Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSIONWASHINGTON, DC 20549



FORM 10-Q

Mark Oneý

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2008.oro

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934for the Transition Period
From                             To           
                  .


Commission file number: 000-25755

WORLDGATE COMMUNICATIONS, INC.(Exact Name of Registrant as Specified in Its Charter)

Delaware(State of Incorporation)

23-2866697(I.R.S. Employer Identification No.)3190 Tremont Avenue
Trevose, Pennsylvania(Address of Principal Executive Offices)

19053(Zip Code)


(215) 354-5100(Registrant's Telephone Number, Including Area Code)

Indicate
by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past
90 days.    Yes ý No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting
company. See the definitions of "large accelerated filer," "accelerated filer", and smaller reporting company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer o

Accelerated filer o

Non-accelerated filer o (Do not check if a smaller reporting company)

Smaller reporting company ý


Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes o No ý

As of November 3, 2008, there were 94,006,345 shares of common stock, par value $.01 per share, outstanding.



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Table of Contents

WORLDGATE COMMUNICATIONS, INC.
QUARTERLY REPORT ON FORM 10-Q
FOR THE THREE MONTHS ENDED SEPTEMBER 30, 2008

TABLE OF CONTENTS



PART I.

FINANCIAL INFORMATION

3Item 1.

Financial Statements

3Item 2.

Management's Discussion And Analysis Of Financial Condition And Results Of Operations

28Item 3.

Quantitative And Qualitative Disclosures About Market Risk

35Item 4T.

Controls And Procedures

35PART II.

OTHER INFORMATION

37Item 1.

Legal Proceedings

37Item 2.

Unregistered Sales Of Equity Securities

37Item 3.

Defaults Upon Senior Securities

37Item 4.

Submission Of Matters To A Vote Of Security Holders

37Item 5.

Other Information

37Item 6.

Exhibits

38


2

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Table of Contents

PART I. FINANCIAL INFORMATION

ITEM 1.    FINANCIAL STATEMENTS

WORLDGATE COMMUNICATIONS, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In Thousands, Except Share and per Share Amounts)

September 30,
2008

December 31,
2007*(Unaudited)ASSETSCurrent assets:Cash and cash equivalents

$
460

$
1,081Trade accounts receivables, less allowance for doubtful accounts of $0 at September 30, 2008 and December 31, 2007


1,192


166Other receivables


0


6Inventory


1,196


1,057Prepaid and other current assets


226


186Total current assets


3,074


2,496Property and equipment


2,506


4,627Accumulated depreciation and amortization


(2,230
)

(3,830
)Property and equipment, net


276


797Deposits and other assets


66


121Total assets

$
3,416

$
3,414LIABILITIES AND STOCKHOLDERS' DEFICIENCYCurrent liabilities:Accounts payable

$
1,778

$
747Accrued expenses


1,290


2,016Accrued compensation and benefits


214


74Detachable warrants


79


236Warranty reserve


18


49Deferred revenues and income


1,850


252Convertible debentures payable (net of unamortized discount of $2,867 at September 30, 2008 and $4,499 at December 31, 2007


1,724


1,502Total current liabilities


6,953


4,876Commitments and contingenciesStockholders' deficiency:Preferred Stock, $.01 par value, 13,492,450 shares authorized; 0 shares issued at September 30, 2008 and December 31, 2007


0


0Common Stock, $.01 par value; 200,000,000 shares authorized; 82,910,937 shares issued and outstanding at September 30, 2008 and 56,939,925 shares
issued and outstanding at December 31, 2007


829


569Additional paid-in capital


261,210


259,544Accumulated deficit


(265,576
)

(261,575
)Total stockholders' deficiency


(3,537
)

(1,462
)Total liabilities and stockholders' deficiency

$
3,416

$
3,414


---

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

3

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WORLDGATE COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

(In Thousands, Except Share and Per Share Amounts)

Three Months ended
September 30,

Nine Months ended
September 30,2008

2007

2008

2007Net revenues:Product revenues

$
938

$
1,162

$
1,769

$
1,553Service revenues


176


195


435


419Other revenues


133


175


412


175Total net revenues


1,247


1,532


2,616


2,147Cost of revenues


811


1,191


1,686


2,023Gross profit


436


341


930


124Engineering and development (excluding depreciation and amortization amounts of $28 and $111 for the three months ended September 30, 2008 and 2007,
respectively, and $121 and $322 for nine months ended September 30, 2008 and 2007, respectively)


631


926


1,707


4,388Sales and marketing (excluding depreciation and amortization amounts of $9 and $15 for the three months ended September 30, 2008 and 2007, respectively,
and $38 and $45 for the nine months ended September 30, 2008 and 2007, respectively)


73


310


431


2,299General and administrative (excluding depreciation and amortization amounts of $6 and $38 for the three months ended September 30, 2008 and 2007,
respectively, and $65 and $131 for the nine months ended September 30, 2008 and 2007, respectively)


797


1,248


2,674


4,204Depreciation and amortization


43


164


224


498Total expenses from operations


1,544


2,648


5,036


11,389Loss from operations


(1,108
)

(2,307
)

(4,106
)

(11,265
)Interest and other income


6


21


16


164Gain on trademark assignment


0


500


0


500Change in fair value of derivative warrants and conversion options


843


131


157


2,541Income from service fee contract termination


1,064


0


2,121


0Amortization of debt discount


(706
)

(917
)

(1,632
)

(3,385
)Loss on equipment disposal


0


0


(295
)

0Interest and other expense


(76
)

(110
)

(262
)

(366
)Total other income (expense), net


1,131


(375
)

105


(546
)Net income (loss)


23


(2,682
)

(4,001
)

(11,811
)Accretion on preferred stock, dividends and deemed dividends


0


0


0


(30
)Net income (loss) attributable to common stockholders

$
23

$
(2,682
)
$
(4,001
)
$
(11,841
)Net income (loss) attributable to common stockholders per common share:Basic

$
0.00

$
(0.06
)
$
(0.06
)
$
(0.27
)Fully Diluted

$
0.00

$
(0.06
)
$
(0.06
)
$
(0.27
)Weighted average common shares outstanding:Basic


69,445,002


46,428,769


61,739,560


44,082,489Fully Diluted


69,445,002


46,428,769


61,739,560


44,082,489


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

4

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WORLDGATE COMMUNICATIONS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

(in Thousands)

Nine Months ended
September 30,2008

2007Cash flows from operating activities:Net loss

$
(4,001
)
$
(11,811
)Adjustments to reconcile net loss to net cash used in operating activities:Depreciation and amortization


224


498Amortization of debt discount


1,632


3,385Change in fair value of derivative warrants and conversion options


(157
)

(2,541
)Non-cash stock based compensation


515


877Bad debt expense


0


6Write down of inventory


0


293Loss on equipment disposal


295


0Changes in operating assets and liabilities:Trade accounts receivable


(1,026
)

(15
)Other receivables


6


12Inventory


(139
)

933Prepaid and other current assets


(40
)

156Deposits and other assets


55


(329
)Accounts payable


1,031


(632
)Accrued expenses and other current liabilities


(726
)

(62
)Accrued compensation and benefits


140


24Warranty reserve


(31
)

3Deferred revenue


1,598


(172
)Net cash used in operating activities


(624
)

(9,375
)Cash flows provided by (used in) investing activities:Capital expenditures


(2
)

(130
)Proceeds from the sale of fixed assets


4


0Net cash provided by (used in) investing activities


2


(130
)Cash flows from financing activities:Proceeds from issuance of common stock


1


1,022Net cash provided by financing activities


1


1,022Net decrease in cash and cash equivalents


(621
)

(8,483
)Cash and cash equivalents, beginning of period


1,081


10,067Cash and cash equivalents, end of period

$
460

$
1,584Non-cash financing activities:Conversion of preferred stock to common stock

$
0

$
167Conversion of convertible debenture to common stock


1,409


2,703Conversion of derivative liability


0


5,384Accretion on preferred stock


0


26Common stock issued for accrued dividends


0


6Common stock and common stock options issued for marketing consulting services


0


300


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

5

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WORLDGATE COMMUNICATIONS, INC.        NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS        (Unaudited)        (In Thousands, Except Share and
per Share Amounts)

1.    Basis of Presentation.

The unaudited condensed consolidated financial statements of WorldGate Communications, Inc. ("WorldGate" or the "Company") for the three and nine months ended September 30,
2008 and 2007 presented herein have been prepared by the Company pursuant to the rules and regulations of the Securities and Exchange Commission for quarterly reports on Form 10-Q.
Certain information and footnote disclosures normally included in financial statements prepared in accordance with United States generally accepted accounting principles ("GAAP") have been condensed
or omitted pursuant to such rules and regulations. In addition, the December 31, 2007 condensed consolidated balance sheet was derived from the audited financial statements, but does not
include all disclosures required by GAAP. These financial statements should be read in conjunction with the audited financial statements for the year ended December 31, 2007 and the notes
thereto included in the Company's Annual Report on Form 10-K. The accounting policies used in preparing
these unaudited condensed consolidated financial statements are materially consistent with those described in the audited December 31, 2007 financial statements.

The
financial information in this Report reflects, in the opinion of management, all adjustments of a normal recurring nature necessary to present fairly the results for the interim
periods. Quarterly operating results are not necessarily indicative of the results that may be expected for other interim periods or the year ending December 31, 2008.

The
preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect
the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, as of the date of the financial statements, and the reported amount of revenues and expenses during
the reporting period. Actual results could differ from those estimates. Judgments and estimates of uncertainties are required in applying the Company's accounting policies in many areas. Following are
some of the areas requiring significant judgments and estimates: revenue recognition, inventory valuation, deferred revenues, stock based compensation, valuation of derivative liabilities, and related
warrants and deferred tax asset valuation allowances.

2.    Restatement of Interim Periods

On November 14, 2008 the Company filed Form 10Q/A to restate its financial statements as of March 31 2008 and June 30, 2008 and for the three months ended
March 31, 2008 and the three and six months ended June 30, 2008 in order to amend and restate Part I, Item 1 and Part I, Item 2, which set forth the
adjustments to the warrants issued and the warrant exercise price as a result of anti-dilution provisions applicable to the warrants issued as part of the June 2004 private placement, and
the fair value of derivative warrants accounting for these warrants. The warrants and warrant exercise price were originally calculated without regard to certain share limitations in dilutive
transactions and with this amendment the warrants and warrant exercise price are being restated to reflect this share limitation. Accordingly, changes will be made to the applicable line items
associated with detachable warrant liability, accumulated deficit, change in fair value of derivative warrants, net loss and net loss per common share. The amendment and restatement will result in a
reduction in the number of warrants as previously identified in the original form 10-Q's to account for the
anti-dilution provisions for the June 2004 private placement and an increase in the exercise price of these warrants.

6

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

2.    Restatement of Interim Periods (Continued)

The
effect of the restatement on specific amounts provided in the consolidated financial statements is as follows:

As of March 31, 2008Consolidated Balance Sheet

As previously
reported

As restatedDetachable warrants

$
369

$
106Total current liabilities


7,464


7,201Accumulated deficit


(263,727
)

(263,464
)Total stockholders' deficiency


(3,486
)

(3,223
)




For the three Months
ended March 31, 2008Consolidated Statement of Operations

As previously
reported

As restatedChange in fair value of derivative warrants and conversion options

$
(133
)
$
129Total other income (expense), net


(433
)

(171
)Net loss


(2,151
)

(1,889
)Net loss applicable to common stockholders


(2,151
)

(1,889
)Net loss per common share:Basic and diluted


(0.04
)

(0.03
)




As of June 30, 2008Consolidated Balance Sheet

As previously
reported

As restatedDetachable warrants

$
2,043

$
922Total current liabilities


8,191


7,070Accumulated deficit


(266,721
)

(265,600
)Total stockholders' deficiency


(5,707
)

(4,586
)




For the three Months
ended June 30, 2008Consolidated Statement of Operations

As previously
reported

As restatedChange in fair value of derivative warrants and conversion options

$
(1,674
)
$
(815
)Total other income (expense), net


(1,715
)

(856
)Net loss


(2,994
)

(2,135
)Net loss applicable to common stockholders


(2,994
)

(2,135
)Net loss per common share:Basic and diluted


(0.05
)

(0.04
)


7

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

2.    Restatement of Interim Periods (Continued)



For the six Months
ended June 30, 2008Consolidated Statement of Operations

As previously
reported

As restatedChange in fair value of derivative warrants and conversion options

$
(1,807
)
$
(686
)Total other income (expense), net


(2,148
)

(1,027
)Net loss


(5,145
)

(4,024
)Net loss applicable to common stockholders


(5,145
)

(4,024
)Net loss per common share:Basic and diluted


(0.09
)

(0.07
)


3.    Liquidity and Going Concern Considerations.

As of September 30, 2008, the Company had cash and cash equivalents of $460. The Company generated cash from operations of $30 during the three months ended September 30,
2008. For the nine months ended September 30, 2008, the Company used cash from operations of $624. The funds the Company received as a result of the agreement signed on March 31, 2008,
have permitted the Company to fund the development of its business since March 31, 2008.

The
Company had $6,953 of liabilities and substantially all of its assets are pledged as collateral as of September 30, 2008. These liabilities include $79 of detachable warrants
related to the Company's private placement of preferred stock in June 2004 and $1,724 of debt (net of unamortized discount of $2,867) related to the Company's financing in August and October 2006.

The
Company's short term cash requirements and obligations include inventory, accounts payable from continuing operations and operating expenses.

The
Company has incurred recurring net losses and has an accumulated deficit of $265,576, stockholder deficiency of $3,537 and a working capital deficit of $3,879 as of
September 30, 2008. These factors raise substantial doubt about the Company's ability to continue as a going concern. The financial statements do not include any adjustments that might be
necessary should the Company be unable to continue as a going concern.

Long
term cash requirement obligations are primarily related to the August and October 2006 secured convertible debenture transactions which mature in 2009 and are reflected as current
debt as of September 30, 2008. The convertible debentures have an interest rate of 6% per annum and can be converted to common stock at the holder's option. The convertible debentures payable,
net of unamortized discounts of $2,867 and $4,499, had a balance of $1,724 and $1,502, respectively, as of September 30, 2008 and December 31, 2007 (See Note 8). As of
September 30, 2008 and December 31, 2007, accrued interest was $911 and $658, respectively.

On
February 5, 2008, February 13, 2008, February 15, 2008, April 8, 2008, and April 23, 2008, the Company received notices from YA Global, holder of
the Company's convertible debentures, claiming that the Company was in default of the terms of the debentures. The Company has notified YA Global that it disputes these alleged defaults (See
Note 8).

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

3.    Liquidity and Going Concern Considerations. (Continued)

The
Company's ability to generate cash is dependent upon the sale of its Ojo product and on obtaining cash through capital markets. The Company began generating revenue from the
commercial shipment of its Ojo product in April 2005 and the Company expects revenues to increase as the product continues to roll out to the marketplace. Depending on the ramp up of sales and the
achievable margins, the increased level of sales activity should have a positive impact on the Company's cash flows from operations, which would support its ability to meet its cash requirements in
the long term. Given that the Company's video phone business involves the development of a new product line with no market penetration, in an underdeveloped market sector, no assurances can be given
that sufficient sales, if any, will materialize. The lack of success of the Company's sales efforts could also have an adverse effect on the Company's ability to raise additional financing.

In
the latter part of the third quarter of 2007 product shipments of the Company's broadband video phone products commenced to a video relay service, or VRS, provider, Aequus. The
Company's Ojo video phone provides this equipment link for the hard-of-hearing VRS user with a Telecommunications Relay Service ("TRS") operator (called a Communications
Assistant,
or "CA") so that the VRS user and the CA can see and communicate with each other using American Sign Language ("ASL") in signed conversation. VRS enables deaf and
hard-of-hearing customers to improve their connection with people in their personal and business lives. This market is particularly attractive since the use of video as part of
the communication link is critical, and accordingly, the video phone is a major contributing component. Entrance to the VRS market has contributed significantly to the Company's efforts to increase
product awareness and sales.

On
February 4, 2008, the Company announced that it was in a dispute with Aequus over the payment of significant monies which the Company believed were owed to it. The customer's
refusal to pay such monies had contributed to a shortfall in the operating cash available to the Company to continue operations, and accordingly, on January 30, 2008, the Company shut down its
operations. The announcement further indicated that this was a first step to winding down its business, which would occur if the Company was not able to secure payment of the monies believed to be
owed to it by the customer, and/or new financing.

On
March 31, 2008, the Company entered into a new agreement with Aequus and Snap!VRS. This new agreement, inter alia, provides for the (i) resolution of a dispute with
Aequus regarding amounts the Company claimed were owed to the Company by Aequus and the termination by the Company of video phone service to Aequus, (ii) payment to the Company by Aequus of
approximately $5,000 in scheduled payments over ten months commencing March 31, 2008, (iii) agreement to arbitrate an additional approximately $1,354 claimed by the Company to be owed by
Aequus and (iv) purchase of an additional $1,475 of video phones by Aequus. As a result of this new agreement Aequus is planning to build a new data center, with support and training provided
by the Company, and upon completion, directly operate a video phone service for its customers. The $1,475 of units purchased per the agreement as of March 31, 2008 are being held by the Company
pending shipment to Aequus customers. For the three and nine months ended September 30, 2008, the Company recognized revenue for units shipped to Aequus customers of $844 and $1,637,
respectively. As of September 30, 2008 the Company had received payments of $1,475 toward the purchase of video phone units and $3,400 of the $5,000 agreed payments. The September 30,
2008 balance sheet reflects $1,758 of such payments

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

3.    Liquidity and Going Concern Considerations. (Continued)

remaining
as deferred revenue and income (See Note 15). In the period October 1, 2008 through November 3, 2008 the Company received additional payments of $800 as part of the
$5,000 agreed payments. The parties have completed the arbitrator selection process and a hearing has been scheduled during the third week in January 2009 for this matter. Aequus has also filed a
motion for summary judgment which is scheduled to be heard on December 29, 2008.

Based
on management's internal forecasts and assumptions, including, among others, the receipt of the payments required by its agreement with Aequus of March 31, 2008, assumptions
regarding the proceeds that might result from the arbitration with Aequus of amounts the Company claims is owed to it by Aequus, the favorable resolution of defaults asserted by the holder of its
convertible debentures and its short term cash requirements and projected revenue growth, the Company expects to have sufficient cash on hand to meet its obligations into the beginning of 2009. It is
unclear whether the Company will have funds beyond that time. Aequus is a new company with an unproven track record and if Aequus is
not successful, or if their activities do not lead to significant sales of its product, their operating results will be adversely affected, and its ability to pay all of the monies obligated per the
agreement, including payment for products purchased or the payment of any monies the Company is awarded as a result of the agreed upon arbitration with Aequus, may not materialize or could be
significantly reduced and the Company may have insufficient capital to operate its business.

The
Company continues to evaluate possibilities to obtain additional financing through public or private equity or debt offerings, asset securitizations, or from other sources. There can
be no assurance that additional financing will be available on terms acceptable to the Company, if at all. If the Company is unable to obtain sufficient funds the Company may suspend operations which
could have a material adverse impact on its business prospects. No assurances can be given that additional financing transactions can be consummated. If the Company is unable to obtain sufficient
funds the Company may further reduce the size of its organization or suspend operations which would have a material adverse impact on its business prospects. In order to stretch its current working
capital, in 2007 the Company significantly cut its operating expenses, including suspension of a portion or all salaries for a time period in the third and fourth quarters of 2007 and the first
quarter of 2008 for certain senior management of the Company. The Company continues to monitor and reduce operating expenses in 2008, however, no assurances can be made that these expense reduction
efforts will be successful.

4.    Recent Accounting Pronouncements.

In December 2007, the Financial Accounting Standards Board ("FASB") issued Statement of Accounting Standard ("SFAS") No. 141R, "Business Combinations," which replaces SFAS
No. 141, "Business Combinations." SFAS No. 141R establishes principles and requirements for determining how an enterprise recognizes and measures the fair value of certain assets and
liabilities acquired in a business combination, including noncontrolling interests, contingent considerations, and certain acquired contingencies. SFAS No. 141R also requires
acquisition-related transaction expenses and restructuring costs to be expensed as incurred rather than capitalized as a component of the business combination. SFAS No. 141R will be applicable
prospectively to business combinations for which the acquisition date is on or after January 1, 2009. SFAS No. 141R would have an impact on accounting for any businesses acquired after
the effective date of this pronouncement.

10

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

4.    Recent Accounting Pronouncements. (Continued)

In
December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in Consolidated Financial StatementsAn Amendment of ARB No. 51." SFAS No. 160
establishes accounting and reporting standards for the noncontrolling interest in a subsidiary (previously referred to as minority interests). SFAS 160 also requires that a retained
noncontrolling interest upon the deconsolidation of a subsidiary be initially measured at its fair value. Upon the adoption of SFAS No.160, the Company would be required to report any noncontrolling
interests as a separate component of consolidated stockholders' equity. The Company would also be required to present any net income allocable to noncontrolling interest and net income attributable to
the stockholders of the Company separately in its consolidated statements of operations. SFAS No. 160 is effective for fiscal years, and interim periods within those fiscal years, beginning on
or after January 1, 2009. SFAS No. 160 requires retroactive adoption of the presentation and disclosure requirements for existing minority interests. All other requirements of SFAS
No. 160 shall be applied prospectively. SFAS No. 160 would have an impact on the presentation and disclosure of the noncontrolling interests of any non-wholly owned business
acquired in the future.

Effective
January 1, 2008, the Company adopted SFAS No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities." ("SFAS 159") permits entities to
choose to measure many financial instruments and certain other items at fair value. The Company did not elect the fair value reporting option for any assets and liabilities not previously recorded at
fair value.

Effective
January 1, 2008, the Company adopted the provisions of SFAS 157, "Fair Value Measurements" for financial assets and liabilities, as well as any other assets and
liabilities that are carried at fair value on a recurring basis in financial statements. SFAS 157 defines fair value, establishes a framework for measuring fair value and expands disclosures
about fair value measurements. SFAS 157 applies under other accounting pronouncements that require or permit fair value measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute. Accordingly, SFAS 157 does not require any new fair value measurements. The Company applied the provisions of FSP
FAS 157-2, "Effective Date of FASB Statement 157," which defers the provisions of SFAS 157 for nonfinancial assets and liabilities to the first fiscal period beginning after
November 15, 2008. The deferred nonfinancial assets and liabilities include items such as property and equipment and goodwill. The Company is required to adopt SFAS 157 for nonfinancial
assets and liabilities in the first quarter of fiscal 2009 and is not expected to have a material impact on its condensed consolidated financial statements.

Effective
January 1, 2008, the Company adopted Emerging Issue Task Force ("EITF") No. 06-1, "Accounting for Consideration Given by a Service Provider to
Manufacturers or Resellers of Equipment Necessary for an End-Customer to Receive Service from the Service Provider" ("EITF 06-1"). This guidance requires the application
of EITF 01-9, "Accounting for Consideration Given by a Vendor to a Customer" ("EITF 01-9"), when consideration is given to a reseller or manufacturer for benefit
to
the service provider's end customer. EITF 01-9 requires the consideration given be recorded as a liability at the time of the sale of the equipment and, also, provides guidance for
the classification of the expense. The adoption of EITF 06-1 did not have a material effect on the condensed consolidated financial statements of the Company.

11

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

4.    Recent Accounting Pronouncements. (Continued)

Effective
January 1, 2008, the Company adopted Staff Accounting Bulletin No. 110 ("SAB 110"). SAB 110 amends and replaces Question 6 of Section D.2 of
Topic 14, Share-Based Payment, of the Staff Accounting Bulletin series. Question 6 of Section D.2 of Topic 14 expresses the views of the staff regarding the use of the "simplified" method in
developing an estimate of the expected term of "plain vanilla" share options and allows usage of the "simplified" method for share option grants prior to December 31, 2007. SAB 110
allows public companies which do not have historically sufficient experience to provide a reasonable estimate to continue use of the "simplified" method for estimating the expected term of "plain
vanilla" share option grants after December 31, 2007. The Company currently uses the "simplified" method to estimate the expected term for share option grants as it does not have enough
historical experience to provide a reasonable estimate. The Company will continue to use the "simplified" method until it has enough historical experience to provide a reasonable estimate of expected
term in accordance with SAB 110. The adoption of SAB 110 did not have a material impact upon the Company's consolidated financial statements.

In
March 2008, the FASB issued SFAS 161, "Disclosures about Derivative Instruments and Hedging Activities an amendment of FASB Statement No. 133", which amends and expands
the disclosure requirements of SFAS 133 to require qualitative disclosure about objectives and strategies for using derivatives, quantitative disclosures about fair value amounts of and gains
and losses on derivative instruments, and disclosures about credit-risk-related contingent features in derivative agreements. This statement will be effective for the Company
beginning on January 1, 2009. The adoption of this statement will change the disclosures related to derivative instruments held by the Company.

In
May 2008, the FASB issued SFAS No. 162, "The Hierarchy of Generally Accepted Accounting Principles" ("SFAS 162"). SFAS 162 identifies a consistent framework, or
hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with Generally Accepted Accounting Principles ("GAAP") for nongovernmental
entities. SFAS 162 is effective 60 days following the SEC's approval of the Public Company Accounting Oversight Board amendments to AU Section 411, "The Meaning of Present Fairly
in Conformity with Generally Accepted Accounting Principles."

5.    Inventory.

The Company's inventory consists primarily of finished goods equipment to be sold to customers. The cost is determined on a First-in, First-out ("FIFO") cost
basis. A periodic review of inventory quantities on hand is performed in order to determine and record a provision for excess and obsolete inventories. Factors related to current inventories such as
technological obsolescence and market conditions are analyzed to determine estimated net realizable values. A provision is recorded to reduce the cost of inventories to the estimated net realizable
values. To motivate trials and sales of its Ojo product, the Company has historically subsidized, and may in the future continue to subsidize, certain of its product sales to customers that result in
sales of inventory below cost. In accordance with Accounting Research Bulletin ("ARB") No. 43, the Company reflects such inventory at the lower of cost or market and reduced its inventory by $0
and $293, respectively, for the three and nine months ended September 30, 2007 to reflect such valuation. Any significant unanticipated changes in the factors noted above could have an impact
on the value of the Company's inventory and its reported

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

5.    Inventory. (Continued)

operating
results. At September 30, 2008 and December 31, 2007 the Company's inventory balance was $1,196 and $1,057, respectively. As a result of the agreement with Aequus on
March 31, 2008, Aequus purchased $1,475 of units which are being held by the Company pending shipment to Aequus customers (See Note 15). For the three and nine months ended
September 30, 2008, the Company recognized revenue for units shipped to Aequus customers of $844 and $1,637, respectively. Also, under this agreement of March 31, 2008, and subsequent to
the initial purchase of $1,475 of units, Aequus purchased an additional $1,153 of units which are also being held by the Company pending shipment to Aequus customers. For the three and nine months
ended September 30, 2008, the Company recognized revenue for such units shipped to Aequus customers of $248. Included in the inventory balance reported on the balance sheet as of
September 30, 2008 are the remaining units purchased in a "Bill and Hold" arrangement by Aequus of $996.

6.    Stock Based Compensation.

The Company accounts for stock based compensation in accordance with the provisions of SFAS No. 123 (Revised 2004), "Share-Based Payment," "SFAS No. 123(R)". SFAS
No. 123(R) requires that all stock based compensation be recognized as an expense in the financial statements, and that such cost be measured at the fair value of the award. SFAS
No. 123(R) also requires that excess tax benefits related to stock option exercises be reflected as financing cash inflows instead of operating inflows. As a result, the Company's net loss
before taxes for the three and nine months ended September 30, 2008 included approximately $264 and $515, respectively, and included $192 and $877, respectively, for the three and nine months
ended September 30, 2007, of stock based compensation. The stock based compensation expense is included in general and administrative expense in the condensed consolidated statements of
operations.

Consistent
with the requirements of SFAS 123(R), the Company has selected a "with-and-without" approach regarding the accounting for the tax effects of
share-based compensation awards. This approach is consistent with intraperiod allocation guidance in SFAS No. 109, "Accounting for Income Taxes," and EITF Topic D-32, "Intraperiod
Tax Allocation of the Tax Effect of Pretax Income from Continuing Operations."

A
summary of awards under the Company's 2003 Equity Incentive Plan is presented below:

Stock
Options

Weighted-Average
Exercise Price

Aggregate
Intrinsic
ValueOutstanding, January 1, 2008


5,907,342

$
1.53

$
0Granted


5,356,107

$
0.11Exercised


0


0Cancelled/forfeited


(5,183,085
)
$
1.54Outstanding, September 30, 2008


6,080,364

$
0.27

$
0Exercisable, September 30, 2008


3,184,250

$
0.39

$
0


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Table of Contents

WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

6.    Stock Based Compensation. (Continued)

As of September 30, 2008, there was $611 of total unrecognized compensation arrangements granted under the Plan. The cost is expected to be recognized through 2012.

The
following table summarizes information about stock options outstanding at September 30, 2008:

Stock Options Outstanding

Stock Options
ExercisableWeighted-
Average
Remaining
Contractual
Life (Years)Range of Exercise Prices

Shares

Weighted-
Average
Exercise
Price

Shares

Weighted-
Average
Exercise
Price$0.00$0.39


5,363,632


7.02

$
0.11


2,565,018

$
0.11$0.40$0.59


86,500


8.42


0.49


26,500


0.48$0.60$0.89


289,492


6.22


0.60


289,492


0.60$0.90$1.34


6,500


3.82


1.20


6,500


1.20$1.35$2.01


83,665


5.44


1.72


58,665


1. 78$2.02$3.02


193,000


4.48


2.39


193,000


2.39$3.03$4.53


54,000


6.45


3.60


41,500


3.59$4.54$6.80


2,025


2.19


6.34


2,025


6.34$6.81$10.20


0


0


0


0


0$10.20$15.31


0


0


0


0


0$15.31$22.95


1,550


.46


16.50


1,550


16.50$22.96$34.43


0


0


0


0


06,080,364


6.89

$
0.27


3,184,250

$
0.39


On
July 29, 2008, the Company's Board of Directors approved a re-pricing of 3,756,132 stock options, which represented all outstanding, pre 2008, stock options for
employees of the Company. The new exercise price was established as the closing price of the Company's stock on that date, which was $0.108. All other terms of such stock option will remain the same.
In accordance with the provisions of SFAS 123(R), this re-pricing resulted in the Company recording additional compensation expense of $133 on July 29, 2008.

Performance
based shares were granted on October 3 and December 20, 2007 to certain senior executives that vest upon the achievement of certain criteria as follows: 10% of
the shares vest upon achieving each of a 10%, 20%, 30% 40% and 50% increase for the Company in total gross revenue in a quarter over its third quarter 2007 total gross revenue shown on its statement
of operations as reported in the SEC filings; and 25% of the shares vest upon the Company achieving each of (1) a quarterly operating cash break-even (defined as zero or positive
"net cash provided by operations" consistent with or as reported on the "Consolidated Statement of Cash Flows" excluding strategic transactions such as the Aequus transaction (See Note 3) in
the financial statements filed with SEC) and (2) a 10% net income as a percent of revenue. These Performance based shares had a fair value of $206 on their dates of grant of October 3
and December 20, 2007. The criteria for these performance based shares were amended to clarify that the criteria is intended to refer to transactions and revenue, operating cash flow and income
generated in the ordinary course of the Company's business, and not to extra-ordinary transactions, such as, by way of example and not limitation, the Rights Fee as defined

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Table of Contents

WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

6.    Stock Based Compensation. (Continued)

in
the March 31, 2008 agreement with Aequus. As of September 30, 2008, it was determined that is was more likely than not that the performance grants would be not be earned and therefore
there was no compensation expense recorded for these grants.

The
following table is the summary of the Company's nonvested restricted shares as of September 30, 2008.

SharesNonvested as of January 1, 2008


901,000Granted


0Vested


0Cancelled/forfeited


(68,000
)Nonvested as of September 30, 2008


833,000


7.    Accounting for Preferred Shares and Derivative Shares.

In June 2004, WorldGate completed a private placement of preferred stock. The preferred stock had a dividend rate of 5% per annum, payable quarterly, either by cash or through the
issuance of common stock at the Company's option. The preferred stock had a staged maturity over three years with scheduled payments of one third due after 18 months, one half of the remainder
due after 24 months and the balance due after 36 months, and the ability to be redeemed at maturity in cash or, at the Company's option, subject to certain conditions which had the
potential to not be solely under the control of the Company, through the issuance of the number of shares of common stock determined by dividing the liquidation preference of the preferred shares by
the then average market price over the ten consecutive trading days prior to the date of conversion. If the effectiveness of the registration statement required to be filed by the Company lapsed, the
Company ceased to be listed on certain specified exchanges and trading in the Company's stock is suspended or a change in control occurred with respect to the Company, the Company could have been
required to settle redemption of the preferred stock with cash instead of its common shares. Furthermore, since the market price of the Company's common stock cannot be predicted, the actual number of
shares of the Company's common stock that could have been required if a redemption was made through the issuance of common stock also could not be predicted. The private placement included numerous
provisions intended to protect these institutional investors including a cash payment penalty of 1.0% per month for unredeemed preferred shares once registration of the shares lapsed and until the
registration again became effective.

The
preferred stock had embedded conversion options. Specifically, the holders of the preferred stock could have converted their shares into the Company's common stock at a conversion
price of $2.35 per preferred share. In addition the Company could have forced conversion of the preferred stock into common stock if the Company achieved certain price targets for its common stock and
satisfaction of certain other conditions, such as the existence of an effective registration statement. In either event the conversion price was subject to adjustment if, at any time after the date
the preferred shares were issued, the Company issues or sells, or is deemed to have issued or sold, any shares of the Company's common stock for per share consideration less than the conversion price
of the preferred shares on the date of such issuance or sale. Accordingly, the number of common shares issuable upon the conversion of the preferred shares could not be predicted. Furthermore,
net-cash settlement could

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Table of Contents

WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

7.    Accounting for Preferred Shares and Derivative Shares. (Continued)

have
been required in the event of conversion default under certain circumstances that could not be solely under the control of the Company. If the effectiveness of the registration statement lapsed,
the Company ceased to be listed on certain specified exchanges and trading in the Company's stock was suspended or a change in control occurs with respect to the Company, the Company could have been
required to settle a conversion of the preferred stock with cash instead of its common shares.

Also,
as part of the private placement the Company issued five-year warrants to purchase up to 803,190 shares of its common stock at an exercise price of $2.69 per share and
five-year warrants to purchase up to 803,190 shares of its common stock at an exercise price of $3.14 per share. The investors also received an additional investment right, for a limited
period of time, to purchase 1,606,383 additional shares of common stock shares at $3.14 a share. This exercise price of the warrants is subject to adjustment if, at any time after the date the
warrants were issued, the Company issues or sells, or is deemed to have issued or sold, any shares of the Company's common stock for per share consideration less than the exercise price of the
warrants on the date of such issuance or sale. Accordingly, the number of common shares that will be issued upon the exercise of the warrants cannot be predicted. As of September 30, 2006,
125,000 warrants exercisable at $2.69 had been exercised and 51,915 warrants exercisable at $3.14 had been exercised. All of the additional investment rights had been exercised as of June 30,
2006. Based on anti-dilution provisions applicable to these warrants the $2.69 warrants were modified to an exercise price of $0.43 as of September 30, 2008 and the number of
outstanding warrants were increased by 3,607,663 related to the issuance of convertible debentures and warrants in August 2006 and October 2006 and as a result of the conversion price related to these
issuances. Based on anti-dilution provisions applicable to these warrants the $3.14 warrants were also modified to an exercise price of $0.46 as of September 30, 2008 and the number
of outstanding warrants were increased by 4,236,853 related to the issuance of convertible debentures and warrants in August 2006 and October 2006 and as a result of the conversion price related to
these issuances.

Of
the 7,550 preferred shares issued under this private placement, all shares have been converted to common stock as of September 30, 2008.

The
terms of the preferred stock included certain conversion options that represent derivative financial instruments under paragraph 12 of SFAS No. 133 "Accounting for
Derivatives Instruments and Hedging
Activities" ("SFAS 133") and thus were separated from the preferred stock and valued using the Black-Scholes option pricing model. The conversion options included certain provisions that could
have resulted in a variable number of shares to be issued upon conversion, adjustment to the strike price at which conversion shares would be determined, or the requirement for the Company to have
settled the conversion options in cash. EITF 00-19, "Accounting for Derivative Instruments Indexed to, and Potentially Settled in, a Company's Own Stock,"
("EITF 00-19") states that if the conversion options require net cash settlement in the event of circumstances that are not solely within the Company's control they should be
classified as a liability measured at fair value on the balance sheet.

The
terms of the five-year warrants include cash penalty provisions in the event that the Company fails to meet its obligations to deliver registered shares to the warrant
holder upon exercise and an anti-dilution provision that could result in a variable number of shares to be issued upon warrant exercise. Additionally, the terms and conditions of the
warrants provide for net settlement through cashless exercise whereby the shares delivered to the warrant holder would be readily convertible to cash. In accordance with EITF 00-19
and given the terms and conditions of the warrants as outlined

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

7.    Accounting for Preferred Shares and Derivative Shares. (Continued)

above,
the Company classified the warrants as a liability on its balance sheet measured at fair value using the Black-Scholes option pricing model.

The
Company accounts for both the conversion options and warrants using the fair value method at the end of each quarter, with the resultant gain or loss recognition recorded against
earnings. On June 23, 2007, the holder converted the remaining 166 shares of preferred stock into 326,471 shares of common stock. As a result of this conversion, the conversion option liability
was reclassified to equity. The remaining warrants are valued using the Black-Scholes valuation model. At September 30, 2008 and 2007, the closing common stock price was $0.03 and $0.39,
respectively, applicable volatility rates were 273% and 99% respectively, and the period close risk-free interest rates as of September 30, 2008 and 2007 were 1.55% and 4.06% for
the instrument's contractual life of 0.75 and 1.75 for years, respectively, for the warrants (continuously compounded), and represent the key assumptions used in the valuation calculation. The result
was a $843 and $157 non cash gain for the three and nine months ended September 30, 2008, respectively, and a $131 and $880, respectively, non cash gain for the three and nine months ended
September 30, 2007.

8.    Accounting for Secured Convertible Debentures and Related Warrants.

On August 11, 2006 and October 13, 2006 the Company completed a private placement with an institutional investor of convertible debentures in the aggregate principal amount
of $11,000. These convertible debentures have a maturity of three years, an interest rate of 6% per annum, and are convertible at the option of the investors into WorldGate common stock at a
conversion price equal to the lesser of $1.75 per share or 90% of the average of the five lowest daily volume weighted closing prices ("VWAP") of the common stock during the fifteen trading days
immediately preceding the conversion date (subject to adjustment in the event of stock dividends and splits and certain distributions to stockholders, fundamental transactions, and future dilutive
equity transactions). The number of shares available is subject to an overall limit on the number of issuable shares, as further described below. Interest is payable at maturity, and the Company may
elect to pay the interest amount in cash or shares of its common stock. There was $911 of accrued interest as of September 30, 2008. Through September 30, 2008 the investor converted
$6,409 of the convertible debt into 39,195,986 shares of the Company's common stock. During the period October 1, 2008 through November 6, 2008 the investor converted an additional $134
of the convertible debt into 11,095,408 additional shares of the Company's common stock.

The
Company has the right to redeem all or any portion of the principal amount of the convertible debentures in cash at any time upon not less than four business days notice if the
closing price of its stock is less than $1.75 per share. Such early redemption will, however, require the Company to pay a 10% prepayment premium. In addition, without any prepayment premium, the
Company has the right to force the holders to convert a maximum of $500 of the principal amount of the convertible debenture in any thirty day period if for five consecutive trading days the VWAP of
its common stock is above $1.925 per share but less than $3.50 per share and providing the daily trading volume exceeds 200,000 shares for these five days, and certain other conditions are met. If the
VWAP of the Company's common stock is greater than $3.50 per share for 30 consecutive trading days, the daily trading volume exceeds 250,000 shares for five days prior, and if certain other conditions
are met, the Company can also force the holder to convert all or any portion of the outstanding principal and interest into shares of its common stock without any prepayment premium.

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

8.    Accounting for Secured Convertible Debentures and Related Warrants. (Continued)

There are some restrictions on the holder's right to convert the convertible debentures. The holder cannot make any conversions below $1.75 per share which would exceed $500 in principal
amount in any calendar month, or which would result in the issuance of more than 840,000 shares of the Company's common stock per calendar month (provided that this maximum share limit will be waived
by the Company unless it elects to pay the holder in cash the difference in value between 840,000 shares and the number of shares the holders wishes to convert, up to the $500 per month conversion
limit). If the Company is in default under the convertible debentures, these limitations are waived. The holder is also not restricted in making conversions at $1.75. In no case, however may the
holder convert the convertible debentures if it would result in beneficial ownership of more than 9.99% of the Company's outstanding common stock (though this provision can be waived by the holder
upon 65 days prior notice). If the Company, at any time while the convertible debentures are outstanding, shall (a) pay a stock dividend or otherwise make a distribution or distributions
on shares of its common stock or any other equity or equity equivalent securities payable in shares of common stock, (b) subdivide outstanding shares of common stock into a larger number of
shares, (c) combine (including by way of reverse stock split) outstanding shares of common stock into a smaller number of shares, or (d) issue by reclassification of shares of the common
stock any shares of capital stock of the Company, then the convertible debenture holder is entitled to have the conversion price adjusted to correspond to common stock holders' rights to any such
stock dividend, stock split, stock combination or reclassification of shares. The $1.75 conversion price is also subject to a weighted average dilution adjustment if the Company issues shares (apart
from certain excluded issuances) of its capital stock at an effective price per share less than the conversion price, as defined above. The Company received a one-time waiver from its
institutional investor of the dilution adjustment related to the issuance of common stock and warrants to Antonio Tomasello, a private investor and father of David Tomasello, a director of the
Company. The Company also granted the convertible debenture holders a security interest in substantially all of its assets. Moreover, the Company is required to register the shares of common stock
issuable to the investor for resale to the public pursuant to a registration rights agreement, containing customary terms, conditions and indemnities. The private placement includes numerous
provisions intended to protect the institutional investor, including a cash payment penalty in which the Company shall pay liquidated damages to the selling security holder in the event that
(i) a registration statement is not timely filed, (ii) a registration statement is not timely declared effective by the SEC or (iii) sales cannot be made pursuant to the
registration statement. Such liquidated damages shall be equal to 1% of the liquidated value of the outstanding convertible debentures for each thirty day period in which the Company fails to satisfy
provisions (i), (ii) or (iii) above. In no event, however, shall liquidated damages exceed 12% of the aggregate purchase price of $11,000, which is $1,320. Pursuant to an Amendment and
Waiver, dated November 22, 2006, as amended, between the Company and the selling security holder, the parties eliminated liquidated damages for the Company's failure to satisfy the clauses
above in connection with the October 2006 tranche. Accordingly, the Company has recorded no liability in connection with these liquidated damage provisions.

In
addition, the aggregate number of shares to be issued upon conversion, exercise of the warrants, payment for commitment shares, and payment of liquidated damages pursuant to the
registration rights agreement has been limited to 61,111,111 shares of common stock. On September 19, 2006, the

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Table of Contents

WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

8.    Accounting for Secured Convertible Debentures and Related Warrants. (Continued)

Company's
registration statement to register the shares under this private placement was declared effective.

As
part of this private placement, the Company issued to the investor 177,419 commitment shares of common stock with a fair value at issuance of approximately $222. The Company also
issued five-year warrants to purchase a total of up to 2,595,000 shares of WorldGate common stock, with 1,145,000 of the warrants having an exercise price of $1.85 per share (with 624,545
of these warrants issued at the closing of the August 2006 tranche and 520,455 warrants issued at the closing of the October 2006 tranche), 1,100,000 of the shares having an exercise price of $2.35
per share (with 600,000 of these warrants issued at the closing of the August 2006 tranche and 500,000 warrants issued at the closing of the October 2006 tranche), and 350,000 warrants having an
exercise price of $2.60 per share (with 190,909 of these warrants issued at the closing of the August 2006 tranche and 159,091 warrants issued at the closing of the October 2006 tranche). The terms of
the warrant agreements provide for the adjustment of the exercise price and the number of shares of common stock to be issued upon the Company's issuance of certain securities deemed to be dilutive
under the agreement. Under certain conditions, the holder may exercise these warrants on a cashless basis.

Upon
any liquidation, dissolution or winding up of the Company, the holder of the convertible debenture will be entitled to receive the principal amount of the convertible debenture,
together with accrued and unpaid interest, prior to any payment to the holders of the Company's common and preferred stock.

On
February 5, 2008, February 13, 2008, February 15, 2008, April 8, 2008, and April 23, 2008 the Company received notices from YA Global, holder of the
Company's convertible debentures, claiming that the Company was in default of the terms of the debentures for stating its intent to wind down its business, failing to maintain current financial
statements in the registration statement relating to the sale of the Company's common stock issuable upon conversion of one of those debentures, failing to comply with a covenant to their satisfaction
that provided for the disclosure of information they considered material, and entering into the agreement with Aequus Technologies Corp. and Snap Telecommunications, Inc. (collectively
"Aequus"), a provider of Video Relay Services ("VRS") and Video Remote Interpreting ("VRI") services for the deaf and hard of hearing, that granted an exclusive license to Aequus for video relay and
interpreting services in North America, indicating that such license was a default of the terms of the debentures because it appeared to YA that such license constituted a sale of more than fifty
percent of the Company's assets and therefore a change of control as that term is defined in the debentures, and, as a result of these notices, YA Global indicated that it was exercising its right to
accelerate payment of the full principal amount of the debentures. The Company has notified YA Global that it disputes these claims and whether they constitute a continuing event of default under the
debentures. The Company has also notified YA Global that their right to accelerate payment is also disputed. Although the Company disputes YA Global's claims of default, and does not believe YA Global
has any basis to accelerate payments on the debenture, the Company has reclassified the YA
Global convertible debenture to a current liability on the accompanying condensed consolidated balance sheet, solely in light of the existence of the alleged claims.

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Table of Contents

WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

8.    Accounting for Secured Convertible Debentures and Related Warrants. (Continued)

Prior
to the May 18, 2007 amendment, subject to the share limitation, as discussed above, the actual number of shares of the Company's common stock that would be required if a
conversion of the convertible debenture was made through the issuance of common stock could not be predicted. If the Company's requirements to issue shares under these convertible debenture agreements
had exceeded the share limitation, or if it was not listed or quoted for trading on at least the NASDAQ OTC Bulletin Board, the Company could have been required to settle the conversion of the
convertible debentures with cash instead of its common stock.

The
Company initially accounted for conversion options embedded in convertible notes in accordance with SFAS No. 133 "Accounting for Derivative Instruments and Hedging Activities"
("SFAS 133") and EITF 00-19 "Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled in, a Company's Own Stock" ("EITF 00-19")
SFAS 133 generally requires companies to bifurcate conversion options embedded in convertible notes from their host instruments and to account for them as free standing derivative financial
instruments in accordance with EITF 00-19. EITF 00-19 states that if the conversion option requires net cash settlement in the event of circumstances that are not
solely within the Company's control that they should be classified as a liability measured at fair value on the balance sheet. Effective January 1, 2007, the Company adopted the provisions of
EITF Issue No. 06-7, "Issuer's Accounting for a Previously Bifurcated Conversion Option in a Convertible Debt Instrument When the Conversion Option No Longer Meets the Bifurcation
Criteria in Financial Accounting Standards Board ("FASB") Statement No. 133, Accounting for Derivative Instruments and Hedging Activities" ("EITF 06-7"). Under
EITF 06-7, at the time of issuance, an embedded conversion option in a convertible debt instrument may be required to be bifurcated from the debt instrument and accounted for
separately by the issuer as a derivative under SFAS 133, based on the application of EITF 00-19. Subsequent to the issuance of the convertible debt, facts may change and
cause the embedded conversion option to no longer meet the conditions for separate accounting as a derivative instrument, such as when the bifurcated instrument meets the conditions of Issue
00-19 to be classified in stockholders' equity. Under EITF 06-7, when an embedded conversion option previously accounted for as a derivative under SFAS 133 no
longer meets the bifurcation criteria under that standard, an issuer shall disclose a description of the principal changes causing the embedded conversion option to no longer require bifurcation under
SFAS 133 and the amount of the liability for the conversion option reclassified to stockholders' equity. On May 18, 2007 the Company and the investor amended the terms of the secured
convertible debentures to remove the investor's ability, upon conversion of the debentures, to demand cash in lieu of shares of common stock and to clarify that the Company may issue restrictive
shares if there is no effective registration statement at the time of conversion. The terms of the convertible debentures were amended to permit the Company to reclassify the derivative conversion
option liability embedded of $4,335 in the convertible debentures from debt to equity.

Through
May 18, 2007 the Company accounted for the conversion options using the fair value method at the end of each quarter, with the resultant gain or loss recognition recorded
against earnings. The conversion option was valued at May 18, 2007, the effective date of the amendment to the convertible debenture to remove the cash settlement option, using the
Black-Scholes valuation model, applying the actual common stock price on May 18, 2007 ($0.53), applicable volatility rate

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

8.    Accounting for Secured Convertible Debentures and Related Warrants. (Continued)

(97%),
and the period close risk-free interest rates (4.82%) for the instrument's remaining contractual lives of 2.24 years for the August 2006 tranche and 2.41 years for the
October 2006 tranche.

During
the three and nine months ended September 30, 2008, $762 and $1,409 respectively, in face value of the convertible debentures were converted, resulting in the issuance of
19,846,180 and 25,962,761 shares of common stock, respectively. The Company waived the 840,000 monthly shares limitation with respect to these conversions. During the three and nine months
ended September 30, 2007, $703 and $2,703, respectively, in the face value of convertible debentures were converted, resulting in the issuance of 1,964,954 and 4,885,160, respectively, shares
of common stock. As a result of the amortization and conversion, $706 and $1,632, respectively, of the discount on the convertible debenture has been charged to discount amortization for the three and
nine months ended September 30, 2008. During the three and nine months ended September 30, 2007, $702 and $2,701, respectively, of the discount on the convertible debenture has been
charged to discount amortization and approximately $0 and $1,048, respectively, of the conversion option on the convertible debt was reclassified to additional paid in capital.

At
September 30, 2008, the balances of the convertible debentures and the offsetting related discount were $4,591 and $2,867, respectively.

9.    Warranty Reserve.

The Company provides a warranty covering defects arising from the sales of its video phone product. This warranty is limited to a specific time period. As of September 30, 2008
and December 31, 2007, the Company had a reserve of $18 and $49, respectively that is based on expected and historical loss rate as a percentage of product sales. Warranty costs are charged to
cost of revenues when they are probable and reasonably estimable. While the Company believes its estimate at September 30, 2008 is reasonable and adequate, it is subject to change based on its
future sales and experience, which may require an increase or decrease in its reserve.

10.    Commitments and Contingencies.

Leases

The Company's current five year lease was signed on September 1, 2005 and covers 42,500 square feet at an annual rate of $11.40
per square foot with a 3% increase annually, cancelable by either party with eight months notice, with a termination by tenant also including six months termination fee. In March 2008 the parties
agreed in principle to a new lease (and the cancellation of the current lease with no termination cost) for a smaller space within the current facility consisting of approximately 17,000 square feet
at an annual fee of $7 per square foot and the Company relocated into this smaller space in April 2008. This new lease is expected to be cancelable by either party upon 90 days notice with no
termination costs. Total rent expense for the three and nine months ended September 30, 2008 amounted to approximately $43 and $207, respectively. Total rent for the three and nine months ended
September 30, 2007 amounted to approximately $164 and $486, respectively. During the three months ended June 30, 2008, certain equipment, furniture and fixtures were sold and disposed of
during the

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

10.    Commitments and Contingencies. (Continued)

Company's
move to smaller facilities. The net loss realized on the sale this equipment, furniture and fixtures during the three and nine months ended September 30, 2008 was $0 and $295,
respectively.

In
November 2003, the Company entered into a 60 month lease for office equipment. In December 2007, the Company entered into a 60 month lease for office equipment. As of
September 30, 2008 there remains a total of $48 to be paid over the remaining period of this lease.

The
future minimum contractual rental commitments under non-cancelable leases (including the lease expected to be cancelled in the third quarter 2008) for each of the fiscal
years ending December 31 are as follows:

2008 (October 1 to December 31, 2008)

$
1362009


5462010


3752011


112012


11Total

$
1,079


11.    Related Party Transactions

The Company has a current multi-year agreement with Mototech, an investor, to provide the Company with engineering and development support. As a result of this agreement, the
Company has expensed approximately $0 and $3, respectively for the three and nine months ended September 30, 2008, and $8 and $194, respectively, for the three and nine months ended
September 30, 2007. Accounts payable to this investor amounted to $1,077 and $733 at September 30, 2008 and December 31, 2007, respectively. Purchases of manufactured video phones
from this investor primarily accounted for the higher accounts payable balances. For the three and nine months ended September 30, 2008, video phone purchases from this investor were $1,249 and
$1,578, respectively. For the three and nine months ended September 30, 2007, video phone purchases from this investor were $802 and $1,417, respectively. This agreement provides for contracted
services, including hardware and software development, and the creation and development of tools to facilitate the Company's engineering efforts. This agreement does not provide for ongoing royalties,
purchase provisions, or for any requirement to provide additional funding to the Company. Net revenues from operations recognized from Mototech were approximately $0 and $1 for the three and nine
months ended September 30, 2008 and $0 and $5, respectively, for the three and nine months ended September 30, 2007. Accounts receivable from this investor were $9 and $8, respectively,
as of September 30, 2008 and December 31, 2007.

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

The Company displays earnings per share in accordance with SFAS No. 128, "Earnings Per Share." SFAS No. 128 requires dual presentation of basic and diluted earnings per
share ("EPS"). Basic EPS includes no dilution and is computed by dividing net income (loss) attributable to common shareholders by the weighted average number of common shares outstanding for the
period. Diluted

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

12.    Net Loss per Share (Basic and Diluted). (Continued)

EPS
includes under the "if converted method" of SFAS No. 128 that the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into
common stock. Outstanding stock options, warrants and other potential stock issuances are not included in the computation when they are not in the money and their effect would be
anti-dilutive. The following table presents the shares used in the computation of fully diluted earnings per share for the three and nine months ended September 30, 2008 and 2007:

Three Months ended
September 30,

Nine Months ended
September 30,2008

2007

2008

2007Net income (loss) per shareBasic and Diluted:Net income (loss)

$
23

$
(2,682
)
$
(4,001
)
$
(11,841
)Basic weighted average common shares outstanding


69,445,002


46,428,769


61,739,560


44,082,489EPSBasic and diluted

$
0.00


(0.06
)

(0.06
)

(0.27
)


Potential
common shares comprise shares of common stock issuable upon the exercise of stock options, and warrants, and upon the conversion of convertible debentures. Potential common
shares excluded from net loss per share for the three months ended September 30, 2008 and 2007 were 44,651,904 and 35,684,849, respectively because their effect would be
anti-dilutive.

13.    Warrants.

A summary of the Company warrant activity for the nine months ended September 30, 2008, is as follows:

Warrants

Weighted Average
Exercise Price

Weighted
Average
Remaining
Contract LifeOutstanding, January 1, 2008


13,234,024

$
1.46


2.66Granted


9,273,982


0.45Expired/cancelled


(5,740,480
)

(0.73
)Outstanding, September 30, 2008


16,767,526

$
1.16


1.66Exercisable, September 30, 2008


16,767,526


The
activity during the nine months ended September 30, 2008 resulted from the anti-dilution provisions applicable to securities issued in the June 2004 private
placement which were triggered by the issuance of convertible debentures and warrants on August 2006 and October 2006 and as a result of the conversion price related to these issuances (See
Note 7).

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

14.    Stockholders' Deficiency.

The following summarizes the transactions in stockholder deficiency from January 1, 2008 through September 30, 2008:

Balance as of January 1, 2008

$
(1,462
)Issuance of common stock under employee stock purchase plan


2Issuance of common stock upon conversion of convertible debentures


1,409Non-cash stock based compensation


515Net loss for the nine months ended September 30, 2008


(4,001
)Balance as of September 30, 2008

$
(3,537
)


15.    Revenue Recognition.

Revenue is recognized when persuasive evidence of an arrangement exists, the price is fixed or determinable, the collectibility is reasonably assured, and the delivery and acceptance of
the equipment has occurred or services have been rendered. Management exercises judgment in evaluating these factors in light of the terms and conditions of its customer contracts and other existing
facts and circumstances to determine appropriate revenue recognition. Due to the Company's limited commercial sales history, its ability to evaluate the collectibility of customer accounts requires
significant judgment.
The Company continually evaluates its equipment customer and service customers' accounts for collectibility at the date of sale and on an ongoing basis.

Revenues
are also offset by a reserve for any price refunds and consumer rebates consistent with the EITF Issue 01-9, "Accounting for Consideration Given by a Vendor to a
Customer."

During
the three and nine months ended September 30, 2008, the Company shipped approximately 0 and 9 units, respectively, with a sales value of $0 and $2, respectively, to
customers with a right of return. These customers may exercise their right of return only if they do not sell the units to their respective customers. Revenue and cost for these units were deferred in
accordance with SFAS 48 "Revenue Recognition when a Right of Return Exists."

From
June 2007 through March 2008 the Company shipped its video phone product to its VRS customer, Aequus. As part of its June 2007 agreement with this customer, the Company began to
recognize product revenue at the time of shipment of its video phone. In addition, the Company also began to receive service fee revenues based on a percentage of the fees earned by Aequus and for
which the customer has received service. The Company recognizes this service fee revenue upon confirmation from Aequus of the fees they have earned. The Company also receives service fee revenues from
end consumers which are recognized after the services have been performed.

On
March 31, 2008, the Company entered into a new agreement with Aequus and Snap!VRS. This new agreement, inter alia, provides for the (i) resolution of a dispute with
Aequus regarding amounts the Company claimed were owed to the Company by Aequus and the termination by the Company of video phone service to Aequus, (ii) payment to the Company by Aequus of
approximately $5,000 in scheduled payments over ten months commencing March 31, 2008, (iii) agreement to arbitrate approximately $1,354 claimed by the Company to be owed by Aequus and
(iv) purchase of an

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

15.    Revenue Recognition. (Continued)

additional
$1,475 of video phones by Aequus. As a result of this new agreement Aequus is planning to build a new data center, with support and training provided by the Company, and upon completion,
directly operate a video phone service for its customers. The $1,475 of units purchased per the agreement as of March 31, 2008 are being held by the Company pending shipment to Aequus
customers. These units purchased are being held by the Company pending shipment to the ultimate consumer and the revenue for these units is being deferred per the SEC Staff Accounting Bulletin Topic
13 A (3) (a), Bill and Hold Arrangements. This revenue will be recognized as and when the units are shipped to the consumer. For the three and nine months ended September 30, 2008, the
Company recognized revenue for units shipped to Aequus customers of $844 and $1,637, respectively. The $5,000 of payments in the agreement are related to multiple deliverables to Aequus that have
standalone value with objective and reliable evidence of fair value, and include the following: (i) a specified amount of non recurring engineering ("NRE", with a fair value of $900),
(ii) support and transition training to Aequus to operate its own data center ("Training," with an estimated fair value of $298), (iii) continued use of the WorldGate video phone service
center during the transition (with an estimated fair value of $178), and (iv) the elimination of previously agreed service fees ("contract termination fee", with a
residual fair value of $3,624). These deliverables are all separate units of accounting in accordance with EITF No. 00-21, "Revenue Arrangements with Multiple Deliverables". The
Company will recognize revenue for the NRE and Training and support as the service is provided. For the three and nine months ended September 30, 2008, revenue of $19 and $108, respectively,
was recognized for NRE, and $114 and $304, respectively, was recognized for training and support. The Company's obligation regarding the NRE is to provide $900 of such NRE which may extend beyond a
period of twelve months. The Training is expected to be performed over approximately 7 months. Revenue from the use of the video phone service center will be recognized on a
straight-line basis over the expected period of use, which is approximately 7 months. Since collectibility is not reasonably assured, the contract termination fee will be recognized
as other income on a straight line basis over the ten months that the $5,000 is to be paid. For the three and nine months ended September 30, 2008, other income was recorded for the contract
termination fee of $1,064 and $2,121, respectively. As of September 30, 2008 the Company had received payment of $1,475 toward the purchase of video phone units and $3,400 of the $5,000 agreed
payments. The September 30, 2008 balance sheet reflects $1,850 of such payments remaining as deferred revenue and income. In the period October 1, 2008 through November 3, 2008
the Company received additional payments of $800 as part of $5,000 of agreed payments. The agreement requires Aequus to pay the remaining balance in 2 installments of $400 per month through January
2009. The parties have completed the arbitrator selection process and a hearing has been scheduled during the third week in January 2009 for this matter. Aequus has also filed a motion for summary
judgment which is scheduled to be heard on December 29, 2008.

16.    Risks and uncertainties.

The Company's primary line of business is the development and sale of video phone products and technology. Although the Company has launched its first product based on this technology
and, although the Company has realized some revenues for the commercial sale of its product, the revenues to date have not been substantial. Given the early stage of its product and the lack of
operating history in the video phone business, it is difficult to predict its future results.

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

16.    Risks and uncertainties. (Continued)

The
Company also depends on relationships with third parties such as contract manufacturing companies, chip design companies and others who may be sole source providers of key components
and services critical for the product the Company is developing in its video phone business. The components and raw materials used in the Company's Ojo video phone product are generally available from
a multitude of vendors and are sourced based, among other factors, on reliability, price and availability. A formal relationship with Mototech has been established for the volume manufacture of Ojo.
The Company's non exclusive agreement with Mototech allows either party to terminate the agreement with 90 days prior notice. At the present time Mototech is the Company's sole manufacturer of
its video phones. If Mototech or other providers of components and/or manufacturing services do not produce these components or provide their services on a timely basis, if the components or services
do not meet the Company's specifications and quality control standards, or if the components or services are otherwise flawed, the Company may have to delay product delivery, or recall or replace
unacceptable products. In addition, such failures could damage the Company's reputation and could adversely affect its operating results. As a result, the Company could lose potential customers and
any revenues that it may have at that time may decline dramatically.

17.    Accounting for the Uncertainty in Income Taxes.

The Company accounts for uncertain tax positions in accordance with FASB Interpretation No. 48 "Accounting for Uncertainty in Income TaxesA Interpretation of FASB
Statement No. 109 ("FIN 48"). FIN 48 establishes for all entities a minimum threshold for financial statement recognition of the benefit of tax positions, and requires certain
expanded disclosures. As part of this assessment the Company completed preliminary analyses under Section 382 of the Internal Revenue Code. Generally section 382 limits the utilization
of an entity's net operating loss carryforward upon a change in control. Based on this analysis, it was determined that as of September 30, 2008 it was more likely than not that a change of
control pursuant to Section 382 has not occurred. Future issuances of common stock may affect this analysis which might cause limitation in the Company's ability to utilize net operating loss
carryforwards.

The
Company has identified its federal tax return and its state tax return in Pennsylvania as "major" tax jurisdictions, as defined in FIN 48. Based on the company's evaluation,
it concluded that there are no significant uncertain tax positions requiring recognition in the Company's financial statements. The Company's evaluation was performed for tax years ended 2004 through
2007, the only periods subject
to examination. The Company believes that its income tax positions and deductions would be sustained on audit and does not anticipate any adjustments that would result in a material change to its
financial position.

The
Company's policy for recording interest and penalties associated with audits is to record such items as a component of income before income taxes. Penalties are recorded in other
expense and interest paid or received is recorded in interest expense or interest income, respectively, in the statement of operations. There were no amounts accrued for penalties or interest as of or
during the nine months ended September 30, 2008 and 2007. The Company does not expect its unrecognized tax benefit position to change during the next twelve months. Management is currently
unaware of any

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WORLDGATE COMMUNICATIONS, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(In Thousands, Except Share and per Share Amounts)

17.    Accounting for the Uncertainty in Income Taxes. (Continued)

issues
under review that could result in significant payments, accruals or material deviations from its position.

18.    Geographical Data.

Financial Information Relating to Foreign and Domestic Operations and Export Sales from Continuing Operations (Dollars in Thousands) for the three and nine months ended
September 30, 2008 and September 30, 2007:

2008

2007Three Months Ended September 30:Net revenues by geographic area:United States

$
1,193

$
1,259Foreign


54


273Total

$
1,247

$
1,532Net income (loss) (all from United States operations)

$
23

$
(2,682
)Nine Months Ended September 30:Net revenues by geographic area:United States

$
2,562

$
1,864Foreign


54


283Total

$
2,616

$
2,147Net loss (all from United States operations)

$
(4,001
)
$
(11,811
)


September 30,
2008

December 31,
2007Identifiable assets within the United States

$
3,317

$
3,243Identifiable foreign assets (hardware and tooling for manufacturing) in Taiwan, R.O.C.

$
99

$
171


19.    Registration rightsAugust 2005 private placement.

In August 2005, the Company sold stock and warrants totaling $17,500 which were subject to a registration rights agreement. The Company accounts for the registration rights agreement in
accordance with FSP EITF 00-19-2. This private placement includes numerous provisions intended to protect these institutional investors including a cash payment penalty
of 1.5% per month for the period above 120 days from the effective date of the agreement that the shares in the transaction fail to be registered or if the registration statement ceases to be
effective for more than twenty days. The registration statement covering the shares under this private placement was not declared effective until June 1, 2006. Until such time as the shares
were registered the Company was subject to the penalty provision under this private placement. The related unpaid penalty accrued as of September 30, 2008 and December 31, 2007 was $157.

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

FORWARD-LOOKING AND CAUTIONARY STATEMENTS

We may from time to time make written or oral forward-looking statements, including those contained in the following Management's
Discussion and Analysis of Financial Condition and Results of Operations. The words "estimate," "project," "believe," "intend," "expect," and similar expressions are intended to identify
forward-looking statements, although not all forward-looking statements contain these identifying words. In order to take advantage of the "safe harbor" provisions of the Private Securities Litigation
Reform Act of 1995, we are hereby identifying
certain important factors that could cause our actual results, performance or achievement to differ materially from those that may be contained in or implied by any forward-looking statement made by
or on our behalf. The factors, individually or in the aggregate, that could cause such forward-looking statements not to be realized include, without limitation, the following: (1) difficulty
in developing and implementing marketing and business plans, (2) industry competition factors and other uncertainty that a market for our products will develop, (3) challenges associated
with distribution channels, including both the retail distribution channel and HSD operators (e.g., uncertainty that they will offer our products, inability to predict the manner in which they
will market and price our products and existence of potential conflicts of interests and contractual limitations impeding their ability to offer our products), (4) continued losses,
(5) difficulty or inability to raise additional financing on terms acceptable to us, (6) departure of one or more key persons, (7) default under, or acceleration of the maturity
of, our convertible debentures, (8) changes in regulatory requirements, (9) delisting of our common stock from the OTCBB and (10) other risks identified in our filings with the
Securities and Exchange Commission. We caution you that the foregoing list of important factors is not intended to be, and is not, exhaustive. We do not undertake to update any forward-looking
statement that may be made from time to time by us or on our behalf, other than as required by the federal securities law.

Results of Operations:

General

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

On
May 9, 2006 the Company entered into a multiyear agreement with Aequus to purchase Ojo video phones through its wholly-owned subsidiary Snap Telecommunications Inc.
("Snap!VRS"), a provider of VRS and VRI services for the deaf and hard of hearing. On June 20, 2007 the Company announced it had expanded its relationship with Aequus and Snap!VRS modifying
their earlier agreement to allow for the parties to work collaboratively to identify the most desired Ojo features and capabilities that will provide the best video phone experience for the VRS user
community and that would enable Ojo to be the preferred VRS video phone. As part of the modified agreement the Company agreed to provide development and engineering resources to accomplish these
features and capabilities and in addition, as a result of Snap!VRS's utilization of the Ojo network, Snap!VRS also placed a purchase order for 10,000 Ojos to begin to fill the current Snap!VRS order
backlog. In the later part of the third quarter of 2007 product shipments were commenced to Snap!VRS' VRS customers.

On
February 4, 2008, the Company issued a current report on Form 8-K indicating that it was in a dispute with Aequus over the payment of significant monies
which the Company believed were owed to it. The customer's refusal to pay such monies had contributed to a shortfall in the operating cash

28

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Table of Contents

available
to the Company to continue operations, and accordingly, on January 30, 2008, the Company shut down its operations. The Form 8-K further indicated that this was a
first step to winding down its business, which would occur if the Company was not able to secure payment of the monies believed to be owed to by the customer, and/or new financing.

On
March 31, 2008, the Company entered into a new agreement with Aequus and Snap!VRS. This new agreement, inter alia, provides for the (i) resolution of a dispute with
Aequus regarding amounts the Company claimed were owed to the Company by Aequus and the termination by the Company of service to Aequus, (ii) payment to the Company by Aequus of approximately
$5,000 in scheduled payments over the next ten months, (iii) agreement to arbitrate an additional approximately $1,354 claimed by the Company to be owed by Aequus and (iv) purchase of an
additional $1,500 of video phones by Aequus. As a result of this new agreement Aequus is planning to build a new data center, with support and training provided by the Company, and upon completion,
directly operate a video phone service for its customers. In anticipation of completing the contract with Aequus the Company resumed operations on March 11, 2008. The parties have completed the
arbitrator selection process and a hearing has been scheduled during the third week in January 2009 for this matter. Aequus has also filed a motion for summary judgment which is scheduled to be heard
on December 29, 2008.

Critical Accounting Policies and Estimates.

Our condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the
United States. These generally accepted accounting principles require management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and the reported amounts of net revenues and expenses during the reporting period. Actual results could differ from those
estimates.

Our
significant accounting policies are described in the notes to the consolidated financial statements included in our annual report on Form 10-K. Judgments and
estimates of uncertainties are required in applying our accounting policies in many areas. Following are some of the areas requiring significant judgments and estimates: revenue recognition, inventory
valuation, stock based compensation, deferred revenues, deferred tax asset valuation allowances and valuation of derivative liabilities and related warrants. Management has discussed the development
and selection of these policies with the Audit Committee of our Board of Directors, and the Audit Committee of the Board
of Directors has reviewed our disclosures of these policies. There have been no material changes to the critical accounting policies or estimates reported in the Management's Discussion and Analysis
section or the audited financial statements for the year ended December 31, 2007 as filed with the Securities and Exchange Commission.

Three and Nine Months Ended September 30, 2008 and September 30, 2007.



Net revenues for the three and nine months ended September 30, 2008 were $1,247and $2,616, respectively, and $1,532 and $2,147,
respectively, for the three and nine months ended September 30, 2007, primarily reflecting the product service and other revenues from our distribution of the Ojo product. The decrease of $285,
or 19%, in these revenues during the three months ended September 30, 2008, with respect to the comparable period in 2007 primarily reflects that the three months ended September 30,
2007 represented an initial launch period for shipments of Ojo phones to Aequus customers. The increase of $469, or 22%, in product service and other revenues during the nine months ended
September 30, 2008, with respect to the comparable period in 2007, primarily reflects an increase in revenues of $340 realized from non recurring engineering services, support and transition
training and service center usage provided to Aequus under the March 31, 2008 agreement

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(See
Note 15 of the accompanying financial statements), and $847 of increased shipments of units to Aequus, offset by decreases in product shipments of $631 to other customers and decreases in
service fee revenues from other customers of $87. During the three and nine months ended September 30, 2008, these shipments to Aequus were $844 and $1,637, respectively. For the same periods
in 2007, these shipments were $785 and $790, respectively. Total product revenues were $938 and $1,769, respectively, for the three and nine months ended September 30, 2008 and $1,162 and
$1,553, respectively, for the three and nine months ended September 30, 2007. Totals service revenues were $176 and $435, respectively, for the three and nine months ended September 30,
2008 and $195 and $419, respectively, for the three and nine months ended September 30, 2007. The decrease in service revenues during the three months ended September 30, 2008, when
compared to the same period in 2007, was $19, or 11%,. For the nine months ended September 30, 2008, service revenues increased by $16, or 4%. The increase of service revenues over the nine
months ended September 30, 2008, was primarily the result of an increase in service revenues from Aequus of $103, partially offset by decreased traditional Ojo phone service revenues of $87
during the nine months ended September 30, 2008 resulting from the shutting down of our operations from January 30, 2008 through March 11, 2008
as a result of our cash shortfall related in part to a dispute with our largest customer over the payment of significant monies which we believed was owed to us and the customer's refusal to pay such
monies. During the three and nine months ended September 30, 2008, other revenues were $133 and $412, respectively, compared to $175 for each of the same periods in 2007. These revenues were
the results of NRE and Training and Support services realized from Aequus noted above. During the three and nine months ended September 30, 2008 we shipped 0 and 9 units, respectively, with a
sales value of $0 and $2, respectively, to customers with a right of return. Revenue for these units were deferred as of September 30, 2008 in accordance with FAS 48 "Revenue Recognition
when a Right of Return Exists." We do expect, however, to begin recording these shipments as revenue as and when these units are sold by our customers. In addition, as part of the agreement reached
with Aequus on March 31, 2008 this customer bought Ojo units valued at $1,475. These units purchased are being held by us pending shipment to the ultimate consumer and the revenue for these
units is being deferred per the SEC Staff Accounting Bulletin Topic 13 A (3) (a), Bill and Hold Arrangements. This revenue will be recognized as and when the units are shipped to the consumer.
For the three and nine months ended September 30, 2008, the Company recognized revenue for units shipped to Aequus of $594 and $1,374, respectively.

Gross
profit of $436 and $930, respectively, was reported for the three and nine month period ended September 30, 2008 compared to a gross profit of $341 and $124, respectively,
reported for the three and nine months ended September 30, 2007. This improvement in gross profit was primarily the result of the increase in revenue from the non-recurring
engineering (NRE), training and service center usage revenues recognized from our agreement with Aequus (See Note 15 of the accompanying financial statements), and increased selling prices and
lower unit costs of the product shipped during the three and nine months ended September 30, 2008 compared to the same period in 2007.



Cost of Revenues.Cost of revenues consists of product and delivery costs relating to the deliveries of video phones. For the three and nine months ended
September 30, 2008, the cost of revenues was $811 and $1,686, respectively. For the three and nine months ended September 30, 2007, cost of revenues was $1,191 and $2,023, respectively.
Primarily, accounting for this decrease in cost of revenues of $380, or 31%, and $337, or 17%, for the three and nine months ended September 30, 2008,respectively, compared to the same periods
in 2007,were reduced product shipments of which reduced the respective cost of revenues by $475, offset by costs incurred of $95 relating to engineering service revenues in the three months ended
September 30, 2008 compared to the same period in 2007, and included in costs of revenues for the nine months ended September 30, 2007 were inventory

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adjustments
for the lower of cost or market valuations of $293 There were no inventory adjustments for the lower of cost or market valuations for the three and nine months ended September 30,
2008.

Engineering and Development.Engineering and development expenses primarily consist of compensation, and the cost of design, programming, testing, documentation
and support of our video phone product. Engineering and development costs were $631 and $1,707, respectively, for the three and nine months ended September 30, 2008, compared with $926 and
$4,388, respectively, for the three and nine months ended September 30, 2007. This decrease of $295, or 32%, for the three months and $2,681, or 61%, for the nine months ended
September 30, 2008, primarily reflects reduced product development expenditures of $94 and $452, respectively, and reductions in staff of $556 and $2,600, respectively. Development costs with
Aequus of $346 were deferred during the three and nine months ended September 30, 2007 offsetting reductions development expenditures and staffing when compared to the same periods in 2008.

Sales and Marketing.Sales and marketing expenses consist primarily of compensation (which includes compensation to manufacturer's representatives and
distributors), attendance at conferences and trade shows, travel costs, advertising, promotions and other marketing programs (which include expenditures for co-op advertising and new
market development) related to the continued introduction of our video phone product. Sales and marketing costs were $73 and $431, respectively, for the three and nine months ended
September 30, 2008, compared with $310 and $2,299, respectively, for the three and nine months ended September 30, 2007. This decrease of $237, or 76%, and $1,868, or 81%, respectively,
for the three and nine months ended September 30, 2008 compared to the three and nine months ended September 30, 2007, is primarily the result of reduced marketing, customer service and
promotional expenditures of $119 and $1,066, respectively, and reduced staffing costs of $84 and $425, respectively, required as a result of reduced available cash.

General and Administrative.General and administrative expenses consist primarily of expenditures for administration, office and facility operations, as well as
finance and general management activities, including legal, accounting and professional fees. General and administrative expenses were $797 and $2,674, respectively, for the three and nine months
ended September 30, 2008, compared with $1,248 and $4,204, respectively, for the three and nine months ended September 30, 2007. This decrease of $451, or 36%, for the three months and
$1,530, or 36%, for the nine months ended September 30, 2008, compared to the three and nine months ended September 30, 2007, is primarily attributable to reduced rent and staffing
expenses including suspension of a portion or all salaries for a time period in the first quarter of 2008 for certain senior management of the Company.

Interest and Other Income and Interest Expense.Interest and other income consisted of interest earned on cash and cash equivalents. Interest and other income
decreased to $6 and $16, respectively, for the three and nine months ended September 30, 2008 compared to $21 and $164 for the three and nine months ended September 30, 2007 primarily
due to reduced interest earned on lower cash balances. During the three and nine months ended September 30, 2008, the Company earned interest on its average cash balances which approximated
$557 and $573, respectively, compared to $1,814 and $4,460, respectively, for the three and nine months ended September 30, 2007. Interest expense was $76 and $262, respectively, for the three
and nine months ended September 30, 2008 and $110 and $366, respectively, for the three and nine months ended September 30, 2007, primarily consisting of accrued interest on the
convertible debentures issued on August 11, 2006 and October 13 2006.

Income from Service Fee Contract Termination.During the three and nine months ended September 30, 2008, we realized $1,064 and $2,121, respectively, of
other income from the elimination of previously agreed service fees with Aequus as stated in our agreement on March 31, 2008, which the Company realized over a ten month period (See
Note 15 of the accompanying financial statements).

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Loss on Equipment Disposal.During the nine months ended September 30, 2008, certain equipment, furniture and fixtures were sold and disposed of during the
Company's move to smaller facilities. The net loss realized during the three and nine months ended September 30, 2008 was $0 and $295, respectively. There was no loss or gain realized during
the three and nine months ended September 30, 2007.

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

Non Cash Change in Fair Value of Derivative Warrants and Conversion Options.For the three and nine months ended September 30, 2008 the non cash change in
fair value of derivative warrants and conversion of options was a gain of $843 and $157, respectively. For the three and nine months ended and September 30, 2007 the non cash change in fair
value of derivative warrants and conversion of options was a gain of $131 and $2,541, respectively. These fair value adjustments are primarily a result of changes in our common stock price at each
reporting period and anti-dilution provisions that increased the number of outstanding warrants and reduced the warrant exercise price as of September 30, 2008 (See Note 7 of
the accompanying financial statements) related to our June 2004 private placement of our Series A Convertible Preferred Stock and Warrants and our August 11, 2006 and October 13,
2006 private placements of secured Convertible Debentures and Warrants.

Amortization of Debt Discount.For the three and nine months ended September 30, 2008 the amortization of the debt discount was $706 and $1,632,
respectively, and $917 and $3,385, respectively, for the three and nine months ended September 30, 2007, relating to the August 11, 2006 and October 13, 2006 private placements of
secured Convertible Debentures. During the three and nine months ended September 30, 2008, the amortization of debt discount reflected $356 and $706, respectively, of accelerated amortization
upon conversion of the debentures and $350 and $925, respectively, of normal discount amortization. For the three and nine months ended September 30, 2007, the amortization of debt discount
reflected $702 and $2,703, respectively, of accelerated amortization upon conversion of the debentures and $215 and $684, respectively, of normal discount amortization. This discount, at the time of
completion of this private placement on August 11, 2006, was initially recorded for $4,446, and the discount for the October 13, 2006 convertible debenture issuance was initially
recorded as $3,979. These discounts will be amortized using the effective interest rate method over the three year term of the convertible debentures.

Liquidity
and Capital Resources.

As
of September 30, 2008, our primary source of liquidity consisted of proceeds from the sale of stock and convertible debentures and from the sale of Ojo video phones. Cash and
cash equivalents are highly liquid, are of high quality investment grade and have original maturities of less than three months.

As
of September 30, 2008, the Company had cash and cash equivalents of $460. The Company generated cash from operations of $30 during the three months ended September 30,
2008. For the nine
months ended September 30, 2008, the Company used cash from operations of $624. The cash used in operations for the three and nine months ended September 30, 2007, was $1,998 and $9,375,
respectively. The increase in cash generated from operations for the three and nine months ended September 30, 2008 of $2,028 and $8,751, respectively, when compared to the same periods in
2007, primarily reflects the funds received from the March 31, 2008 agreement (see Note 15 of the accompanying financial statements), and our reduction in staff and overall cost of
operations during the three and nine months ended September 30, 2008, including the shut down during the period from January 30, 2008 through March 11, 2008.

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The
Company's short term cash requirements and obligations include inventory, accounts payable and capital expenditures from continuing operations and operating expenses.

Cash
provided by investing activities was primarily a result of the sale of equipment for product development and manufacture as well as general administrative and project management
purposes. For the three months ended September 30, 2008, cash used was $2 and for the nine month period ending September 30, 2008, the cash provided was $4. For the three and nine months
ended September 30, 2007, cash used for investing activities was primarily a result of investments in equipment for product development and manufacture as well as general administrative and
project management purposes were $76 and $130, respectively.

Cash
provided by financing activities during the three and nine months ended September 30, 2008 were $0 and $1, respectively, and $1,007 and $1,022, respectively for the three and
nine months ended September 30, 2007. During the three months ended September 30, 2007, the Company received a $1,000 investment from a related party.

Operations
and Liquidity.

The
Company has incurred recurring net losses and has an accumulated deficit of $265,576, stockholder's deficiency of $3,537 and a working capital deficit of $3,879 as of
September 30, 2008. These factors raise substantial doubt about the Company's ability to continue as a going concern. The accompanying financial statements do not include any adjustments that
might be necessary should the Company be unable to continue as a going concern.

The
Company had $6,953 of liabilities and substantially all of its assets are pledged as collateral as of September 30, 2008. These liabilities include $79 of detachable warrants
related to the Company's
private placement of preferred stock in June 2004 and $1,724 of debt (net of unamortized discount of $2,867) related to the Company's financing in August and October 2006.

Long
term cash requirement obligations are primarily related to the August and October 2006 secured convertible debenture transactions which mature in 2009. The convertible debentures
have an interest rate of 6% per annum and can be converted to common stock at the holder's option. The Company has current debt as of September 30, 2008 on the balance sheet reflecting the
convertible debentures issued on August 11 and October 13, 2006. The convertible debentures payable, net of unamortized discounts of $2,874 and $4,499, had a balance of $1,724 and
$1,502, respectively, as of September 30, 2008 and December 31, 2007 (See Note 8 of the accompanying financial statements). As of September 30, 2008 and December 31,
2007, accrued interest was $911 and $658, respectively.

On
February 5, 2008, February 13, 2008, February 15, 2008, April 8, 2008, and April 23, 2008 the Company received notices from YA Global, holder of the
Company's convertible debentures, claiming that the Company was in default of the terms of the debentures for stating its intent to wind down its business, failing to maintain current financial
statements in the registration statement relating to the sale of the Company's common stock issuable upon conversion of one of those debentures, failing to comply with a covenant to their satisfaction
that provided for the disclosure of information they considered material, and entering into the agreement with Aequus, a provider of VRS and VRI services for the deaf and hard of hearing, that granted
an exclusive license to Aequus for video relay and interpreting services in North America, indicating that such license was a default of the terms of the debentures because it appeared to YA that such
license constituted a sale of more than fifty percent of the Company's assets and therefore a change of control as that term is defined in the debentures, and, as a result of these notices, YA Global
indicated that it was exercising its right to accelerate payment of the full principal amount of the debentures. The Company has notified YA Global that it disputes these claims and whether they
constitute a continuing event of default under the debentures. The Company has also notified YA Global that their right to accelerate payment is also disputed. Although the Company disputes YA
Global's claims of default, and does not believe YA

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Global
has any basis to accelerate payments on the debenture, the Company has reclassified the YA Global convertible debenture to a current liability on the accompanying condensed consolidated balance
sheet, solely in light of the existence of the alleged claims.

The
Company's ability to generate cash is dependent upon the sale of its Ojo product and on obtaining cash through capital markets. The Company began generating revenue from the
commercial shipment of its Ojo product in April 2005 and the Company expects revenues to increase as the product continues to roll out to the marketplace. Depending on the ramp up of sales and the
achievable margins, the increased level of sales activity is expected to have a positive impact on the Company's cash flows from operations, which will support its ability to meet its cash
requirements in the long term. Given that the Company's video phone business involves the development of a new product line with no market penetration, in an underdeveloped market sector, no
assurances can be given that sufficient sales, if any, will materialize. The lack of success of the Company's sales efforts could also have an adverse ability to raise additional financing.

In
the latter part of the third quarter of 2007 product shipments commenced to a VRS, Aequus. The Company's Ojo video phone provides this equipment link for the
hard-of-hearing VRS user with a Telecommunications Relay Service ("TRS") operator (called a Communications Assistant, or "CA") so that the VRS user and the CA can see and
communicate with each other using American Sign Language ("ASL") in signed conversation. VRS enables deaf and hard-of-hearing customers to improve their
connection with people in their personal and business lives. This market is particularly attractive since the use of video as part of the communication link is critical, and accordingly, the video
phone is a major contributing component. Entrance to the VRS market has contributed significantly to the Company's efforts to increase product awareness and sales. Depending on the continued ramp up
of sales, and the achievable margin, the increased level of sales and service activity should have a positive impact on the Company's cash flows from operations.

On
February 4, 2008, the Company announced that it was in a dispute with Aequus over the payment of significant monies which the Company believed were owed to it. The customer's
refusal to pay such monies had contributed to a shortfall in the operating cash available to the Company to continue operations, and accordingly, on January 30, 2008, the Company shut down its
operations. The announcement further indicated that this was a first step to winding down its business, which would occur if the Company was not able to secure payment of the monies believed to be
owed to it by the customer, and/or new financing.

On
March 31, 2008, the Company entered into a new agreement with Aequus and Snap!VRS (See Note 15 of the accompanying financial statements). This new agreement, inter alia,
provides for the (i) resolution of a dispute with Aequus regarding amounts the Company claimed were owed to the Company by Aequus and the termination by the Company of video phone service to
Aequus, (ii) payment to the Company by Aequus of approximately $5,000 in scheduled payments over ten months commencing March 31, 2008, (iii) agreement to arbitrate an additional
approximately $1,354 claimed by the Company to be owed by Aequus and (iv) purchase of an additional $1,475 of video phones by Aequus. As a result of this new agreement Aequus is planning to
build a new data center, with support and training provided by the Company, and upon completion, directly operate a video phone service for its customers. The $1,475 of units purchased per the
agreement as of March 31, 2008 are being held by the Company pending shipment to Aequus customers. During the three and nine months ended September 30, 2008, the Company shipped $844 and
$1,637, respectively, of units to Aequus customers. As of September 30, 2008 the Company had received payment of $1,475 toward the purchase of video phone units and $3,400 of the $5,000 agreed
payments. The September 30, 2008 balance sheet reflects $1,850 of such payments remaining as deferred revenue and income. In the period October 1, 2008 through November 3, the
Company received additional payments of $800 as part of $5,000 of agreed payments.

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Based
on management's internal forecasts and assumptions, including, among others, the receipt of the payments per its agreement with Aequus of March 31, 2008, assumptions
regarding the proceeds that might result from the arbitration with Aequus of amounts the Company claims is owed to it by Aequus and assumptions regarding its short term cash requirements and its
projected revenue growth, the Company expects to have sufficient cash on hand to meet its obligations into the beginning of 2009. It is unclear whether the Company will have cash beyond that time.
Aequus is a new company with an unproven track record and if Aequus is not successful, or if their activities do not lead to significant sales of its product, their operating results will be adversely
affected, and its ability to pay all or any of the monies obligated per the agreement, including payment for products purchased or the payment of any monies the Company is awarded as a result of
agreed arbitration with Aequus, may not materialize or could be significantly reduced and the Company may have insufficient capital to operate its business.

The
Company continues to evaluate possibilities to obtain additional financing through public or private equity or debt offerings, bank debt financing, asset securitizations, or from
other sources, to obtain such financing. There can be no assurance that this additional financing will be available on terms acceptable to the Company, if at all. If the Company is unable to obtain
sufficient funds the Company may suspend operations which could have a material adverse impact on its business prospects. No assurances can be given that additional financing transactions can be
consummated. If the Company is unable to obtain sufficient funds the Company may further reduce the size of the organization or suspend operations which could have a material adverse impact on its
business prospects. In order to stretch its current working capital to provide more time for this to happen, in 2007 the Company significantly cut its operating expenses, including suspension of a
portion or all salaries for a time period in the third and fourth quarters of 2007 and the first quarter of 2008 for certain senior management of the Company. No assurances can, however, be made that
these efforts will be successful.

ITEM 3.    QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not required

ITEM 4T.    CONTROLS AND PROCEDURES.

The Company maintains disclosure controls and procedures (as defined in Exchange Act Rule 13a-15(e) and
15d-15(e)) that are designed to ensure that information required to be disclosed in reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed,
summarized, and reported within the time periods specified in the Securities and Exchange Commission's rules and forms, and that such information is
accumulated and communicated to its management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding the required disclosures. In
designing and evaluating the disclosure controls and procedures, the Company recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable
assurance of achieving the desired control objectives.

As
previously reported in our Form 10-K for the year ended December 31, 2007, we identified a material weakness with respect to the Company's application of
GAAP as a result of several significant deficiencies, including lack of segregations of duties, lack of appropriate IT security and program change controls, insufficient documentation of
period-end reviews, the improper recording of revenues, not recording inventory at the lower of cost or market, and the incorrect determination of grant dates for stock based awards. The
temporary shift in the Company's focus and resources toward keeping the Company solvent contributed to the material weakness. As a result of the material weakness identified the Chief Executive
Officer and Chief Financial Officer concluded that as of December 31, 2007, its disclosure controls and procedures were not designed properly and were not effective in ensuring that the
information required to be disclosed by the Company in the reports that we file and submit under

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the
Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Commission's rules and forms.

We
carried out an evaluation, under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of
the design and operation of our disclosure controls and procedures as of September 30, 2008. As a result of the evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that, as of September 30, 2008, the material weakness identified at December 31, 2007 still existed as the Company's focus was on getting funding to continue operations and, did not
pursue remedies to the material weaknesses, as well as a material weakness in accounting for complex transactions. Going forward, to address the material weakness related to the application of GAAP,
the Company is examining options, subject to available resources, to increase staffing, including increasing expert consultants, to ensure segregation of duties, enhancing IT security and program
change controls and procedures, increasing documentation for period ending reviews, ensuring the proper recording of revenues, properly recording inventory, and properly determining the grant date for
stock based awards. There can be no certainty that the resources necessary to accomplish these procedural enhancements will be available or that the reduced staffing level under which we are operating
will be adequate to achieve the desired level of controls.

There
has been no change in our internal control over financial reporting that occurred during the three months ended September 30, 2008 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial reporting. The Company is also still in the process of implementing a financial system that it believes will improve the
internal control over financial reporting and will eliminate any identified deficiencies.

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PART II. OTHER INFORMATION

ITEM 1.    LEGAL PROCEEDINGS.

Although from time to time we may be involved in litigation as a routine matter in conducting our business, we are not currently
involved in any litigation which we believe is material to our operations or balance sheet. During the first fiscal quarter 2008 we were involved in a dispute with Aequus Technologies, our largest
customer which was settled as part of the March 31, 2008 agreement with this customer. As part of this settlement certain non-recurring engineering, or NRE, in the amount of
approximately $1,354, remains the subject of an agreed upon arbitration between the parties. The parties have completed the arbitrator selection process and a hearing has been scheduled during the
third week in January 2009 for this matter. Aequus has also
filed a motion for summary judgment which is scheduled to be heard on December 29, 2008.

ITEM 2.    UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3.    DEFAULTS UPON SENIOR SECURITIES.

On February 5, 2008, February 13, 2008, February 15, 2008, April 8, 2008, and April 23, 2008 the
Company received notices from YA Global, holder of the Company's convertible debentures, claiming that the Company was in default of the terms of the debentures for stating its intent to wind down its
business, failure to maintain current financial statements in the registration statement relating to the sale of the Company's common stock issuable upon conversion of one of those debentures, to
comply with a covenant to their satisfaction that provided for the disclosure of information they considered material, and entering into the agreement with Aequus Technologies Corp. and Snap
Telecommunications, Inc. (collectively "Aequus"), a provider of Video Relay Services ("VRS") and Video Remote Interpreting ("VRI") services for the deaf and hard of hearing, that, specifically
the Company's grant of an exclusive license for video relay and interpreting services in North America, was a default of the terms of the debentures because it appeared to YA that such license
constituted a sale of more than fifty percent of the Company's assets and therefore a change of control as that term is defined in the debentures. and as a result of these notices YA Global was
exercising its right to accelerate payment of the full principal amount of the debentures. While the registration statement was not effective as of December 31, 2007, the underlying alleged
default with respect to the registration statement was in any event cured by the amendments to Rule 144 that became effective on February 15, 2008, obviating the need to maintain that
registration statement. The Company has notified YA Global that it disputes these claims and whether they constitute a continuing event of default under the debentures. The Company has also notified
YA Global that their right to accelerate payment is also disputed. Although the Company disputes YA Global's claims of default, and does not believe YA Global has any basis to accelerate payments on
the debenture, the Company has reclassified the YA Global convertible debenture to a current liability on the balance sheet, solely in light of the existence of the alleged claims.

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

None.

ITEM 5.    OTHER INFORMATION.

None.

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ITEM 6.    EXHIBITS.

The following is a list of exhibits filed as part of this report on Form 10-Q. Where so indicated by footnote,
exhibits that were previously filed are incorporated by reference. For exhibits incorporated by reference, the location of the exhibit in the previous filing is indicated parenthetically except in
those situations where the exhibit number was the same as set forth below.

Exhibit

Description3.1

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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SIGNATURES

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

WORLDGATE COMMUNICATIONS, INC.Dated: November 14, 2008

/s/ HAL M. KRISBERGH Hal M. Krisbergh Chairman and Chief Executive Officer
(Principal Executive Officer)Dated: November 14, 2008

/s/ JOEL BOYARSKI Joel Boyarski Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)


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