**UNITED STATESSECURITIES AND EXCHANGE COMMISSION**

**WASHINGTON,DC 20549**

 

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

 
| **Mark One** |
|--------------|
| **ý**   | **Quarterly  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
|         | **for the Quarterly Period Ended  September 30, 2004.** |
|         | ** ** |
| **or**       |
|         |   |
| **o**        | **Transition  Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of  1934** |
| ** **   | **for the Transition Period From                      To                      .** |

 

**Commissionfile number:  000-25755**

 

**WORLDGATE COMMUNICATIONS, INC.**

(Exact Name ofRegistrant as Specified in Its Charter)

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

 

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

Yes    ý    No    o

 

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

Yes    o    No    ý

 

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

Yes    o    No    ý

 

As of November 8, 2004,there were 28,310,475 shares of common stock, par value $.01 per share,outstanding.

 

 

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**EXPLANATORY NOTE**

 

WorldGate Communications, Inc. (the “Company”) is filing this AmendmentNo. 1 on Form 10-Q/A to amend its Quarterly Report on Form 10-Q for the quarterended September 30, 2004, as filed with the Securities and Exchange Commission(the “SEC”) on November 17, 2004 (the “Original Filing”).  The purpose of this Amendment No. 1 is toamend and restate Part I, Item 1 and Item 2 which set forth the accounting forthe warrants and additional investments rights issued in private placements ofthe Company’s common stock during the fourth quarter of 2003 and the firstquarter of 2004.  These securitycomponents were originally treated as non-cash expenses and with this amendmentare being restated as equity transactions. Accordingly, changes have been madeto the applicable line items associated with additional paid-in capital,accumulated deficit, general and administrative costs, net (loss) income andnet loss per common share.  In addition,Part I, Item 1, Item 2, Item 3 and Item 4 and Part II, Item 4 and Item 6 havebeen amended and restated to reflect certain clarifications made in response tothe SEC’s comments as raised in its review of the Company’s registrationstatement on Form SB-2/A2, as filed with the SEC on May 24, 2005, and annualreport on Form 10-K for the year ended December 31, 2004, as filed with the SECon March 31, 2005, and subsequent review of the Company’s registrationstatement on Form SB-2/A, as filed with the SEC on August 30, 2005, and annualreport on Form 10-K/A for the year ended December 31, 2004, as filed with theSEC on August 30, 2005. Finally the certifications attached as Exhibits 31.1,31.2, 32.1 and 32.2 have been updated to reflect the filing date of thisamendment and interim changes in the regulations applicable to thesecertifications.  Except as describedabove, no additions or modifications have been made to this Amendment No. 1 toreflect facts or events occurring subsequent to the date of the OriginalFiling.

 

2

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WORLDGATECOMMUNICATIONS, INC.

 

QUARTERLY REPORTON FORM 10-Q

FOR THE THREEMONTHS ENDED SEPTEMBER 30, 2004

 

TABLE OF CONTENTS

 
| PART  I. FINANCIAL INFORMATION                                                                      | 4      |
|-----------------------------------------------------------------------------------------------------|--------|
|                                                                                                |   |
| Item  1. Financial Statements                                                                       | 4      |
| Item 2. Management’s  Discussion And Analysis Of Financial Condition And Results Of Operations | 14     |
| Item 3. Quantitative And  Qualitative Disclosures About Market Risk                                 | 18     |
| Item  4. Controls And Procedures                                                                    | 18     |
|                                                                                                |   |
| PART  II. OTHER INFORMATION                                                                         | 20     |
|                                                                                                |   |
| Item  1. Legal Proceedings                                                                          | 20     |
| Item 2. Unregistered Sales  of Equity Securities And Use Of Proceeds                                | 20     |
| Item 3. Defaults Upon Senior  Securities                                                            | 20     |
| Item 4. Submission Of  Matters To A Vote Of Security Holders                                        | 21     |
| Item  5. Other Information                                                                          | 21     |
| Item 6. Exhibits And Reports  On Form 8-K                                                      | 22     |

 

3

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PART I. FINANCIALINFORMATION

# ITEM1.  FINANCIAL STATEMENTS

#  

**WORLDGATECOMMUNICATIONS, INC.CONSOLIDATED BALANCE SHEETS**

**(Dollarsin Thousands)**

 
| ** **                                                                                                                                                                                                     | ** ** | **As of  September 30,  2004** | ** ** | **As of  December 31,  2003** | ** ** |
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------|------------|------------------------------------|------------|
| ** **                                                                                                                                                                                                     | ** ** | **(Unaudited and as  restated)**    | ** ** | **(Audited and as  restated)**     | ** ** |
| ASSETS                                                                                                                                                                                                         |       |                                |       |                               |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Current assets:                                                                                                                                                                                                |       |                                |       |                               |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Cash and cash  equivalents                                                                                                                                                                                     |       | $                                   | 8,290      |                               | $          | 3,365 |   |
| Accounts  receivable, less allowance for doubtful accounts of $0 at September 30,  2004 and $381 at December 31, 2003                                                                                |       | 82                                  |       | 146                                |       |
| Prepaid and  other assets                                                                                                                                                                                      |       | 285                                 |       | 199                                |       |
| Total current  assets                                                                                                                                                                                          |       | 8,657                               |       | 3,710                              |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Property and  equipment                                                                                                                                                                                        |       | 2,802                               |       | 2,605                              |       |
| Less:  accumulated depreciation and amortization                                                                                                                                                               |       | (1,648                              | )          | (1,338                             | )          |
| Property and  equipment, net                                                                                                                                                                                   |       | 1,154                               |       | 1,267                              |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Deposits and  other assets                                                                                                                                                                                     |       | 0                                   |       | 140                                |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Total assets                                                                                                                                                                                                   |       | $                                   | 9,811      |                               | $          | 5,117 |   |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| LIABILITIES AND  STOCKHOLDERS’ EQUITY                                                                                                                                                                     |       |                                |       |                               |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Current  Liabilities:                                                                                                                                                                                          |       |                                |       |                               |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Accounts payable                                                                                                                                                                                               |       | $                                   | 110        |                               | $          | 440 |   |
| Accrued expenses                                                                                                                                                                                               |       | 1,557                               |       | 594                                |       |
| Accrued  compensation and benefits                                                                                                                                                                             |       | 228                                 |       | 238                                |       |
| Dividend payable  on Preferred Stock                                                                                                                                                                           |       | 103                                 |       | 0                                  |       |
| Detachable  warrants                                                                                                                                                                                           |       | 1,223                               |       | 0                                  |       |
| Notes payable                                                                                                                                                                                                  |       | 147                                 |       | 0                                  |       |
| Conversion  option on Preferred Stock                                                                                                                                                                          |       | 1,124                               |       | 0                                  |       |
| Deferred  revenues                                                                                                                                                                                             |       | 494                                 |       | 0                                  |       |
| Deferred rent  credit                                                                                                                                                                                          |       | 143                                 |       | 30                                 |       |
| Total current  liabilities                                                                                                                                                                                     |       | 5,129                               |       | 1,302                              |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Deferred rent  credit                                                                                                                                                                                          |       | 0                                   |       | 135                                |       |
| Total  liabilities                                                                                                                                                                                             |       | 5,129                               |       | 1,437                              |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Redeemable  Preferred Stock                                                                                                                                                                                    |       | 3,121                               |       | 0                                  |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Total  stockholders’ equity:                                                                                                                                                                              |       |                                |       |                               |       |
|                                                                                                                                                                                                           |       |                                |       |                               |       |
| Preferred Stock,  $.01 par value, 13,500,000 shares authorized                                                                                                                                                 |       | 0                                   |       | 0                                  |       |
| Redeemable  Preferred Stock, $.01 par value, shares authorized, 7,550 shares issued  and outstanding at September 30, 2004, and 0 outstanding at  December 31, 2003                             |       | 0                                   |       | 0                                  |       |
| Common stock,  $.01 par value, 50,000,000 shares authorized, 28,235,456 shares  issued and outstanding at September 30, 2004 and 25,706,843 shares  issued and outstanding at December 31, 2003 |       | 282                                 |       | 262                                |       |
| Additional paid-in  capital                                                                                                                                                                                    |       | 205,616                             |       | 201,766                            |       |
| Unearned  compensation                                                                                                                                                                                         |       | (400                                | )          | (400                               | )          |
| Accumulated  deficit                                                                                                                                                                                           |       | (203,937                            | )          | (197,943                           | )          |
| Less Treasury  Stock, at cost –  0 and 500,000 shares  as of September 30, 2004 and December 31, 2003, respectively                                                                             |       | 0                                   |       | (5                                 | )          |
| Total  stockholders’ equity                                                                                                                                                                               |       | 1,561                               |       | 3,680                              |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                               |       | $                                   | 9,811      |                               | $          | 5,117 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

4

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**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDSTATEMENTS OF OPERATIONS**

**(Unaudited)**

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

 
| ** **                                                                                                                                                                                                                                                         | ** **    | **Three Months ended September 30,** | ** ** | **Nine Months ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|---------------|-------------------------------------------|------------|------------------------------------------|------------|
| ** **                                                                                                                                                                                                                                                         | ** **    | **2004**                                  | ** ** | **2003**                                 | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                                                                                                                                                         | ** **    | ** **                                | ** ** | ** **                               | ** ** | **(As restated)** | ** ** | ** ** | ** ** |
| Revenues                                                                                                                                                                                                                                                           |          | $                                         | 106        |                                     | $          | 0 |   | $ | 106 |   | $ | 0 |   |
| Cost of revenues                                                                                                                                                                                                                                                   |          | 50                                        |       | 0                                        |       | 50 |   | 0 |   |
| Gross Margins                                                                                                                                                                                                                                                      |          | 56                                        |       | 0                                        |       | 56 |   | 0 |   |
| Engineering and  development (excluding depreciation and amortization amounts of $2 and $0 for  the three months ended September 30, 2004 and 2003, respectively, and $2  and $0 for the nine months ended September 30, 2004 and 2003, respectively)    |          | 1,038                                     |       | 660                                      |       | 2,637 |   | 1,922 |   |
| Sales and  marketing (excluding depreciation and amortization amounts of $6 and $0 for  the three months ended September 30, 2004 and 2003, respectively, and $6  and $0 for the nine months ended September 30, 2004 and 2003,  respectively)           |          | 324                                       |       | 130                                      |       | 924 |   | 354 |   |
| General and  administrative (excluding depreciation and amortization amounts of $99 and $0  for the three months ended September 30, 2004 and 2003, respectively,  and $302 and $0 for the nine months ended September 30, 2004 and 2003,  respectively) |          | 1,762                                     |       | 862                                      |       | 3,805 |   | 1,562 |   |
| Depreciation and  amortization                                                                                                                                                                                                                                     |          | 107                                       |       | 0                                        |       | 310 |   | 0 |   |
| Total costs and  expenses from continuing operations                                                                                                                                                                                                               |          | 3,231                                     |       | 1,652                                    |       | 7,676 |   | 3,838 |   |
| Loss from  operating activities of continuing operations                                                                                                                                                                                                           |          | (3,175                                    | )          | (1,652                                   | )          | (7,620 | ) | (3,838 | ) |
| Interest and  other income                                                                                                                                                                                                                                         |          | 37                                        |       | 0                                        |       | 56 |   | 0 |   |
| Change in fair  value of warrants and conversion options                                                                                                                                                                                                           |          | 1,623                                     |       | 0                                        |       | 1,971 |   | 0 |   |
| Interest and  other expense                                                                                                                                                                                                                                        |          | (2                                        | )          | 0                                        |       | (5 | ) | 0 |   |
| Loss from  continuing operations                                                                                                                                                                                                                                   |          | (1,517                                    | )          | (1,652                                   | )          | (5,598 | ) | (3,838 | ) |
| Income (loss)  from discontinued operations                                                                                                                                                                                                                        |          | 7                                         |       | 1,755                                    |       | 36 |   | (943 | ) |
|                                                                                                                                                                                                                                                               |          |                                      |       |                                     |       |   |   |   |   |
| Net (loss)  income                                                                                                                                                                                                                                                 |          | (1,510                                    | )          | 103                                      |       | (5,562 | ) | (4,781 | ) |
| Accretion on  preferred stock and dividends                                                                                                                                                                                                                        |          | (400                                      | )          | 0                                        |       | (431 | ) | 0 |   |
| Net (loss)  income applicable to common stockholders                                                                                                                                                                                                               |          | $                                         | (1,910     | )                                        | $          | 103 |   | $ | (5,993 | ) | $ | (4,781 | ) |
|                                                                                                                                                                                                                                                               |          |                                      |       |                                     |       |   |   |   |   |
| Net loss per  common share (basic and diluted)                                                                                                                                                                                                                     |          | $                                         | (0.07      | )                                        | $          | 0.00 |   | $ | (0.22 | ) | $ | (0.20 | ) |
| Weighted average  common shares outstanding:                                                                                                                                                                                                                       |          |                                      |       |                                     |       |   |   |   |   |
| •                                                                                                                                                                                                                                                             | Basic         |                                      | 28,235,349 |                                     | 23,580,543 |   | 27,662,870 |   | 23,579,690 |   |
| •                                                                                                                                                                                                                                                             | Fully Diluted |                                      | 28,235,349 |                                     | 23,662,115 |   | 27,662,870 |   | 23,579,690 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

5

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**WORLDGATECOMMUNICATIONS, INC.**

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

**(Unaudited)**

**(Dollarsin Thousands)**

 
| ** **                                                                                        | ** ** | **Nine months ended  September 30,** | ** ** |
|---------------------------------------------------------------------------------------------------|------------|-------------------------------------------|------------|
| ** **                                                                                        | ** ** | **2004**                                  | ** ** | **2003** | ** ** |
|                                                                                              |       | **(As restated)**                         |       |   |   |
| **Cash  flows from operating activities of continuing operations:**                               |       |                                      |       |   |   |
| Net loss                                                                                          |       | $                                         | (5,598     | ) | $ | (3,838 | ) |
| Adjustments to  reconcile net loss to cash used in operating activities of continuing  operations |       |                                      |       |   |   |
| Depreciation and  amortization                                                                    |       | 310                                       |       | 0 |   |
| Change in fair  value of warrants and conversion options                                          |       | (1,971                                    | )          | 0 |   |
| Non-cash stock  based compensation                                                                |       | 608                                       |       | 43 |   |
| Changes in  operating assets and liabilities from continuing operations:                          |       |                                      |       |   |   |
| Accounts  receivable                                                                              |       | 48                                        |       | 0 |   |
| Prepaid and  other assets                                                                         |       | 201                                       |       | 432 |   |
| Accounts payable                                                                                  |       | (330                                      | )          | 503 |   |
| Accrued expenses                                                                                  |       | 962                                       |       | 348 |   |
| Accrued  compensation and benefits                                                                |       | (10                                       | )          | 478 |   |
| Other                                                                                             |       | 472                                       |       | 0 |   |
| Net cash used in  operating activities of continuing operations                                   |       | (5,308                                    | )          | (2,034 | ) |
| **Cash  flows from investing activities of continuing operations:**                               |       |                                      |       |   |   |
| Capital  expenditures                                                                             |       | (197                                      | )          | 0 |   |
| Net cash used by  investing activities of continuing operations                                   |       | (197                                      | )          | 0 |   |
| **Cash  flows from financing activities of continuing operations:**                               |       |                                      |       |   |   |
| Proceeds from  the issuance of common stock                                                       |       | 2,521                                     |       | 0 |   |
| Proceeds from  the issuance of redeemable preferred stock                                         |       | 7,111                                     |       | 0 |   |
| Proceeds from  the exercise of stock options                                                      |       | 126                                       |       | 1 |   |
| Proceeds from  the exercise of stock rights and warrants                                          |       | 620                                       |       | 0 |   |
| Net cash  provided by financing activities of continuing operations                               |       | 10,378                                    |       | 1 |   |
| **Net  cash contributed to continuing operations from discontinued operations**                   |       | 52                                        |       | 1,772 |   |
| **Net  increase in cash and equivalents**                                                         |       | 4,925                                     |       | 261 |   |
| **Cash  and cash equivalents, beginning of period**                                               |       | 3,365                                     |       | 589 |   |
| **Cash and  cash equivalents, end of period**                                                     |       | $                                         | 8,290      |   | $ | 850 |   |
|                                                                                              |       |                                      |       |   |   |
| **Cash  paid for interest**                                                                       |       | $                                         | 5          |   | $ | 15 |   |
| **Non-cash  financing activity:**                                                                 |       |                                      |       |   |   |
| Issuance of note  payable to finance D&O insurance                                            |       | 256                                       |       | 560 |   |
| Termination of  contractual obligation related to equity financing                                |       | 0                                         |       | 3,283 |   |

 

The accompanyingnotes are an integral part of these financial statements.

 

6

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WORLDGATECOMMUNICATIONS, INC.

NOTES TOCONSOLIDATED FINANCIAL STATEMENTS

 

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

(Unaudited)

 

1.             Basisof Presentation.

 

The unaudited financialstatements of WorldGate Communications, Inc. (“WorldGate” or the “Company”) forthe three and nine months ended September 30, 2004 presented herein havebeen prepared by the Company pursuant to the rules and regulations of theSecurities and Exchange Commission for quarterly reports on Form 10-Q.  Certain information and footnote disclosuresnormally included in financial statements prepared in accordance with generallyaccepted accounting principles have been condensed or omitted pursuant to suchrules and regulations.  These financialstatements should be read in conjunction with the financial statements for theyear ended December 31, 2003 and the notes thereto included in the Company’sAnnual Report on Form 10-K.

 

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

 

Certain prior yearamounts have been reclassified in the accompanying financial statements forconsistent presentation to current period amounts.

 

2.             Restatement 

 

The Company hasrestated its financial statements for the nine months ended September 30, 2004to amend and restate the accounting for the warrants and additional investmentsrights issued in a private placement of the Company’s common stock during thefourth quarter of 2003 and the first quarter of 2004.  These security components were originallytreated as non-cash expenses and with this restatement are being restated asequity transactions. There is no cash impact associated with theserestatements. There were also related adjustments to the Company’s consolidatedstatement of cash flows and consolidated statement of stockholders’ equity.

 

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

 
| ** **                      | ** ** | **As of September 30, 2004** | ** ** |
|---------------------------------|------------|------------------------------|------------|
| **Consolidated Balance Sheet**  | ** ** | **As previously reported**   | ** ** | **As restated** | ** ** |
|                            |       |                         |       |   |   |
| Accumulated deficit             |       | $                            | (205,267   | ) | $ | (203,937 | ) |
| Additional-paid-in capital      |       | 206,946                      |       | 205,616 |   |
| Total stockholders’ equity |       | 1,561                        |       | 1,561 |   |
|                                 |            |                              |            |  |  |  |  |

 
| ** **                                                           | ** ** | **For the nine months ended September 30, 2004** | ** ** |
|----------------------------------------------------------------------|------------|--------------------------------------------------|------------|
| **Consolidated Statement of Operations**                             | ** ** | **As previously reported**                       | ** ** | **As restated** | ** ** |
|                                                                 |       |                                             |       |   |   |
| General and  Administrative expenses                                 |       | $                                                | 4,435      |   | $ | 3,805 |   |
| Total expenses –  operating activities of continuing operations |       | 8,306                                            |       | 7,676 |   |
| Net loss                                                             |       | (6,192                                           | )          | (5,562 | ) |
| Net loss  applicable to common shareholders                          |       | (6,623                                           | )          | (5,993 | ) |
|                                                                 |       |                                             |       |   |   |
| Net loss  applicable to common shareholders per share:               |       |                                             |       |   |   |
| Basic                                                                |       | $                                                | (0.24      | ) | $ | (0.22 | ) |
| Diluted                                                              |       | (0.24                                            | )          | (0.22 | ) |

 

In addition, theCompany has included restatements to reflect certain clarifications made inresponse to the SEC’s comments as raised in its review of the Company’sregistration statement on Form SB-2 as filed with the SEC on May 24, 2005, onForm SB-2/A as filed with the SEC on August 30, 2005 and on Form 10KA as filedwith the SEC on August 30, 2005. These restatements include

 

7

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expanded clarifications on the preferred stock transaction the Companycompleted in June of 2004, liquidity and going concern considerations andchanges to the Notes to Consolidated Financial Statements. 

 

3.             Liquidityand Going Concern Considerations

 

As of September 30,2004 the Company had cash and cash equivalents of $8,290. The operating cashusage from continuing operations for the three and nine months ended September 30,2004 was $1,867 and $5,308, respectively. During the third quarter of 2003, we completed a sale of certain assets,including our ITV intellectual property rights and our membership interest inTVGateway, LLC, for $3,000 in cash to TVGateway, LLC, a company we wereinstrumental in forming. Our transaction with TVGateway, LLC, marked a shift inour business away from the ITV business and toward a new video phone productand associated business.  The funds wereceived from the sale of assets to TVGateway, LLC, as well as the funds wereceived as a result of private placements of our securities on December 1,2003, December 4, 2003, January 21, 2004, April 22, 2004, and June 23,2004, have permitted us to fund the development of our new business.

 

In December 2003 andJanuary 2004, WorldGate received investments aggregating $3,100 by certaininstitutional investors.  These investorspurchased an aggregate of 3,000,000 shares of newly issued common stock. Theinvestors also received a right, for a limited period of time, to purchaseadditional shares of up to 20% of the common stock purchased by the investorsin their investment, at the same price as their investment, and five-yearwarrants to purchase up to 30% of the common stock purchased by the investorsin their investment, at an exercise price equal to a twenty-five percentpremium to their purchase price for the investment.  The purchase price for the 2,000,000 sharespurchased in December 2003 transactions was $0.80 per share, with thewarrants having a $1.00 per share exercise price.  The purchase price for the 1,000,000 sharespurchased in the January 2004 transaction was $1.50 per share, with thewarrants having a $1.875 per share exercise price.  All additional investment rights associatedwith the December 2003 transaction were exercised during January and February of2004, resulting in an incremental investment of $320.  All additional investment rights associatedwith the January 2004 transaction were exercised in May 2004, resulting inan incremental investment of $300.

 

In December 2003,WorldGate reached agreement with Mototech, Inc. (not an affiliate of Motorola) forthe purchase of 625,000 shares of newly issued common stock at $0.80 per share,in return for future design and engineering services by Mototech.  WorldGate had previously contracted withMototech to assist the Company with the design and volume manufacture ofWorldGate’s Ojo personal video phone. The purchase price for these shares hasbeen partially paid as of September 30, 2004 by an equivalent reduction inthe development and initial procurement payments that would otherwise be due toMototech.  The value of this transactionwas $600 (based on the closing stock price of $0.96 on the date of thetransaction) of which $200 was recorded as an expense for the year endedDecember 31, 2003.  The remaining $400was recorded as unearned compensation in stockholders equity section in theaccompanying balance sheet.  Mototech isan affiliate of Accton Technology Group. Mototech currently manufactures and distributes a full range of highperformance high speed data and computer networking products, including cableset top boxes, home gateways, wireless LANs, hubs, switches, routers, and otherrelated products.  In addition, in April 2004,Mototech invested $1,000 to purchase 666,666 shares of newly issued commonstock at $1.50 per share.

 

8

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In June 2004,WorldGate completed a private placement of 7,550 shares of its Preferred Stockat a stated value of $1,000 per share, which preferred stock is convertibleinto the Company’s common stock at a conversion price of $2.35 per share;five-year warrants to purchase up to 803,190 shares of our common stock at anexercise price of $2.69 per share; and five-year warrants to purchase up to803,190 shares of our common stock at an exercise price of $3.14 per share. Theinvestors also received an additional investment right, for a limited period oftime, to purchase 1,606,383 additional shares of common stock shares at $3.14 ashare.

 

The Company has $5,129 of liabilities andits assets are not pledged as collateral as of September 30, 2004. These liabilitiesinclude $2,450 related to the Company’s private placement of Preferred Stock(refer to Footnote 6), building rent obligation of $785 as of September 30,2004 (refer to Footnote 8) and $494 of advanced funds from Motorola for futureshipments of video phones in conformity with the Agreement signed in April 2004.

 

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

 

Our ability togenerate cash is dependant upon the sale of our Ojo product and on obtainingcash through capital markets.  We havenot generated any revenue from commercial shipments of our Ojo product and wedo not know when or if we will. Given that our video phone business involvesthe development of a new product line with no market penetration, in anundeveloped market sector, no assurances can be given that sufficient sales, ifany, will materialize. 

 

Additionally, asneeded, we plan to generate cash by turning to the capital markets forfunding.  Although we raised anadditional $7,550 in financing in June 2004, no assurances can be given that,if pursued, additional financing transactions can be consummated.  We continue to evaluate possibilities toobtain additional financing through public or private equity or debt offerings,bank debt financing, asset securitizations, or from other sources, should weneed to obtain such financing.  Suchadditional financing would be subject to the risk of availability, may bedilutive to our shareholders, or could impose restrictions on operatingactivities. There can be no assurance that this additional financing will beavailable on terms acceptable to us, if at all. 

 

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

 

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

 

4.            RecentAccounting Pronouncement.

 

In January 2003, the FASB issuedInterpretation No. 46, *Consolidation ofVariable Interest Entities*. Interpretation No. 46 addressesconsolidation by business enterprises of variable interest entities, which areentities that either (a) do not have equity investors with vesting rights or(b) have equity investors that do not provide sufficient financial resourcesfor the entity to support its activities. The interpretation is effectiveimmediately for variable interest entities created after February 1, 2003.In December 2003, the FASB published FASB Interpretation No. 46 (revised December 2003),*Consolidation of Variable Interest Entities*(FIN 46(R)). FIN 46(R), among other things, defers the effective date ofimplementation for certain entities. The revised interpretation is effectivefor the first interim or annual reporting period ending after March 15,2004, with the exception of structures that are commonly referred to asspecial-purpose entities, for which the statement is effective for periodsending after December 15, 2003. The adoption of Interpretation No. 46 didnot have a material impact on WorldGate’s results of operations or financialposition.

 

9

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5.             Inventories.

 

Inventories aresummarized as follows:

 
| ** **                                    | ** ** | **September 30, 2004** | ** ** | **December 31, 2003** | ** ** |
|-----------------------------------------------|------------|-----------------------------|------------|----------------------------|------------|
|                                          |       |                        |       |                       |       |
| Raw material (from discontinued operations)   |       | $                           | 1,622      |                       | $          | 1,622 |   |
| Work in progress (from continuing operations) |       | —                      |       | —                     |       |
| Finished goods                                |       | —                      |       | —                     |       |
| Inventory held by customers and vendors       |       | —                      |       | —                     |       |
| Total inventory                               |       | 1,622                       |       | 1,622                      |       |
| Inventory reserve                             |       | (1,622                      | )          | (1,622                     | )          |
| Inventory, net                                |       | $                           | —     |                       | $          | — |   |

 

6.             Accountingfor Preferred Shares and Derivative Shares (Restated)

 

The followinginformation has been restated to provide a more complete description of theaccounting method and policy related to redeemable preferred shares andderivative shares. 

 

InJune 2004, WorldGate completed a private placement of Preferred Stock. ThePreferred Stock has a dividend rate of 5% per annum, payable quarterly, eitherby cash or through the issuance of common stock at the Company’s option. ThePreferred Stock has a staged maturity over three years with one-third of thePreferred Stock to be redeemed after 18 months, one-third after 24 months andone-third after 36 months, and may be redeemed at maturity in cash or, at theCompany’s option, subject to certain conditions that may not be solely underthe control of the Company, through the issuance of the number of shares ofcommon stock determined by dividing the liquidation preference of the preferredshares by the then current market price. If the effectiveness of the registration statement lapses, the Companyceases to be listed on certain specified exchanges and trading in the Company’sstock is suspended or a change in control occurs with respect to the Company,the Company may be required to settle redemption of the preferred stock withcash instead of its common shares. Furthermore, since the market price of the Company’s common stock cannotbe predicted, the actual number of shares of the Company’s common stock thatwill be required if a redemption is made through the issuance of common stock,can also not be predicted.

 

ThePreferred Stock has embedded conversion options. Specifically, the holders ofthe Preferred Stock may convert their shares into the Company’s common stock ata conversion price of $2.35 per share. In addition the Company may forceconversion of the Preferred Stock into common stock if the Company achievescertain price targets for its common stock and satisfaction of certain otherconditions, such as the existence of an effective registration statement. Ineither event the conversion price is subject to adjustment if, at any timeafter 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 stockfor per share consideration less than the conversion price of the preferredshares on the date of such issuance or sale. Accordingly, the number of common shares issuable upon the conversion ofthe preferred shares cannot be predicted. Furthermore, net-cash settlement may be required in the event ofconversion default under certain circumstances that may not be solely under thecontrol of the Company.  If theeffectiveness of the registration statement lapses, the Company ceases to be listedon certain specified exchanges and trading in the Company’s stock is suspendedor a change in control occurs with respect to the Company, the Company may berequired to settle a conversion of the preferred stock with cash instead of itscommon shares.

 

Also as part of theprivate placement, the Company issued five-year warrants to purchase up to803,190 shares of our common stock at an exercise price of $2.69 per share andfive-year warrants to purchase up to 803,190 shares of our common stock at anexercise price of $3.14 per share. The investors also received an additionalinvestment right, for a limited period of time, to purchase 1,606,383additional shares of common stock shares at $3.14 a share. This exercise priceof the warrants is subject to adjustment if, at any time after the date thewarrants were issued, the Company issues or sells, or is deemed to have issuedor sold, any shares of the Company’s common stock for per share considerationless than the exercise price of the warrants on the date of such issuance orsale.  Accordingly, the number of commonshares that will be issued upon the exercise of the warrants cannot bepredicted.  As of September 30, 2004,none of the warrants and none of the additional investment rights had beenexercised.

 

Ofthe 7,550 preferred shares issued under this private placement, there were noshares redeemed as of September 30, 2004.

 

Withrespect to the Company’s accounting for the Preferred Stock, EITF Topic D-98,paragraph 4, states that Rule 5-02.28 of Regulation S-X requires securitieswith redemption features that are not solely within the control of the issuerto be recorded outside of permanent equity. As described above, the terms ofthe Preferred Stock include certain redemption features that may be triggeredby events that are not solely within the control of the Company, such as apotential failure in the Company’s ability to maintain an effectiveregistration statement. Furthermore, the actual number of shares of commonstock required to satisfy redemption is based upon the market value of thecommon stock at the time of the redemption, which cannot be predicted.Accordingly, the Company has classified the Preferred Stock as temporary equityand the value ascribed to the redeemable preferred stock upon initial issuance,i.e. at June 23, 2004, was the amount received in the transaction minus thefair value ascribed to the conversion options and warrants. The initial valueof the redeemable preferred stock is accreted up to the redemption value (the

 

10

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amount received in thetransaction) over the future relevant periods using the interest method. .  The value of the redeemable preferred stockat September 30, 2004 was $3,121.

 

Theterms of the Preferred Stock include certain conversion options that representderivative financial instruments under paragraph 12 of SFAS No. 133 and thuswere separated from the Preferred Stock and valued using the Black-Scholesoption pricing model.   The conversionoptions include certain provisions that could result in a variable number ofshares to be issued upon conversion, adjustment to the strike price at whichconversion shares will be determined, or the requirement for the Company tosettle the conversion options in cash EITF 00-19, “Accounting for DerivativeInstruments Indexed to, and Potentially Settled in, a Company’s Own Stock”,state that if the conversion options require net cash settlement in the eventof circumstances that are not solely within the Company’s control they shouldbe classified as a liability measured at fair value on the balance sheet. 

 

Theterms of the five-year warrants include cash penalty provisions in the eventthat the Company fails to meet its obligations to deliver registered shares tothe warrant holder upon exercise and an anti-dilution provision that couldresult in a variable number of shares to be issued upon warrant exercise.Additionally, the terms and conditions of the warrants provide for netsettlement via cashless exercise whereby the shares delivered to the warrant holderwould be readily convertible to cash. In accordance with EITF 00-19 and giventhe terms and conditions of the warrants as outlined above, the Company hasclassified the warrants as a liability on its balance sheet measured at fairvalue using the Black-Scholes option pricing model.

 

TheCompany accounts for both the conversion options and warrants using the fairvalue method at the end of each quarter, with the resultant gain or lossrecognition recorded against earnings. Both the warrants and conversion optionsare valued using the Black-Scholes valuation model. Actual period close commonstock prices, applicable volatility rates, and the period close risk-freeinterest rate for the instrument’s expected remaining life (continuouslycompounded), are the key assumptions used in the valuation calculation. TheWorldGate share price changed from $2.10 per share as of June 30, 2004 to $1.67per share at September 30, 2004 making the warrants and preferred stockconversion elements less valuable, and therefore less costly, relative to theirstrike price. The result was a $1,600 non cash gain for the quarter endedSeptember 30, 2004.

 

7.             Stock-BasedCompensation (Restated).

 

The Company accounts forstock-based compensation in accordance with Accounting Principles Board OpinionNo. 25, “Accounting for Stock Issued to Employees,” and relatedinterpretations. 

 

The Company appliesAccounting Principles Board Opinion No. 25, “Accounting for Stock Issued toEmployees” and related interpretations in accounting for its plans, andaccordingly, no compensation cost has been recognized for the Company’s fixedstock based compensation. Had compensation cost been determined consistent withSFAS No. 123, as amended by SFAS No. 148, the Company’s net loss would havebeen increased or decreased to the following pro forma amounts:

 

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| ** **                                                                                                                           | ** ** | **For the Three Month Period  Ended September 30,** | ** ** | **For the Nine Month Period  Ended September 30,** | ** ** |
|--------------------------------------------------------------------------------------------------------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                                                                                                                           | ** ** | **2004**                                                 | ** ** | **2003**                                                | ** ** | **2004** | ** ** | **2003** | ** ** |
| ** **                                                                                                                           | ** ** | ** **                                               | ** ** | ** **                                              | ** ** | **(as restated)** | ** ** | ** ** | ** ** |
| Net (loss)  income:                                                                                                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| As reported                                                                                                                          |       | $                                                        | (1,510     | )                                                       | $          | 103 |   | $ | (5,562 | ) | $ | (4,781 | ) |
| Add: Stock-based  compensation expense included in reported net loss, net of related tax  effects of $0                              |       | 0                                                        |       | 43                                                      |       | 0 |   | 83 |   |
| Deduct: Total  stock-based employee expense determined under the fair value based method for  all awards, net of related tax effects |       | (544                                                     | )          | (1,359                                                  | )          | (1,627 | ) | (4,129 | ) |
| Pro forma net  loss                                                                                                                  |       | $                                                        | (2,054     | )                                                       | $          | (1,213 | ) | $ | (7189 | ) | $ | (8,827 | ) |
|                                                                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Net Loss per  share:                                                                                                                 |       |                                                     |       |                                                    |       |   |   |   |   |
| Basic and  diluted– as reported                                                                                                 |       | $                                                        | (0.07      | )                                                       | $          | (0.00 | ) | $ | (0.22 | ) | $ | (0.20 | ) |
| Basic and  diluted - pro forma                                                                                                       |       | $                                                        | (0.07      | )                                                       | $          | (0.51 | ) | $ | (0.26 | ) | $ | (0.37 | ) |

 

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

 

8.             SignificantAgreements and Transactions.

 

In 1997, the Companyentered into agreements with certain customers who are investors. Revenues fromcontinuing operations recognized from such investors were approximately $106and $0, respectively, for the three months ended September 30, 2004 and2003, and approximately $106 and $0, respectively, for the nine months ended September 30,2004 and 2003. This customer accounted for 100% of the revenues for the threeand nine months ended September 30, 2004. Amounts received in advance asof September 30, 2004 of $494 is included in deferred revenue in theaccompanying balance sheet.

 

Revenues fromdiscontinued operations recognized from such investors were approximately $0 and$65 (included in discontinued operations), respectively, for the three monthsended September 30, 2004 and 2003, and approximately $0 and $2,068(included in discontinued operations), respectively for the nine months ended September 30,2004 and 2003. Accounts receivable from such investors amounted toapproximately $81 at September 30, 2004 and $153 at December 31,2003.

 

The Company has a currenttwo year agreement with an investor, and previously had agreements with certainother investors, to provide the Company with engineering and developmentsupport. As a result of those agreements, the Company has expensedapproximately $0 and $394 (included in discontinued operations), respectively,for the three months ended September 30, 2004 and 2003, and approximately$0 and $950 (included in discontinued operations), respectively, for the ninemonths ended September 30, 2004 and 2003. Accounts payable to theseinvestors amounted to $5 and $170 at September 30, 2004 and December 31,2003, respectively. Some of these stockholders were suppliers of technology andcomponents for the Company’s discontinued ITV products and services. Theseagreements provided for licensing of technology, as well as contractedservices, including hardware and software development, product testing andcertification, and the creation and development of tools and systems tofacilitate the Company’s engineering efforts. These agreements did not providefor ongoing royalties, purchase provisions, or for any requirement to provideadditional funding to the Company.

 

On April 28, 2004,we entered into a Development and Distribution Agreement with GeneralInstrument Corporation d/b/a the Broadband Communication Sector ofMotorola, Inc., or Motorola. In connection with the Development and DistributionAgreement with Motorola, we issued warrants to Motorola to purchase 600,000shares of our common stock, 300,000 at an exercise price of $1.4375 per shareand 300,000 at an exercise price of $1.75, and agreed to issue additionalwarrants to purchase up to an additional 1,650,000 shares of our common stock,upon the achievement of certain product and sales milestones, at an exerciseprice based upon the average closing sales price of our common stock during the20 day period preceding the issuance of each warrant.

 

In 1998 the Companyentered into a leasing arrangement for a building with an entity formed bynon-employee investors. Included in deposits and other assets at September 30,2004 and December 31, 2003 is $0 and $388, respectively, related to this lease.We have not paid our rent on our current facility since May 2003. As a result,our landlord, 3190 T General, Inc. in September 2003, filed an action inthe Court of Common Pleas, Bucks County Pennsylvania to perfect its interest totake possession of our facility at anytime, and to establish damages for pastrent and expenses. In lieu of rent payments our landlord has drawn from oursecurity deposit to satisfy the unpaid rent and such deposit has now been fullydepleted. A judgment was also granted allowing our landlord to regainpossession of the facility, although we remain in the facility, albeit insubstantially reduced space. During

 

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this process we attemptedto negotiate a settlement of our lease obligation with the landlord in aneffort to reduce our outstanding liability and secure the continued right tooccupy the facility with a reduced ongoing lease obligation. We also workedwith the landlord to secure other tenants for the unused space. However, thelandlord informed us that this process was complicated by the requirement forthe landlord’s mortgage holder to approve any such amendments to our lease aswell as any arrangements with other prospective tenants. The landlord was not ableto obtain such approvals from the mortgage holder and ultimately the landlordand the landlord’s mortgage holder reached an agreement for the landlord’smortgage holder to become a successor to the landlord’s interest in theproperty. We have already commenced negotiations directly with the mortgageholder’s representatives to secure the continued right to occupy the facilitywith a reduced ongoing lease obligation, and are currently awaiting a proposalfrom the mortgage holder, although there can be no assurance that an agreementcan be reached with the mortgage holder. Concurrently we are exploring otherfacility opportunities in the event an agreement cannot be reached. In lieu ofmonthly rent payments of $104 (offset by monthly sublease payments by TVGatewayof $19 during the period February 1, 2003 through January 31, 2004),the Company’s landlord has drawn down from its security deposit to satisfy $388of the unpaid rent of $1,173 as of September 30, 2004. As of September 30,2004, the amount of the deposit remaining after deduction for the unpaid rentis $0.  The Company has continued toaccrue the full rent expense through September 30, 2004.

 

9.             TVGatewayJoint Venture and related Cable Operator Agreements.

 

On July 24, 2000,the Company formed a separate joint venture, TVGateway, LLC, with four cableoperators.  As part of this ventureWorldGate entered into a management agreement with TVGateway to provideengineering, operations and administrative support services. In addition toproviding for the terms and conditions under which such services were to beprovided, the management agreement provided for WorldGate and TVGateway tocooperate to transition to TVGateway some or all of the support services beingprovided by WorldGate and/or the employees providing these services. Inaddition, this provision required WorldGate to remain available to providesupport services until July 24, 2005. During 2002 WorldGate and TVGatewayagreed to commence the transition of services pursuant to this provision. In addition,the parties agreed that the management agreement would be of no further forceand effect with respect to the services that are transferred as of the date ofcompletion of the specific transfers. The companies completed this transitionin the first quarter 2003, and accordingly, WorldGate has now been relieved ofany continuing obligation to provide such transitioned services.   WorldGate no longer receives revenues fromthe management agreement with TVGateway.

 

Revenues for suchservices, which are included in service fee revenue, totaled $0, and $0,respectively for the three months ended September 30, 2004 and 2003, and$0 and $794 (included in discontinued operations), respectively, for the ninemonths ended September 30, 2004 and 2003. In addition, product sales toTVGateway totaled $0 and $0 for the three months ended September 30, 2004and 2003, respectively, and $0 and $1,074 (included in discontinued operations),respectively, for the nine months ended September 30, 2004 and 2003.Accounts Receivable from TVGateway amounted to $0 at September 30, 2004and $0 at December 31, 2003. WorldGate was accounting for its 18%investment in the TVGateway joint venture, which was previously reduced to acarrying value of $0 due to prior losses, under the equity method.

 

On September 30,2003 the Company announced that it had sold to TVGateway, LLC certain ITVintellectual property rights and certain software and equipment related to theITV business, which TVGateway was currently using, for $2,400.  In addition, on August 7, 2003,WorldGate and TVGateway entered into a redemption agreement pursuant to whichTVGateway redeemed WorldGate’s equity interest in TVGateway for $600 incash.  The purchase price for theseassets in the aggregate was $3,000 and was used by the Company to fundcontinuing operations, as well as to develop and distribute its new Ojo videotelephony product. As part of this transaction WorldGate retained aroyalty-free license to certain of the transferred intellectual property rightsand software. At this time the Company has completely exited from theinteractive television (ITV) business.

 

In connection with theAsset Purchase Agreement we entered into with TVGateway for the sale of certainITV Business assets, we have an obligation to indemnify TVGateway for anylosses from breaches of our representations or warranties in the Asset PurchaseAgreement that occur within twelve months after the closing date of theTVGateway transaction or within the applicable statute of limitations periodfor claims relating to our ownership of our assets, payment of our taxes, andour compliance with applicable laws, if longer. Our indemnification obligationsare limited by an overall cap of $500 on the amount of the indemnification.Although we know of no breaches of our representations or warranties and theinitial twelve-month period has expired, the payment of any suchindemnification obligations would adversely impact our cash resources and ourability to

 

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pursue our video phonebusiness.

 

10.           NetLoss per Share.

 

Basic and diluted netloss per common share is computed by dividing the net loss available to commonstockholders for the period by the weighted average number of shares of commonstock outstanding during the period.  Thecalculation of diluted net loss per common share excludes potential commonshares if the effect is antidilutive. Potential common shares comprise shares of common stock issuable uponthe exercise of stock options and warrants. The number of potential common shares which would have been assumed tobe converted in the periods ended September 30, 2004 and 2003 and have adilutive effect if the Company had income from continuing operations, or if theoptions’ exercise price was less than the average market price of the commonshares, is 13,590,347 and 5,861,201, respectively.

 

11.           Revenue recognition

 

Revenue is recognized when persuasive evidence of anarrangement exists, the price is fixed or determinable, the collectibility isreasonably assured, and the delivery and acceptance of the equipment hasoccurred or services have been rendered. Management exercises judgment in evaluating these factors in light ofthe terms and conditions of its customer contracts and other existing facts andcircumstances to determine appropriate revenue recognition. Due to our limitedcommercial sales history, our ability to evaluate the collectibility ofcustomer accounts requires significant judgment. The Company evaluates itsequipment customer, and service customers’, accounts for collectibility at thedate of sale and on an ongoing basis.

 

Presently the Company has only one customer for thepurchase of its equipment and the agreement with this customer includes severalelements relevant to revenue recognition including: (a) The customer has nogeneral right to return the product.  (b)The customer can earn warrants upon the purchase of significant video telephonyunits and the value of these warrants would result in a reduction of recognizedrevenue (the value of these warrants is routinely monitored by the Company andis currently deemed to be insignificant, however, should the value of thesewarrants become material an offset would be made against revenues). (c)Penalties are payable to the customer if certain excessive field failure ratesare exceeded.  (d) The Company and thecustomer share in the benefit achieved by product cost reductions. (e)Penalties are payable to the customer if the Company fails to deliver shipmentson a timely basis. (f) The Company extends to the customer a limited productwarranty for a term not to exceed three years (the Company maintains a warrantyreserve based upon the percentage of product sales consistent with industrycomparable failure rates and the warranty period provided by the agreement.) 

 

Revenues are also offset with a reserve for any pricerefunds and consumer rebates consistent with the Emerging Task Force (“EITF”)Issue 01-9, Accounting for Consideration Given by a vendor to a Customer.

 

12.           Risks and uncertainties

 

Our primary line of business is the development ofvideo phone products and technology. We are still in the process of launchingour first product based on this technology and, although we have realized somerevenues for the commercial sale of our product, the revenues to date have notbeen substantial. Given the early stage of our product and the lack ofoperating history in the video phone business, it is difficult to predict ourfuture results.

 

We have entered into a six year distribution agreementwith Motorola, Inc. for the marketing and distribution of our Ojo video phone.This agreement provides for Motorola to be WorldGate’s exclusive distributor ofits broadband video phone products and for WorldGate to be Motorola’s exclusivesupplier of its broadband video phone products. Although the agreement requires Motorola to provide for certainmarketing and promotional activities for the Ojo video phone, there are norequired sales quotas for the agreement to remain in effect, and Motorolacontrols the volume of the Company’s products being distributed.  Neither party can terminate the agreementexcept in cases of uncured breaches of the agreement or as a result ofinsolvency events suffered by the other party. After a period of 18 monthsfollowing the commercial availability of the Ojo video phone the mutualexclusivity will terminate unless Motorola elects to continue the mutualexclusivity after having achieved certain minimum sales targets for the Ojovideo phone. Motorola may, however, at its option, elect to terminate theexclusivity at any time.

 

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In the event mutual exclusivity terminates or is terminated, then for aperiod of twelve months thereafter, WorldGate will continue to be Motorola’sexclusive supplier of broadband video phones but will be free to sell videophones to customers other than certain defined Motorola accounts. During thistwelve month period, Motorola has a right of first refusal to accept and fillany orders for video phone products that WorldGate obtains from non-Motorolaaccounts, and is obligated to use good faith efforts to solicit and acceptproduct orders from Motorola accounts in a commercially reasonable manner.During any period of exclusivity under this agreement we are reliant uponMotorola and its distribution partners, including, for example, wholesalers,retailers and service providers, to provide the worldwide sales anddistribution of the Ojo video phone. If Motorola and its partners are not successful,or if their activities do not lead to significant sales of our product, ouroperating results will be adversely affected, our revenue could besignificantly reduced and we could lose potential customers.

 

We also depend on relationships with third partiessuch as contract manufacturing companies, chip design companies and others whomay be sole source providers of key components and services critical for theproduct we are developing in our video phone business. A formal relationshipwith Mototech, Inc. (not an affiliate of Motorola) has been established for thevolume manufacture of Ojo. Mototech is currently the sole volume manufacturerof Ojo. Our agreement with Mototech allows either party to terminate theagreement with 90 days prior notice.  If Mototech,Inc. or other providers of components and/or manufacturing services do notproduce these components or provide their services on a timely basis, if thecomponents or services do not meet our specifications and quality controlstandards, or if the components or services are otherwise flawed, we may haveto delay product delivery, or recall or replace unacceptable products. Inaddition, such failures could damage our reputation and could adversely affectour operating results. As a result, we could lose potential customers and anyrevenues that we may have at that time may decline dramatically.

 

13.           DiscontinuedOperations

 

During the first quarterof 2004, the Company decided to transition from the business of developing andselling interactive television, or ITV, technology, products and services foruse in conjunction with cable TV broadband networks (the “ITV business”) to thedevelopment of videophone products. In accordance with Statement of FinancialAccounting Standards 144, Accounting for the Impairment or Disposal ofLong-Lived Assets, all assets related to the ITV business have been writtendown to their net realizable value. Related operating results of the ITVbusiness have been reported as discontinued operations for all years presented.

 

Revenue and net incomebefore income taxes from discontinued operations were as follows:

 
| ** **                            | ** ** | **For the Three Month Period  Ended September 30,** | ** ** | **For the Nine Month Period  Ended September 30,** | ** ** |
|---------------------------------------|------------|----------------------------------------------------------|------------|---------------------------------------------------------|------------|
| ** **                            | ** ** | **2004**                                                 | ** ** | **2003**                                                | ** ** | **2004** | ** ** | **2003** | ** ** |
|                                  |       |                                                     |       |                                                    |       |   |   |   |   |
| Revenues                              |       | $                                                        | 0          |                                                    | $          | 941 |   | $ | 82 |   | $ | 3,497 |   |
| Net income (loss) before income taxes |       | 7                                                        |       | 1,755                                                   |       | 36 |   | (943 | ) |
|                                       |            |                                                          |            |                                                         |            |  |  |  |  |  |  |  |  |

 

Assets and liabilities ofdiscontinued operations include the following:

 
| ** **                                                                                                | ** ** | **2004** | ** ** | **2003** | ** ** | ** ** | ** ** | ** ** | ** ** |
|-----------------------------------------------------------------------------------------------------------|------------|----------|------------|----------|------------|------------|------------|------------|------------|
| Assets                                                                                                    |       |     |       |     | ** ** | ** ** | ** ** | ** ** | ** ** |
| Inventory, net  reserve of $1,622 as of September 30, 2004 and December 31, 2003,  respectively |       | $        | 0          |     | $          | 0          |       |       |       |   |   |
|                                                                                                           |            |          |            |          |            |            |            |            |            |  |  |

#  

# ITEM2.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTSOF OPERATIONS.

#  

(Dollar Amountsare in Thousands, Except per Share Amounts)

 

FORWARD-LOOKINGAND CAUTIONARY STATEMENTS.

 

The Company may from timeto time make written or oral forward-looking statements, including thosecontained in the following Management’s Discussion and Analysis of FinancialCondition and Results of Operations. The words “estimate,” “project,” “believe,”“intend,” “expect,” and similar expressions are intended to identifyforward-looking statements, although not all forward-looking statements containthese identifying words. In order to take advantage of the “safe harbor”provisions of the Private Securities Litigation Reform Act of 1995, we arehereby identifying certain important factors, which could cause our actualresults, performance or achievement to differ materially from those that may becontained in or implied by any forward-looking statement made by or on behalfof WorldGate.  The factors, individuallyor in the aggregate, that could cause such forward-

 

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looking statements not tobe realized include, without limitation, the following: (1) difficulty orinability to raise additional financing on terms acceptable to us, (2)difficulty in developing and implementing marketing and business plans, (3)continued losses, (4) industry competition factors and other uncertainty that amarket for our products will develop, (5) challenges associated with broadbandoperators (including, uncertainty that they will offer our products, inabilityto predict the manner in which they will market and price our products andexistence of potential conflicts of interests and contractual limitationsimpeding their ability to offer our products), (6) departure of one or more keypersons,  (7) delisting of our CommonStock from the NASDAQ Small Cap Market, (8) changes in regulatory requirements,and (9) other risks identified in our filings with the Securities and ExchangeCommission.  We caution you that theforegoing list of important factors is not intended to be, and is not,exhaustive.  We do not undertake toupdate any forward-looking statement that may be made from time to time by oron behalf of WorldGate.  

 

Results of Operations:

 

General

 

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

 

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

 

Critical AccountingPolicies and Estimates.

 

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

 

The significantaccounting policies of the Company are described in the notes to theconsolidated financial statements included in the annual report on Form10-K.  Judgments and estimates ofuncertainties are required in applying the Company’s accounting policies inmany areas.  Following are some of theareas requiring significant judgments and estimates:  revenue recognition, accounts receivable,inventories, and cash flow and valuation assumptions on equity relatedtransaction and in performing asset impairment tests of long-lived assets.

 

Discontinued Operations

 

During the first quarterof 2004 the Company transitioned from the business of developing and selling interactivetelevision, or ITV, technology, products and services for use in conjunctionwith cable TV broadband networks (the “ITV business”) to the development of ourvideo phone products as our primary business focus. During the three monthsended September 30, 2004 the Company had revenues from discontinuedoperations of $0, compared to revenues of $941 for the three months ended September 30,2003. For the nine months ended September 30, 2004 and 2003, respectively,revenues were $82 and $3,497 respectively. This reduction reflects servicerevenues of $0 and $253, respectively, for the three months ended September 30,2004 and 2003. For the nine months ended September 30, 2004 and 2003,service revenues were $0 and $1,573 respectively. Equipment revenues were $0and $688 for the three months ended September 30, 2004 and 2003,respectively, and $82 and $1,924, respectively, for the nine months ended September 30,2004 and 2003. Cost of revenues for the three months ended September 30,2004 and 2003, were $0 and $1,524, respectively. For the nine months ended September 30,2004 and 2003, cost of revenues were $43 and $4,218, respectively.Concurrently, operating expenses, consisting of Research and Development,Marketing, General and Administration, and Depreciation and Amortization costswere also reduced as a result of the transition from the ITV business. Theseexpenses were $0 for the three months ended September 30, 2004, comparedto $563 for the three months ended September 30, 2003, and $16 and $3,122,respectively, for the nine months ended September 30, 2004 and 2003.

 

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

 

Three and Nine MonthsEnded September 30, 2004 and September 30, 2003 (Restated)

 

Revenues.

 

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Revenues.  Revenues from continuing operations of $106were realized during the three and nine months ended September 30, 2004.These revenues represent the initial deliveries of video phones for pre-market testing.There were no revenues from continuing operations for the three and nine monthsended September 30, 2003.

 

Costs and Expenses.

 

Cost of revenues. Thecost of revenues from continuing operations relating to the initial deliveriesof video phones was $50 for the three and nine months ended September 30,2004. There were no cost of revenues from continuing operations for the threeand nine months ended September 30, 2003.

 

Engineering andDevelopment.  Engineering and developmentexpenses primarily consist of compensation, and the cost of design,programming, testing, documentation and support of the Company’s video phoneproduct.  Engineering and developmentcosts were $1,038 for the three months ended September 30, 2004, comparedwith $660 for the three months ended September 30, 2003. For the ninemonths ended September 30, 2004 and September 30, 2003, engineeringand development expenses were $2,637 and $1,922, respectively. These increasesin 2004 over 2003 of $378, or 57%, for the three months ended September 30,2004, and $715, or 37%, for the nine months ended September 30, 2004,reflect the Company’s increased concentration of its engineering staff, andrelated costs, for the continuing development of its video phone product. 

 

Sales and Marketing.  Sales and marketing expenses consistprimarily of compensation, attendance at conferences and trade shows, travelcosts, promotions and other marketing programs related to the introduction ofthe Company’s video phone product.  Salesand marketing costs were $324 for the three months ended September 30,2004, compared with $130 for the three months ended September 30, 2003.For the nine months ended September 30, 2004 and 2003, sales and marketingexpenses were $924 and $354, respectively. These increases of $194 and $570,respectively, or 149% and 161%, respectively, for the three and nine monthsended September 30, 2004, reflect the increased marketing and promotionalexpenditures, primarily related to trade shows attendance, for the Company’svideo phone product. 

 

General andAdministrative –as restated.  General andadministrative expenses consist primarily of expenditures for administration,office and facility operations, finance and general management activities,including legal, accounting and professional fees.  General and administrative expenses were$1,762 for the three months ended September 30, 2004, compared with $862for the three months ended September 30, 2003. For the nine months ended September 30,2004 and 2003, general and administrative expenses were $3,805 and $1,562,respectively. The increases of $900 and $2,243, respectively, or 104% and 144%,respectively, for the three and nine months ended September 30, 2004, areattributable primarily to the Company’s transition of nearly all of itsadministrative management compensation, facility, legal, finance andprofessional consulting fees toward the further development of the video phonebusiness, and a non cash charge of $606 for the three and nine months ended September 30,2004, reflecting a Black Scholes estimate of the value of warrants issued toMotorola in September 2004 in conformity with terms of the Agreementsigned in April 2004.  For the threeand nine months ended September 30, 2003, video phone related costs were63% and 54%, respectively, of total General and Administrative expense of$1,150 and $2,957, respectively.

 

Interest and Other Incomeand Interest Expense.  Interest and otherincome and interest expense from continuing operations consisted of interestearned on cash and cash equivalents, interest expense on short-term debt andchange in fair value of warrants and conversion options.  Total interest and other income increased to$1,660 for the three months ended September 30, 2004 from $0 for the threemonths ended September 30, 2003, and increased to $2,027 for the ninemonths ended September 30, 2004 from $0 for the nine months ended September 30,2003. Included in Other Income for the three and nine months ended September 30,2004 were non cash change in fair value of warrants and conversion optionsreported of $1,623 and $1,971, respectively, for marked to market adjustmentsas of September 30, 2004 related to the Company’s June 23, 2004private placement of its Preferred Stock and Warrants. During the three andnine months ended September 30, 2003, the Company earned interest onaverage cash balances of approximately $800 and $2,077, respectively, andincurred interest expense related to its insurance financing.  In comparison, during the three and ninemonths ended September 30, 2004 the Company earned interest on averagecash balances of approximately $6,693 and $6,049, respectively, and incurredinterest expense related to its insurance financing.

 

Income Taxes.  TheCompany has incurred net operating losses since inception and accordingly hadno income taxes and has not recorded any income tax benefit for those losses.

 

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Liquidity and CapitalResources.

 

As of September 30,2004, our primary source of liquidity consisted of cash and cash equivalentsthat are highly liquid, are of high quality investment grade and havematurities of less than one year.

 

At September 30,2004, we had cash and cash equivalents of $8,290 (and no short-term investments)as compared to cash and equivalents of $3,365 (and no short-term investments)at December 31, 2003.  Net cash usedin continuing operations was $5,308 for the nine months ended September 30,2004, as compared to $2,034 (included in discontinued operations) used for thesame period in 2003. This increase in net cash used for continuing operationswas primarily attributable to the Company’s increase in expenditures related tothe video phone business.  The Companyrecorded bad debt expense in the amount of $16 from discontinued operationsduring the nine months ended September 30, 2004 to reflect its currentassessment of the collectability of certain receivables. 

 

Cash provided byfinancing activities from continuing operations during the nine months ended September 30,2004, totaled $10,378 compared to $1 provided during the same period in2003.  During the nine months ended September 30,2004, net proceeds from our maturing short-term investments were $0 compared to$3,423 (included in discontinued operations) for the nine months ended September 30,2003.  Capital expenditures were $197 and$0 for the nine months ended September 30, 2004 and 2003, respectively.  During the third quarter of 2003, we completeda sale of certain assets, including our ITV intellectual property rights andour membership interest in TVGateway, LLC, for $3,000 in cash to TVGateway,LLC, a company we were instrumental in forming.

 

Operations and Liquidity.

 

To date, the Company has funded operations primarilythrough private sales of equity securities and through an initial publicoffering of common stock in April 1999. As of September 30, 2004 the Company had cash, and cash equivalentsof $8,290. The operating cash usage from continuing operations for the ninemonths ended September 30, 2004 was $5,308. As of September 30, 2004we have $147 of outstanding debt and our assets are not pledged ascollateral.  However, we have not paidour monthly rent of $104 (offset by monthly sublease payments by TVGateway of$19 during the period February 1, 2003 through January 31, 2004) onour current facility since May 2003.  Asa result, our landlord, a non-employee investor, has perfected its interest totake possession of our facility at any time and has drawn down from our rentdeposit to satisfy $388 of the unpaid rent of $1,173 as of September 30,2004.  As of September 30, 2004 theamount of the deposit remaining is $0 after deduction for the unpaid rent.  The Company has continued to accrue the fullrent expense through September 30, 2004. Although we are presently not earning additional funding we continue toexplore and negotiate to resolve this matter (refer to Part II, Item I LegalProceedings).  We also continue toevaluate possibilities to obtain additional financing through public or privateequity or debt offerings, bank debt financing, asset securitizations, or fromother sources.  Such additional financingwould be subject to the risk of availability, may be dilutive to our shareholders,or could impose restrictions on operating activities.  There can be no assurance that thisadditional financing will be available on terms acceptable to us, if atall.  The Company has limited capacity tofurther reduce its workforce and scale back on capital and operationalexpenditures to decrease cash burn given the measures it has already taken toreduce staff and expenses. 

 

With the private placement of the Company’s common in January 2004,which provided proceeds of $1,500, the private placement of the Company’scommon stock in April 2004 providing proceeds of $1,000, and the June 2004private placement of the Company’s redeemable preferred stock providingproceeds to the Company of $7,550, the Company projects it will have sufficientfunding to continue operations into the third quarter of 2005, assuming noadditional funding is received and assuming no impact from sales. Depending onthe timing and magnitude of the ramp up of video phone sales, it is possiblethat our current cash may be sufficient to get the company to a cash breakevenposition.  No assurances can be giventhat sufficient sales, if any, will materialize, or that a funding transactioncan be consummated prior to the depletion of our available cash.  We however remain hopeful that sufficientfunding can be developed through funding or ongoing operations to continue theCompany’s operations.

 

The report of theindependent registered public accounting firm for the year ended December 31,2003 included an explanatory paragraph stating that our Company had sufferedrecurring losses from operations and had a net accumulated deficiency of $198,000,and that these issues raised substantial doubt about our Company’s ability tocontinue as a going concern. Our short term cash requirements and obligationsinclude accounts receivable, inventory, accounts payable and capitalexpenditures from continuing operations, operating expenses, and leasecommitments.   We expect, based on our internal forecasts andassumptions relating to our operations (including among others, assumptions regardingour short term cash requirements and our projected revenue growth ) that wehave sufficient cash on hand to meet our obligations for at least the nexttwelve months.

 

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

 

Additionally, as needed,we plan to generate cash by turning to the capital markets for funding.  Although we raised an additional

 

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$7,550 in financing in June2004, no assurances can be given that, if pursued, additional financingtransactions can be consummated.  Wecontinue to evaluate possibilities to obtain additional financing throughpublic or private equity or debt offerings, bank debt financing, assetsecuritizations, or from other sources, should we need to obtain suchfinancing.  Such additional financingwould be subject to the risk of availability, may be dilutive to ourshareholders, or could impose restrictions on operating activities. There canbe no assurance that this additional financing will be available on termsacceptable to us, if at all. 

 

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

 

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

 

In December 2003, WorldGate reached agreement with Mototech, Inc. (not anaffiliate of Motorola) for the purchase of 625,000 shares of newly issuedcommon stock at $0.80 per share, in return for future design and engineeringservices by Mototech. WorldGate had previously contracted with Mototech toassist the Company with the design and volume manufacture of WorldGate’s Ojopersonal video phone. As compensation for these shares the Company willreceive an equivalent reduction in future development and initial procurementpayments that would otherwise be due to Mototech.  The value of this transaction was $600 (basedon the closing stock price of $0.96 on the date of the transaction) of which$200 was recorded as an expense for the year ended December 31, 2003.  The remaining $400 was recorded as unearnedcompensation in stockholders equity section in the accompanying balance sheet.  Mototech is an affiliate of Accton Technology Group,a groupof Taiwanese manufacturers that we believe are well-known in the electronicsindustry. Mototech currently manufactures and distributes a full range of highperformance high speed data and computer networking products, including cableset top boxes, home gateways, wireless LANs, hubs, switches, routers, and otherrelated products. In addition, in April 2004, Mototech invested $1,000 topurchase 666,666 shares of newly issued common stock at $1.50 per share.

 

ITEM 3.  QUANTITATIVEAND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

 

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

 

As of September 30,2004, the Company’s cash and cash equivalents were $8,290, most of which weresecurities having a maturity of less than one year, and it had no short-terminvestments.  Due to the average maturityand conservative nature of our investment portfolio, management believes asudden change in interest rates would not have a material effect on the valueof the portfolio. Management estimates that had the average yield of ourinvestments decreased by 100 basis points, our interest income for the ninemonths ended September 30, 2004 would have decreased by approximately $69.This estimate assumes that the decrease occurred on the first day of 2004 andreduced the yield of each investment instrument by 100 basis points.  The impact on our future interest income offuture changes in investment yields will depend largely on our totalinvestments.

 

Foreign Currency ExchangeRisk.  Although we transact business invarious foreign countries, the principal portion of our current business is inthe United States and substantially all of our costs to date have beendenominated in U.S. dollars.  Althoughour agreement with Mototech (not an affiliate of Motorola), our contractmanufacturer in Taiwan, is denominated in U.S. dollars, their materialacquisition costs are subject to exchange rate changes that could impact ourproduction costs.

 

# ITEM4.  CONTROLS AND PROCEDURES.

#  

Asof the end of the period covered by this Form 10-Q/A, our management, with theparticipation of our chief executive officer and chief financial officer,conducted an evaluation of the effectiveness of our disclosure controls andprocedures (as defined in Rules 13a-15(e) and 15d -15(e) under the SecuritiesExchange Act of 1934, as amended (the “Exchange Act”)).

 

Basedon that evaluation, our chief executive officer and chief financial officerdetermined that we have a material weakness (as defined under the standardsestablished by the American Institute of Certified Public Accountants) thatexists with respect to our reporting of complex transactions. As a result ofthis material weakness, we restated our financial statements in our quarterlyreports for 2004 (including this report).

 

Toaddress this material weakness, we have engaged outside experts to providecounsel and guidance in areas where we cannot economically maintain therequired expertise internally (e.g., with the appropriate classifications andtreatments of complex and non-routine transactions).

 

As a result of the material weakness identified withrespect to our reporting of complex transactions, the chief executive officerand chief financial officer concluded that our disclosure controls andprocedures are not designed and effective in ensuring that the informationrequired to be disclosed by our company in the reports that we file and submitunder the Exchange Act is recorded,

 

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processed, summarized andreported within the time periods specified in the Commission’s rules andforms.  Except as identified above, therehave been no changes in our internal control over financial reporting thatoccurred during the quarter ended September 30, 2004, that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting.

 

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PARTII. OTHER INFORMATION

 

(Dollar Amountsare in Thousands, Except per Share Amounts)

 

# ITEM 1. LEGALPROCEEDINGS.   

#  

The Company has not paidits rent on its current facility since May 2003. As a result, our landlord,3190 T General, Inc. in September 2003, filed an action in the Court ofCommon Pleas, Bucks County Pennsylvania to perfect its interest to takepossession of our facility at any time, and to establish damages for past rentand expenses. In lieu of rent payments our landlord has drawn from our securitydeposit to satisfy the unpaid rent and such deposit has now been fullydepleted. A judgment was also granted allowing our landlord to regainpossession of the facility, although we remain in the facility, albeit insubstantially reduced space. During this process we attempted to negotiate asettlement of our lease obligation with the landlord in an effort to reduce ouroutstanding liability and secure the continued right to occupy the facilitywith a reduced ongoing lease obligation. We also worked with the landlord tosecure other tenants for the unused space. However, the landlord informed usthat this process was complicated by the requirement for the landlord’smortgage holder to approve any such amendments to our lease as well as anyarrangements with other prospective tenants. The landlord was not able toobtain such approvals from the mortgage holder and ultimately the landlord andthe landlord’s mortgage holder reached an agreement for the landlord’s mortgageholder to become a successor to the landlord’s interest in the property. Wehave already commenced negotiations directly with the mortgage holder’srepresentatives to secure the continued right to occupy the facility with areduced ongoing lease obligation, and are currently awaiting a proposal fromthe mortgage holder, although there can be no assurance that an agreement canbe reached with the mortgage holder. Concurrently we are exploring otherfacility opportunities in the event an agreement cannot be reached.

 

# ITEM2.  UNREGISTERED SALES OF EQUITYSECURITIES AND USE OF PROCEEDS.    

#  

None.

 

# ITEM3.  DEFAULTS UPON SENIOR SECURITIES.

#  

None.

 

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

#  

TheCompany held its annual meeting of stockholders on October 13, 2004. Thefollowing items reflect the matters that were voted upon at the annual meetingand the results of each vote.

 

(1)   Election of Directors:

 
| **Nominee**             | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|-------------------------|------------|------------|------------|--------------|------------|
| ** **              | ** ** | ** ** | ** ** | ** **   | ** ** |
| Hal M. Krisbergh        |       | 26,183,611 |       | 90,771       |       |
| Steven C. Davidson      |       | 26,198,630 |       | 75,752       |       |
| Clarence L. Irving, Jr. |       | 26,040,254 |       | 234,128      |       |
| Martin Jaffe            |       | 26,201,996 |       | 72,386       |       |
| Jeff Morris             |       | 26,185,945 |       | 88,437       |       |
| Lemuel Tarshis          |       | 26,199,580 |       | 74,802       |       |

 

(2)     Ratification and approval of the Company’sissuance of common stock in accordance with the terms of the June 2004private placement to certain institutional investors of $7,550 in securities.

 

| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 10,809,490 |       | 267,947     |       | 31,362      |       |

 

(3)     Approval of the amendment of the Company’sCertificate of Incorporation to increase the number of authorized shares of theCompany’s common stock from 50,000,000 to 80,000,000.

 

| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 25,855,524 |       | 382,056     |       | 36,802      |       |

 

(4)     Ratification and approval of the Company’s 2003Equity Incentive Plan.

 

| **For**    | ** ** | **Against** | ** ** | **Abstain** | ** ** |
|------------|------------|-------------|------------|-------------|------------|
| 10,405,028 |       | 623,248     |       | 77,413      |       |

 

# ITEM 5.  OTHER INFORMATION.

 

None.

 

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

 
| (a) Exhibits. |
|--------------------|
|               |   |   |
| 3.1                |   | Amended  and Restated Certificate of Incorporation ** |
|               |   |   |
| 3.2                |   | Certificate  of Designations, Preferences and Rights of the Series A Convertible Preferred  Stock of the Company ** |
|               |   |   |
| 3.3                |   | Certificate  of Amendment to Certificate of Incorporation ** |
|               |   |   |
| 3.4                |   | Amended  and Restated Bylaws (incorporated by reference to Exhibit 3.2 to our Form  10-Q Report for the quarter ended March 31, 1999) |
|               |   |   |
| 4.1                |   | Amendment  to Securities Purchase Agreement and Warrants dated as of September 2,  2004 by and among WorldGate and certain investors ** |
|               |   |   |
| 31.1               |   | Certification  of Chief Executive Officer Pursuant to Rule 13a-14(a) * |
|               |   |   |
| 31.2               |   | Certification  of Chief Financial Officer Pursuant to Rule 13a-14(a) * |
|               |   |   |
| 32.1               |   | Certification  of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as adopted by  Section  906 of the Sarbanes-Oxley Act  of 2002 * |
|               |   |   |
| 32.2               |   | Certification  of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as adopted by Section   906 of the Sarbanes-Oxley Act of 2002  * |

 

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*Filed herewith.

**Previously filed.

 

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(b)           Reportson Form 8-K.

 

During the fiscal quarterended September 30, 2004, the Company filed the following Current Reportson Form 8-K:

 

On July 13, 2004, aCurrent Report on Form 8-K was filed, reporting under Items 5 and 7 that, on April 28,2004, the Company had entered into an exclusive multi-year Development andDistribution Agreement with General Instrument Corporation d/b/a the BroadbandCommunications Sector of Motorola, Inc. for the worldwide development anddistribution of our OjoTM personal video phone.

 

SIGNATURES

 

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

 

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

 

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