of equipment.  Included inequipment revenues for the three months ended June 30, 2003 and 2002, weresales of excess inventory of $7 and $0, respectively.  For the six months ended June 30, 2003 and 2002, the sale ofexcess inventory included in equipment revenues were $42 and $0, respectively.  TheCompany currently plans to continue providing the WorldGate service to itscustomers, and accordingly expects to continue to receive revenues from theoperation of this business, although given the Company’s going concernconsiderations no assurances can be provided as to amount and collectability ofsuch revenues or to the period such revenues will continue to be received.  WorldGate does not expect to generate anysignificant revenues from its videophone product for the remainder of this yearand fiscal 2004.

 

Costs andExpenses.

 

Cost ofRevenues.  Cost of revenues consistsprimarily of equipment product costs related to initial trials and commercialdeployments and service fee revenue costs, related primarily to the provisionof engineering and administrative services. Costs of equipment product revenues for the three and six months endedJune 30, 2003, were $1,250 and $1,890, respectively, or approximately 2,551%and 153%, respectively, of equipment product revenues, compared to the productcosts of revenues of $2,462 and $3,643, respectively, or approximately 2,647%and 1,718%, respectively, of equipment product revenues, for the three and sixmonths ended June 30, 2002.  Thesedecreases in the cost of equipment product revenues for the three and sixmonths ended June 30, 2003, as compared to the three and six months ended June30, 2002, were primarily the result of approximately $760 of equipment sales toTVGateway, which primarily consisted of equipment previously expensed orwritten-off, and reduced manufacturing overhead costs for the three and sixmonths ended June 30, 2003 of $436 and $1,215, respectively.  Included in product costs the Companyrecorded $1,002 and $1,040, respectively, in inventory reserves in the threeand six months ended June 30, 2003.  Forthe three and six months ended June 30, 2002, inventory reserves were$1,431.  Service fee costs of revenuesfor the three and six months ended June 30, 2003, were $20 and $803,respectively, or approximately 6% and 61%, respectively, of service feerevenues.  Service fee costs of revenueswere $3,499 and $5,855, respectively, or approximately 87% and 85%,respectively, of service fee revenues for the three and six months ended June30, 2002.  These decreases in servicefee cost of revenues for the three and six months ended June 30, 2003 of $3,479and $5,052, respectively, when compared to the same period in 2002, areprimarily attributable to decreased staffing levels required as a result of theTVGateway transfer.

 

Engineeringand Development.  Engineering anddevelopment expenses primarily consist of the cost of design, programming,testing, documentation and support of the Company’s hardware, software andservices.  Engineering and developmentcosts were $874 for the three months ended June 30, 2003, a decrease ofapproximately 65% when compared to $2,476 for the three months ended June 30,2002.  For the six months ended June 30,2003, engineering and development costs were $1,945, a decrease ofapproximately 59%, when compared to $4,791 for the six months ended June 30,2002.  These decreases in expenses areprimarily attributable to declines in staffing over the last two years whichresulted in a significant payroll cost reduction, a significant portion ofwhich is the result of termination of all of the personnel of the former DVAand of the engineering development consultants for TVGateway.  Employee compensation costs declined for thethree and six months ended June 30, 2003 by $1,364 and $2,944, respectively, or68% and 69%, respectively, when compared to the same periods in 2002.

 

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Sales andMarketing.  Sales and marketing costsconsist primarily of compensation, attendance at conferences and trade shows,travel costs necessary to cover a domestic and international customer marketbase, promotions and other marketing programs substantially related to initialtrial installations and commercial deployments.  For the three months ended June 30, 2003, sales and marketingexpenses were $231.  This represents adecrease of approximately 72%, when compared to sales and marketing expenses of$833 for the three months ended June 30, 2002. For the six months ended June 30, 2003, sales and marketing expenseswere $572, a decrease of approximately 62%, when compared to $1,509 for the sixmonths ended June 30, 2002.  Thesedecreases in expenses are primarily attributable to declines in staffing overthe last two years.  These actionsresulted in employee compensation costs declining in the three and six monthsended June 30, 2003 by $427 and $720, respectively, or approximately 69% and59%, respectively, when compared to the same periods in 2002.  Conferences and trade show costs alsodeclined for the three and six months ended June 30, 2003 by $10 and $720,respectively, or approximately 100% and 93%, respectively, when compared to thesame periods in 2002, as a result of reduced participation by the Company.

 

General andAdministrative.  General and administrativeexpenses consist primarily of expenditures for administration, office andfacility operations, finance and general management activities, includinglegal, accounting and other professional fees. General and administrative expenses were $845 and $1,807, respectively,for the three and six months ended June 30, 2003, an increase of approximately5% and 33%, respectively, when compared to expenses of $807 and $1,358,respectively, for the same periods in 2002. These increases in expenses are primarily attributable to facilityoverhead costs that are no longer allocable to TVGateway, partially offset bydeclines in staffing, and the issuance of 150,000 stock options to aninvestment financial advisor with a fair value of $40 to assist us in evaluatingvarious strategic and financial alternatives available to the Company.  Employee compensation costs declined in thethree and six months ended June 30, 2003 by $210 and $292, respectively, orapproximately 47% and 34%, when compared to the same periods in 2002, as aresult of decreases in staffing. Facility expenses increased for the three and six months ended June 30,2003 by $372 and $636, respectively, or approximately 433% and 261%,respectively, when compared to the same periods in 2002, also as a result ofthe facility overhead costs no longer allocated to TVGateway.

 

GoodwillImpairment.  During the second quarterof 2002, in an effort to cut costs and achieve operational efficiencies, theCompany commenced the termination of all personnel of the former DVA whichperformed engineering development services. In conjunction with this action, itwas determined that the carrying amount of the Company’s remaining goodwill,which was originally recorded with the Company’s acquisition of DVA, exceeded itsfair value. As such, the Company measured the impairment loss by the amount thecarrying value exceeded the implied fair value of the goodwill. The amount ofthe non-cash impairment loss was $3,006. The fair value of goodwill wasestimated using the expected present value of future cash flows.

 

Interest andOther Income and Interest Expense. Interest and other income and interest expense consist of interestearned on cash and cash equivalents and short-term investments, and interestexpense on equipment financing and short-term debt.  Interest and other income decreased from $39 for the three monthsended June 30, 2002 to $12 for the three months ended June 30, 2003, anddecreased from $105 for the six June 30, 2002 to $39 for the six months endedJune 30, 2003, primarily due to declining average cash balances and todeclining interest rates.  During thethree and six months ended June 30, 2002, the Company earned interest onaverage cash balances of approximately $8,963 and $10,913, respectively, andincurred interest expense related to its $1,100 equipment financingfacility.  In comparison, during thethree and six months ended June 30, 2003 the Company earned interest on averagecash balances of approximately $1,518 and $2,618, respectively, and incurredinterest expense related to its insurance financing.

 

Income Taxes.  The Company has incurred net operatinglosses since inception and accordingly had no income taxes and has not recordedany income tax benefit for those losses.

 

Liquidity andCapital Resources.

 

As of June 30,2003, our primary source of liquidity consisted of cash and cash equivalentsand short-term investments that are highly liquid, are of high qualityinvestment grade and have maturities of less than one year.

 

At June 30,2003, we had cash and cash equivalents of $763 as compared to cash andequivalents of $589 (in addition to $3,218 in short-term investments) atDecember 31, 2002.  Net cash used inoperations was $2,449 for the six months ended June 30, 2003, as compared to$7,259 used for the same period in 2002. The decrease in net cash used for operations was primarily attributableto the Company’s decrease in expenditures, including its

 

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reduction in workforceprograms.  Accounts receivable andinventory reductions were partially offset by other changes in working capitalduring the quarter.  The Companyrecorded bad debt expense in the amount of $257 during the six months endedJune 30, 2003 to reflect its current assessment of the collectability ofcertain receivables, primarily Latin and South America.  The Company has instituted tighter creditprocedures to minimize its collection exposure with particular emphasis oninternational customers.

 

Cash providedby investing activities during the six months ended June 30, 2003, totaled$3,232 compared to $5,651 provided during the same period in 2002.  During the six months ended June 30, 2003,we utilized the net proceeds from our maturing short-term investments of $3,218compared to $5,719 for the six months ended June 30, 2002.  Capital expenditures were $0 and $68 for thesix months ended June 30, 2003 and 2002, respectively.

 

Operations andLiquidity

 

To date, the Companyhas funded operations primarily through private sales of equity securities andthrough an initial public offering of common stock in April 1999. As ofJune 30, 2003 the Company had cash, cash equivalents of $763. The operatingcash usage for the six months ended June 30, 2003 was $2,449. In October 2002,the Company announced multiple actions that it believed would further reduceoperating expenses and increase operating efficiencies. These actions includeda reduction in work force as well as the implementation of an agreement withTVGateway to transfer to TVGateway certain WorldGate employees and functionsthat WorldGate was currently providing for TVGateway. During the first quarter2003, the Company substantially finalized the transition settlement and othermatters with TVGateway and in January 2003 received $2,428 in cash as part ofthis settlement. This amount largely comprises payment of our receivablebalance as of December 31, 2002 in the amount of $1,000, payment of January2003 service fees in the amount of $300 and other payments largely related to ourJanuary 2003 sale of certain equipment and inventory in the approximate amountof $1,055. This transition of services removed both the obligation of WorldGateto provide the service as well as TVGateway’s obligation to pay WorldGate forrendering the service. As such, WorldGate was negatively impacted in that itwill no longer receive any significant revenues from providing theseservices.  Although WorldGate’s revenueattributable to the transitioned service was reduced, so was the correspondingexpense of providing the service. Also, there was  overhead which was reduced or otherwise allocated and which waspreviously passed on to TVGateway.

 

As of June 30, 2003, we have no outstandingdebt and our assets are not pledged as collateral.  However, we did not pay our rent on ourcurrent facility for the months of June, July and August 2003.  As a result, our landlord, a non-employeeinvestor, has perfected his interest to potentially enable him to takepossession of our facility and is drawing down from our rent deposit of $750 tosatisfy the unpaid rent.  We continue toevaluate possibilities to obtain additional financing through public or privateequity or debt offerings, bank debt financing, asset securitizations or fromother sources. Such additional financing would be subject to the risk ofavailability, may be dilutive to our shareholders, or could impose restrictionson operating activities. There can be no assurance that this additionalfinancing will be available on terms acceptable to us, if at all.  The Company has limited capacity to furtherreduce its workforce and scale back on capital and operational expenditures todecrease cash burn given the measures it has already taken to reduce staff andexpenses.

 

Upon closing of the TVGateway transaction and the receipt in theaggregate of $3 million from TVGateway (less the associated costs forsoliciting shareholder approval and fees for our investment advisors), theCompany projects it will have sufficient funding to continue operations intothe first quarter of 2004, assuming no additional funding is received. We continue to seek funding to keep the Companyviable beyond this period, exploring investments, mergers, sale of the Companyas well as the sale or licensing of some or all of the Company’s assets, amongother means of funding.  To this end, wehave been, and continue, discussing possible transactions with several partiesand at the same time we are broadening and formalizing the solicitationprocess.  We seek to obtain any and allexpressions of interests in sufficient time to ensure that we can properlyevaluate all funding opportunities.  Noassurances can be given that a transaction can be consummated prior to thedepletion of our available cash.  Wehowever remain hopeful that sufficient funding can be obtained to continue theCompany’s operations.

 

The Company received a letter dated October8, 2002, from the NASDAQ, which notified it that the bid price for its commonstock had been below $1.00 per share for a period of thirty consecutive days.  Subsequently the Company sought and receivedNASDAQ approval to transfer its listing to the NASDAQ Small Cap Market, and onJanuary 9, 2003 the Company’s common stock commenced trading on this market.  WorldGate cannot offer any assurance thatother NASDAQ requirements for continued listing will be satisfied.  If the Company’s common stock

 

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is delisted, this may have a negative impact on the liquidity and priceof its common stock and investors may find it more difficult to purchase ordispose of, or to obtain accurate quotations as to the market value of, itscommon stock.  Furthermore, the listingof the Company’s common stock on the NASDAQ Small Cap Market, makes itineligible for certain exemptions from the various state securities or “bluesky” laws, which makes it more difficult for the Company to raise capitalthrough issuances of securities.

 

ITEM 3.   QUANTITATIVE AND QUALITATIVE DISCLOSURESABOUT MARKET RISK.

 

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

 

As of June 30,2003, the Company’s cash and cash equivalents and short-term investments were$763, most of which were debt securities having a maturity of less than oneyear.  Due to the average maturity andconservative nature of our investment portfolio, management believes a suddenchange in interest rates would not have a material effect on the value of theportfolio.  Manage­ment estimates thathad the average yield of our investments decreased by 100 basis points, ourinterest income for the six months ended June 30, 2003 would have decreased byapproximately $12.  This estimateassumes that the decrease occurred on the first day of 2003 and reduced theyield of each investment instrument by 100 basis points.  The impact on our future interest income offuture changes in investment yields will depend largely on our totalinvestments.

 

ForeignCurrency Exchange Risk.  Although wetransact business in various foreign countries, the principal portion of ourbusiness is in the United States and substantially all of our revenues andcosts to date have been denominated in U.S. dollars.  As a result, adverse movements in foreign currency exchange rateswould not have a material adverse effect on us.

 

ITEM 4.   CONTROLS AND PROCEDURES.

 

As of the endof the period covered by this Form 10-Q, the Company’s management, includingits chief executive officer and chief financial officer conducted an evaluationof the effectiveness of the Company’s disclosure controls and  procedures. Based on that evaluation, the chief executive officer and chieffinancial officer, concluded that the Company’s disclosure controls andprocedures were effective.  There havebeen no  changes in the Company’sinternal control over financial reporting that occurred during the period endedJune 30, 2003, that have materially affected, or are reasonably likely tomaterially affect, the Company’s internal control over financial reporting.

 

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PART II. OTHERINFORMATION

 

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

 

ITEM 1. LEGAL PROCEEDINGS.

 

The Companyhas not paid our rent on our current facility for the months of June, July andAugust 2003.  As a result, our landlordhas perfected his interest to potentially enable him to take possession of ourfacility, and is drawing down from our rent deposit balance of $750 at June 30,2003 to satisfy the unpaid rent.  We arein the process of negotiating a settlement of our lease obligation with thelandlord in an effort to reduce our outstanding liability and ongoing leaseobligations, although there can be no assurance that a settlement can beobtained.

 

ITEM 2.  CHANGES IN SECURITIES AND USE OF PROCEEDS.

 

On January 21,2003 WorldGate issued 150,000 options, with an exercise price of $.625 pershare to an investment advisor in consideration for financial services.  The options were issued pursuant to anexemption under Section 4(2) of the Securities Act of 1933, as amended.

 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

 

None.

 

ITEM 4.  SUBMISSION OF MATTERS TO A VOTE OF SECURITYHOLDERS.

 

None.

 

ITEM 5. OTHER INFORMATION.

 

The Company has announced that it has enteredinto a definitive agreement to sell to TVGateway, LLC certain ITV intellectualproperty rights and certain software and equipment related to the ITV businesswhich TVGateway was currently using, for $2.4 million in cash, to be paidat closing.  In addition, concurrentlywith the execution of the Agreement, WorldGate and TVGateway entered into aredemption agreement pursuant to which TVGateway redeemed WorldGate's equityinterest in TVGateway for $600,000 in cash, paid concurrently with theexecution of the redemption agreement. The purchase price for these assets in the aggregates, will be $3million which WorldGate will use to fund continuing operations, as well as todevelop and distribute new products and services for the broadband market.  The initial $600,000 payment, in addition tothe cash on hand, is expected to provide sufficient funds to continue operationsthrough the closing.  In connection withthis transaction the Company will incur certain costs associated withsoliciting shareholder approval for the transaction as well as certain advisorfees for the transaction.  Upon closingof the TVGateway transaction and receipt of the $2.4 million from TVGateway(less these associated costs), the Company projects it will have sufficientfunding to continue operations into the first quarter 2004, assuming noadditional funding is received.

 

As the first of its new product and service offerings, WorldGate hasbeen developing, and will continue to develop, a videophone with high quality,full motion video.  Since this productis designed to work with existing broadband infrastructures, the Company plansto leverage its longstanding relationships and business partnerships within thebroadband marketplace as well as its expertise in video and broadbandtechnology.  The Company believes thatit has overcome many of the historical obstacles to consumer acceptance of videotelephone products by producing a unique combination of superior technology andconsumer-friendly style. The TVGateway transaction will allow WorldGate torefocus its efforts from interactive cable television toward videophone and tocontinue to explore other new broadband technology and products. With thisrefocus the Company has also continued to implement measures, includingsignificant personnel reorganizations, intended to reduce its operating costsand improve efficiencies.

 

WorldGate’s Board of Directors has approved, and unanimouslyrecommended shareholder approval of, the TVGateway sale.  Pending shareholder approval and thesatisfaction of various closing conditions contained in the definitive agreement,the sale is expected to close sometime in September or October of 2003.  WorldGate has set a record date of August 5,2003 for shareholders entitled to notice of, and to vote at, a shareholdermeeting relating to the sale, which meeting is expected to be held duringSeptember or October of 2003.  Uponcompliance with the requirements of the Securities Exchange Act, WorldGateexpects to mail definitive proxy materials to shareholders who held WorldGatecommon stock as of the record date..

 

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Over the course of the past year, various staff members of WorldGatehave worked to investigate and help define new products and services that couldleverage the Company’s expertise and resources and potentially provide valuebeyond the ITV business.  During thisperiod the parameters for a video telephone were developed.  Although other companies have, over the past35 years, unsuccessfully expended significant efforts to develop a videophoneproduct, the Company believes that the emergence of technical advances and theevolution of consumer tastes have sufficiently come together to permit thedevelopment of a successful product. The Company further believes that the emergence of H.264 videocompression, camera technology, DOCSIS 1.1, and DSL high-speed modems pave theway for “true-to-life” video to be delivered efficiently by high-speed dataproviders.

 

WorldGate has developed a personal videophone which it plans to marketunder the trademark Ojo.  We believethis product revolutionizes the technology approach and advances videotelephony to economic reality.  Ojoemploys proprietary image processing and system designs to deliver “true tolife” synchronized images and sound at an affordable price to consumers.  Ojo takes a unique approach to videotelephony and redefines the product and the perception of video telephony toovercome past constraints.  Based uponreactions to date, the Company believes Ojo will generate customer excitementand acceptance when it is introduced into the marketplace.

 

Through an assembled team of engineers and management chosen from thecable, telecommunications, high-definition television and computer industries,WorldGate has developed an affordable wireless videophone, ergonomicallydesigned specifically for in-home and business, personal videocommunication.  WorldGate identifiedseveral past issues that have interfered with commercial success and consumeracceptance of videophones and addressed each of these issues within Ojo.  We believe that Ojo is differentiated, bothfrom competitors and from previous efforts at personal video telephony byproviding: true to life communication, interoperability with the PSTN (publicswitched telephone network), wireless implementation, easy deployment by cableand DSL operators as well as businesses, and all packaged in a highly styledergonomic design.  In addition, Ojo isfurther differentiated versus competition and past video telephony efforts bythe development of a state of the art connectivity infrastructure, whichleverages the convergence of latest compression technology, processing powerand increased bandwidth availability to help ensure, enable and maintaindedicated high quality end-to-end connections.

 

The WorldGate Board of Directors, in evaluating its options, hasconcluded that investing the proceeds from the TVGateway transaction in thecontinued development and distribution of products and services for thebroadband market, including our new videophone business, will create the bestvalue for shareholders.

 

The initial market for videophones is expected to be comprised ofexisting high-speed data customers, including both existing DSL and cable modemsubscribers.  According to KaganWorldwide Media (Kagan Broadband Technology, May 13, 2003), by the end of 2008there will be almost 45 million modem subscribers in the United States whilethe international market is projected to approach 170 million DSL and DOCSISmodems by 2008.  We believe that thesemodem users provide a fertile and large target market for a quality, low costvideophone offering.  Additionalvideophone growth is expected to be derived from new technology adopters andregular long distance communicators such as families and close friends.

 

We also find the business-to-business opportunity attractive as a meansto improve interpersonal communication and multi-location productivity.  According to AMI Partners, (Cable andTelecommunications Association for Marketing, Commercial Services Seminar, May15, 2003) leader in Global SMB Market Intelligence and Business Consulting,there are 7.5 million small businesses in the US, representing 67.5 millionemployees and 100,000 medium businesses representing 25 million employees who,the Company believes, will find that videophone offers a more intimate customerexperience while reducing travel costs. Furthermore AMI Partners estimate that the number of small and mediumbusinesses in markets outside the US is approaching 65 million.  US small and medium companies spent $214billion on data transmission in 2002, $80 billion on PC and networking hardwareand peripherals and $78 billion on wireless and paging communication and localand long distance.  This is an areawhere we expect the cable and DSL industries to concentrate sizable resourcesto capture incremental revenue from this untapped market.  Our marketing objective is to havevideophones, and Ojo in particular, supplement and hopefully replace ordinaryhome and business phones worldwide.

 

 

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We arecurrently in the process of manufacturing prototype units to demonstrate thefunctionality and expected ease of use of our Ojo videophone, with customertrials expected to commence in the first quarter of 2004.  We anticipate the formal commercial launchof Ojo sometime in the fall of 2004.

 

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

 

(a)          Exhibits.

 

The following is a list of exhibits filed aspart of this report on Form 10-Q.  Whereso indicated by footnote, exhibits which were previously filed are incorporatedby reference.  For exhibits incorporatedby reference, the location of the exhibit in the previous filing is indicatedparenthetically except in those situations where the exhibit number was thesame as set forth below.

 
| **Exhibit No.** |   | **Description**                                                             |
|-----------------|--------|-----------------------------------------------------------------------------|
|            |   |                                                                        |
| 3.1             |   | Amended and  Restated Certificate of Incorporation*                         |
| 3.2             |   | Amended and  Restated Bylaws*                                               |
| 31.1            |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002**  |
| 31.2            |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002**  |
| 32.1            |   | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*** |
| 32.2            |   | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002*** |

 

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*                                                           Incorporatedby reference to the exhibits to the Company’s Form 10-Q Report for the quarterended March 31, 1999.

**                                                    Filedherewith.

***                                             Furnishedherewith

 

(b)         Reports on Form 8-K.

 

None.

 

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SIGNATURES

 

Pursuant tothe requirements of the Securities Exchange Act of 1934,  the registrant has duly caused this reportto be signed on its behalf by the undersigned thereunto duly authorized.

 

 
|   |                                                            | WORLDGATE  COMMUNICATIONS, INC.             |   |
|--------|-----------------------------------------------------------------|---------------------------------------------|--------|
|   |                                                            |                                        |   |
|   |                                                            |                                        |   |
|   | Date:       August  14, 2003 | /s/ Hal M.  Krisbergh                       |   |
|   |                                                            | Hal M.  Krisbergh                           |   |
|   |                                                            | Chairman and  Chief Executive Officer       |   |
|   |                                                            |                                        |   |
|   |                                                            |                                        |   |
|   | Date:       August  14, 2003 | /s/ Joel  Boyarski                          |   |
|   |                                                            | Joel  Boyarski                              |   |
|   |                                                            | Vice  President and Chief Financial Officer |   |
|        |                                                                 |                                             |        |  |

 

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**Exhibit Index**

 
| **Exhibit** |   | **Description**                                                          |
|-------------|--------|--------------------------------------------------------------------------|
|        |   |                                                                     |
| 31.1        |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 31.2        |   | Certification  pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 |
| 32.1        |   | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |
| 32.2        |   | Certification  pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 |

 

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